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Edited Transcript of BBSE3.SA earnings conference call or presentation 7-Aug-18 2:30pm GMT

Q2 2018 BB Seguridade Participacoes SA Earnings Call

BRASILIA DISTRITO F Aug 20, 2018 (Thomson StreetEvents) -- Edited Transcript of BB Seguridade Participacoes SA earnings conference call or presentation Tuesday, August 7, 2018 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Rafael Sperendio

* Werner Romera Süffert

BB Seguridade Participações S.A. - CFO, IR Director & Member of Executive Board

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Conference Call Participants

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* Carlos Grein Macedo

Goldman Sachs Group Inc., Research Division - VP

* Mario Lucio Pierry

BofA Merrill Lynch, Research Division - MD

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Presentation

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Operator [1]

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Good morning, everyone, and thank you for waiting. Welcome to BB Seguridade's Second Quarter 2018 Earnings Conference Call. This event is being recorded. (Operator Instructions) The presentation is available in the financial information presentation section of BB Seguridade's RI website at www.bbseguridaderi.com.br/en.

Before proceeding, let me mention that forward-looking statements that may be made during the conference call regarding expectations, growth estimates, projections and future strategies of BB Seguridade are based on management's current expectations, projections of future events and financial trends that may affect the business of the group and do not guarantee future performance, since these projections involve risks and uncertainties that could extrapolate control of management. For more information on the statements of the company, please check on the MD&A.

With us today are Mr. Werner Süffert, BB Seguridade's CFO; and Mr. Rafael Sperendio, Head of Investor Relations. Please, Mr. Sperendio, you may now begin.

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Rafael Sperendio, [2]

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Thank you, and good morning, everyone, welcome to our second quarter 2018 earnings call. I'm going to take you through these presentations. So let's start on Slide #2, where we have the main highlights of the quarter. Well, our accounting net income reaching BRL 1.1 billion in the second quarter this year 11% year-on-year. It's worth mentioning that in the second quarter, we have classified 2 events one-off. So the first one impacted company at Seguridade for the Brazil, which is actually (inaudible) and this was truly driven by some changes in the valuation that now establishes the requirements to the liability of equity, and on which product that have premiums recorded on that different time frame from (inaudible) we can now look at the provisions on a global basis whereas you can use the actual -- actuarial surplus of some products to offset the actuarial deficit of some other product. And considering these new rules, we will allow that we were overprovisioned. So we're heading the second quarter with also in these provisions that were in excess according to (inaudible) and these had a positive impact on the BB Seguridade's net income of roughly BRL 232 million, which we set apart to calculate our recurring net income.

And the second impact is Mapfre Seguros Gerais, which is actually 2 subsidiaries and this one was related to the work that has been progressed to reconcile the accounting balances of (inaudible) cohort from reinsurance, and also the equalization of the balance of third-party deposits. So the company from the previous one is impacted negative and impacted our net income by BRL 79 million, which we also set apart as (inaudible) as both impacts -- one that was related to the change in regulation. And this one we don't believe that it's going to be recurring, it's onetime. So that's why we think that make sense to split to impact. And the recurring net income, which at BRL 910 million in second quarter down 4.8% year-on-year. And you can see here on your lower left-hand side, the decline in the recurring net income was totally driven by the net investment income, which was down 34% year-on-year, while our noninterest operational (inaudible) even accelerated from the 3.5% growth (inaudible) to 5.4% in Q2 despite the still challenging economic environment. And here the key drivers were the increase of 11.8% previously (inaudible) At SH1 (inaudible) stronger base up at 13.3% year-on-year with our Credit life (inaudible) up 41% year-on-year. (inaudible) 13% to BRL 242 million even and premium bond collection was 20% year-on-year, another very important highlight this year. And finally, on dividend, our board of directors has approved (inaudible) percent payout of net income for the first half 2018, which means that we're going to pay BRL 1.6 billion. It's important to note here that dividends will be paid (inaudible) accounting net income, which was higher than the recurring net income.

Turning to financial results on Page 3, as usual we are going to cover the main (inaudible) That affected our net investment income. And as you can see on this page, our financial results were negatively impacted considering almost every aspect here and these explain 34% were up year-on-year representing the all-time low contribution to earnings were roughly 18% in the second quarter. So on the upper left hand side, we had as expected negative impact from the lower average Selic rate. The average Selic rate is down by roughly 40% here on a year-on-year basis. It has a very material impact on our floating securities. On the upper right-hand side you can see the net investment income also hit by the item in the forward yield curve, which caused some mark-to-market losses in our zero coupon bonds and prefixed securities in general.

And at the bottom of the slide, we also had a negative impact coming from inflation. I mean, the IGP-M, which recorded inflation in the second Q last year and increased its material in the second quarter of this year at 3.9% as compared to 2.7% inflation, and it had a direct impact on the financial expenses at (inaudible) [a hit] . And another hit that are being considered, I think, are our reduced in negative effect coming from the spike in the forward yield curve. We think that -- [hopefully] they are temporary. Generally, Selic rates for this year are going to remain, but these other 2 we believe that we can recover a little bit in the -- from the third quarter on.

Moving on to the performance of our main business lines, it's starting on Page 4 with our (inaudible) . In terms of commercial performance, as I mentioned in the beginning premiums written were roughly 12% year-on-year, in the back half of very strong performance of Credit Life, which grew 41% year-on-year. The Term Life and Rural will also presented a group performance. Term Life was up 8.5% and Rural grew 7.10%. Regarding the operating metrics loss ratio was up 530 bps year-on-year, and this was totally driven in higher frequency offerings in term Life, it's very usual during winter time, and higher frequency and severity of claims related to Rural machinery, and then increasing volume of claims related to crop insurance regarding to the drought that affected the corn crops in some states in Brazil . Accretion cost remain at almost flat on a year-on-year basis and the G&A ratio was down 200 bps partially offsetting this increases in the loss ratio, but not enough to avoid the impact on the combined ratio. But you can see in the lower left-hand side, which are burdened by 3.1 percentage points year-on-year.

Financial results were down 18% on our (inaudible) partially offset by the increase in the volume of financial investments. And mainly inflation, mainly [ICCA] (inaudible) approval inflation protected securities (inaudible) by the health maturity. And when we look at the final outcome of how these moving parts net income on a recurring basis was down 11% reaching a return on average equity of 52%.

Turning now to our P&C business on Page 5, premiums written were down 4.3% year-on-year, dragged by casualties, in general, independent broker channel while the auto insurance premiums were up 4% year-on-year.

Regarding the operating performance, the (inaudible) ratio improved by 200 bps, on a better performance in the auto insurance segment. Commission rates remain flat on a year-on-year basis, while G&A was (inaudible) by 160 bps dragged by high impairments and premiums receivable.

As a result, combined ratio improved by 4 bps year-on-year, while financial results down 41%, pretty much in line with the decline in the Selic rate. So recurring net income dropped by 58% year-on-year, 3.1% return on (inaudible).

On next page, we have our performance in private pension plans. Contributions were down 13.6% year-on-year. (inaudible) ratio increased by 4 bps mainly on (inaudible) occurred throughout the quarter, which scared a little bit our clients and made our life more difficult (inaudible) new deposits for pension accounts. As a result net inflows amounted to BRL 1 billion down 69% year-on-year.

Patient reserves BRL 243 billion up 13% over the last 12 months, which is helping management fees to [keep grow] , 15% grow year-on-year, despite the -- keeping that trend, that decline in the average management fee charges that are very much in line where we have been seeing in the former quarters; 1 to 2 bps down for quarter. Cost-to-income ratio improved by 610 bps, while financial results declined by 6.3% both in line (inaudible) financial results of the second last year were helped by the IGP-M deflation, and what we didn't see in 2018. So that's why financial results declined and as a result, net income increased 14% year-on-year, which is equivalent to a return on equity average of 43%.

On Premium bonds, Page 7, we managed to keep a very strong sales performance with collections growing 20% year-on-year this quarter. But on the other hand, we recorded a net investment loss given the spike in the forward yield curve, our net interest margin was compressed here by 300 bps, which is 0.6% in the second quarter. The company is very sensitive to financial results given (inaudible) that we have in the conglomerate. We ended the second quarter almost at breakeven with a loss BRL 654,000 as compared to BRL 45 million in the second quarter last year. And finally, on Page 8 our insurance broker, as you can see on the upper left-hand side, the strong performance in areas of credit Life, Mortgage Life and then premium bonds drove the brokerage income up 4% year-on-year, but the net income of the segment declined by 3% year-on-year given weaker financial results. And the compression in the EBIT margins, the compression in EBIT margin was totally driven by the increase in the total items sold. As you can see here on the chart at the lower left-hand side, total items sold were 134% year-on-year in Q2 at 66% year-to-date through June, (inaudible) qualifying that given the still are challenging economic environments we decided to shift sales a bit more forward to lower ticket products like sort of term Life insurance products and home insurance. It enabled us to keep selling without committing too much of clients' overall income. It's also going to offer some excellent opportunity in the future once the macroeconomic environment [will] improves, but on the fleet side within (inaudible) margin in the first month as the cost of products sold to consumer big part of the commission and important (inaudible) the costs is paid -- the reimbursement cost is paid on a cash base as well. The brokerage commission is deferred throughout the lease term of the product. That's why it's coming to see some margin compression when we have these spike in the number of items sold. I think one-time effect that might be the diluted over time.

And (inaudible) presentation Page 9, we have our (inaudible) monitor. So year-to-date through June, we underperformed the guidance. Our recurring net income was down 6.8% when we expect the net income to stay within the range of minus 2 to plus 2 for the full year. And it's worth mentioning that as we discussed in our last earnings call, this underperformance in this first half of the year was already expected. To give the scenario of interest rates in 2018 as opposed to the scenario of interest rates that we saw in 2017. We were expecting to see a convergence to the range in the second half of this year as we were expecting more easier comps for full interest rate. But the main point that lead us to revise the guidance range from minus 2 to plus 2, to minus 6 to minus 4 was related that we tried to expect that the pace of decline that we saw, which dates through June, was 6.8 was a slightly higher than the one that we were predicting. But it's worth noting that throughout the (inaudible) what we were expecting like some internal factors (inaudible) right, and also external factors like rising estimate for interest rates in U.S. So the consensus for GDP growth is lower now than we -- than the one that we had when we gave the guidance, the economic rate expected to improve, and there was a huge volatility in the forward yield curve which impacted not only our financial results, but also the return on our clients' pension account. So given this background, we decided to assume our estimate for the adjusted net income variation to this new scenario.

But if we were to look at more carefully and understand why we have this underperformance in the first half, the main deviation from our estimates came in the performance at SH2. I would say that roughly 3/4 of it came from the commercial performance in -- sorry, came from the operating performance at SH2 and the balance came from the weaker than expected performance in pension plans. So both effects they can be considered as temporary given that the current situation in SH2 already addressed. Just as a mandate, we received the first of 4 approvals. We received the approval from the Brazilian Antitrust Agency some weeks ago. And also regarding to the commercial performance at the pension business, it's more a matter of the current economic environment, which we expect that might improve when these uncertainties reduce once we know who's going to be the next president of the country. So that's something that emphasize why we think that can be considered temporary. It is worth highlighting here that despite the tougher environment, we managed to increase our operating results by 4.5% year-to-date, which can be a good proxy of how much earnings could have been growing without the negative rate from the low interest rates and financial results. And there is another important point here in line of what -- when we look at the line that showing the fastest growth rate -- in the slide, see the one that have the longest period of deferrals. I mean, we are not seeing yet the benefit of the strong commercial recovery in SH1. It's going to accrue in the P&L over the next 2 to 3 years. We can make it tangible by analyzing (inaudible) commissions that (inaudible) which have a balance of roughly BRL 1.7 billion, up 8.4% in 12 months. So it's future results that's going to accrue to the P&L. We are quite confident that we are building a very strong future earnings stream and we are committed to deliver an earnings performance within these new revised range for 2018.

Well, that's all I would like to emphasize. We can now jump into the Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mario Pierry with Bank of America.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [2]

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Let me ask you 2 questions. First one, the strong growth that we saw in credit life premiums up 41% year-on-year, I wanted to hear from you the sustainability of this growth. What is driving this growth? At what level or what rates can be maintained? Second question is related to the capitalization business. You've mentioned, right, that this business is most sensitive to interest rates or to lower rates. You are running at a loss right now. Historically, you used to post at around BRL 45 million, BRL 50 million per quarter in gains. Do you think you can return back to those levels if rates don't move? Or if there is a new sustainable profitability of this business with interest rates at current levels of 6.5%. So I'm trying to get from you is much more a sensitivity of the net income to interest rates at Brasilcap.

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Werner Romera Süffert, BB Seguridade Participações S.A. - CFO, IR Director & Member of Executive Board [3]

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Werner speaking, firstly, about Credit life growth that we had during this quarter a very strong 131%. 55% in the first half of this year. It's a very strong one. Of course this is not the level that we expect to sustain at throughout the years, but as we are review this portfolio in our company this is the kind of pace that we will have in the first quarter. After that, of course, we have higher premiums coming from this portfolio, it will be harder to sustain the same level of growth, but from the first quarter, first months of this new cycle it's the kind of level that we have. Of course, when we have its credit Life improving at the same pace this boost even more this growth coming from this shorter term Credit Life product, comparing with this payroll loans credit life products that are longer than the SME products. So the effect that we will have in the coming quarters will be positive from this line and because Banco do Brasil they are also doing a very strong effort to increase their payroll loans. And we believe that we will be able to increase our penetration by this payroll loan book from Banco do Brasil. We are quite confident that this pace will continue to be very strong in the coming quarters with a positive impact in SH1 with a very strong positive effect also in our broker. So this is for Credit life. And for the premium bond business we, of course, have now in this business our results come -- they are coming from 2 sites (inaudible) side and our -- the part that we have in Brasilcap, so of course ROE now, it's more than the one that we have in the last years because of the level of the interest rates that we have [no date] . With an interest rate increasing in 2018 like it's expected by focus estimate June 13 close to 8%. This will be enough to bring a very good level of profitability to the business, again, and with the commissions that flow through the book helping to improve our margin. So this will continue to be an important product, of course, clients that we believe that they are able to move from this accumulation product -- shorter-term accumulation product to product that are longer life pension plans, we are also trying to do this effort trying to move them from this premium bond to pension plans as soon as we are able to change this -- their mindset and change their goals, and making them -- they will be able to understand that this longer-term products are better in the long term. So this is a long-term objective for the business with us, but until we reach this kind of cultural awareness from our clients we will continue to have as our peers good contributions come into -- through -- to the premium bond business Brasilcap. So this level will change from now to -- with higher interest rates like 7.5% or 8% that the average Selic rate for 2019. It will be enough to improve the ROE of the business but not enough to reach the same level that we've had when the interest rates were higher than 14% 1 year. So this new level will get our growth running but in a different profitability than the one that we have in the past.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [4]

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Okay. Very clear. Since you mentioned Brasilprev, you're trying to make people shift their investments or their choices into longer-term products, we saw Brasilprev a big declining contributions as well. If you can give us some color here that this drop in contributions, is it related to you to your market share normalizing? Or does it reflect a slower environment for the market?

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Werner Romera Süffert, BB Seguridade Participações S.A. - CFO, IR Director & Member of Executive Board [5]

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Mario, I will say that it is a brand of this effect, of course, we have, we reached in the last quarters level market share, that's very -- it's above our fair share in the market reaching more than 50% in the net flow inflow or even more than 43% in contribution. So it's much more than we have in our bancassurance product size, of course, rural insurance, but all other products we have less than, I would say, close to 25% -- from 20% to 25% of market share. In this case, our reserves (inaudible) from this business is close to 30% of the market share. We have been able to sustain this level of market share in reserves and this is our main goal. So, of course, with this change in the mix that we have, with clients with smaller ticket coming from insurance products as Rafael explained, and also from pension plan products to change the quality of this improved -- of this increase in reserves to a more -- to decrease the concentration that we have now in high net worth individuals, to clients from the retail banking part of Banco do Brasil clients. So this is a very important strategy in the long run, but, of course, there is a price to pay in the first quarters as this -- so this is part of the strategy, but also an impact of this competition that changes and increases in the recent quarters. And on the other hand, you have also have this short-term effect that we have in the end of May, in the beginning of June, get you the strike from the strike truck drivers and this affect the forward yield curve and impacted the return on June. So while we look this information that are already available on the market looking to performance we have from June on, this will be able to see that the returns are increasing, again, and when we look at year-to-date returns from the same funds that we have comparing with our peers that (inaudible) they are very well positioned in the first product with higher returns distributed in Brazil. So we are quite confident that this trend will continue, but as you said, of course, this -- some quarters we achieved a very high level of market share, and now this is starting to stabilize. It's important to mention that we are -- we remain the leaders in the segment and select the contributions (inaudible) and reserves as well. So this is our target to remain in the leadership with very good margins coming from this product.

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Operator [6]

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Our next question comes from Carlos Macedo from Goldman and Sachs.

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Carlos Grein Macedo, Goldman Sachs Group Inc., Research Division - VP [7]

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A couple of questions. Just following up on Mario's third question on Brasilcap, you say you're moving to -- away from the prime (inaudible) Focusing as much in the prime, doing a lower ticket items to retail investors. Maybe trying to work them and bring them some of the (inaudible) some of your clients that were investing in Brasilcap. What kind of potential do you see in that specific market? How much you think you can penetrate incrementally? That I mean, I have to imagine you're already penetrated to some degree today, but how much do you think Brasilprev can gain going into that? And how much of (inaudible) reserves? Second question, you talked about early inflection point coming that would be slightly delayed. When we look at the year-over-year growth from those metrics in terms of written premiums across most of your businesses, it's already hit the bottom and it's now moving up even though it's still negative in many places. Is it going to be a slower recovery because of the way we behave? Is this going to be a lower peak when it finally recovers? What should we expect given that you guided lower net income? Does that mean that net income next year growth is going to be higher because you're going to be at the same level? Or will you just push that off 3 or 4 years down the road?

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Werner Romera Süffert, BB Seguridade Participações S.A. - CFO, IR Director & Member of Executive Board [8]

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Thank you, Macedo, for your questions. The first one linked to the lower ticket products in Brasilprev, given the trend we -- our one of our goals there in the strategic initiatives that we have in place is to reduce the concentration of clients that are responsible for this reserves in Brasilprev. Of course, this is also linked to some cultural aspects, so we need to increase this portfolio in the consumer client-facing even more difficult than the retail banking segment broadly. This linked to -- some changes in the control (inaudible) Of the average Brazilian, we are trying do that. What we think that lower interest rate environment, they are a good way to do that. So, and now also, we think that with this new platform, the digital approach trying to sell this product and clients trying -- now having access to this kind of product via this digital platforms. This will increase the size of the market and we will try to move up our client base that already -- Brasilprev client base to this product. We already have this 1 kind of this product available in our mobile platform in Banco do Brasil, and we're trying to increase this portfolio as fast as possible to capture this growth, but we don't think that this will be a short-term change in this reserve. In fact that we need to start now, and then have also our initiative in [Selic] trying to capture this nonbanking clients that they want to have this pension plan product, but trying to -- we are trying to reach all the alternatives to improve the quality of this increase of this AUM on Brasilprev. And we think that this initiative in place to reduce the concentration on our client base for Brasilprev, is a very good way to reduce the pace of reduction of -- fees that we are charging there. So it's reducing 1 bp each quarter and 1 initiative in place to reduce the space is this change in the concentration of our client base. And that's something that will have an impact effect in the next couple of quarters, it's something that we will have a positive impact in the long term, but it's important to start now because this interest rate environment with the business -- a good initiative to implement. On the other question, that you had.

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Carlos Grein Macedo, Goldman Sachs Group Inc., Research Division - VP [9]

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It was regarding the growth. I mean, you already mentioned (inaudible) in terms of growth. I guess, the question I think was to rephrase it, you lowered your earnings expectation for growth for this year. For next year, are you still at the same earnings level? Or do you lower that too? Do you expect with rates possibly going higher next year and then really have recovery you think, you can accelerate growth next year [in earnings] ?

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Werner Romera Süffert, BB Seguridade Participações S.A. - CFO, IR Director & Member of Executive Board [10]

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I will say that when you look the operational results that has improved there, 5.4% in the quarter and 4.5% in the semester, it will continue to improve throughout the year. So business is the best way to look 2019 so we are not going to have this headwind coming from financial results and also maybe the (inaudible) Selic rate for 2019 will be even a little bit higher than the ones that we had in 2018. So this will bring some tailwind for us and this will be the first time after 3 years that this outcome from financial results. At the same time this new portfolio that we are reviewing from credit life will help a lot. So we will have more -- the revenue stream coming from the broker, the credit life products linked to the commission side. So revenues coming from the broker linked to this Credit life product and also the impact -- the positive impact coming from SH1 with higher profitability will guide higher numbers in 2019. It's very hard to say that now and we don't have a guidance yet for 2019, but we believe that 2019 will be easier than 2018 without this headwind coming from financial results and with better operational performance coming from our product mainly the credit linked products.

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Operator [11]

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(Operator Instructions) This concludes today's question-and-answer session. I'd like to invite Mr. Rafael Sperendio to proceed with his closing statements. Please, Mr. Sperendio, go ahead.

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Rafael Sperendio, [12]

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Well, I would like to thank you, everyone for joining our Q2 earnings call and let me emphasize that the main factors that allows us to drive the guidance we think they are not structural and one-off (inaudible) the issue that had will (inaudible) and I would say challenge that we still have in terms of our raising real deposits for long-term investments, I mean pension funds, we believe that it's something that's going lower (inaudible) . (inaudible) to be it's going to be the next president of the country (inaudible) uncertainty (inaudible). So we believe that postelection environment is going to improve a lot, but something that we might see maybe a more stronger inflow maybe just in 2019. And we believe that we have been bringing a very strong earnings stream. We've talked about the earned commissions at the broker that reached BRL 1.7 billion; it is growing, again, it grew roughly 8% from on a year-on-year basis. (inaudible) related to future earnings that's going to accrue into the P&L of the broker, it's going to accrue into the P&L of the insurance company, so we are quite confident that we reached the bottom. We are committed to deliver an earnings within the guided range of the guidance. But for 2019, we are much more optimistic (inaudible) accounting them financial results have a tailwind from next year on, instead of a headwind like most of last year. It's what we are seeing in 2018. So thank you, once again, and have a good day.

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Operator [13]

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With this, we conclude BB Seguridade's conference call for today. As a reminder, the materials used in this conference call is available on BB Seguridade's Investor Relations website. Thank you very much for your participation. And have a nice day. You may now disconnect.