Credicorp Ltd (BAP) 2008 Q3 法說會逐字稿

Welcome to today's Credicorp Ltd. Third Quarter 2008 Earnings Release Conference Call. As a reminder, today's conference is being recorded. Your call today will be hosted by Chief Operating Officer, Walter Bayly; CFO, Alvaro Correa, and Investor Relations Manager, Aida Kleffmann. Mr. Bayly, please go ahead, sir.

Thank you, Trica. Good morning to everybody. And welcome to Credicorp's third quarter '08 conference call. This third quarter is without doubt one of the most turbulent quarters for the world's financial markets and world economy we have experienced in recent times. International events are certainly intertwined with and partially behind the local events of this year. That is, the initial weakness of the US currency, growing domestic demand, which added to the international hike in food and oil prices, generated strong local inflationary pressures.

The restrictive measures of the Peruvian Central Bank increasing the reference rate for sols to curb inflation, the further deterioration of international financial markets, worldwide inflation, the collapse of the world's financial system, which dried up credit and liquidity in the markets, generating a crisis that brought the world capital markets to nosedive, bringing values further down and dropping commodity prices, massive government intervention, et cetera, et cetera.

Credicorp is by no means completely immune to such developments. But we're extremely pleased with results and can confidently say that the impact of all the year's events up to now has been extremely mild.

Local growth remains strong. But the extreme income volatility we experienced in the first half of the year shifted our focus this third quarter to reduce such high volatility, though not without a cost. Furthermore, the restrictive measures of the Central Bank also had their toll on our results, as we will see further on.

Given the depth of this economic crisis, we want to spend a few minutes looking at Peru's economy, which finds itself in the best position to withstand the world economic turbulence, especially since Credicorp growth is strongly dependent on Peru's growth. So I would like to start with just some [macro] numbers on Peru. Next page, please.

The first problem generated by this financial crisis was one of liquidity as troubled assets were identified throughout the world's financial system, bringing down the most reputable financial institutions and creating a confidence crisis that dried up the financial markets. This crisis caught Peru in a very strong [foot] since the country's dependence and need of such liquidity is at a historical low.

International reserves reached the highest levels ever. And the coverage rations of its monetary base, liquidity, and short-term debt is comfortably high. In fact, reserves are since 2007 and for the first time in Peru's history higher than all Peruvian international debt.

Furthermore, the local economy is also for the first time in Peru's history mostly funded by internal savings, mainly through the Peruvian capital markets, which grew from basically nil to approximately 30 billion in size within 13 years, and becoming the main source of funding for corporations operating in the country, driving domestic economic growth.

Nevertheless, domestic funding has been impacted by the Central Bank's restrictive measures intended to curb inflation. It is important to mention that the events in the recent weeks have led the Central Bank to change policies. Reserve requirements have been partially eased with the intention to provide abundant liquidity to the local financial system. We further expect the Central Bank to gradually reduce the domestic reference rate as inflation is expected to come down in the following months. And the focus shifts towards policies aimed at maintaining growth. Next page, please.

In fact, investments in the country continue, if not at the same aggressive pace as at the beginning of the year, but still at a very high rate, since expansions and new investments announced and already underway are not being stopped.

Most foreign direct investment is oriented towards long-term projects, which are still viable given their long-term views, and which add up to over 35 billion of announced and known projects. Nevertheless, the Central Bank has produced this chart with projected investments growth numbers, which adjust the growth rate of foreign direct investment downwards, but keeps it still at above 10% growth for the next two years. Next page, please.

Therefore, the most impressive numbers continue being those of GDP growth, which have consistently been increasing in the last years. According to the Central Bank forecast, GDP growth for the month of September reached again an impressive 9.8%, adding to the cumulative growth rate of 9.9% for the year 2008. In other words, no significant slowdown yet is being recorded.

The most significant drivers of this growth are the construction, commerce, manufacturing, and primary sectors, which are all still growing at lively rates. Nevertheless, acknowledging the serious of the economic crisis, an adjustment is being made to projections, as can be appreciated in the chart with GDP growth projections for 2009 resulting in a 6% growth rate expected. The projections from local and international economists range from the most optimistic 6.8% to the most pessimistic 5%. That is still significant and solid growth expected for the next year. Next page, please.

Within the Peruvian economy, the financial system is also extremely solid and healthy. Liquidity in the financial system is very high. Furthermore, the Central Bank is today aware of the implications the world economic slowdown could have on Peru's growth and is prepared despite original concerns about inflation to provide any necessary liquidity to the financial system to avoid an overreaction and too much of a slowdown in economic activity.

Peru's financial system is today probably one of, if not the most, profitable, at least within the region, with return on average equity of close to 30%, a number which is even more relevant when considering the high asset quality involved. It is within this relatively solid scenario that Credicorp's results stand out. Next page, please.

So turning now to Credicorp's results, we see that net income attributable to Credicorp recorded for the third quarter reached $92.6 million. That is 26% higher than the strongly depressed earnings through negative translation results from the second quarter and only 3% higher year-over-year.

Translation gains and losses, which affected so significantly previous quarters, did not reach such high levels for the third quarter, since the unusually high currency volatility was curbed by the Central Bank measures and the local currency at hedged position on Credicorp's balance sheet gradually reduced following an asset liability management decision. Thus, translation results reached only a positive $7 million this quarter, back in line with more normal levels reported in the past.

However, on an operating level, the numbers obviously reflect the toll of the restrictive Central Bank monetary measures geared to reduce growth and control inflationary pressures and of the effects of the international financial crisis on Credicorp's decision on liquidity and currency positions.

Nevertheless, the lower operating results are still high compared with the previous year and, given the magnitude of the financial crisis, reflect only a relatively mild impact. Given the high volatility in earnings this year, the cumulative numbers for Credicorp are probably a better reflection of our performance this year.

Year-to-date results attributable to Credicorp do reflect a significant increase of 34% in net earnings, reaching $344 million, versus $256.7 million last year. This is certainly a significant achievement in view of the turbulent year and reflects the strength of the Peruvian economy and financial system as well as the prudent policies and appropriate strategy followed by Credicorp. Page eight, please.

Thus, assets growth for year-to-date of 17.3% and loan portfolio growth of 20.3% revealed the lively economy in which we are operating, while the even stronger net earnings growth of 34% resulted in year-to-date return on average equity of 25.6% on an analyzed basis versus almost 23% in the same period last year.

These results are still above our target, despite having behind us probably one of the most difficult quarters for the world's financial markets. Nevertheless, as mentioned before, results of Credicorp this third quarter absorbed not only the full effect of the Central Bank's measures to reduce growth and control inflation, but also the impact of the international financial bank crisis. So far, such impact on Credicorp's overall performance has been mild, though different for each subsidiary, as we will see in the next slides. Slide nine, please.

BCP was more affected by the local turbulence than by a direct impact from the financial crisis, given its conservative investment portfolio and since it has no exposure to international troubled assets and is little dependent from international funding. Furthermore, BCP did not see growth of its loan portfolio affected, which remains strong at 6.6% growth for the quarter. However, the increase in Nuevo Sols reference rates and increase in reserve requirements impacted the local financial markets and players in different ways.

On the one side, the higher reserve requirements forced liquidity into very low and non-yielding deposits of the Central Bank. And on the other hand, the high volatility in local currency in the first half of the year led us to a more conservative currency exposure management in the third quarter. Thus, we shifted liquidity from high return, solid denominated CDs to US dollar deposits, which added to a preventive policy of maintaining high levels of liquidity, which affected significantly the yields achieved by BCP on its large liquidity investment position.

So there were four effects that clearly affected our net interest margin. Just to summarize again and have it very clear--one, increased reserve requirements from the Central Bank. Two, our decision to increase our dollar position thus, we shifted assets from higher-yielding local currency assets into lower-yielding US dollar assets.

Third, the fact that we decided to maintain a substantial portion of excess liquidity to take us through the troubled times. And last but not least, the increase in local currency interest rates. Because of competitive pressures, we were unable to translate those into higher interest rates, particularly in credit cards and in our small business portfolio.

Of these four events, some of them will be maintained for quite awhile. We have maintained still a relatively large position of liquidity. We are slowly repositioning those assets. The reserve requirements have partially been eased. We are slowly increasing interest rates. And the foreign exchange position will most likely be increased further on. Thus, the impact of this lower margin is probably going to be felt to a lower extent in this last quarter.

This lower interest income generation, coupled with high cost of funding, resulted in the 5% drop in net interest income. In addition, loan provisions increased compared to the previous quarters, given not only the lower level of provisioning reversals for this quarter, but also a more conservative provisioning policy for the retail loan book.

Non-interest income also dropped compared to the previous quarter as lower fees to market-related activities, our brokerage and our mutual fund, were recorded and lower foreign exchange commissions were booked as volatility in the foreign exchange market dropped.

At the same time, operating expense related to our network expansion continued and increased as planned. The bulk of the branches we are opening will be in the last quarter. But in order to prepare for those branch opening, a substantial portion of the employees that will be working in those branches need to be hired prior to that and are already in our payroll.

All of the described events contributed to squeezing net operating earnings. This time, our currency exposure reduction aimed at reducing the income volatility generated by the currency translation gain losses in the previous quarter led to a small positive impact from currency translation for the quarter.

The bottom line of these developments was a net income of $93.1 million for the third quarter, which shows a 90% improvement from the depressed results of the last quarter but only, as I mentioned before, 3% higher quarter over quarter. Next page, please.

We're on page ten. The lower interest income generated by BCP's assets becomes clear with this chart. The recomposition of interest earning assets toward less profitable assets is reflected by the increase from 15.7% to 19.2% of total interest earning assets of the lowest yielding portion of assets, the deposits of banks, and the Central Bank. These are the result of increased reserve requirements and low-yielding US dollar denominated deposits following the more conservative currency exposure management and liquidity policy as a preventive measure given the financial crisis.

This resulted in turn in a reduction of highly profitable interest-earning assets available for sale, most of which was invested in high-yielding Central Bank CDs, which dropped from 28.7% to 21% of total interest-earning assets. Next page, please.

The higher funding cost on the other hand was generated by some competitive pressure for capturing liquidity through higher time deposit rates, which increased the cost of overall deposits from 3% to 3.12% within the quarter, and to a lesser extent the impact of the international financial crisis on the cost of our international inter-bank funding.

In fact, short-term international financing accounts for only 5% of BCP's total funding, having therefore only a marginal impact on cost of funds, while 79% of BCP's funding is provided by deposits. This has and we continue to believe it is one of the strengths of BCP's position in this market. Next page, please.

The impact of the squeeze in income on net interest margin is therefore not small. Net interest margin falls to 4.3% this quarter, compared to 4.66% the previous quarter and even 4.82% a year ago. Nevertheless, when isolating the net interest margin for our loan portfolio, this reveals an increasing trend from 6.7% a year ago to 7% in the second quarter as the loan portfolio mix compensates for higher funding cost, except for this quarter, when the funding cost increase is stronger and net interest margin for loans dropped slightly to 6.9%.

In fact, all business segments have expanded despite the strong measures in the first half to reduce liquidity to slowdown loan growth. Consequently, the contributions to operating income coming from the loan portfolio remains strong and rising in line with loan volume growth. Thus, the drop in net interest margin is more related to restrictive Central Bank measures and impact of the international financial crisis on Credicorp's pressure management, rather than pressure on lending margins.

Page 13. It is therefore important to point out that this lower operating income is by no means a result of any business slowdown since total loans at end quarter balance continued to grow at a strong 6.9% compared to last June and 32% compared to one year ago. BCP's loan portfolio has continued to grow steadily in all business segments.

Our corporate portfolio, measured as daily average balances throughout this quarter, grew 5.6% quarter over quarter. The middle market business grew 9.6%, while retail banking expanded 6.3% quarter over quarter. Year-over-year growth rates are also very strong, as you can see in the chart.

The above growth is even more impressive when seen against the backdrop of more expensive credit and high rates coupled with jittering international markets, which do not seem to have significantly slowed down domestic market thirst for credit.

Furthermore, looking ahead, there is still ample room for growth considering bank penetration in the country has only just started in the economy. Though not immune to international world economic slowdown, it's still expected to grow at healthy rates. Page 14, please.

The past due loans at 0.78% and provisioning coverage of close to 300 are among the highest indicators in Peru and region wide. The overdue loan indicators for the retail segment are also very low at 2.7% for credit cards, 2.5% for consumer loans, 2.5% for small and medium companies, 1.2% for mortgages, and 0.7% for car loans.

Furthermore, personal and corporate debt is relatively low in the Peruvian market, while credit information is widespread and efficient. All the above coupled with conservative credit regulation and risk policies contributed to preserve a healthy portfolio.

Despite this strength in portfolio quality, we are using more sophisticated assessment methodologies, revisiting our provisioning policies, becoming more conservative, and increasing our provisions for a fast-growing retail portfolio. Nevertheless, we should mention that we have to take no signs of any deterioration in the near future. Next page, please.

Our network expansion continues and we'll continue to complete the expansion plans for the end of the year. We are convinced of the need of this expansion and the contribution it will bring to business growth in the coming years. However, the cost of the expansion will only be fully reflected in the coming year 2009 while business growth in view of the world economic slowdown is being revised downwards, a change that could put pressure on net earnings growth.

Therefore, we are being cautious and will not accelerate the expansion rate as we at some point considered, but rather measure carefully the results of this inconvenience of further expansion before giving the green light to the continuation of our expansion plan for next year.

Page 16. The expansion of our network is also directly linked to our growing operating expenses, which are increasing rapidly as the number of branches opened accelerated well in line with expectations. Nevertheless, the falling operating income this quarter reinforced the expected decline in the efficiency ratio beyond our goals to 52.3%. Profitability ratios, however, continue showing BCP's strength with return on average equity at close to 29%. Next page, please.

BCP's strong financial performance is made even more evident when looking at cumulative results to September this year. Year-to-date earnings grew 37% to $336.9 million this year, versus $245.5 million over the same period a year ago. Yearly adjusted return on average equity in the year-to-date reached 35.75%, largely above initial expectations for the year.

Furthermore, loan growth for the first nine months is already over 20%, thus confirming its expected lively pace of growth. Loan quality is very high. And despite the aggressive expansion of our network, the efficiency ratio is also better than our target at 47.8% for the year. Page 18 -- next page, please.

This good performance is notorious within today's financial environment and the strong capitalization of BCP at 12.25% capitalization ratio, even more meaningful considering the high quality of its assets and extremely liquid position. Next page, please.

Looking at Atlantic Security, Atlantic is affected more directly by the international financial crisis since its main business is asset management, both on and off balance sheet.

The direct impact on Atlantic's on-balance-sheet investment portfolio has so far been relatively mild, given the very conservative investment approach and is reflected by an unrealized loss for the quarter of only 2.9% of the portfolio, which affected net equity, and a provision of $5.7 million, which net of provision reversals included in other income results in losses of around $3.2 million this quarter, depressing earnings contribution. Thus, Atlantic reports a contribution of 19% quarter over quarter, reaching $4.2 million for the third quarter '08.

The off-balance-sheet asset management business was affected through the lower valuation of its managed portfolio. Nevertheless, even here, the conservative investment approach of Atlantic preserved value for our customers.

Page 20. While the insurance business reports a good quarterly net premiums growth of 7.7% and claims in the property and casualty sector dropped, as revealed by the improvement of net earned loss ratio to 86.9%, this continues being too high, leading to an improvement but still very poor technical results of minus $0.4 million.

It became again evident that the profitable life insurance business carries the weight for the Company, which reported a positive bottom line result of $1.2 million based on the life business, $4.6 million net earnings, and a $5.9 million gain on the sale of securities to Credicorp. Thus, after the consolidation adjustments, they eliminate such security sale and minority interest. The contribution to Credicorp reaches a disappointing minus $3.6 million for the third quarter '08. On a year-to-date basis, Pacifico reports a total loss of minus $8.5 million.

Therefore, turning the property casualty business into profitable operations continues being our company's main focus, though it is providing to be troublesome. Following this objective, significant efforts are being made to develop the more massive and better predictable retail business and limit exposure to the wholesale insurance property casualty business as well as to improve the financial investment management to achieve better overall results. Next page, please.

Finally, Prima's business results were in line with expectations, showing a 29% year-over-year income growth. Prima reported good operating profits. But the currency translation effects depressed again its results this third quarter, though not as much as in the previous quarter, leading to earnings of $1.7 million versus a bottom line loss of $0.95 million in the second quarter.

Year-to-date results for Prima reflect its performance more accurately with $9.8 million earnings contribution to Credicorp for the year to date, which is above plan. Prima's business results should improve further as of next year when the increase fee, which was raised from 1.5 to 1.75 becomes effective.

Prima captures important market shares, 31% of assets under management, 32.9% of collections, and 45% of voluntary contributions to private pension funds. An important evolution in this market is a possible change in the regulations, which is today being broadly discussed to determine a new fee structure for the pension fund system, which could lead to a change from a fixed fee based on the monthly contributions into the fund as it is today to a mix where a portion of the fee is based on the contribution and another portion is a variable fee dependent on the performance of the fund.

If properly structured, this could be a welcome change. Nevertheless, since this change has to pass through Congress, there is a certain degree of uncertainty around the results of these discussions. Next page, please.

A summary of those results is reflected in the following contributions chart. The impact on the quarterly results of the financial turmoil and resulting contributions of the individual subsidiaries is clearly appreciated, showing the still good earnings contribution of BCP, the reduced contributions of Atlantic, the poor results of Pacifico, and Prima's improved contribution.

However, given the high volatility throughout the year, it is on the year-to-date numbers that the performance is better seen. Altogether, Credicorp's year-to-date net earnings, including the only netted out translation effects, reached $334.3 million, outperforming all expectations and reflected our return on average equity for the period of 25.7%.

We understand that the results of this quarter could be disappointing to analysts and to the market in general. But we are satisfied with the results, given the extreme volatility and the depth of the financial crisis that has evolved in the past couple of months.

Page 23. As a result of this unusual evolution in the year, profitability ratios for Credicorp reflect the high volatility in these quarterly reported net earnings. Therefore, its performance is also better reflected on our year-to-date ratios, which revealed improved results with a return average of 25%, return on assets of 2.3%, and efficiency at 40%. Last page, please.

Our stock, however, has been dragged down together with the worst hit financial sector and the emerging markets' additional perceived risk and has been strongly penalized. We do believe, however, that Peru is on a very solid macroeconomic position that would allow the country to continue growing at probably the highest rates in the region.

This should set the stage for Credicorp to go on through this massive financial and today also economic crisis with less damage than most financial corporations. Our fundamentals have not changed with the crisis. The strength of our assets is there. And we will continue growing profitably in a market that is also showing signs of resilience in this turbulent world environment.

Thank you very much. And we are ready to go into the question and answer period.

Thank you.

(Operator Instructions)

And our first question is from Saul Martinez with JPMorgan.

Hi. Good morning, Walter. A couple of questions, first on your net interest income and net interest margin -- thank you for the color there. That was very helpful in terms of what the dynamics were in this quarter. Going into October-November, though, it seems like there are a lot of moving parts. Obviously, the financial crisis has worsened, which might lead you to become very -- lead you to continue to be very conservative. But at the same time, the Central Bank seems to be easing reserve requirements.

Can you just help us -- and I know it's difficult -- try to quantify the impact on your net interest margin in the fourth quarter and going into '09? It seems like you think this quarter was abnormally low. But to what extent do you think your net interest margin and net interest income could improve in the coming quarters as some of the trends you talked about play out?

And the second question is general in nature in terms of your earnings power. Obviously, the second quarter was very strong and perhaps unsustainably strong. If I look at 3Q, 4Q, 1Q of this year, third quarter of this year, your earnings have been consistently $90 million to $100 million pretty consistently. I think you've talked about maintaining a 25% ROE in the past. It seems like you're running below that right now.

Can you just talk about what you think your earnings power will be as we go into '09 and what kind of -- given the current environment -- what kind of sustainable levels of return on equity you think you can generate?

Sure. Thank you very much for the questions, Saul. The dynamics that are all happening simultaneously that impact our net interest margin are several. And I will try to address each one of them and how I see them evolving further.

Number one clearly is growth. We continue to see growth in all our loan portfolio, though, looking forward, if our original numbers for next year were 25% or higher, we probably are looking at 20% growth rates for our portfolio for next year. So dynamic number one, growth, we think it will continue in line with GDP growth in the country of around 5%. So we see growth continuing, though obviously at a slower pace than what I would have told you six months ago.

The second is that this rebalancing of our portfolio were more--the growth in the retail sector is higher than the wholesale. Thus, it allows us to maintain the net interest margin. That dynamic will continue. And we see good reasons why that will continue.

The other factor is that international banks, which to a certain extent compete with us domestically, are probably going to be a little bit--are pricing their loans into Peru more expensively. Thus, we probably have an opportunity to increase our margins a bit on the wholesale side -- that is on the wholesale side. So there is an opportunity with increased risk perception to increase margins.

Now the impacts this quarter were four factors--one, the fact that we have increased our US dollar position. We will maintain that position high and even probably increase it a bit further. Clearly, we have not seen the end of the crisis. We expect more volatility in the next couple of months. So we will continue playing a conservative asset liability management. We will keep our dollar position high. And we will maintain liquidity levels at abnormally high levels. So those two decisions, which we will maintain for the next couple of months, will continue to negatively impact our margins.

The increased cost of local currency funding, which we were unable to pass through to customers, we think there is an opportunity to pass that cost along to customers. And we are already in the process of doing that.

So as you mentioned, a lot of factors playing one against the other. If I were to summarize all this, I would say that we have for this quarter -- our net interest margin will still be affected, not as good as the first quarter or the second quarter, but not as bad as the third quarter. We will maintain high liquidity levels. We will maintain a high dollar position in a relatively--in what we see as still volatile international financial markets.

So somewhere in between, I would say that if one looks at the high net interest margin on the second quarter, we should probably get back there in the first quarter next year and in this quarter will be somewhere in between. We will -- some of the issues that have affected our net interest margin will start to get fixed. And the others will start to disappear. And some will maintain. I don't know if that -- all that that I've spoken makes any sense to you.

No, it's very helpful.

In terms of earnings potential, no, the long-term view has not changed. We see a lot of potential growth in this country, in this economy. We see the banking penetration still low. We see growth happening in the domestic economy. I guess the consensus of international economies is that we will see the developed world having negative results this last quarter of the year and probably the first half of the year, and probably a marginally positive result the second half of next year so that year-over-year next year will probably be close to zero. That is what I hear from the consensus.

Fortunately, that practically zero growth for the year for the world will not -- something similar will not happen in Peru, where we expect to grow at least 5% next year. So we continue operating in an environment that we think is positive. 5% growth is what we had a year and a half ago. And we were all extremely positive and bullish. And we see that nothing dramatic has changed there.

Okay. But in terms of the more specifics in terms of your earnings power, with the exception -- if I normalize for translation gains and losses, it seems that with the exception of the second quarter of this year, which you had a very strong -- where you had a very strong quarter, it seems like the earnings have been running at a sort of a $90 million to $100 million rate. And that's well below sort of the 25% return on equity guidance that you've given in the past. I mean, that's still a very good number, clearly.

But how do you think about internally what kind of profitability you can generate on a normal basis and in the current environment, which is obviously perhaps more challenging?

I would say that if one takes out this quarter, which again I think will still be affected by a certain amount of volatility, for next year I don't see anything that should allow us not to reach our 25% return on equity target. Pacifico clearly will have a better year next year. We will see better results at Prima. And the bank, as I mentioned, will continue growing. So I see that all of our business will have better results next year than this year. And I feel relatively comfortable about the 25% return on equity for next year.

Okay. Great. Thank you very much.

You're welcome.

(Operator Instructions)

Our next question is from Daniel Abut with Citi.

Daniel Abut from Citi. Good morning, Walter. Would you comment on the impact of all this on Bolivia? If I'm making the number correctly, these are becoming meaningful results for you. They represented 12% of your earnings this quarter. How is all this global crisis and liquidity going to affect Bolivia? And what is the risk because those earnings are again starting to be meaningful for your bottom line?

Sure. Thank you for the question, Daniel. Yes, Bolivia is becoming an important contributor. I think the return on equity for the quarter was I think 50% or something. Bolivia is relatively isolated from the world international crisis. It has no external funding. It's all funded via deposits.

What will happen, though, is that the troublesome scenario in Bolivia is more related towards the medium term. Because of all the recent political events, very little investment is taking place. People are not investing in the country. And this on the long run will definitely have an impact on the country.

On the short run, there is zero effect from the international financial crisis. The bank is funded via its own deposits. The government has a good amount of reserves because of the larger portion of the revenues from the exports of gas, which the government now receives after increasing the royalties and expropriating some of the operations there. So they have ample resources.

But the problem is in the long run, not on the short run to be very frank. It has zero impact of the international crisis so far. And we do not expect any impact in Bolivia.

So the condition of Bolivia, say, in 2009, where you feel comfortable, you will continue to hit your 25% ROE. You think it should be in the levels that we've seen this year.

Correct.

If I could follow up with a second question, Walter, you did say at the end of your response to the prior question that for sure Pacifico will have a very nice year. Now we've heard that before. And it's becoming a little frustrating for everybody, of course, for you as well. And that's not happening. What should we look for next year as that will make definitely a better year for Pacifico than this year?

You are right. It has been frustrating to all of us. And I think that the most frustrated person is David Saettone, who is the CEO of the Company and who is sitting right next to me. So I will use the opportunity to give him a chance to explain what is happening in Pacifico and what are the activities we are doing and what his view is looking forward.

Hi, Daniel. How are you?

Hi, David.

Definitely, I guess Walter's comment is in the sense that we expect to bring the property and casualty business to a breakeven level next year. This year, property business has been hit in an unusual way. Usually, the fire lines of business, that's about a 30% or 40% loss ratio.

And we've experienced a loss ratio in excess of 100% this year. There are many reasons for that. The principle reason I think is a structural change that occurred in the Company in 2004 when we moved away from our proportional treaties towards excess of loss. And that means that we repaid between $1 million and $1.5 million for each loss at each exposure.

The other effect has been that there has been a very soft market in terms of rates internationally. And Peru, as you know, has no protection against that because Peruvian companies can hire their insurance anywhere. And there is no tax penalty or anything like that. So we've seen a reduction in rates in the order of 15% since 2005.

At Pacifico, we have decreased our market share in the fire lines of business because of this. We usually have about 50% market share in 2005. We currently have about 30%. Obviously, we have long-term relationships with our clients. And it's very difficult for us to stop servicing them. And what that has meant is that there has been little premium to face these exposures.

And in addition, there've been the effects of an economic boom, where you have a lot of these businesses operating at maximum capacity. And that means that they're operating at a higher level of risk. And once they suffer a loss, the business interruption losses are much greater.

So those effects are the ones that explain the losses for this year. And what we're doing here, we're administering our exposures. We're trying to bring our retention levels down. We're setting up treaty facilities with international reinsurers in order to have a lower level of exposure. And most importantly, what we see is that this effect has been at the market-wide level. And we're looking at rate increases in the order of 20% to 30%. So these effects will help to bring I think a better result for next year.

But obviously, we cannot expect a big turnaround. As you know, it takes awhile to put these changes into effect. And the other thing that's reassuring for us is the solid performance of the life insurance business. And we see it growing. And we should expect life insurance to have a bigger share of Pacifico's portfolio in the coming years.

Thank you, David.

Our next question is from [Fred Maurice] with JPMorgan.

Hi, everyone. My questions have been answered. Thank you.

Our next question is from Jordan Hymowitz with Philadelphia Financial.

Most of my questions have been answered as well. My main question is you talked about 20% loan growth next year despite the slowing economy. Can we talk about bottom line growth because, especially in the second quarter, you had a big boost on recurring net income? So do you have any targets for recurring net income growth for next year?

Yes, sorry, but we usually try not to give bottom line predictions for the future. We try to give analysts and the market in general an expectation of where our -- the different variables of our businesses we see moving going forward in terms of rates, margin, expenses. But as a policy, we try not to give predictions of bottom line results.

Well, how about this? You're talking 20% loan growth, but your NIM has been contracting. What about just net interest income growth next year?

We don't see -- we think that the dynamics that I mentioned before, which is the fact that the net interest margin of our loan portfolio will probably be maintained. As the dynamics happened, there is loan growth. And there is probably a tightening of margins in each individual product. But the rebalancing of our portfolio, where the retail growth had a faster pace than the wholesale will probably allow us to maintain the overall margin of the loan portfolio.

On the other hand, I also explained that we will for this quarter be maintaining a relatively liquid and relatively inefficient liquidity position. But that will slowly be coming down. And we should expect that we will be able to reach the net interest margins that we were generating in the second quarter. Those should come back for the first quarter next year.

So you would say that the margin should be somewhat flat next year with this year.

That's a good -- yes.

Okay. And last question--with the slowing economy a little bit although still growing, do you think you'll be taking up your loss provisions even more? Your reserve coverage is pretty good now.

Yes, we are probably going to increase our provisioning in the coming months. There are two factors. One is a recent change in regulations by our superintendency, whereby they are taking as banks to create anti-cyclical provisions. And we think that's healthy. That's good.

So you will probably see a little bit more provisioning, more in line what you have seen this last quarter than what you have seen at the beginning of the year, also taking into effect that we have been provisioning. But we're having less and less recoveries from previously written down loans. So I would say that the number going forward is probably going to be closer to what you've seen this quarter than what you saw at the beginning of the year.

And what type of provision to -- are you going to try and maintain a 300% coverage ratio to NPAs or reserve-to-loan ratio? Or, how are you thinking about the provision now?

Because of the diverse nature of the portfolio, we look at having provisions by each type of loan. The result of the overall portfolio in terms of provisioning or coverage is really a result of the product mix. We look at a certain level of provisions we want to have in our mortgage portfolio.

We look at a certain level of provisions we want to have in our microfinance portfolio, in our consumer portfolio, in the wholesale and retail. And the end result of the whole portfolio is more a result of how each of the different pieces grow than as a target as the overall. Did I explain that?

Yes, but as we try an model it, since we can't model each line, I mean, are you saying the reserve coverage -- if the mix doesn't change and the mix is moving towards more retail, which means more reserves, not less, should we maintain at least the 300% reserve ratio to NPAs or at least the current reserve-to-loan ratio? Or, how should we be thinking about modeling it? I mean, we can't just put in the dollar amount and grow it. You know what I'm saying?

I understand your difficulties. But I think you should model by the different loan portfolio pieces. You should model a growth in the retail portfolio at a different pace than the middle market and the top corporate and assign a loan provision to each one of those similar to what has been mentioned in the chart and do that. Otherwise, the number will be a little not accurate.

Okay. And final question --

We can help you do that if you want probably in another forum.

Okay. Thank you very much.

You're welcome, sir.

And, Mr. Bayly, there were no further questions.

Okay. Well, thank you, all, very much for joining us. As I mentioned briefly in my conversation, I understand that there's a certain level of disappointment in the analysts and in the market because of results. We have been conscious that we were going to--that the different measures that we have taken in terms of liquidity, currency position, and provisioning all being a conservative nature were going to have an effect on our earnings.

Nevertheless, we felt that that was what had to be done, considering the turmoil in the recent months. We will slowly unwind these very conservative positions and become more aggressive and probably show more results. But frankly, we feel very comfortable with the results we have had. We are satisfied with them. And we hope we have been able to translate that to the market in general.

Thank you very much for joining us. And goodbye.

This concludes today's conference call. We thank you for your participation. You may now disconnect.