Grupo Aval Acciones y Valores SA (AVAL) 2018 Q2 法說會逐字稿

Welcome to the second quarter 2018 consolidated results under IFRS. My name is Sylvia, and I'll be your operator for today's call. (Operator Instructions) Grupo Aval Acciones y Valores S.A. Grupo Aval is an issuer of securities in Colombia and in the United States registered with the Colombia's National Registry of Shares and Issuers, Registro Nacional de Valores y Emisores, and the United States Securities and Exchange Commission, SEC.

As such, it is subject to the control of the Superintendency of Finance and compliance with applicable U.S. securities regulation as a foreign private issuer under Rule 405 of the U.S. Securities Act of 1933.

All of our banking subsidiaries, Banco de Bogotá, Banco de Occidente, Banco Popular and Banco AV Villas, Porvenir and Corficolombiana are subject to inspection and surveillance as financial institutions by the Superintendency of Finance.

Although we are not a financial institution as a result of the enactment of Law 1870 of 2017, also known as Law of Financial Conglomerates, starting on 2018, Grupo Aval will be subject to the supervision and regulation of the Superintendency of Finance.

Grupo Aval, as the holding company of this financial conglomerate, will become responsible for the compliance with capital adequacy requirements, corporate governance standards, financial risk management and internal control framework and criteria for identifying, managing and revealing conflicts of interest applicable to its financial conglomerate.

The unaudited consolidated financial information included in this document is presented in accordance with the IFRS as currently issued by the IASB. Details of the calculations of non-GAAP measures, such as ROAA and ROAE, among others, are explained when required in this report.

The results for first quarter 2018 and second quarter 2018 are not comparable to previous quarters due to the prospective adoption in Colombia of IFRS 9 and IFRS 15 starting in January 1, 2018. Although adoption of this accounting standards had no impact on net income, figures for impairment loss on loans and accounts receivable and interest income on loans for first quarter 2018 have been slightly adjusted to reflect the full effect of netting out of Stage 3 net interest income and impairment, both on the Statement of Financial Position and the Statement of Profit or Loss.

This report may include forward-looking statements, which actual results may vary from those stated herein as consequence of changes in general economic and business conditions, changes in interest and currency rates and other risk factors as evidenced in Form 20-F available at the SEC web page. Recipients of this document are responsible for the assessment and use of the information provided herein. Grupo Aval will not have any obligation to update the information herein and shall not be responsible for any decision taken by investors in connection with this document. The content of this document and the unaudited figures included herein are not intended to provide full disclosure on Grupo Aval or its affiliates. When applicable in this document, we refer to billions as thousands of millions.

Today's conference will be conducted Mr. Luis Carlos Sarmiento, President and CEO; Mr. Diego Solano, Chief Financial Officer; and Mr. Tatiana Uribe, Financial Planning and Investor Relations Officer. I will now turn the call over to Mr. Luis Carlos Sarmiento. Mr. Sarmiento, you may begin.

Thank you, Sylvia. Good morning, all, and thank you very much for joining our 2018 second quarter results call.

I will start by saying that our net income and profitability results for the quarter were strong. These results were boosted by a stable net interest margin on loans, a much better cost of risk expense, arising from a positive shift in the trend of consumer loan deterioration, particularly in the formation of 30-day past due loans.

It is appropriate to note that this trend shift was partly a consequence of digital innovations designed in our digital labs to streamline our collection processes. Results were also boosted by a corporate-wide effort to control costs and to optimize our branch network, and by a come-back performance from Corficolombiana. Having said this, partly it's a result of our efforts to focus on profitability that growth of our commercial loan portfolio continued to be sluggish. Given the recent news on the economic front, we expect to see profitable growth in this portfolio during this third quarter. In fact, let me address the latest political, economic and regulatory developments.

First, we have a new market-friendly president in office. And from what we have already heard from President Duque and his newly appointed cabinet, we feel the government understands that the private sector has carried the heavier part of the impact of the oil crisis in the fiscal front, and that this situation needs to be corrected in order to improve competitiveness and boost foreign direct investment in our country. We are supporters of Mr. Duque and believe he will help our country grow at a faster pace than in the last few years. Second, on the Colombian economic front, a GDP growth trend has started to consolidate, this proven by 2 consecutive quarters of seasonally adjusted growth of 2.6% and 2.5%, respectively, which is 2.2% and 2.8% unadjusted for seasonality and calendar days in a month.

Needless to say, we are not there yet. But it is safe to say that a recovery of the oil crisis years continues in an orderly fashion, supported in higher private consumption and higher, more stable prices of oil. We currently expect the year to grow at 2.5% to 2.6% versus the 1.8% observed in 2017.

Inflation continues to be within the acceptable range of the Central Bank, and it is now at 3.12% on a last 12-month basis. We expect inflation to pick up a bit, and finish the year at approximately 3.25% as food prices might still be impacted by a forecasted El Niño climate period and naturally by a faster-growing economy.

Inflation could end up higher than our current expectation if we continue to see the dollar strengthening as a consequence of the trade wars in the international markets. On the labor front, we continue to see average unemployment to be around 10%, and we expect it to continue to be around those levels, and it would only improve and go down to single digits after the economy grows close to the 3% area.

We foresee that the Central Bank will maintain at least for the remainder of the year its intervention rate at 4.25%, which is a somewhat expansionary rate given the expected inflation level. We believe that eventual and slow hikes might begin at some point during the first or second quarter of next year. Finally, we also expect that 3.1% fiscal deficit target for 2018 will be met.

In the next few days, the government will present to Congress its fiscal reform proposal. Although we have not officially seen it, we do know that it is a corporation-friendly proposal. We expect that the reform will lower the base of corporate taxes, which currently stands close to 50% if you add up the income tax, the value-added tax, the ICA and the tax on monetary transactions.

On the external accounts front, the level of current account deficit continues to be favored by both the higher price of oil and somewhat of a pickup in nontraditional exports. We expect the current account deficit to finish the year at 3% to 3.2%, which is a very healthy level compared to the 7.3% we saw just a few years back.

On the regulatory front, important new decrees were issued in the last few months. First and foremost, decrees which especially impact the Colombian financial system were published to regulate the law of conglomerates. To start with, conglomerates and the companies that conform them have been identified, and we expect that in a few weeks an official list of conglomerates will be published by the Superintendency of Finance.

Additionally, Decree 1486 of 2018 defined which companies are considered as related to conglomerates and established procedures to define limits of exposure to those related parties. This decree also defines how conflicts of interest must be addressed and communicated by the holding company of conglomerates to the ruling organs. Finally, this decree included very positive news related to new more expansive investment criteria by pension fund administrators. Overall, we feel very positive about this decree since we believe that it will level the field for everybody, contribute to activate the capital markets and give more transparency about direct and indirect ownership of Colombia financial institutions.

Another very important published Decree 1477 of 2018, virtually moves Colombia to adopt Basel III. Just as in the previous decree, we were very supportive of this initiative as we believe that it is very important that the rating agencies, the investors and the community of research analysts are able to compare in a better way our capital levels to the ones of our international peers.

Bear in mind that full comparison is highly unlikely as it is clear that every Basel III compliant country has customized to some extent this regulation to adapt to its own situation. What I can say for sure is that this decree fully incorporates post-crisis Basel III principles.

The main changes contained in the decree with respect to current capital adequacy regulations are that: first, it implements capital adequacy buffers, conservation and systemic risk. Also, establishes specific buckets for hybrids, additional Tier 1. Also, it fully deducts intangibles in common equity Tier 1, including previously grandfathered goodwill. It adjusts weighing of risk-weighted assets to international standards, applying the standardized approach and counter-party risk model. It also implements the leverage ratio as defined in Basel III, and finally, it establishes capital contribution of OCI accounts, net income and capital resource.

As far as the final adoption of this decree, after an 18-month period of adjustment, which starts now to allow for IT preparation, banks will have to fully utilize the new Basel III measures and standards for capital adequacy contained in the decree.

And 4 year later, banks will have to comply with the following metrics: First, a minimum core Tier 1 of 4.5%, a minimum code Tier 1 plus additional Tier 1 of 6%, a minimum Tier 1 plus Tier 2 of 9%. This last measure is more stringent even then Universal Basel III, which called for 8%. A conservation buffer made of CET1 of 1.5%, and a systemic risk buffer of 1% for systemic relevant banks. In full effect, systemic risk banks will need to show capital adequacy measurements of at least 11.5%, when all it's done.

It is not my intention to boggle you down with details, so therefore, we have included a slide as an appendix in which we show the levels of minimum capital required for the banks based on the new decree. As it might interest you and it certainly interests us, we have run our numbers for the 4 banks, and we can comfortably say that currently we're fully compliant with the new regulation in all respects.

This is partly the consequence of a material decrease in risk-weighted assets for the Colombian financial system. Just as we had explained to the market, current regulations in Colombia in terms of risk-weighting is very severe and thus demands far more capital than required.

Now that the standardized model is applied, our banks will see a relief that offsets the impact of the net deductions to CET1, including the full deduction of previously grandfathered goodwill. Our risk-weighted assets will reduce by approximately 15% due to a lesser demand of capital in retail loans and in guaranteed loans.

As it stands, the first quarter in which we will report Basel III figures is the first quarter of 2020. The banks in Central America continue to perform well. Obviously, our main focus of concern in the region is the current social and political situation in Nicaragua. We are following the situation closely and are conducting estimates of the possible impact on the country's economy.

We also keep a very high level of liquidity in the Nicaragua bank to manage any unforeseen circumstances. However, based on recent news, we're hopeful that this difficult situation will be resolved without further bloodshed and in a diplomatic way.

If the conditions worsen, we will make sure the market is properly informed. To give a figure of magnitude of the $80 billion of assets that we have on our consolidated balance sheet, less than $1.75 billion is Nicaragua exposure. Our digital strategy continues on track. These are a few examples.

Last month, digital savings accounts in Banco de Bogotá represented 19% of the total savings accounts openings for the bank with a compound monthly growth rate of 40% since December 2017.

Digital credit card sales have grown exponentially and have demonstrated a better credit quality than the bank's average. This month, we expect digital to represent more than 15% of the monthly credit card sales for Banco de Bogotá and become the bank's second largest issuing channel.

We launched a first-to-market fully digital auto loan product that guarantees a client response in less than 3 minutes. We also launched a fully digital payroll loan product that guarantees responses in 5 minutes, and more importantly, is connected to 80% of our public sector entities.

We designed the methodology to create independent digital products for each of our banks, which run identically in the back office, thus effectively reducing our times to market by as much as 1 year in certain cases.

In data analytics, we have started to achieve important milestones. For example, we built out an integral data strategy team to increase cross-selling and reduce churn through algorithms that predict product demand, churn and next product to buy.

We have also improved our credit collection standards through digitalization. Concrete results and reduced cost of risk have been attained, and we're very excited at the opportunities we've also identified in terms of gaining client share of wallet.

As a result of our continually improving migration of sales through lower-cost channels, we've been able to generate cost savings illustrating our philosophy that digital is not only important to improve client experience, but also is a financially accretive play for the group. These savings have concretely manifested themselves this year in the form of being able to optimize 71 branches and reduce the corresponding headcount.

With respect to our consolidated performance during the quarter, these are the main highlights. First, we were able to maintain our NIM both due to a solid performance of our NIM and investments and our ability to cut cost of deposits, both CDs and savings accounts. Our NIM for the quarter was 5.6%. Second, our cost of risk at 1.7% for the quarter started to show signs of recovery. About 10 basis points of improvement is due to less cost of risk related to the big corporate names such as Electricaribe, CRDS and SITP even after increasing our coverage on these loans.

Additionally, less provisions were required as a result of lower months of new loans coming into the books. Our 30-day past due loan figure shows improvement, and we expect the 90-day past due loan figure to follow in the coming quarters.

Third, we continue to work hard on fee income initiatives, both on the asset and the liability side, and thus we continue to grow this line at a slightly higher pace than the loan portfolio itself. Fourthly, we continue to emphasis our cost control initiatives via headcount reduction, branches being closed or reconfigured to optimize productivity, migration of transactions to ATMs and digital channels, among others.

Finally, in the presence of fiscal optimization that we begin some years back, during the quarter, we were able to recover a marginal amount of taxes paid in previous year. However, during the second half of this year, our implicit tax rate should go back to historical levels. We made a slight change to our first quarter results related to the adoption of IFRS 9. As explained in the last call, interest income of Stage 3 loans is now presented net of its provisions, which means that net interest income is lower, and also the cost of risk is lower by such amount.

Therefore, our first quarter NIM appears 13 basis points lower than previously reported and our cost of risk appears 16 basis points lower than previously reported. Second quarter effects on these 2 metrics were similar. With regards to our guidance, we now believe that our loan portfolio will grow during the year at a 5% to 7% range, mainly driven by the consumer book, but with better performance expected from our corporate book in the second half of the year.

Our NIM should remain in the same 5.6% area. Our cost of risk should finish the year at around 1.9%. Our OpEx should grow at about 3% year-on-year. Our fee income should continue to slightly outperform our loan growth. And our tax rate should normalize.

All in all, we're looking at an ROE of approximately 15% for the year. With that, let me pass it to Diego, who we will address in more detail our results for the quarter. Thank you.

Thank you, Luis Carlos. I will now move to our consolidated results of Grupo Aval under IFRS starting on Page 9 with our asset evolution. Assets grew 1% during the quarter as our loan growth in Colombia and a contraction in dollar terms of our fixed income investments in Central America drove this result.

Currency movements favored the contribution of our Central American operation to overall growth. The impact of foreign exchange fluctuations on balance sheet growth was relevant to our growth dynamics during this period, as we experienced a 5.4% depreciation of the Colombian peso during the quarter and a 3.9% appreciation relative to a year earlier.

During the quarter, our Colombian assets decreased by 0.6% and our central American assets decreased by 0.5% in dollar terms, a 4.9% growth when translated into Colombian pesos.

Over the 12-month period ended on June 30, our Colombian assets increased 1.5% while our Central American assets grew 6% in dollar terms, 1.8% when translated into Colombian pesos.

Asset structure remained substantially unchanged during the quarter, with loans representing 70 -- 67.5% of our assets and fixed income investments 10.5%. Finally, our Central American operation increased its share of our assets by 110 basis points to 29.4% in line with the depreciation of the Colombian peso.

On Page 10, we present the evolution of our loan portfolio. Gross loans, excluding repos, grew 2% during the quarter and 2.8% over the last 12 months, both in peso terms.

The performance during the quarter resulted from a 0.1% growth of our Colombian book and a 1.3% growth in dollar terms of our Central American book, a 6.8% expansion when translated into pesos. Colombian operations account for 71% of our gross loan book.

In Colombia, commercial loans drove the soft growth dynamics. As mentioned in our recent calls, the modest GDP dynamics and the presidential election have dampened commercial loan growth and tightened the consumer -- and the tightening of the consumer and SME underwriting policies have reduced the retail loan growth.

In addition, we have focused on profitable growth. We expect growth to pick up over the second half considering the positive macro trends, and as President Duque in office since last week advances with his economic and tax agenda.

Colombian consumer and mortgage business continues to lead the growth of our Colombian operations, expanding 2% and 4.8%, respectively, during the quarter, and 7.7% and 19.6%, respectively, over the last 12 months, while our Colombian corporate loan portfolio contracted [1.23%] in the quarter and 1.1% over the year. Central American countries continue to be more dynamic than Colombia, growing 7.6% and 1.3% in dollar terms over the 12-month and 3-month periods, respectively. These are 3.4% and 6.8% when translated into Colombian pesos. Broken down by type of loan, quarterly growths in Central America in dollar terms were 2.2%, 0.6% and 0.9% for commercial consumer and mortgage loans, respectively. These growths were 7.7%, 6.0% and 6.4%, respectively, when translated into Colombian pesos. We expect 2018 loan growth to be in the 5% to 7% area.

On Pages 11 and 12, we present several loan portfolio quality ratios. Positive trends that signal that the worst of the Colombian credit cycle is behind us continued to consolidate. The 30 days PDL ratio was stable, incorporating an improvement in the quality of consumer and mortgage loans and a slight deterioration in commercial loans. New 30 days PDL formation was lower, particularly that of the consumer loan portfolio. We recorded a slight deterioration on the 90 days PDLs reflecting the aging of the uptick in the 30 days PDLs reported on our last call, particularly in commercial loans.

As mentioned in the past, caution is still due as GDP dynamics, even though strengthening, are still soft in absolute terms and an unemployment hasn't recovered yet. Quarterly cost of risk, net of recoveries of charge-off assets improved by 44 basis points to 1.72%. This improvement incorporates a positive performance in the 30 days PDLs formation, a lower impact of the large corporate cases that we have discussed on our last calls, and a contraction of the Colombian corporate portfolio.

The 30 days new PDLs formation is particularly [irrelevant] to cost of risk under IFRS 9, given that this event has a strong impact on loan loss reserves for consumer loans. The 3 corporate cases that we have been following on our last calls, Electricaribe, Ruta del Sol and SITP accounted for 10 basis points of cost of risk reduction. These 3 corporate cases explained 14 basis points during the quarter, down from 24 basis points a quarter earlier.

It is worth mentioning that we have increased our coverage of SITP from 15% to 21%, and still expect that to take it up to 30%. Coverage ratios for Electricaribe and Ruta del Sol stand at 80% and 13%, respectively. Cost of risk in Colombia and Central America decreased from 2.3% to 1.6%, and increased from 1.8% to 2.1%, respectively, over the quarter.

We expect 2018 cost of risk net of recoveries to be in the 2% area. Finally, our charge-offs to average 90 days PDLs ratio was substantially stable at 0.67x, allowance to PDLs coverage ratios closed at 147% on a 90 days base, and 103% on a 30 days base. Allowance covered 4.3% of our gross loans.

On Page 12, you will find further detail on the quality of our loan portfolio. As mentioned in previous page, our 30 days PDLs ratio was stable at 4.2%. This performance incorporates an improvement in the performance of our consumer portfolio receding back to a level close to that observed a year ago.

New 30-day PDLs formation fell during this quarter. Lower 30 days PDLs formation in Colombia was the driver of this positive result. Not only Colombian consumer PDLs formation was the lowest since 2016. The aging of the uptick in commercial 30 days PDLs formation reported on our last call affected our 90 days PDLs formation during this quarter.

On Page 13, represent funding and deposit evolution. Funding dynamics were consistent with loan growth. Our funding structure remains stable with deposits representing 77% of total funding. In addition, our capital ratio was 58%. Our deposits to net loan ratio was 96%. We maintained our strong liquidity position with cash-to-deposits ratio of over 14%. The structure of our funding was -- has enabled us to capture the benefits of the Central Bank reduction in Colombia in cost of funds.

Deposits grew by 1.2% over the last 12 months and 0.1% in the quarter. Our 12-month growth, excluding the impact of FX movements in Central America, was 2.4%.

By region, Colombia accounted for 72% of funding and 70% of total deposits. Deposits in Colombia decreased 0.3% over the last 12 months and 1.8% during the quarter, consistent with our asset dynamics.

Our total funding grew 1.1% over the last 12 months and decreased by 0.3% during the quarter. Central American deposits grew 9.4% in dollar terms over the last 12 months and contracted 0.3% during the quarter, a 5.1% increase in Colombian peso terms over these periods -- over both periods.

Total funding grew 5.9% in dollar terms or 12 months and decreased 1.1% over the last quarter, 1.8% and 4.2% in Colombia peso terms. We expect deposits to grow at a similar pace for our loan portfolio during 2018.

On Page 14, we present the evolution of our total capitalization, our attributable shareholder's equity and the capital adequacy ratio of our banks. Our total equity grew 4.8%, while attributable equity grew 5.9% over the quarter, mainly driven by earnings during the quarter. All of our banks show appropriate Tier 1 and total solvency ratios. Consolidated Tier 1 ratios at the end of the period ranged between 8.3% for Banco Popular to 10.6% for other regions. Total solvency ratios ranged between 10% for Banco Popular to 13.3% for Banco de Bogotá. As mentioned by Luis Carlos in his introduction, we estimate that all of our banks are fully compliant with the new solvency regulation.

On Page 15 represent our yield on loans, cost of funds and spreads. Yield on loans and cost of funds dynamics were driven by the Central Bank intervention rate evolution. The end of period Central Bank rate fell 25 basis points to 4.25% as of June 30, 2017, while the average rate fell 25 basis points from 4.58% in first quarter '18 to 4.33% in the second quarter '18. In addition, the quarter averaged DTF rate fell 36 basis points to 4.73%.

During the quarter, the average yield on loans fell 20 basis points to 10.4%, mainly driven by a lower yield on our Colombian commercial portfolio that incorporated the change in Central Bank intervention rate and DTF experienced throughout the recent months.

An 18 basis points contraction in spread between loans and cost of funds resulted from the movement described before. Even though we expect some additional pressure on spreads to continue as our yield on commercial loans fully incorporates the Central Bank rate cuts, we expect the downward bottom cycle to be close to an end consistent with the change in monetary policy guided by the Central Bank.

With regard to the consumer portfolio, we could see increased pricing competition as the improvement in quality of consumer loans consolidates and a more dynamic growth increases the share of newly priced loans in our mix.

On Page 16, we present our NIM for the financial sector and Grupo Aval's consolidated operations. Our net interest income for the quarter was COP 2.7 trillion, remaining stable when compared to the previous quarter. The net interest margin of our consolidated operation, including net trading income from investments held for trading through profit and loss, for the quarter remained stable at 5.6%.

Our NIM, excluding net trading income for investments held for trading through profit and loss, decreased 12 basis points from 5.7% to 5.6%. These results incorporate the pressure on NIM on loans described in the previous chart, and a recovery in the NIM on investments to a level more consistent with historical performance.

The consolidated NIM on loans for the first quarter decreased 16 basis points to 6.6% compared to a quarter earlier, where our net interest margin and investments increased by 68 basis points to 0.9%. Nonfinancial activities had a negative impact of 20 basis points on the net interest margin. As guided in the previous call, we expect our net interest margin to be in the 5.6% area for the full year.

On Page 17, we present net fees and other income. Gross fee income expanded faster than our assets at 2.6% compared to a quarter earlier, and 3.7% 12 months earlier. Excluding the effect of our FX movement on our Central American operation, growth would have been 2.9% in the quarter and 4.8% over the last 12 months.

Broken down by geography, Colombia accounted for 60% of total gross fees for the second quarter of 2018. Domestic fees increased by 2% compared to a quarter earlier, while Central American fees increased by 4.2% in dollar terms, a 3.5% in Colombian peso terms. We expect fee income to continue growing at a slightly higher rate than our balance sheet during 2018.

The right of the page, you can find our nonfinancial sector broken down by sector. Its contribution increased 25.8% as compared to a quarter earlier with a strong performance from energy and gas and infrastructure companies. On the bottom of the page, we present other operating income. Other operating for the quarter was COP 390 billion, materially unchanged from a quarter earlier.

On Page 18, we present some efficiency ratios. Cost control initiatives continue to deliver positive results. Personnel and administrative expenses increased 3.5% during the quarter and 3.3% compared to a year earlier. Cost control in Colombia was a key contributor to the positive result. Our efficiency ratio measured as operating expense to total income showed a slight deterioration of 44 basis points to 47% compared to the previous quarter, and 15 basis points versus second quarter 2017.

Central America and Colombia reported ratios of 52.6% and 44.4%, respectively, for the second quarter 2018. Our efficiency measured as operating expenses to average assets of 3.6% for the second quarter 2018 remained relatively stable compared to the second quarter 2017, and up 14 basis from 3.4% a quarter earlier. Central America and Colombia reported ratios of 4.5% and 3.2%, respectively, for the first quarter 2018.

Regarding efficiency, as we will continue our cost control initiatives, including headcount reduction, reformatting and closure of inefficient branches, migration of transactions to ATMs and digital channels. As a result, we expect to maintain a 3.5% on a cost-to-asset basis for the full year 2018 in spite of the low asset growth that we have experienced so far.

Finally, on Page 19, we present our net income and profitability ratios. Total net income for the second quarter 2017 -- 2018 was COP 682 billion or COP 31 per share, showing an increase of 14% versus the previous quarter. This result incorporates a positive effect in taxes of some onetime recoveries with an effect of COP 43 million on [attributable] net income.

Return on assets was 2% and a return on equity was 17.7%. Before we move into questions and answers, we'll now summarize our general guidance for 2018.

We expect 2018 loan growth to be in the 5% to 7% area. Deposit growth will be fairly similar to loan growth. We expect 2018 cost of risk, net of recoveries, to be in the 2% area. We expect full year 2018 net interest margin to be in the 5.6% area. We expect fee income to grow at a slightly faster pace than volume -- loan volume. Regarding efficiency ratios, we expect cost to assets to be in the 3.5% area. We expect no material change in our marginal tax rate for a year -- from a year earlier. Finally, we expect 2018 return on equity to be in the 15% area.

We are now available to address your questions.

(Operator Instructions) And our first question comes from Yuri Fernandes from JPMorgan.

My first question is regarding nonfinancial sector income, it was very strong this quarter, it was like more than 100% year-over-year and the increase is mainly driven by infrastructure revenues increased about COP 100 million versus the first quarter. Can you provide more color what's happened here? How is the recurrency of this line? And also if you can discuss a little bit the Corficolombiana offering, the decision of the group not to participate and the offering being likely diluted. Just wanted to have more clarity on that? And my second question is regarding asset quality. It's basically to see if the worst is really behind you. What drove you here? My take is that the 30 days past due loans, they are improving, the interests are improving. So maybe I should wait for better asset quality for Grupo Aval. But you still have very low provisions for the corporate cases. So if you also can discuss why you are keeping the level of coverage low for some of those large cases, which you are treating them as judicial claims, and only we need to increase provisions as this show -- as cases evolve in the future. So basically the idea to have a better color on future asset quality.

Okay. Let me address a couple of -- I think I got everything you said. Let me see if I can maybe address a couple of your issues. With regards to the ongoing capitalization of Corficolombiana, let me start there and then I'll address Corficolombiana's -- the performance that Corficolombiana is showing this year and then maybe Diego and/or Tatiana can address asset quality and coverage. Let us give you our thoughts behind the capitalization of Corficolombiana and the decision of both Banco de Bogotá and Aval to cede its rights to capitalize onto their own shareholders. Corficolombiana has important -- well first of all, Corficolombiana has started to construct at least 2 if not 3 of the 4G infrastructure projects that was adjudicated a couple of years ago. And obviously those projects on average require maybe $1 billion of funds, of which about 30% come from equity. Corficolombiana obviously generates equity through its own investments, but not at enough rate to come up with the equity necessary to capitalize the concessions that are going to build those roads. So we decided it was a perfect time to go and raise capital. Additionally, an opportunity presented itself to increase our participation in the electrical utility company in Bogotá, which has been a powerful and very good investment for Corficolombiana. So bearing all that in mind, Corficolombiana decided it was a good time to raise some capital. Now obviously, as in any capital raise, the shareholders that are entitled to the participative are the current book of shareholders of the company; among those are banks in Grupo Aval. However, with current regulations, as you know or you probably know, our banks have to deduct from their core equity Tier 1 the cost of their investment in Corficolombiana. And also Aval, which really doesn't have to deduct it as it makes investments in its subsidiaries, will have to use its own liquidity or raise debt to do so. Aval has a good position of liquidity in dollars -- a very good position of liquidity in dollars, but not so much in pesos. We don't really aim to keep very large liquidity positions in pesos. And obviously, if Aval decides to invest in a subsidiary and raises debt to do so, its double leverage is going to increase. So let's take the 2 positions. First, the banks decided, with all that is going on with the new implementation of Basel III, and bear in mind that the Basel III decree was published after the launch of the capitalization of Corficolombiana, so we didn't have the final decree on hand. But the bank decided, with all that is going on with around capital, maybe it's not the time to invest in something that will further reduce the Tier 1 capital. So they decided to pass it on to their shareholders. We are very, very confident, almost sure that the shareholders will take the offer and capitalize Corficolombiana in the total capitalization amount. So that was the rationale of the banks. And in terms of Aval, we decided 2 things. Number one, we did not want to increase our double leverage at this point. Number two, even with the dilution that will result from this, but based on what we now know of how Corficolombiana should perform, we will more than recover dilution or the corresponding share of the profits that are diluted by the better performance of Corficolombiana, including the capitalization. And finally, the other rationale from Aval was that it did not want to use its own dollar-denominated liquidity to participate in the capital raise because then it would open up its balance sheet into dollar liability invested in a peso asset. So with all that in mind, we -- and feeling fairly confident that the capital raise would be achieved and we still feel that way, we decided to proceed that way. And that's the whole rationale behind the capitalization of Corficolombiana. In terms of the performance of Corficolombiana, it is having a very good year as you probably all saw in the first semester, it's already performing better than it did the whole of last year. There are various reasons for this. One is that virtually the Ruta del Sol -- at least financial problem is behind us in Corficolombiana. Secondly, Corficolombiana is now actively building, as I said, 2 or at least 3 other concessions that it was adjudicated to it a couple of years ago. And thirdly, Promigas keeps showing very, very solid results. And we all know that Corficolombiana has 3 main businesses. Its own treasury trading business, an investment banking advisory business, but most importantly, Corficolombiana generates profits from its investment book. And its investment book is performing very, very well. With that, we feel that Corficolombiana is on a good trend. And that it shall continue to perform equally well. So that in terms of that, and then you have some questions on assets and coverage and all that, so Diego wants to answer to that.

Regarding asset quality, I think that, reiterating on what I said before on the call, we're seeing very positive signals improvement in the quality of the overall portfolio, but particularly on the consumer side. Even though as mentioned, we're still cautious, we need to see unemployment improving, we have already started to see a lot of things happening outside of our banks, meaning the economy, but also inside our banks through the upgrade -- substantial upgrade of our collection activity and our collection processes. When you look at the numbers, we have started to see not only stable ratios, particularly on the 30 days bracket, but also a reduction in the new PDL formation, particularly in consumer and particularly in Colombia. When you take those into account, combined to a positive view on how Colombia is expected to evolve, plus the results already obtained through what Luis Carlos described in upgrading our collection processes and digitalization, we are quite confident that these numbers at some point should continue to turn around. Having said so, I would say that we need to bear caution and that the allowance numbers that we have are comfortable for the kind of expectation that we have.

Our following question comes from Gabriel Nóbrega from Citi.

Following the election do you believe that corporates who were actually postponing projects have begun to resume that? We have saw during the quarter that commercial loan book was actually flat year-over-year, and I just wanted to understand when do you believe that the pickup could happen? And also as you have guided for a loan growth of around 5% to 7%, could you just provide maybe a breakdown of what you expect for each of your segments? And I'll make a second question afterwards?

Okay. I'll start and pass it to Tatiana on growth type by segment. What we're seeing is, you have to understand that president is in office since last week, the new president. And the second round of election happened actually very late during the process of reporting of second quarter. So this kind of numbers don't yet show any impact of the change in political environment and expectations from the community as a whole. What we have started to see is very positive expectations on what's going to happen on the economic front and the tax front. We're seeing President Duque and his minister of Finance delivering on what they promised on the campaign at least on the plans that they are drafting. And if you take those into consideration, plus what is happening on the oil front that is helping the overall numbers for Colombia and the trade side, the ground is set for a recovery of Colombia. It is very early to give you any guidance there, but we have started to feel some stronger dynamics in our credit committees with loans coming in. We would be very happy to be able to show this into numbers in our future calls, but we've seen a change not only in mood but also starting to see better demand.

And I guess, to answer your question with regards to growth, first of all, bear in mind that there is a seasonality effect, so for example, in Central America our loan portfolio tends to grow much, much faster in the second half versus the first half. In terms of types of products, we expect the growth of the consumer plus mortgage loan portfolio to grow between 8% to 10%. So slight pickup from the numbers that we have already. And then corporates should actually start to grow at least, more in the fourth quarter than in the third quarter. End of period balance sheet should show a 3% growth. That's our expectation. But then average balance should grow somewhat lesser than that. So I guess, that should be an answer to your question on segments.

Our next question comes from Frederic De Mariz from UBS.

I wanted to get back to the question on asset quality, if I may. We saw that you mentioned the coverage ratios for the 3 large corporate exposures. I wanted to understand when should we expect those exposures to get out of the books? When do you think you can write off, like you don't have to increase the coverage anymore for those 3 large exposures? And then on asset quality, but on the other side for the consumer side, obviously low inflation is helping the consumers. You mentioned during your presentation some initiatives on the digital side that were helping collections. Could you give a bit of color just to understand what you're doing? How -- like intensive it is? And what would be the prospect for this? And then my second question would be especially on the digital strategy. You mentioned during your presentation also that you were expecting a cost to assets close to 3.5% for this year, but I would love to hear your thoughts about the medium and the long term, how do you think that the digital strategy can change the efficiency at the group and at the banks? And do you have any targets in terms of cost to income or cost to assets or whatever other way you want to think about efficiency?

All right. Let me address the digital strategy first. As far as what we've done in digitalizing collections on the consumer side, it's honestly been simple, but it's been very effective. And what we were able to do is determine who in our -- and this is basically some algorithms that we were able to put together, and what we've done is we've been able to identify who has to be called first and who we can call later to accelerate collections. And actually, we've been able to pinpoint to a certain degree with precision what has the most impact in terms of digital calls, obviously, and of text messages and of e-mails and when to call and how to call and what to ask for and what not. And that's basically -- so it's fairly simple. It's very effective, but it takes putting together the algorithm. And what we have shown is quick -- is really quick gain with that -- a quick win. Going forward, our digital strategy, we've always insisted and I am a big believer of this, there are 2 ways that you can get results from a digital strategy. On the one hand, you should generate more revenues via launching new innovative sexy products, but really the difference that a digital strategy makes is in cost savings. And what it is, is on being able to especially launch products faster by working more intelligently, by using all the technology available at your resources, and obviously, in cases like ours where we have 4 banks, by trying to do what we call now triple and quadruple plays, which is we are now being able to design 4 different-looking products, but with identical back-office processes. And that has taken some doing, but it's also starting to yield cost savings results. And the other thing that we've mentioned is through our digital we've been able to -- digital strategy, we've been able to identify which branches need to be optimized via conversion, via closure, via movement, and how to migrate those transactions to more digital channels. And as I mentioned, we have gone ahead and closed about 71 branches. Some of the cost savings of the personnel reduction are being seen already. Obviously, there is some indemnifications that need to be paid, but going forward, that should also have a positive effect in the following years, and that is one of the reasons that we can start to estimate a better cost to -- a better efficiency ratio. Finally, as also as a result of all the digitalization product, we have reestimated all our technology investment strategy for the next 5 years. And the one very good news there is that we have been able to sort of make an inventory of all the technology, all the technological projects at the bank levels, at the holding company level, put them all together, do a whole refurbishing of the corporate governance and the strategy. And right now it looks that we are talking about savings going forward in the next 3 years of about $200 million in technology CapEx. So all that comes from -- we call it the digital strategy, but it is really much more than that. And we're fairly confident that's really, really helping us out. Obviously, when you join that with the fiscal reform that we're waiting to officially read and know, we have 2 very important components working in our favor. In terms of the 3 loans -- sometimes I feel like [URAD], we should just go ahead and reserve 100% of the 3 loans and be done with it. But the truth is that it doesn't really look like we will lose 100% of our investment in those 3 loans. So it's really not convenient to go ahead and just charge them off, especially when it comes to Ruta del Sol, where the financial -- the Colombian financial system is still exposed to the tune of about $630 million. What we have to do and is just we got be patient. The courts of law are deciding the value of liquidation of that contract. And that is in fact moving in the right direction. There are basically 2 judicial instances where that will be decided. One is in a court of arbitration and the second one it's in an administrative tribunal. In the administrative tribunal, we have presented conclusions -- closing arguments, and we'll see what comes out of that. And in the arbitration tribunal, we had our -- unfortunately our third judge or arbitrator in that tribunal died, and we are -- we have -- the tribunal was suspended until the third arbitrator is named again. It's sad news obviously, but the good news is that it has given this new government a time to inform itself of what really has gone on with Ruta del Sol. And this government understands perfectly that the financial system is looking at the judicial system to see how this case is finally decided, how banks make out at the end because that is really crucial to the financial system opening up again to continue the financing of 4G going forward. In terms of Electricaribe, there are things happening as well. Electricaribe has been, I think, covered to the point of about 80%. So there's really not that much more to go anymore. And the only reason that we have stopped for now is there are now active conversations to move the company out of the government's intervention and to have a new operator start operating it. And we have demanded, and obviously this needs to be seen, but we have demanded that the new operator, as a way to be given the contract, must negotiate with the banks the repayment of the loans. And in terms of the transportation system, that is also moving pretty actively because -- I'd say pretty actively, but at the pace that a government moves actively, which as we all know it's almost at no pace. But it is moving, and especially through the Mayor of Bogotá who as you probably know has really been the force behind all the integrated transportation system in Bogotá. So we will continue to make coverage and to provide for those loans as we see that our chances of collections are getting larger or smaller, but as you also know, as those loans become Stage 3 under IFRS, they have to be analyzed on a case-by-case basis, and it's just not a template of additional provisions. So that's what happening with those, I don't know if I didn't cover everything.

No. I think you're good.

Our following question comes from Jason Mollin from Scotiabank.

My question is a follow-up on the cost of risk. You talk about expectations for the full year of close to 2%, and we saw 1.7% number for the quarter. I just wanted to make sure that we understand well the change in accounting from IFRS 9. So we see lower NII and lower loan-loss provisions first half of the year. I guess, you gave us a number of -- the number on both sides there would be COP 250 billion. I just wanted to make sure if we're looking historically that we should adjust for that, and therefore, really the net impact on the bottom line was 0. So it really wasn't so much that the quarterly move in cost of risk that generated the good bottom line this quarter. It looks more to be lower taxes, trading and a good post-provision NIM, I guess in my view. And so if we kind of adjust for taxes and trading, maybe the ROE instead of being 17.5% in the quarter, is closer to the 15% that you're looking for in the year. Is that -- would you agree with that?

Jason, you have partially -- you're right, but to try to sharpen your numbers, the ROE would have been more in the 16% area if you adjust for that. And this is more of a P&L presentation, discussion what is happening here rather than something that is changing bottom line under IFRS 9. Just try to -- I'm going to try to make it as simple as possible, but to tell you the difference between what we're doing now, now means first quarter and second quarter. So for comparability, you should be able to compare first quarter with second quarter. But to compare to what happened in the past, there is some differences that do not change bottom line, but do change your ratios. What you do under IFRS 9 is you take your -- once your loan moves into Stage 3 that means it's already advancing in the process of deterioration or you expect it to be past due in a substantial way, you start to account different for interest and provisions. If you were under the old system, you would account for the full interest and then go ahead and provision on those. But what you started to when you move into Stage 3, is given that you already have, I would say, a percentage of provision that you need to apply to the loan, you start doing exactly the same with what is happening with the interest and you start [nuts] or you start reducing that from your net interest income line as well as from your cost of risk line. Net-net, it becomes exactly the same number you would have had in the past, but rather than having those numbers higher, you ended up netting those. As a result, you end up with a lower net interest margin and a lower cost of fund -- cost of risk, I'm sorry. To your question of, should you change these numbers moving on, this is something that you'll start to apply with IFRS 9, you do not go back and change the numbers in the past. That's why we have only affected our 2018 numbers, but as you said for comparability, that's why when Luis Carlos mentioned that we have around 15 basis points' impact given this change.

And if I may, I guess, Jason, to your point vis-a-vis our expectation and cost of risk versus last year, what we are expecting or hoping is that second half will not have a huge impact of these large corporates. And as we are seeing our 30 days past due loans and our 90 days past due loans behaving in a more adequate way, that is why we are foreseeing an improvement in the cost of risk. So for sure, yes, part of the comparison between this year and last year will be a thing of reclassification, but then some part of will also be a consequence of an improvement in the quality of the loan portfolio.

Also, to give you some comfort and the cost of risk for this period, just remind you, there were a number of things that did help us in a relevant manner and it is the improvement in our consumer portfolio. That is something that we start to see consolidating and that is something that does change compared to what was happening in the past and it is not the best argument for reducing our cost of risk, but when you're not growing in your corporate portfolio, then you do not need to record provisions for growth. So wrapping up, yes, there would have been a different number, number would be around 16%. And that's why we're guiding into something in the 15% area.

Our next question comes from Andres Soto from Santander.

I have a few of them. The first one regarding Aval loan growth next year. Considering the full implementation of Basel III, what level of growth can your banking subsidiary sustain 2019 in order to remain compliant with the target established by the regulator. And I am curious specifically about Banco de Bogotá. The second question, this is a continuation of the regulation issue, this time on the conglomerates loan. You mentioned that you will level the field to all players. Does that mean that Porvenir, your pension fund manager, will be able to purchase shares of Grupo Aval? And if so, what will be the maximum limit that they would be allowed to buy? And finally, given the recent volatility in the Colombia peso, I was wondering if you can please remind us what is the sensitivity of your main indicators, including profitability and capitalization to the COP depreciation?

Andres, to your question on Basel, please bear in mind as Luis Carlos pointed out that the first quarter in which we will comply with Basel III is the first quarter of 2020. Having said so, and to answer specifically your question in Banco de Bogotá, Banco de Bogotá will not have an issue. It's fully compliant with full Basel III adoption. We're not giving public -- we're not making public our numbers because there are still certain points that we need to discuss as an industry, as a whole with Superintendency of Finance. But initial numbers even that we have reported to the government show that Banco de Bogotá and all of our banks are fully compliant, even more so the small ones and Banco de Bogotá will be compliant. This means that unexpected growth of 10% or low teens areas with profitability that will come with that growth will be enough and that means that capital at Banco de Bogotá will be sufficient to fund that growth. With regards to Porvenir?

With regards to Porvenir, yes, you're right. The law, the decree that came out, the ruling on the law of conglomerates that -- it's a decree that has to do with related parties, included an article which we consider of the utmost importance, which basically levels the field in the sense that Porvenir will now be able to invest up to 8% of its total administered funds in related parties, including in equities of Aval and fixed-income obviously. So yes. And the current regulation is that, well, currently Porvenir wasn't able to do so. Other pension funds were able to invest up to 10% in their own related parties because of the ownership structures. Now it looks like everybody will be able to bring that position to 8%. So yes it's -- I think it -- what I think it is a great opportunity for the financial markets, for the capital markets in Colombia because it really expands a flow of funds into the capital markets. So yes, the answer to your question is that Porvenir will be able to invest in its own related-party equities up to 8% of its funds.

And regarding your last question on the sensitivity to FX, first of all, we can't give you straight numbers to this, but we can give you some ways to think about it. The main place where we have impact from FX is our Central American operation. It weighs around 30% of our full net income. If you think of balance sheet, our balance sheets are hedged across the board. So there is no substantial change happening there. The other piece to bear in mind is our P&L is moving more with average depreciation, while our balance sheet is moving with end of period depreciation or appreciation. That might generate temporary changes, but when you look over time, those numbers should look similar. In this case, when you compare first quarter to second quarter, when you look at average depreciation, the number was quite unsubstantial, it was 0.7%. What happened there compared to the end of period 5.4%. So yes there might be some temporary distortion but when you look over time, it fades away.

If the average currency depreciates then our net income will show higher results because of the Central American operations. In terms of solvency and capital, current regulation implies that the movements of FX are absorbed because you have the risk-weighting assets going up, but then you have an adjustment in the technical capital also. So no results in insolvency because of the high depreciation of the currency or the eventual high depreciation.

Our following question comes from Sebastián Gallego from CrediCorp Capital.

I have 2 questions, probably follow-ups from previous questions. The first one regarding double leverage at the Aval level. Can you provide how do you see the evolution on double leverage going forward for Aval, particularly given the growing position of the concession rights of Corficol? The second question is regarding also follow-up on the initial question on Corficol's transaction. I know you point out your rationale, and so on, but my question is, is it possible that the controlling shareholder of Aval may use another vehicle? Or are you willing to have a strategy where new investors take the whole transaction?

On double leverage question about Aval, Aval has about 116% double leverage index now, which is under what the rating agencies like us to have. They actually -- rating agencies like holding companies to have as high as 120%. In some cases higher, but with us they feel very comfortable at 120%. So we feel comfortable keeping it under 120%, and we are at 116%. With regards to -- and basically because we are not participating in the share subscription, it should remain virtually unchanged. With regards to who will participate, well, obviously, we can't control those who receded the right of participating, too. We obviously can't control if they decide to or not, but obviously from what we know the subscription will be taken entirely. And also, actually there will be -- we really can't predict right know if there will be none shareholders of Banco de Bogotá and/or Aval who will participate because the shareholders of Banco de Bogotá and Aval do have the right to cede the rights they got from the Banco Aval to participate. We have started to see some cessions, and we have seen the book coming together. So I guess, we'll just have to wait until the time is done, which is I think how many days?

End of this month.

So the end of this month, it's not too much longer to hang on to. At the end of this month, we'll know how the new shareholder book of Corficolombiana looks.

Our following question comes from [Marina Watchland from Key Rowprice].

Just a quick question on your tax rate. So corporate tax is coming down, so we'll see the impact of that '19. What do you expect your effective tax rate to be next year?

Actually what we pointed out for tax rates was that, what we saw during this quarter was something temporary and that we expect to see that taxes to remain stable as expected for the full year. For next year, the way we expect things to move is Colombia weighs around 70% of our income and Central America the remaining portion. Central America is at 28% and will depend very much on how the tax discussions in Colombia [will evolve]. We could be positive with an eventual tax reform, but at this point, we should continue at the...

Current scenario is that the level of taxes will come down next year. So it will come down by 3 percentile point. So we will capture about 1 percentile point of less implicit tax rate. So next year we will have a lesser tax rate than this year.

We have no further questions at this time.

All right, Sylvia, thank you very much, and thank you all for attending the call. And hopefully, we'll continue the good work and the good news and we'll see you next quarter.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.