Peruvian Banks vs. US Banks

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1 Overview Earlier this year we published a series of notes that described the banking systems in Jamestown Latin America s target markets. On a quarterly basis, we will provide updates on the financial performance and growth indicators of the various countries banking systems, while also highlighting any relevant news that could impact the local mortgage markets. Executive Summary Peruvian banks valuations compare favorably to US banks Banking penetration in Peru is still very low when compared to other emerging market countries US dollar deposits are outpacing soles deposits, with the number of depositors doubling since 2007 Credit growth is now primarily in local currency Credit quality in Peru remains solid as the non-performing loan ratio for the system remains low The outstanding mortgage to GDP ratio is just 5%, or about one-fourth the level in Chile, and well short of Brazil s 9% ratio

2 Based on a number of major metrics, the Peruvian banking system performs well when compared to the United States major banks. Major Peruvian banks price-to-book ratios greatly exceed those of large US banks. The two major publicly traded Peruvian banks, Credicorp (the holding company for Banco de Credito) and Intercorp (the holding company for Interbank), have price to book ratios of 2.7x, according to Citigroup s Latin American financial institutions research group. Meanwhile, the price to book ratio for the major U.S. banks is 1.1x (as of end-june 2014), versus a 20-year average for the same universe of U.S. banks of 1.7x. 1 Large U.S. regional banks have an average price to book ratio of 1.4x, according to. Price to Book Ratios Peruvian Banks v Major Global Banks The higher price to book ratios at the Peruvian banks is a reflection of the market s optimism over their future growth prospects, and higher profitability ratios. Peruvian banks are more profitable than their US counterparts. In terms of profitability indicators, Peru s publicly traded banks have an average ROE of 20%, while estimates that Credicorp has a sustainable ROE of 19%. In comparison, the most recent return on equity on all U.S. FDIC-insured banks is 8.8%, with the median ROE since 1975 at 11.9%. The universe of major U.S banks has a ROE of 9%. Return on Equity Peruvian Banks v Major Global Banks 25% 20% 15% 10% 5% 0% -5% -10% Return on assets for the U.S banks averages 1.0%, well short of Credicorp s 1.9%, while Intercorp s exceeds 2%. Return on Assets Peruvian Banks v Major Global Banks 3% 2% 1% 0% -1% -2% -3% -4% -5% 1. Includes,,, Citigroup, and JPMorgan according to s financial institutions research group TRENDS + VIEWS SEPTEMBER 2014 PAGE 2

3 Net interest margin at Credicorp is 4.9%, and at Intercorp an eye-popping 7.0%. Meanwhile U.S. banks average 3.2% for the large banks. Notably, margins on consumer loans in Peru remain very high. The average rate on these credits, according to official statistics, stands out at a rate of 43% Growth: In Peru loan growth is forecast to reach 15%, with deposit growth slated to increase by 15% this year. Meanwhile loan growth for the U.S. universe of banks is just 3%, according to the most recent data, and forecasted to reach 4% for the year, while deposit growth is 7%. Capitalization: Tier 1 ratios at the Peruvian banks average 10%, which is comparable to 10% for the US banks. The last reported BIS ratio, an indicator of solvency which reflects the ratio of risk-bearing capital to risk-weighted assets, is a healthy 15% on average for the publicly traded Peruvian banks. Provisions: To manage future delinquencies, Peru s coverage ratio of 165%, which reflects provisions over nonperforming loans (NPLs), is down from 183% a year ago. U.S. banks display an average coverage ratio of 192%, above what is observed in the Peruvian system. NPL ratios for the entire Peru banking system average 2.8% according to Superintendencia de Banca, Seguros (SBS), the Peruvian banking regulator. This compares to 3.4% for the major banks in the United States, 2.0% for the large regional banks and 1.2% for the smaller regional banks. 2 As of the last quarterly reporting cycle, Credicorp and Intercorp have NPL ratios of 3.3% and 2.5%, respectively. 3 Low banking penetration The level of banking penetration in Peru is still very low when compared to other emerging market countries, whether looking at credit penetration, number of depositors, or other indicators. Key Indicators Peruvian Banks v Major US Banks Peruvian Banks US Banks 4 Forecasted Loan 15% 4% Growth Forecasted 15% 7% Deposit Growth Tier 1 Ratios 10% 10% Coverage Ratio 165% 192% NPL Ratios 2.8% 3.4% For example, cumulative deposits in the system total just over 218 billion soles as of June (up 12.5% year over year), or just over one-third of GDP. Total loans of 212 billion soles also comprise around one-third of GDP, on par with Mexico. By comparison, in Chile loans to GDP are approximately 75% and in China are well over 125%. Rapid credit growth now mainly in local currency Typically credit growth in Peru trends at three times real GDP growth, which was 5% in Based on data through June, credit growth was running at 16% year over year, with credit in local currency expanding at 23%, compared to 6% in US dollars. While loan growth was decelerating toward the end of 2013 and early 2014, due to a slowdown in economic activity and some greater risk aversion on the part of the Peruvian banks, credit expansion has been increasing thanks to measures adopted by the central bank. The monetary authority has reduced reserve requirements on soles on several occasions, which serves to stimulate credit in the economy. 2. US Coverage Universe 3. Ibid. 4. Ibid. TRENDS + VIEWS SEPTEMBER 2014 PAGE 3

4 Year-on-year credit expansion in Peru (June 2014) Overall credit 16% Credit growth (PEN) 23% Credit growth (USD) 6% Corporate Credit 29% Consumer Loans 12% Auto Loans 40% Credicorp, Peru s largest bank, reported loan growth of 2.4% in 2Q versus 1Q, but is guiding investors to expect a pickup in the months ahead, as economic activity bounces back in the latter part of 2014 with additional momentum expected for (economists look for 5.5%-6% GDP growth in ). Credicorp projects 14%-15% loan growth this year, both for itself and the banking system as a whole. In particular, corporates, which account for 20% of the system s total loans, have been expanding their demand for credit. Overall loan growth reached 29% from this segment in June, with a 42% expansion in local currency. Demand for corporates should remain robust, due to some major infrastructure projects and concessions in the pipeline which will initiate construction in the months ahead. Small and micro enterprises have been less active clients, with loans mainly flat, a reflection of less dynamic conditions for these segments. Meanwhile consumer lending has been expanding at 12% year over year, led by auto loans which are growing at over 40%. There has been some deterioration in credit quality at the consumer level of late. US dollar deposits outpacing soles deposits While total deposits are increasing at 12% year over year, US dollar deposits are growing at 26%, a faster rate than that observed in soles, which rose 4% according to the most recent data. Depositors are shifting some of their assets into dollars, as a means of protecting against further depreciation of the sol, which hit a 52-week low against the dollar, at , on August 26th, representing a depreciation of 1.4% year to date. Since January 2013, the sol lost 11% of its value versus the dollar. However, with the highest ratio of central bank reserves to GDP in the region, the central bank has ample firepower to counteract any potential volatility in the sol. Some weakness in credit quality The non-performing loan (NPL) ratio for Peru rose to 2.84% in June 2014 versus 2.52% in June Loan delinquencies for small enterprises increased from 7.16% to 8.71%. However, this segment remains very profitable since average rates in soles to small businesses average 21%, according to SBS. In its quarterly earnings conference call, held in August, management of Credicorp stated that there has been an increased incidence of NPLs (50 basis points quarter over quarter) for small and medium-sized enterprises in its loan portfolio. Meanwhile NPLs at large corporates rose from 0.01% to 0.11%. The NPL ratio on mortgages is very low, at 1.25%. However this figure has risen from 0.92% a year ago. Banks have an important cushion as loan spreads on mortgages remain high in Peru. As competition increases in this segment, we would expect mortgage rates to fall. According to the most recent data provided by SBS, average mortgage rates are 7.64% in US dollars and 9.25% in soles, compared to the central bank s policy rate of 3.75%. Overall, credit quality in Peru remains solid as the nonperforming loan ratio for the system remains low, when compared to other emerging market countries. Soles-denominated mortgages on the rise Mortgages in Peru can be issued in soles or in US dollars, but there has been a trend toward greater issuance of mortgages in soles over the last 1-2 years. Of the total stock of mortgages, 35% (as of June) is now denominated in dollars versus 43% a year ago, and 65% as recently in TRENDS + VIEWS SEPTEMBER 2014 PAGE 4

5 In general, sol-denominated mortgages dominate the middle market, while the higher tier buyers tend to seek dollardenominated mortgages. The depreciation of the sol in has been a factor accounting for the shift in demand toward mortgages denominated in local currency, a healthy development. The June figures showed mortgage growth of 32% year over year in local currency, versus an 8% contraction in dollars. The decision of the central bank to release liquidity in soles by lowering reserve ratios, as it has done repeatedly in recent months, has also contributed to the divergence in demand for mortgages by currency. This move toward de-dollarization removes potential currency mismatches from the banks balance sheets. Number of depositors has nearly doubled since 2007 Banks in Peru are conservatively run. One indicator supporting this, as mentioned above, is that provisions (for losses) are 1.7x the level of non-performing loans, and were 2.0x as of January For mortgages, provisions are 2.1x the level of delinquent mortgages. Despite the conservative stance, growth in banking penetration is impressive: the number of depositors has increased from 6.5 million in 2007 to nearly 12 million currently. Banks are gradually expanding into regions of the country that thus far have seen an absence of financial intermediation. USD PEN system remains vulnerable Underdeveloped mortgage market The outstanding mortgage to GDP ratio is just 5%, or about one-fourth the level in Chile, and well short of Brazil s 9% ratio. Mortgages represent just 17% of total credit in the financial system. Only 216,000 mortgages exist in Peru, a small amount for a country with a population of 30 million but this figure is up 10% from a year ago. Mortgages issued via the subsidized Mi Vivienda program for lower income individuals have lost some momentum year to date. Through May, the number of Mi Vivienda loans fell 15% year over year. Analysts believe this is a function of slower economic growth, a more conservative stance on the part of banks toward extending mortgages to lower income individuals, and bottlenecks pertaining to processes to secure a Mi Vivienda loan. Takeaways The banking system of Peru remains healthy and well capitalized, and demand for mortgages continues to be robust. Banks are prioritizing the issuance of mortgages as a means of leveraging the ability to issue other consumer credits. Indeed, the consumer sector is especially profitable: the average rate on consumer loans in soles is 44% and 28% in US dollars. The central bank has been especially supportive of the banking sector, based on cuts in reserve requirements in soles and reductions of the policy rate, now at 3.75%, from 4.25% in October The dual currency financial system remains a vulnerability, and is a legacy of the hyperinflation days of the 1980s and early 1990s. US dollars and soles are generally interchangeable on the streets of any major Peruvian city, and Peru remains one of the few countries in the region where deposits and loans are quoted in both currencies. Fortunately, there has been a steady trend of de-dollarization of credit as the country s macro environment has solidified over the years. Loans denominated in dollars represent 39% of outstanding loans, down from 43% a year ago. Meanwhile, 41% of deposits are denominated in dollars, up from 36% a year ago, as a multiyear appreciation trend in the sol concluded, and citizens looked to protect themselves against additional currency weakness. TRENDS + VIEWS SEPTEMBER 2014 PAGE 5