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Edited Transcript of GRUPOAVAL.BG earnings conference call or presentation 19-Nov-19 2:00pm GMT

Q3 2019 Grupo Aval Acciones y Valores SA Earnings Call

Dec 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Grupo Aval Acciones y Valores SA earnings conference call or presentation Tuesday, November 19, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Diego Fernando Solano Saravia

Grupo Aval Acciones y Valores S.A. - CFO

* Luis Carlos Sarmiento Gutiérrez

Grupo Aval Acciones y Valores S.A. - President

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Conference Call Participants

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* Alonso Acuna Aramburú

Banco BTG Pactual S.A., Research Division - Strategist

* Carlos Enrique Rodríguez

Ultraserfinco S.A. Comisionista de Bolsa, Research Division - Director of Equity Research

* Gabriel da Nóbrega

Citigroup Inc, Research Division - Research Analyst

* Jason Barrett Mollin

Scotiabank Global Banking and Markets, Research Division - MD of LatAm Financial Services

* Julian Felipe Amaya Restrepo

Corredores Davivienda S.A., Research Division - Equity Research Analyst

* Sebastián Gallego

CrediCorp Capital, Research Division - Associate of Andean Banks

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Presentation

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Operator [1]

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Welcome to Grupo Aval's Third Quarter 2019 Consolidated Results Conference Call. My name is Sylvia, and I'll be operator for today's call. Grupo Aval Acciones y Valores S.A., Grupo Aval is an issuer of securities in Colombia and in the United States, registered with 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 compliance with securities regulation in Colombia and applicable U.S. securities regulation. All of our bank subsidiaries, Banco de Bogotá, Banco de Occidente, Banco Popular and Banco AV Villas, Porvenir and Corficolombiana, are subject to inspection and supervision as financial institutions by the Superintendency of Finance. Grupo Aval is now also subject to inspection and supervision of the Superintendency of Finance as a result of Law 1870 of 2017, also known as Law of Financial Conglomerates, which came in effect on February 6, 2019. Grupo Aval, as the holding company of its financial conglomerate, is responsible for the compliance with capital adequacy requirements, corporate governance standards, risk management and internal control and criteria for identifying, managing and revealing conflicts of interests applicable to its financial conglomerate. The 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 the non-GAAP measures, such as ROAA and ROAE, among others, are explained when required in this report. Grupo Aval has adopted IFRS 16 retrospectively from January 1, 2019, but has not restated comparatives for the 2019 (sic) [2018] reporting period, as permitted under the specific transitional provisions in the standard. The reclassifications and adjustments arising from the new leasing rules are therefore recognized in the opening condensed consolidated statement of financial position on January 1, 2019. Consequently, quarterly results of 2019 are not fully comparable to previous periods.

IFRS 16 introduced a single on-balance sheet accounting model for lessees. As a result, Grupo Aval, as a lessee, has recognized right-of-use assets representing its rights to use the underlying assets and these liabilities representing its obligations to make lease payments. Lessor accounting remains similar to previous accounting policies. Assets and liabilities arising from a lease are initially measured on a present value basis. The lease payments are discounted using the interest rate implicit in the lease if that rate can be determined, or the group's incremental borrowing rate.

This report includes forward-looking statements. In some cases, you can identify these forward-looking statements by words, such as may, will, should, expects, plans, anticipates, beliefs, estimates and predicts, potential or continue or the negative of these other comparable words. Actual results and events may differ materially from those anticipated herein as a consequence of changes in general economic and business conditions, changes in interest and currency rates and other risks described from time to time in our filings with the Registro Nacional de Valores Y Emisores and the SEC. Recipients of this document are responsible for the assessment and the use of information provided herein. Matters described in this presentation and our knowledge of them may change extensively and materially over time, but we expressly disclaim any obligation to review, update or correct information provided in this report, including any forward-looking statements, and do not intend to provide any update for such material developments prior to our next earnings report.

The content of this document and the figures included herein are intended to provide a summary of the subjects discussed rather than a comprehensive description. When applicable in this document, we refer to billions as thousands of millions. (Operator Instructions)

I will now turn the call over to Mr. Luis Carlos Sarmiento Gutiérrez, Chief Executive Officer. Mr. Luis Carlos Sarmiento Gutiérrez, you may begin.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [2]

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Good morning, Sylvia, and thank you. Apologizing in advance because I'm getting rid of a cold so I'm most stuffed up. But here we go. Good morning, all, and thank you for joining us in our third quarter 2019 conference call. Once again, it is my pleasure to share with you our strong financial results for the quarter that ended on September 30. Today, I will cover the following subjects: An overview of the country's macro scenario, highlights of our results and update regarding the legal processes of Ruta del Sol and also, our recent announcement of the agreement to acquire Multi Financial Group holding of Multibank in Panama.

So let's start with the macro scenario. Colombia's economy, where almost 70% of our consolidated business resides, continues its path of acceleration despite a worldwide broad-based economic growth slowdown. In fact, as all of you already know, GDP growth during the third quarter accelerated to 3.3%, the strongest quarter in the last 4 years and higher than the 3% average of the first half of this year. This result was mainly driven by stronger private consumption and investment from demand side, while driven by commerce and financial services from the supply side. In fact, sectors such as commerce, financial services and professional services grew at a stronger pace than average GDP, while sectors such as construction, industry, oil & mining and communications grew at a slower pace. The biggest drag on the economy continues to be the country's trade deficit, amid weak exports and robust imports. All in all, we continue to expect that GDP will grow 3.2% during the year. Assuming a slowdown in government spending next year, a slow recovery in the trade deficit, but sustained private consumption and growth contribution from infrastructure, we forecast a slightly -- a slight improvement in GDP growth to 3.3% in 2020. Employment continues to be soft with unemployment currently averaging 10.4%. As mentioned in previous calls, we believe that this indicator is being impacted by the notorious inflow of Venezuelan immigrant and the consistent minimum wage increases in excess of inflation. Unemployment numbers will only start to improve as the labor-intensive sectors of the economy gain momentum. As such, we currently expect a slight, and only a slight, improvement in unemployment for next year. 12-month inflation continues to push towards the 4% upper limit of the Central Bank's range, closing at 3.86% in October as compared to last year's inflation of 3.2%. However, the pickup in core inflation has been moderate, while food prices have accounted for approximately 90% of the increase. Also contributing to the acceleration in inflation is a pass-through of the devaluation of the currency, resulting in more costly imports when denominated in Colombian pesos. We expect inflation for 2019 to be 3.8%. Food prices should somewhat ease in 2020, and thus, we expect inflation to return to the 3.5% area next year.

Despite higher inflation pressures due to the yet to consolidate economic recovery and the worldwide trend of monetary policy easing, we believe that the Central Bank will continue with a stable repo rate of 4.25% throughout the remainder of 2019 and most, if not all, of 2020. As I briefly mentioned before, current account deficit continues to be one of major vulnerabilities of Colombia's economy. Despite a significant increase in foreign direct investment during 2019, Colombia's internal demand growth continues to push for the importation of more expensive goods, while weakening external economies and lower oil prices have precluded an increase in export and export revenues at a similar pace. Finally, on the fiscal front, tax revenues for the year have been a positive price, thus increasing the probability that the government will meet its expectation of achieving a lower fiscal deficit than the 2.7% demanded by the fiscal rule target. However, meeting 2020's targets of 2.3% will post a bigger challenge due to the recent revocation by Columbia's Constitutional court of the December 2018 financing loss. I must note that the effects of this law were not revoked for 2019, except for the surcharge income tax of 4% that the law imposed on the financial sector. The biggest challenge for the government arises from the need to get a new or the same law approved by Congress during the remainder of this year to take effect on January 1, 2020. This was a quarter of high volatility in the exchange rate ranging between COP 3,170 and COP 3,480 per dollar and recently averaging in the COP 3,400 per dollar area. The devaluation of the Colombian peso has been driven by a strengthening of the U.S. dollar globally and a higher risk perception for emerging economies. Given the current economic indicators, we expect the exchange rate to hover around COP 3,400 and COP 3,500 per dollar for the remainder of the year and for 2020.

Moving on to Central America. Our growth outlook continues to be positive. We expect the region's economy will grow slightly less than 3% during 2019 and closer to 3% in 2020. A contributor to the region's slow growth is Nicaragua, whose economy is expected to continue contracting as much as 5% in 2019 and to not grow during 2020. On the other hand, we were pleasantly surprised by the appointment of the new Finance Minister, Rodrigo Chaves in Costa Rica after the resignation of the previous Minister. Mr. Chaves is currently a high-ranking official of the World Bank in Asia. And according to his first public statement, his mandate points towards a sturdy in-public spending and macroeconomic stability. It is believed that he will continue to work on solving Costa Rica's pronounced fiscal deficit.

Moving on to our financial highlights. To highlight a few of our figures, our attributable net income for the quarter was COP 743 billion or COP 33.4 per share. Excluding provisions for CRDS, this number approximated COP 891 billion for the quarter or COP 40 per share. Unadjusted accumulated attributable net income for the 9 months ended September 30 was COP 2.3 trillion, showing an increase of 12.5% versus the same period in 2018. Return on average equity for the quarter was approximately 16% and approximately 19% when excluding the mentioned provision for CRDS. Our unadjusted cumulative return on average equity for the year was -- is 17%. Our loan portfolio grew strongly, close to 11% year-on-year and 5% in the quarter, with a distinct pickup in the commercial portfolio. Our net interest margin for the quarter was 5.7%, in line with our expectations, as a result of a 6.4 NIM -- 6.4%, I should say, NIM on loans and 2.3% NIM on investments. As expected, our cost of risk, excluding CRDS provisions, was 1.8% for the quarter and 2.5% if unadjusted. Cumulative cost of risk for the first 3 quarters was 2.2% and 1.9% excluding provisions for CRDS.

Our net fee income for the 9 months ended September 30 increased by 12% when compared with the same period in 2018, almost 14% increase versus the same quarter in 2018 and remained stable versus the previous quarter, due mainly to strong banking and pension fund fees. Corficolombiana non-financial sector investments continue to contribute during the quarter and thus income from nonfinancial investments increased 10% versus the previous quarter. Personnel, including severance costs, and SG&A expenses grew by 6.2% for the 9 months ended September 2019 versus the same period in 2018. Allowances for past due loans more than 90 days at 153%. Our deposit to loan ratio at 1x liquidity at approximately 16%, and tangible equity at 8.9%, all as of September 30, 2019, complemented the balance sheet's strength. Diego will refer later to each of these points in a few minutes. With regards to digitalization, our digitalizing efforts continue to show results as evidenced by figures such as the following: In Colombia, digital sales in the third quarter represented 40% of our total retail sales, up from 23% in the last quarter of 2018, 28% in the first quarter of 2019 and 31% in the second quarter of 2019. We now have close to 2 million digital customers in our Colombian banks, increasing 13% in the last 12 months.

In Central America, 40% of the transactions are done through digital channels. And we now have in excess of 1.3 million digital customers. Moving then to legal matters. Regarding ongoing legal matters related to Ruta del Sol, I will briefly share with you an update on the most relevant developments since our last call. The main development is related to the Tribunal Administrativo de Cundinamarca or TAC, where last December, a class action suit was ruled in first instance against CRDS, its shareholders, including Episol and other individuals and entities not related to Aval or its affiliates jointly and severally to pay damages to the nation for approximately COP 715 billion. Subsequent appeal to this ruling was granted by the TAC in February 2019, and the effects of the ruling were suspended until the appeal is decided by a higher court. In this case, the Consejo de Estado. On October 24, 2019, the Consejo de Estado, which has not yet ruled the appeal, modified the suspended effects of the appeal. Immediately, the lawyers of other parties involved submitted legal requests to get that decision overturned. We're still waiting to hear the court's decision regarding those requests. However, if the decision is upheld, the first instance ruling will become immediately effective with respect to that ineligibility of the defendants to contract with the Colombian Government for a term of 10 years. The ruling should only affect contracts held directly by Episol and not by any of its affiliates. In that respect, Episol has never directly contracted with the government. Just as importantly, the eventual payment of damages by the defendants will only become effective in the case that the appeal against the first instance decision is lost. On other fronts, in the antitrust investigation during the last 3 months, the Superintendency of Industry and Commerce (SIC), has conducted hearings to ratify previous testimonies and has formally interviewed new witnesses. In the arbitration tribunal, nearly a dozen appeals were filed for the annulment of the arbitration ruling. Among those filing appeals were Episol and our banking subsidiaries. Recurring reasons to justify the appeals included gross arithmetic errors, lack of competence of the tribunal to decide over certain matters and decisions of the tribunal not based on the applicable legal statutes. That Consejo de Estado will hear the appeal and reach a final decision, which could take several months.

Moving on to our acquisition. On October 31, we announced that Banco de Bogotá through one of its wholly owned affiliate had entered into an agreement to acquire MFG holdings of Multibank Panama. This transaction represents an important step in strengthening our presence in Central America. In fact, we will become the second largest player in terms of assets in Panama, with a market share of almost 11%. Just as important, this transaction is highly complementary to our own operation in Panama, as it expands our customer base and expand also our product offering and capabilities, particularly in the commercial and corporate segments. As of June 30, 2019, MFG had consolidated assets of approximately $5 billion and total shareholders' equity of $560 million. In the last 12 months ended June 30, 2019, MFG's income amounted to approximately $60 million. The price offered, which may be adjusted as a result of certain events, represents 1.3x its total shareholders' equity. Through this acquisition, we will add to our consolidated balance sheet, approximately $3.5 billion in loans and approximately $3 billion in deposits.

Central America, as of June 30, 2019, we held through back BAC Credomatic, $16 billion in loans and $16 billion in deposits. After this transaction, 13% of our total consolidated loan exposure will be in Panama and 35% in Central America. The transaction is expected to close in the second quarter of 2020 after the required regulatory approval processes are completed.

And with that, I'll pass this to Diego, who will explain in detail our business results.

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [3]

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Thank you, Luis Carlos. I will now move to the consolidated results of Grupo Aval under IFRS and wrap up with our guidance for 2019 and 2020. Third quarter 2019 was a strong quarter for Grupo Aval when taking into account that we recorded COP 148 billion impact on attributable net income of Ruta del Sol provisions. The sound performance was driven by a strong pickup of our loan dynamics during the quarter in Colombia and Central America, in particular, that of our corporate portfolio. Improving cost of risk aside of Ruta del Sol alone. Solid performance of our fixed income portfolio and a sustained contribution from our nonfinancial sector investments.

Starting on Page 9. Assets grew 13.4% over the year and 3.5% during the quarter. Colombian assets grew by 9.8% over the year and 1.2% during the quarter, driven by cash, net loans and intangibles and financial assets from our concessions and right-of-use assets. Despite of our annual and quarterly contraction of 14.8% and 4.4% of Nicaraguan assets, Central America delivered a 4.5% and 0.5% 12-month and 3-month growth in dollar terms.

Moving to Page 10. Loans excluding repos grew 10.8% for the year and increased 5% during the quarter. Loan dynamics in Colombia posted solid growth, and Central America picked up from the lackluster activity evidenced throughout the first half of the year. As anticipated, our Colombian corporate loan portfolio growth accelerated to 2.6% over the quarter and 4% over the year. Our Colombian retail portfolios posted strong growth with consumer and mortgage businesses expanding 9.8% and 15.7%, respectively, over the 12 months. Quarterly growth were 2.2% and 3.8%, respectively. Our Central American operations, excluding Nicaragua, expanded 5.9% in dollar terms over the year and 2.6% during the quarter. Nicaragua, which weighs approximately 5% of our Central American loans contracted 26.7% and 5.6% during the quarter.

On Pages 11 and 12, we present several loan portfolio quality ratios. Overall, 30 and 90 days PDLs remained relatively stable. Commercial loan portfolios showed a mild deterioration during the quarter. We recorded a 13 basis point increase in 30 days commercial PDLs and 12 basis points in 90-day PDLs in Colombia. In Central America, 30-day and 90-day commercial PDLs showed some deterioration with 30 days PDLs increasing 7 basis points, and 90 days 11 basis points. As mentioned by Luis Carlos, we substantially increased our provision for Ruta del Sol this quarter, recording COP 295 billion provision expense, reaching an 86% coverage. We expect to fully provision the remaining COP 102 billion of Ruta del Sol during the fourth quarter of 2019. Our coverage for SITP companies stood at 40% at the end of the quarter. Delinquency ratios for consumer loans continued improving during the quarter. In Colombia, improving trend in delinquency of consumer loans persisted with 30 days past due loans falling 13 basis points to 4.9%, accumulating a reduction of 112 basis points since peak in first quarter 2018. The 90 days past due loans improved 2 basis points to 3% relative to second quarter 2019 and were 36 basis points lower than a year earlier. In Central America, 30 days PDLs for consumer loans increased 5 basis points to 4.9% while 90 days PDLs increased 8 basis points to 2.1%. Our mortgage PDLs increased during the quarter, driven by Central America. Both 30 and 90 days new PDL formation improved in both geographies when excluding FX movements. Our new 30-day past due loans formation in absence of FX movements was COP 1.2 trillion during the quarter COP 122 billion lower than the previous period. Our cost of risk was 2.5%, with a quarterly increase of 26 basis points, driven by commercial loans in Colombia, stability in Central America and improvement in Colombian consumer loans. The Ruta del Sol provisions accounted for 68 basis points of cost of risk during the quarter. PDL coverage for 90-day PDLs was stable at 1.53x.

On Page 13, we represent funding and deposit evolution. Funding dynamics were consistent with loan growth. Our funding structure remained materially stable with deposits representing 76% of total funding and our deposits-to-net loans ratio stable at 1x. Our liquidity position continues to be strong with cash-to-deposit ratio at 16%. Deposits increased 4.8% in the quarter and 13.6% over the last 12 months.

During the quarter, Colombia grew at 2.3% and Central America grew at 2% in dollar terms. For the 12-month period, Colombia grew at 9%, while Central America grew 6.6% in dollar terms.

On Page 14, we present the evolution of our total capitalization, our attributable shareholders' equity and the capital adequacy ratio of our banks. Our total and attributable equity increased during the quarter mainly driven by our net income. Attributable equity increased by COP 1 trillion, while our total equity increased by COP 1.8 trillion. OCI also contributed to our equity during the quarter. As of third quarter 2019, our banks shows a profit in Tier 1 and total solvency ratios.

On Page 15, we present our yield on loans, cost of funds, spread and net interest margin. Our net interest margin increased 17 basis points to 5.7%, mainly driven by a tighter net interest margin on loans in Colombia. Our NIM and investments continued to be particularly strong at 2.3%. As anticipated, pricing in Colombia became more aggressive during the quarter due to the improvements in consumer loan quality and a better outlook of the corporate portfolio, resulting from stronger GDP.

We continue to expect some pressure on our NIM and loans growth as growth increases and the share of newly priced loans enters our mix.

On Page 16, we present net fees and other income. Gross fee income grew 13.7% when compared to a year earlier and was slightly higher than that of a particularly strong second quarter. Gross fee increased 10.1% in Colombia and 5.7% in dollar terms in Central America compared to third quarter 2018. In addition, our nonfinancial sector continues to be a strong contributor to our income, adding 10% more than in the previous quarter.

Finally, our other operating income was particularly strong this quarter as our banks realized gains and fixed income investments, taking advantage of the current interest rate environment.

On Page 17, we present some efficiency ratios. Year-to-date, personnel and general and administrative expenses increased 6.3%, with a 2.1% increase in Colombia and a 1.2% increase in Central America in dollar terms. FX fluctuations explain the remainder of this growth. Year-to-date, personnel expenses increased 6.8%, with 2.1% increase in Colombia affected by termination expenses and a 1.2% increase in Central America in dollar terms. Year-to-date, general and administrative expenses increased 5.9%. When adding IFRS 16 related depreciation and amortization to administrative expenses, the figure was 7.9% in Colombia and 8.2% in Central America in dollar terms. Certain nonrecurring expenses increased our Colombian expenses while Central America incorporated the introduction of VAT and services in Costa Rica as a temporary increase in marketing expenses. Nonrecurring events that affected our expense during this quarter include, first, a COP 63 billion non-income tax expense recorded as a general and administrative expense was incurred in order to raise the fiscal cost of certain fixed assets which will enable us to sell them in the future with lower income tax expense. This charge was offset by deferred income tax recoveries of COP 99 billion, resulting in a COP 29 billion positive net effect on attributable net income. Second, we recorded COP 18 billion of termination expenses in Banco Popular. Year-to-date, total dollar expenses that include personnel, general and administrative, depreciation and amortization and other expenses, grew 9.6% relative to a year earlier.

Total expenses grew 5% in Colombia and 4.8% in Central America in dollar terms during this period. FX fluctuations explain the remainder of this growth.

Finally, on Page 18, we present our net income and profitability ratios. Attributable net income for the third quarter 2019 was COP 743 billion or COP 33 per share. Year-to-date, attributable net income was COP 2,319 billion or COP 104 per share. Return on average equity and return on average assets for the quarter were 15.8% and 2%, respectively. This incorporates 314 basis points of negative impact of Ruta del Sol provisions and return on average equity. Before we move into questions and answers, I will now summarize our general guidance for the remainder of 2019 and for 2020. We expect loan growth to be in the 9% area in 2019 and picking up to 10% to 12% in 2020. We expect our cost of risk, net of recoveries to be in the 2.2% area in 2019, falling to 1.9% area in 2020. We expect full year net interest margin to be in the 5.7% area in 2019, contracting to 5.6% in 2020. Finally, we expect a return on average equity to be in the 16.25% area in 2019 and in the 15.75% area in the 2020 year. Now I will open it to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Jason Mollin from Scotiabank.

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Jason Barrett Mollin, Scotiabank Global Banking and Markets, Research Division - MD of LatAm Financial Services [2]

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Hello, everyone. My first question is related to the recent announcement of the acquisition of Multibank Panama. You talked about the strategic rationale for doing this. Can you give us some color on what financing options Aval is considering and potential implications for capital at Aval and/or subsidiaries, such as Banco de Bogotá? And my second question is on the outlook for provisions. You've mentioned guidance for cost of risk in the 1.9% range. I -- should we be considering provisions for Ruta del Sol something of the past now? And are there any other specific cases that we should be aware of that could come up in the upcoming quarters?

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [3]

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Sure, Jason. Thank you. Regarding your first, I'll take the Multibank question and Diego can take the provisions question. Regarding Multibank, well, the good news is that we are now sure that we won't need any new capital or capital influxes to pay for the bank. And we are considering several types of funding options, Jason, we really have a whole array of options available to us, including, maybe, upstreaming some dividends from BAC to its holding company Leasing Bogotá Panama, which is the company that we've selected to buy the bank. And BAC has already been preparing for that event. It just did an issue of credit card receivables and where it -- just that issue alone would pay bank at about 2.7% after tax cost of funds. So as I said, we are considering several alternatives, we will probably put together a package of funding and obviously, we'll do it in a way that the acquisition is accretive for the -- for our share and for the intra bank level. With that, go ahead, Diego.

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [4]

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Regarding the provisions, I didn't highlight it during the presentation, but I need to point out that we've actually reduced our guidance for this year of cost of risk from 2.3% to 2.2%, including fully provisioning Ruta del Sol. At this point, the larger cases that we have been discussing over the past couple of years are pretty much done with. Electricaribe many quarters ago, Ruta del Sol will be done by year-end. And then SITP, the one we needed to provision, we've already provisioned. And by the way, as of October, we have already written off. The other companies of SITP are performing actually much better than expected. Therefore, we are not foreseeing more provisions there. In 2020, I think there's 2 sorts of provisions, some are good to have and some are bad to have. The good to have are those that are related to growth. And the bad to have are the bad case. At this point, we feel that we're moving into more of the first kind of provisions related to growth rather than expecting negative surprises. That applies for Colombia and also for Central America, where the troubling countries are all improving as we have highlighted before.

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Operator [5]

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Our next question comes from Gabriel Nóbrega from Citibank.

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Gabriel da Nóbrega, Citigroup Inc, Research Division - Research Analyst [6]

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So my first question, it's actually a follow-up on the MFG agreement of acquisition. When we look at the numbers from the Panamanian superintendence, we actually see that the profitability of this bank has been reducing over the past few years. So if you could just give us a bit more color on what are your strategies for increasing the ROE of this bank once again? And as for my second question, it's actually on your NIM guidance, I see that you're expecting a NIM contraction of around 10 bps in 2020. I just wanted to understand if this is the fruit of maybe higher competition? Or if it's still going to be fruit from the higher and the faster growth of term deposits, which have actually been pressuring your funding cost?

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [7]

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Yes, I'm willing to take your first one, I'll be happy to do that, but I missed a part of it. I'm sorry if you would just mention again what have you said, has been reducing over the last few years in MFG? I'm sorry, I didn't catch that.

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Alonso Acuna Aramburú, Banco BTG Pactual S.A., Research Division - Strategist [8]

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Yes, sorry. The ROE of the bank has been reducing over the past few years.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [9]

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Okay. I'm sorry. All right, fine. Well, listen, yes, the bank has grown very fast, and there's probably some contraction of margins and some additional expenses. Actually, we have a nice plan in place to do a good work on ROE, specifically through very important synergies in the running of the bank in conjunction with our shared services center in Costa Rica, out of which we run the 6 banks in Central America. We will be putting that plan in place quickly. And I think that over the next 12 months, we'll see very significant improvements in efficiency in the acquired bank. Also, we should be able to extend to the bank some of our cost of funding better rates. And also some of the treasury that we do in our own banks, we should be able to extend to the new bank. And all in all, we expect that after obviously going through some acquisition expenses as we implement all these new changes it will come out being a much, much more robust bank.

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [10]

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Now regarding net interest margin contraction, it's a combination of a few things. The first one is more of arithmetic effect of the changes we have already seen throughout this quarter on net interest margin. As you pointed out, part of that is related to higher competition, higher competition that is related to stronger growth and a better outlook for the quality of the portfolio. So in our net interest margin, we're including that as an effect that we'll add up to what happens next year on the NIM on loans side. On the other hand, the net interest margin on investments has also been quite strong throughout this year. This is related to the overall interest rate environment that we've seen globally. And we believe that part of that will not continue into next year, we should migrate to slightly lower, more similar to historical average, net interest margin on investments.

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Operator [11]

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Our next question comes from (inaudible) from CrediCorp.

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Unidentified Analyst, [12]

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I have a couple of questions. I wanted to know more about the NPL ratio of Central America, if you could give me more details on that because we saw an increase -- an important increase in the NPL ratio of Central America. And if you could explain me a bit more on the Episol case, I got a bit lost over there.

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [13]

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Okay. Let me take the first one. Regarding NPLs in Central America. You're right in the past, we had experienced some NPLs, particularly in 2 countries that we have highlighted in the past calls. One is Nicaragua and the other one was Costa Rica. Both for very different reasons. In the case of Nicaragua, this was a political unrest disrupted how the country was performing. And the case of Costa Rica, we had a high or still have high fiscal deficit, but actions were taken. What we see is changing trends in both countries. In the case of Nicaragua, even though it's not yet over, the cycle has started to improve, the contraction has started to decelerate, and we've seen an improvement in some of the segments of our business there that should impact an improvement in PDLs. On the Costa Rican side, we've seen some positive events there. The fiscal reform, even though not enough to solve long-term the fiscal deficit problem in Costa Rica, has reduced pressure and rates throughout the country. And then we see as a very positive evolution, the new Minister of Finance, who's at least at this point, verbally pointing in exactly what the right actions should be. Therefore, this cycle that we've seen in Central America, we are quite positive on how it should be evolving into the future.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [14]

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Okay. Let me try to give you a very quick response, if at all possible, regarding your second question. Some time ago, Putla Procuraduría General of Columbia brought a class action suit against about 20 or 20-something defendants all related to the CRDS scandal. That class action suit was ruled against those defendants and first instance by the Tribunal Administrativo de Cundinamarca where it was being considered. The ruling had 2 effects: one, it declared or it ruled that the defendants had to pay COP 715 billion, about $200 million to the government, to the nation; and secondly, it declared that those defendants themselves, they personally, that those who lost the losses could not contract with the government for the next 10 years. The ruling was appealed, and it's being heard by the Consejo de Estado. The first feedback that we got regarding the appeal, was that the 2 effects of the appeal were suspended up until the Consejo de Estado ruled on the appeal itself.

And just recently, one of the judges, who is considering the case, issued a statement saying that regarding the 2 effects of the first instance ruling, one of the effects that which precluded the defendants from contracting with the government for the next 10 years, was to be immediately put in effect. That in itself has a lot of contradictions and we have appealed that statement. But what I was saying was that in case that the statement stood and that, in fact, the defendants could not contract with the government for the next 10 years, the highlight that I was making of Episol was that Episol itself which is one of the defendants has never contracted with the government and have no intentions of contracting with the government. The entity that contracted with the government was Concesionaria Ruta del Sol in which Episol was, as you know, minority shareholders. So all that I was saying is, obviously, we are appealing the decision but it will, in fact, have no effect regarding Episol itself.

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Operator [15]

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Our next question comes from Sebastián Gallego from CrediCorp Capital.

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Sebastián Gallego, CrediCorp Capital, Research Division - Associate of Andean Banks [16]

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I have 2 questions. The first one, can you provide a bit more color on growth expectations within the Central American operation? And the second question is related to OpEx. Can you just provide further explanation on growth on OpEx, excluding the FX? And what are your -- what is your guidance for OpEx growth going forward?

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [17]

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Regarding growth expectations, we've seen Central America picking up over the past quarter. As mentioned, this has happened in the corporate segment, and it has also happened broadly throughout the region, except Nicaragua. In the case of Nicaragua, the changes, the contraction is happening at a much lower pace. Part of what we will be working throughout next year at some point is the integration of MFG that will provide us some inorganic growth there. And in the rest of the country is also working on organic growth as we usually do. Regarding expenses, I need to say we were not that happy with our expense performance during the quarter. And the action has been taken, particularly in Central America, where some of the expenses could become recurrent to adjust them down and work is being done throughout the region to attend that area. Colombia has been performing pretty well. As mentioned in the past, it's been a combination of discipline, plus some of the results from the digital strategy that are helping us contain costs. What we expect to see into next year is cost growth in the order of 6% -- 5% to 6%, that should be short of what we're pointing out for asset growth and for loan growth, therefore, we should see some improvement in that front.

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Operator [18]

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Our next question comes from Carlos Rodriguez from Ultraserfinco.

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Carlos Enrique Rodríguez, Ultraserfinco S.A. Comisionista de Bolsa, Research Division - Director of Equity Research [19]

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I have 2 questions. The first one is, could you give us more detail in the increase of the trading assets in the balance sheet. And if this trend will continue in the coming quarters? And my second question is just a follow-up on the OpEx. If you could share with us your medium and long-term target inefficiency in Central America and in Colombia, how much you can push the efficiency in Colombia?

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [20]

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I'm not sure I got your question right. For the first one, I believe you were referring to the trends in assets. Trading assets, I'm sorry. Regarding the trading assets, what we saw this year was a particularly healthy return on the portfolio. Part of the reason why we're guiding into a slightly shorter return on equity for next year compared to this year is we do not see this kind of returns being maintained for the long term. We do expect to see positive results on the trading side, however, not as solid as this year. On the efficiency front.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [21]

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And on your second question regarding the efficiency, short and medium-term targets. I think that what we've been working on and when -- and it's still too early to say exactly how much we will be able to improve our efficiency, but we have, as I mentioned briefly, just recently inaugurated Central -- shared services center in Costa Rica. Where we are in the process of moving all those services that we can share for the 6 banks and now it's 7 banks in Central America. And we should start seeing results very soon with that. That shared services center is also located in the duty-free zone, and that obviously will help with the fiscal situation. And in Colombia, we are in the process of moving in the same direction. It's still too early to tell. We're starting all the consultancy work that is required. But we will be putting together a similar shared services center in the next few years and we'll keep you abreast of that.

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Operator [22]

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Our next question comes from Julian Amaya from Davivienda Corredores.

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Julian Felipe Amaya Restrepo, Corredores Davivienda S.A., Research Division - Equity Research Analyst [23]

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I have 2 questions. During this quarter, the effective tax rate was way below of other quarters. Could you explain a little bit what are these results? And also regarding the elimination of the 4% surcharge tax, it would be -- would there be any impact on the fourth quarter?

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [24]

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Okay. Regarding the low income tax. I mentioned that we went through our process of raising the fiscal cost of some fixed assets, I mentioned that, that generated an expense, but also said that it had generated COP 99 billion positive income impact on deferred income taxes. So the reason why you see that low number during this quarter is that we had that positive effect on taxes, as I mentioned, the net effect of both of those were around COP 29 billion. Regarding the elimination of the surcharge, there is 2 different sort of effects. One, regarding the surcharge and the other part regarding what the fiscal reform could look like. Regarding the first one, what we see in our initial numbers is we could have around COP 60 billion positive impact from that surcharge. This is in the makings at this point because we need to see how the new fiscal reform comes out and what the impact on deferred taxes looks like. So our preliminary numbers are looking more into what the current tax effect would be. But there should be a deferred tax effect that at this point it's too soon to tell because we have no clue on how the final fiscal reform would look like.

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Operator [25]

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Our next question comes from (inaudible).

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Unidentified Analyst, [26]

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I've got 2 questions. So basically 2 topics. So the first one is on NPL, and the second one is on capital. I'll kick off with the NPL number. So in a country where you have an unemployment of roughly 11% I'm just wondering, what is your unique selling point in terms of, I mean, not underwriting more toxic assets because, I mean, it is, I think, I mean, I think, I mean, it is quite unique to have a stable NPL across the cycle. And I was also just wondering when you look at your NPLs number, which is 4.5%., I'm just wondering which portion of that has been carried forward over -- longer than a year? So basically, I want to understand your write-off strategy. Whether you're going to write-off any NPLs in 1 year or 180 days. So if you could give color on that. And on the capital, I'm just wondering, like, I mean, ahead of Basel III implementation. What is your capital planning for next year because it screams, like, you might be a bit low on capital, assuming moving to a Basel III framework. And also in terms of, I mean, in your capital stack, your equity. I just want to understand which portion is tangible and which portion is intangible?

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Diego Fernando Solano Saravia, Grupo Aval Acciones y Valores S.A. - CFO [27]

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Okay. Let me take the first one regarding NPLs. Just to make sure that I understood your question, you said that you hadn't seen a strong variation of NPLs throughout the cycle. I need to say that we actually did have a quite strong or a visible effect of the cycle. We used to run at a cost of risk that was between 1.5% and 1.8% precycle. This went up to the kind of numbers that we've mentioned recently and that we had last year. And at this point, we are returning to something that is below 2% for next year. The driver of this cycle was at first, what was happening with the consumer portfolio that came first into deteriorating and then was first to recover.

And then with some lag of around 2 to 3 quarters, we saw the corporate portfolio, particularly on the commercial side, starting to deteriorate. At this point, we see the process passing. We haven't yet seen the improvement in the cycle. But given that we are forecasting GDP growth above 3% and growth picking up, so the denominator should be improving, we should see also some movement in that front. Regarding your write-offs. Perhaps the only relevant loan that has been provisioned already for some time that is still on our books and hasn't been written-off is Electricaribe, which we're actually looking into if it's the right time to write it off. The reason not to write it off is there has been uncertainty and potential recovery on that debt, and that has deferred our decisions, but we're in the point of looking at that decision now.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [28]

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Thanks, Diego. And regarding your question on capital. Well, let me state, to start with, we have informed the superintendency of banks that we will be early adopters of Basel III. We expect that to happen within the first 2 quarters of next year. As we adopt Basel III, as you probably know, our first calculation is that our risk-weighted assets will drop substantially based on Basel III. And on the other hand, we will have some additions to Tier 1 that -- which we don't count now. In terms of regulatory capital. For example, all the OCI account will count towards regulatory capital, as well, as all the earnings generated within a period, which they don't actually. So at least in 3 of our banks, Banco de Occidente, Banco Popular and Banco AV Villas, we will see a substantial increase in regulatory capital.

When we talked about Banco de Bogotá, there are many more things happening when we adopt Basel III. On the one hand, we will have a decrease in Tier 1 capital due to the fact that because we were grandfathered by regulation some years ago, the goodwill that we generated when we purchased BAC which was about $1 billion has not counted towards a reduction in Tier 1 capital, and it will, from the moment that we adopt Basel III. But on the other hand, with OCI, with earnings coming part of -- becoming part of the regulatory capital as well as with the way that Banco de Bogotá will account for its investment in Corficolombiana with respect to regulatory capital, were it now under Basel II discount from its Tier 1 regulatory capital, the full of its investment in Corficolombiana, which is about $1 billion, it will not have to discount all of the COP 3.4 billion -- yes, COP 3.4 trillion or $1 billion in Corficolombiana's -- in Banco that's Corficolombiana -- investment in Corficolombiana.

So one thing we'll tend to offset the other, we will have to discount regulatory capital for the goodwill booked when we purchased BAC, but it will recover in a way the $1 billion more or less that is now discounting of a Tier 1 regulatory capital with respect to the investment it has Banco de Bogotá has in Corficolombiana. And it also expects that its risk-weighted assets will have -- will, all in all, probably decrease, except that we're waiting for -- to hear what exactly the superintendency in Colombia wants Banco de Bogotá and its consolidated balance sheet to account in terms of regulatory risk-weighted assets for the assets that he has in Central America.

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Operator [29]

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We have no further questions.

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Luis Carlos Sarmiento Gutiérrez, Grupo Aval Acciones y Valores S.A. - President [30]

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Great. Well, Sylvia, thank you very much and thank you all for attending this call. And we certainly hope to keep producing the results that you expect us to, and we'll see you in our next call.

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Operator [31]

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Thank you, ladies and gentlemen. I will now -- this concludes today's conference. Thank you for participating. You may now disconnect.