Operator: Good afternoon, everyone, and welcome to Banco de Chile's Second Quarter 2023 Results Conference Call. If you need a copy of the management financial review, it is available on the company's website. With us today, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer; Mr. Pablo Mejia, Head of Investor Relations; and Daniel Galarce, Head of Financial Control and Capital.

Before we begin, I would like to remind you that this call is being recorded and that the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements. I will now turn the call over to Mr. Rodrigo Aravena.

Please go ahead, sir.

Rodrigo Aravena: Good afternoon, everyone. Thank you for attending this conference call where we will present the main achievements and financial results posted by our bank during the second quarter of this year. We are glad to host this webcast today in a period where Banco de Chile once again showed its unquestionable leadership in the financial industry in the country. Some of the main highlights of this quarter include, first, we posted the highest net income in the industry by achieving a bottom line of CLP352 billion equivalent to an ROE of 28%, therefore we remain as the most profitable bank in Chile.

Second, despite the weak economic cycle, we continue delivering sound asset quality figures. In the second quarter, we posted a cost of risk of only 0.7% and NPLs of 1.3%, both well below figures posted by the industry. And third, by achieving a CET1 ratio of 15.5%, we continue to be the bank with the sounded capitalization, confirming we are the best prepared for facing a challenging economic cycle and further regulatory requirements in connection with the implementation of Basel III in Chile. All these results were accomplished in a period when we carry out important advances in our core strategic priorities, including advances in our digital transformation process and in ESG matters. We will present a deep analysis of all these topics through this presentation.

But before moving to these topics, I'd like to share our view on the micro-financial environment we have faced in our forecast for these in the following year. Please go to slide number three. The chart on the upper left clearly shows that the overall activity remains weak. In the first quarter, the GDP contracted by 0.6% year-on-year after the 2.3% year-on-year drop in the last quarter of 2022. This recession has largely been explained by the decline in consumption which went down by 4.8% year-on-year in the first quarter, driven by the substantial fall of 28% year-on-year in durable consumption.

Gross investment has also contributed to the negative growth by falling 2.1% year-on-year in the same period. All-in-all, domestic demand declined by 8% in the first quarter, which was partially offset by the slight recovery of total export. Available information from the second quarter shows a similar trend as the Imacec, which is the monthly GDP figure went down by 1.4% year-on-year. The chart on the other right displays the evolution of the overall activity sequentially. Generally, the graph shows how the economy has extenuated.

As the level of the Imacec remains below the level posted in December of 2021 due to an important decline in the commerce sector. This negative trend has resulted from several factors, including the normalization of liquidity levels and the contractionary fiscal and monetary policies implemented mainly in 2022. Inflation has also affected disposable income levels, reducing household purchasing power. In this environment, we've seen a gradual increase in the unemployment rate to 8.5% in the second quarter, 70 basis points above one year ago, as shown on the chart on the bottom left. This has resulted from the greater acceleration in the labor force, which went up by 3% year-on-year, while employment increased by 2.2% year-on-year.

The greatest dynamism in the labor force has increased the participation rate to 61%, although it remains below the pre-pandemic level. This recession has contributed to reducing macroeconomic imbalances. The current account balance, for instance, improved significantly at the beginning of this year as this chart on the bottom right displays. In the first quarter, it posted a surplus of $700 million, achieving the highest figure since 2010, and the first positive balance in three years. As a result, the latest month's balance improved to one point of the GDP to minus 6.9%.

It is worth highlighting the importance of normalizing the channel deficit since it is one of the most relevant sources of macro stability for a country. I'd like now to analyze the evolution of the main nominal figures of the economy. Please move to the next slide number four. The inflation rate has been decreasing, as the upper left chart shows. In June, the annual inflation rate was 7.6%, the lowest since December of 2021, while the core CPI, which is the measure that excludes food and energy prices fell to 6.9%, also the lowest figure in several quarters.

These trends have been accompanied by lower annual increases and all the alternative core measures and a lower deficient index, which represents the proportion of articles that increased prices in the month, which posted a historically low figure of only 42%. The lower inflation has resulted from different factors, including the subdued activity which reduced pressures on non-tradable goods and the combination of the stronger trend in peso and the lower CPI in trade partners, factors that drove a decline in tradable inflation to 7.3% year-on-year in June from a peak of 17.3% in August of last year. In fact, as you can see in the chart on the bottom right, the local currency appreciated nearly 7% from one year ago, while the real exchange rates have strengthened by 14% in the same period. In this environment, the Central Bank began an easing cycle in monetary policy by reducing the overnight rate to 10.25% or 100 basis points in the meeting held in July. This is the first cut in the policy rate since early 2020 when the pandemic affected the economy.

The press release showed an expansionary bias as the board signaled further interest rate reduction in the coming meetings. This bias was reinforced by the Governor of the Central Bank who anticipated reductions towards levels below 8% by the end of this year. As a response of the new tone in monetary policy, market interest rates have been anticipating, both lower inflation and interest rate, which can be clearly seen in the chart on the bottom right, which shows the recent decline in the nominal 10-year sovereign rate despite the opposite trend observed in global rate. I'd like to briefly discuss our microeconomic forecast for these in the next year. Please go to the next slide number five.

We expect that the second quarter was the bottom in this negative cycles with a GDP decline of around 1.4% year-on-year. For the second half, we estimate a gradual recovery of the overall activity driven by the lower inflation and interest rate. Nevertheless, despite this expected recovery, we continue to forecast in a negative growth for the year of around minus 0.2%. For 2024, we foresee an expansion in line with the potential growth close to 2%. This combination of factors such as subdued growth, a stronger currency a laggard effect of the interest rate hike is consistent with a further inflation rate decline.

In this environment, we have reassessed our prior expectation of inflation for this in the next year. As such, now we expect headline inflation of 3.8% at the end of this year and 3% in 2024. We believe a lower inflation rate should leave room for the Central Bank to reduce the interest rate to 7.5% this year and to 4% next year, as the right chart shows. All these forecasts are subject to risk. Given the important integration of Chile into the global economy, it's important to analyze the evolution of its trade partners such as China, even more after its weaker-than-expected expansion during the last quarter.

In the local front, the evolution of laggard factors such as labor market and political considerations, including discussions related to changes in taxes, pensions and the constitution are worth monitoring. Based on this aspect, we now let downside risk in our growth forecast. Let me now share a brief overview of recent trends in the financial industry. Please go to slide number six. This quarter the banking industry reported a net income of CLP1.3 trillion, resulting in an ROE of 18.4%, as indicated in the chart on the top left.

This year-on-year decline in net income is mainly attributed to lower inflation that went from 4.3% in second quarter 2022 to 1.4% in second quarter 2023, which impacted operating income, as displayed in the chart in the middle of this slide. Furthermore, a rise in loan loss provisions, excluding additional provisions has affected most banks in the industry as evidenced by an increase of 16% in the second quarter versus second quarter last year. As shown on the chart to the right, this is in line with the trend that we have forecasted over the last quarters in relation to the normalization of customer risk profile, which has been reflected by delinquency that rose weekly from 1.4% to 2% during the same period. Persistent high-interest rate levels, weak economic environment and political uncertainty have reduced the banking industry loan growth to only 4% nominal year-on-year. Mortgage loans was the main driver of growth, increasing 11% nominal year-on-year, followed by consumer loans that rose 4.9% nominal in the same period.

This was partially offset by a slight contraction in commercial loans. Looking ahead, we anticipate as economic conditions improve, we should see a potential recovery in loan demand in a more favorable lending environment. Lastly, it's worth mentioning that the composition of the Chilean banking industry asset differs from other regions. Unlike some geographies, banks in Chile have a significant concentration in loans, accounting for 62.3% of total assets. In terms of financial instruments, including derivatives, this make up only 17.6% of total assets, while the held-to-maturity portfolio constitutes only 3.7%.

As a result of this asset composition, the local banking industry in Chile is relatively less exposed to recent financial events that have impacted certain banking players worldwide early this year. A strict and conservative banking regulation as well as lower reliance on financial instrument and held-to-maturity investments contribute to a more stable and resilient banking landscape in Chile. It's important to note that today, the amount of financial assets held by the Chilean banking industry is even above average levels since prior to the pandemic, as banks are currently in the process of replacing FCIC collaterals, which should be totally composed of high-quality liquid assets by the maturity of their obligation. Now I'd like to pass the call to Pablo who will go into more detail about Banco de Chile advances and the financial performance.

Pablo Mejia: Thank you, Rodrigo.

I'd like to begin with our main accomplishments in our key strategic projects. Please go to slide number eight. Our consistent and outstanding result has been a direct outcome of our effective strategic approach, which places customers, efficiency and ESG at the core. We've implemented this during the approach of six key priorities, allowing us to surpass our mid-term objectives as evidenced on the right. In the upcoming slides, we will explore the advancements we've made in digital transformation, productivity and sustainability, illustrating our commitment to progress and excellence in these crucial areas.

Let me start with digital banking. Please move to slide number nine. In recent years, we've dedicated our efforts in constructing a robust front-office digital banking ecosystem aimed at enhancing our customers' journey and overall experience. This slide highlights some key components in advances of this ecosystem. When it comes to digital banking, we cater the various customer segments with tailored options.

Cuenta FAN, our pioneering online onboarding service has been exceptionally successful, attracting over 1 million users. Moreover, we provide digital accounts for SMEs, teenagers and offer both digital current accounts in Chilean pesos and in dollars. Additionally, our diverse range of online products enables customers to effortlessly open accounts and manage their finances conveniently at any time without the necessity of visiting the branch. This approach empowers our customers with greater control of their banking experience, putting the power of managing their finances right at their fingertips. We take immense pride in being the pioneers in the Chilean banking industry by establishing a virtual building in the Metaverse, a significant milestone aimed at promoting engagement among young people.

Additionally, we have facilitated SME customers to receive payments through QR codes using our app, demonstrating our commitment and enhancing convenience and efficiency and financial transactions. Furthermore, we continually strive to elevate service quality through the implementation of cutting-edge technologies such as artificial intelligence. By leveraging advanced tools to manage costs, analyze customer behaviors and gather post-service feedback, we ensure that our customers' needs are met with the utmost efficiency and satisfaction. Our relentless efforts to deliver exceptional customer journeys through digital initiatives have not gone unnoticed. Thanks to our dedication, we've been recognized as the leading bank for customer experience by the esteem Praxis Xperience Index.

This recognition reinforces our commitment to putting customers at the heart of everything we do and providing them with unparalleled banking experience. We continue to strive to improve our efficiency and productivity, which are a key pillar of our strategy. Please turn to slide 10 to review recent developments we've made in enhancing productivity and reducing costs. Alongside our efforts in productivity, we have remained firm in optimizing processes and enhancing customer experience. In this regard, we have introduced various changes to our deposit service model to encourage higher digital adoption.

As a result, there has been a significant operational and management enhances in their deposit processes, leading to a noteworthy 18% surge in digital channel adoption within the first month, reducing costs and optimizing margins simultaneously. Additionally, we have fine-tuned our cash management sales process for enterprise payment agreements with SMEs resulting in the substantial 32% annual increase in the stock of active contracts of cash management payment contracts for companies, strengthening client relationships and fostering future growth. Another area of focus on productivity during the last quarter was branch customer service. The successful improvement in back office processes resulted in a 50% reduction in branch waiting times compared to the first quarter of 2023. This improvement is essential for ensuring a positive impact on customer experience, promoting loyalty and fostering a positive image of the bank in their minds of their customers.

On the cost reduction front, a comprehensive review of our entire physical infrastructure identified areas for space rationalization, unlocking important and potential savings while ensuring our infrastructure remains efficient and optimized. We are improving our investment planning methodology to ensure that all of our strategic initiatives are aligned with our long-term objectives and driving value creation and long-term sustainability for the bank. Furthermore, we are reviewing our end-to-end procurement process to identify key improvements to be addressed during the renewal of our ERP system, especially the procure-to-pay processes. We expect that this project will modernize our current system, enabling faster and more automated procure-to-pay processes, streamlining our operations. In conclusion, efficiency and productivity are at the heart of our bank.

We firmly believe that by consistently seeking opportunities for improvement and optimizing our operations, we can sustain our leadership in the industry and continue to drive sustainable growth. Please turn to slide 11. Sustainability has been fundamental for us. As illustrated on this slide, our bank has been actively involved in supporting the community, especially during times of crisis and natural disasters like earthquakes, large-scale fires among others. In recent years, environmental, social and governmen's criteria have become increasingly crucial in shaping a strategic direction.

Our ESG journey has shown remarkable progress since 2014. Notably, we have achieved several milestones, such as enhancing transparency through our annual reports, fostering sustainable finance by establishing an ESG financing framework and bolstering governance with the creation of ESG-related policies and the establishment of foremost sustainability committee led by the CEO which reports advances regularly to the Board. These initiatives, along with numerous other advancements in this domain have led our performance to be acknowledged and recognized by the leading international ESG rating firms. Our commitment ESG practices continues to drive positive outcomes and reinforces our position as a responsible and forward thinking institution. Please turn to slide 12.

During the quarter, we continued to progress in sustainability and this was recognized by our strong improvement in our Annual Sustainability ESG rating score, which positioned us once again as the bank with the highest score in the Chilean banking industry. Additionally, we issued two social bonds overseas raising over $80 million under our ESG financing framework with a focus on supporting women-owned enterprises to drive economic growth and to promote gender equality. We also actively promoted entrepreneurship by not only participated in the Fogape Chile Apoya program, but also by being the private bank that granted the most loans to SMEs under this assistant package. And we organized the National Entrepreneurship Contests targeting SMEs, university and high school students. We also remain committed to providing our employees with knowledge on sustainable finance and climate change through specialized training initiatives, which is crucial in building a workforce that is well-informed and equipped to integrate sustainability principles into all areas of operations, especially risk management.

Finally, we actively engaged in the community on several fronts. We conducted multiple financial education tasks to empower individuals with valuable financial knowledge and skills that lead to better financial decision-making within the community. Our reforestation and volunteering program also sits in rehabilitating the areas impacted by the summer forest fires among other activities. All of these initiatives reaffirm our commitment to making a positive impact on society, the environment and to continue creating long-term value for our stakeholders. Please turn to slide 14 to begin our discussion on our results.

We have a consistent track record of outperformance and this quarter is no exception. Once again, we recorded an impressive bottom line of CLP332 billion equal to an ROAE of 27.6% greatly surpassing all of our peers as depicted on this slide. Our success stems from the strength of our dedicated team and well-crafted long-term strategy that prioritizes sustainable growth with a balanced approach to risk and return as reflected by our market-leading position in terms of capital adequacy and NPLs. As a result, we have established ourselves as the most resilient and sustainable bank in Chile. We expect our long-term ROAE should settle at approximately 18%, but in the short-term, ROAE will surpass this range and we estimate it to reach a level of around 22% in 2023.

For 2024, under a normalized scenario, it's reasonable to expect an ROAE of around 18%. This is primarily due to an expected decrease in inflation, lower short-term interest rates, and the normalized level of cost of risk of around 1.2%. Additionally, it's important to mention that we will repay CLP4 trillion of FCIC funding to the Chilean Central Bank for putting further pressure on net interest margin. Please turn to slide 15. Operating revenues were up 6% when compared to the first quarter of 2023, but fell 12% year-on-year.

The annual drop was a product of several drivers associated with market factors, including a sharp decrease in inflation that went from 4.3% in the second quarter of 2022 to 1.4% in the second quarter of 2023. As a reminder, a change of 100 basis points in inflation is roughly CLP70 billion in net interest income. In addition, revenue generated by Treasury also declined on a year-on-year basis. These factors were partially offset by a steady 10% expansion of customer income, and on a sequential basis, customer income continued growing, posting an increment of 3% quarter-on-quarter because of stronger demand deposit contribution given a scenario of high-interest rates. It's essential to emphasize that quarterly fees grew by 7%.

However, the growth would have been higher if the accounting treatment for income from collection services for overdue loans did not change as now it's recognized under operating income instead of fee income. This change took effect this year. Taking this into account, fees would have grown 12% year-on-year this quarter double-digits. The yearly rise in fees was primarily from increased usage of transactional services due to a higher use of credit cards as a result of personalized campaigns to promote this method of payment to customers which coupled with a larger quantity of credit card users by -- and by higher checking account commissions due to an increase in the number of current account holders and the effect of inflation on fees. Additionally, there was a boost in insurance brokerage related to an annual increase of 55% in written premiums in line with the recovery in the level of consumer loan origination, and to a lesser extent, to the effect of inflation.

On a sequential basis, fees remained relatively flat with some growth in credit cards and current account administration fees offset by higher commissions paid for electronic transfers and expenses related to our loyalty program, primarily due to exchange rate increases. In terms of noncustomer income, we generated less revenues year-on-year from our US GAAP position due to the sharp drop in inflation during the period versus the same period last year. This was further amplified by higher results managed by our trading and investment portfolio in the second quarter of 2022, as we greatly benefited from the positive impact of interest rate movements and the financial positions held at that point. This was partially offset by income from management of term spreads and interest rate gapping under the current scenario of high short-term interest rates, extraordinary income from the sale of a branch in the metropolitan region, and non-recurrent income associated to VAT reimbursements and the reclassification of fee income associated with the collection of services previously mentioned. On a sequential basis, noncustomer income posted an incremental 15% quarter-on-quarter due to higher inflation during the quarter as well as the previously mentioned tax reimbursement and property sale.

The charts on the right demonstrate how our performance has compared to our peers. This quarter, NIM reached 4.6%, significantly surpassing all of our competitors. A similar trend is evidenced in fees and overall operating income as indicated in the charts on this slide. Our remarkable comparative performance is a result of our unwavering commitment to our business strategy and our proactive approach to managing risks, all backed by a robust corporate and government standards. Please turn to slide 16.

Banco de Chile is a universal bank catering to clients across all segments in the retail and commercial banking. As shown in the chart, 65% of our loans are focused in the retail segment with the remaining 35% in wholesale banking. As you can note, the Retail segment participation in the overall portfolio has slightly increased compared to previous quarters due to the weaker loan demand from the Wholesale segment. During the pandemic, as for many banks, our growth mainly centered in low-risk and low-margin products, resulted in a significant shift in the loan mix and the balance sheet structure. However, we anticipate their expansion in the upcoming period will gradually restore the loan mix to the levels that we had before the pandemic in higher margin products, thereby, helping to increase loan spreads and offset temporary factors which are still impacting interest income from loans.

Nevertheless, total loans experienced 2% annual growth and the 1.6% decline compared to the first quarter 2023, as illustrated on the chart on the right. In turn, mortgage loans expanded by 9% during the 12 months period, primarily driven by inflation. However, in real terms, residential mortgage loans remained relatively flat due to the weaker demand caused by high long-term interest, the unstable inflation prospects and the weak economy. In terms of consumer loans, growth was primarily fueled by both originations of installment loans and has allowed us to recover the nominal balance we managed before the pandemic and an increase in credit card-related loans. This has been based on improved segmentation of customers that has been supported by our business intelligence tools while enabling us to maintain credit risk at low levels.

These drivers resulted in a notable annual surge of 12%, achieving a market share of consumer loans of around 18%, which represents an increase of 130 basis points over the last 12 months, notably higher than the average in the industry, as shown on the bottom right graph. However, we expect the strong growth level in consumer loans will gradually slow to level slightly above inflation by the year-end, reflecting the current economic situation and customers debt levels as well as the higher comparison base. Commercial loans experienced a decline of 4% on a yearly basis, primarily due to the adverse effects of the still weak investment, which has been attributable to the remaining uncertainty and elevated interest rates. These economic conditions directly impacted customer demand to seek financing for new projects. From a concentration standpoint, it's important to highlight the diverse nature of our commercial loan portfolio covering a wide range of economic sectors, as depicted on the chart on the bottom left.

This diversification ensures that we don't have significant dependence or concentration risk in any specific industry, providing a safeguard against potential effects arising from economic contractions in sectors such as real estate, construction or the ongoing challenges affecting the private health industry. The construction sector, for instance, represents only 2.7% of commercial loans at Banco de Chile, while the health insurance industry represents less than 1%. Nevertheless, we remain vigilant and well prepared to promptly adapt their lending strategies to foster growth and appropriate relationship between risk and return. Please turn to slide 17 to discuss our solid balance sheet structure. Our asset and liability structure are well diversified and robust, as shown on the chart at the top left.

Our primary focus is on commercial banking with loans being the main revenue source, accounting for 67% of our total assets as of June 2023. It's also worth mentioning that before the pandemic, total loans used to be in the range of 72% to 78% of our total assets. We should return to near these figures once the FCIC fundings are totally paid off by June 2024. For this reason, financial instruments make up 15.1% of our total assets as of June 2023, with a minimal 1.7% exposure in held to maturity financial instruments, significantly lower than our peers, as indicated on the chart on the right. It's also important to note that we are in the process of replacing FCIC collaterals by pledging high-quality liquid assets in lieu of loans as requested by the Central Bank.

Accordingly, the share of financial instruments would continue to increase versus cash or overnight deposits already presence in their balance sheet to fully secure the obligation with the Central Bank. In this regard, it's important to note that we shouldn't need to raise additional funds to deal with explorations of the FCIC. Furthermore, we have managed our balance sheet position appropriately for the economic cycle, which has provided stability in our results with lower sensitivity to changes in market interest rates and adjusting appropriately our UF position to optimize margin. Moreover, our prudent risk management criteria has proven crucial and navigating through these different economic cycles, making the critical difference between banks in the current environment. Regarding our liabilities, our main funding source consists deposits, making up approximately 51% of our assets.

Specifically, our ratio of demand deposits to time deposits is gradually approaching their historical levels, as indicated by the chart on the bottom left. It's worth mentioning that our overall customer liquidity, which was present in 2021 and most part of 2022 has been preserved. However, instead of keeping these funds in zero interest-bearing accounts, customers have opted to place them in time deposits, which today have very attractive rates. It's also important to highlight that approximately 46% of our total liabilities, excluding equity relates to retail counterparties of which deposits represent a huge portion. This reflects that regardless of the high share represented by demand deposits and time deposits, our diversified customer base enables us to reduce liquidity risk.

Likewise, we rely on bonds, constituting 18% of our liabilities, which are primarily utilized to finance our mortgage portfolio. This approach is particularly important as it helps to reduce liquidity risk given that bonds provide a more stable funding source compared to time deposits. As for liquidity coverage ratio, we recorded in the third quarter a level of 318%, 218 percentage points above the limit, and in the case, of our net stable funding ratio, we reached a level of 137% in June 2023, 67 points above the regulatory limit. Both of these indicators are well above the levels maintained by our peers and reflect our solid balance sheet structure and prudent term mismatches. Finally, we have maintained our end-of-period UF GAP relatively stable, due to our expectations of lower inflation for the second half of 2023, as you can see on the chart on the bottom right on the slide.

This means that for every 100 basis point change in inflation, we generate approximately CLP68 billion more in net interest income from our current UF GAP position. It is worth noting that an important part of our UF exposure is structural as it pursues the hedge or equity from inflation in the long-term. As such, over the coming quarters, our UF GAP will be determined by both directional positions and inflation index fair value through comprehensive income securities to take advantage of market opportunities and the funding strategy followed by the banking book. Please turn to slide 18. Banco de Chile is the most capitalized bank in the industry.

As of June 2023, our Basel III ratio was 17.8%, well above the fully loaded Tier 1 limit of 12.25% applying for us, as shown in the table on the right. Regarding CET1, we reached 13.5% this quarter, significantly surpassing our main competitors, as shown in the chart on the bottom left and well above the fully loaded limit established by the regulator of 8.75%. With these levels of capital, we're easily complying with the fully loaded Basel III requirements. Finally, I want to highlight that during the second quarter, the regulator has established a countercyclical buffer of 0.5% for all banks in the Chilean banking industry to be fulfilled by May 2024. I want to emphasize that this change has no effect on our strategy, our outlook as we are more than sufficiently capitalized to comply with this.

Please turn to slide 19. In the second quarter of this year, expected credit losses amounted to merely CLP67 billion, representing a substantial 37% reduction when compared to the same period last year and the 36% decrease compared to the first quarter of 2023. The year-on-year decline is attributed to the CLP40 billion of additional provisions established in the second quarter of 2022 compared to this quarter, where we did not set additional provisions. Additionally, this decline was further boosted by a reduction in commercial loan provisions, resulting from an internal risk rating improvement for one specific wholesale customer during the second quarter of 2023 as well as lower exposure to this segment due to a decrease in commercial loan exposures. However, the positive impact was partially offset by the increase in credit charges in our retail loan portfolio, which is a result of gradually returning to more normal levels of cost of risk.

On a sequential basis, the decline in cost of risk is due to the improvement previously mentioned in commercial loans as well as lower provisions related to consumer loans due to higher loan volume expansion in credit cards during the first quarter. We are confident that the leading level of coverage ratio that we maintained, coupled with the highest level of additional provisions should provide adequate protection in an embedded and prolonged economic downturn and increasing delinquencies, as demonstrated on the chart to the [Technical Difficulty]

Operator: Thank you very much. We'll be moving to the Q&A part of the call. The first question comes from Mr. Yuri Fernandes from JPMorgan.

Please go ahead, sir.

Yuri Fernandes: Hey, guys. So I have a first question here regarding the sensitivity for rates. I guess, Pablo mentioned in the call, the sensitivity for inflation, I think it was CLP60 billion every 100, but just checking the sensitivity for rates here. And also regarding loan growth, when should we see loan growth accelerating because you have some pressure from inflation, you have some pressure from FCIC and we are seeing like very lackluster loan growth in Chile.

So just trying to understand what should we expect for 2024. And if I may, a final one, very quickly dividends. What is the expectation for payout this year if Banco de Chile will continue to pay I think 100% of the distributable earnings that last year was around 70% payout on reported earnings? Thank you.

Pablo Mejia: Hi, Yuri. We had an issue.

I just cut off. Let me just finish the last page and we'll go into your questions. So if we can turn to slide number 20, as you can see on the slide on the left, high inflation figures continue to impact total expenses. In nominal terms, operating expenses increased by 12% compared to the same period last year and remained flat versus the first quarter of 2023. Considering that the average inflation measured in terms of UF in the last 12 months was 10.7% and our expenses grew 1.6% in real terms.

This nominal annual increase is primarily influenced by inflation. Index line items in a lesser extent to IT-related expenses. It's important to note that advances in efficiency across various areas have allowed for significant growth in disbursements allocated to IT-related expenses, as a result of our ongoing digital transformation program which is essential for addressing these transformative changes demanded by digitalization. Regarding the efficiency ratio, we achieved the ratio of 35.4% this quarter, which is well below the industry average, and that of our main peers, as shown in the chart on the bottom right. As mentioned earlier in the presentation, this level of efficiency is a result of several initiatives implemented through our productivity plan and cost control measures.

Finally, it's worth mentioning that as previously indicated in our reports, the upward trend of our efficiency ratio towards normalized figures was expected and remains well below the midterm target of 42%. Please go to slide 21. Before I answer the questions now, I just want to recap some of the main points and give some guidance for 2023. So after a period of strong growth and a record levels of inflation, the Chilean economy is undergoing an adjustment. Accordingly, we expect the current recession to last about the second quarter of 2023, and during the second half of 2023, we should begin to see signs of growth.

As a result of the high overnight rate, GDP will continue posting a negative rate for the full year. Nevertheless, this approach of the Chilean Central Bank to control inflation has been very effective, reducing inflation more quickly than expected. Currently, we estimate that inflation will end the year slightly lower than 4%, and December 2023 was approximately one percentage point down from the level that we saw last quarter. In this environment, given the Central Bank's delay in adjusting the monetary policy, we expect that the overnight rate ending the year below 8% is reasonable. In this context, we have changed our outlook for NIM, reducing the guidance from 4.6% to 4.3%.

In terms of cost of risk, we expect levels of around 1.2% for the year with an efficiency ratio of around 38%. This baseline scenario should provide us with the return on equity of around 22% for this year, depending on the evolution of these indicators. In the current economic landscape and our prudent improvement business strategy has consistently set us apart from our peers, reinforcing Banco de Chile's position as the best bank in terms of profitability, capital and risk management. Moreover, we are very proud to be recognized as a leading bank in Chile with respect to ESG risk. This acknowledgment reflects our unwavering commitment to sustainable practices and responsible business operations, solidifying our reputation as a trusted and esteem financial institution within the industry.

Our dedication in ESG principles further strengthens our position as a forward-thinking and responsible leader, driving the positive impact and fostering sustainable growth in the market, which is key for our shareholders. So now we'll go into the questions. So the first question was from Yuri dividends. So what we've seen and whether dividend policy as today is -- dividend policy of 60% of distributable net income, which means net income less the effect of inflation on capital, you get to distributable net income. Last year, we distributed or this year versus the prior year's earnings, we distributed around 60%.

In the future and depending on the environment, the economy, politics, which affects the industry and the environment, we should -- we need to think of Banco de Chile using our capital effectively. So we can't rule out changes in our dividend policy or in the dividend payout in the future taking this into consideration. So we can't rule out a similar payout in coming periods.

Rodrigo Aravena: So in that, let me add. Yes, one quick idea.

I'm Rodrigo Aravena here. So in that matter, it's very important to analyze the potential implication of different scenarios of economic growth for the future. Important to remember that Chile is still under a recession. We continue posting a negative year-on-year growth rate of activity for the next year. Even though we're expecting an economic growth of 2%, as we said in the presentation, we have a downward bias in that estimate because there are several sources of risk.

So that's why we acknowledge possibility of having still weak growth for the next quarter. So obviously, it also impacts the perspective of the growth dividend for the future. Growth is still a matter of uncertainty for the future.

Pablo Mejia: And can you -- Yuri, can you repeat the other questions?

Yuri Fernandes: Yeah, sure. It was regarding loan growth and dividends.

They are somewhat connected. I'll do another one here. I think it's more important. You mentioned, Pablo, I think 1.2% cost of risk I think for 2023, and you are running below 1%, right? It was 0.7% this quarter and I think the first Q was around 1%. So my question is, are you thinking that cost of risk will accelerate materially in the second half? And how do you see this versus your high coverage ratio because maybe something I was thinking for you is that Banco de Chile could consume the additional -- part of the voluntary provisions in the coming years like basically keeping cost of risk closer to 1% like at lower levels.

So I don't get like the 1.2% seems a little bit too high given you have such a high coverage ratio and given the first half was below 1% on cost of risk. So if you can add some color on this would be great. Thank you.

Pablo Mejia: So cost of risk should be around this range of 1%. There's a lot of uncertainty still today in the economy and how this can proceed in the future.

But around 1% is -- I mean it could be slightly higher, but around 1% is reasonable, and in the medium term, 1.2% is a long-term level for Banco de Chile under a more normalized scenario with the normalized asset quality book where we have a good relationship between risk and return. Remember that during the pandemic, we had a strong growth in low-margin products, SME loans with government guarantees, loans, upper income segments with lower margins. And this has affected the -- this has positively impacted the cost of risk temporarily and this should be normalized in the future and which should also be noticeable in the NIM. So today, we have NIM in 4.6%, and in the medium term, we should think about levels similarly to this because there are many factors that have to be considered in these unusual scenarios that we've lived in over the last couple of years, which had affected the assets and liabilities in different ways, including the loans as I mentioned.

Rodrigo Aravena: Hi.

Yuri. I'm Rodrigo Aravena, and again sorry. Yeah. Important also to mention the rule of the access of liquidity that we have in previous years, which also was very important in terms of asset quality indicators, et cetera. So basically what we're assuming for the future is that a further normalization in total level of liquidity, but additionally, we're expecting a higher unemployment rate for the future.

So basically, we're beginning to see a slight increase in the unemployment rate. Today, we are at a level of 8.5%. However, we have different lean indicators, anticipating a further deterioration in terms of employment growth. So we can't rule out that the unemployment rate over the next quarter will be around 9%. We can't rule out the possibility that total unemployment rate will surpass the level of 9%, which is consistent with a normalization cost of risk as well in the future.

Yuri Fernandes: Super clear, Rodrigo and Pablo. I was thinking that 1.2 was the full year, but it is clear. This is kind of a mid-term guidance indication and not that your full year would be around this level. Thank you very much.

Pablo Mejia: Thank you.

Rodrigo Aravena: Thanks, Yuri.

Operator: Thank you very much. The next question comes from Juan Recalde from Scotiabank. Please go ahead, sir. Your line is open.

Juan Recalde: Hi. Congrats on the strong results, and thank you for the opportunity to ask questions. My first one is related to financial results, which were very strong in the quarter, around CLP120 billion. I think that you mentioned the drivers in your remarks so my question is going forward how sustainable these levels are?

Daniel Galarce: Hi. This is Daniel Galarce.

Regarding financial results, of course, we are seeing still some non-long-term ratios, of course, and non-long-term market factors. Treasury income of course has been quiet affected now and probably will be more affected in the future considering the factors estimated for interest rate in the short-term and in the long-term as well and also inflation. So probably we're considering a slide in Treasury revenues, of course, for the next year, but basically approaching to the long-term levels basically, I mean, to a normalized scenario over the next two years I could say.

Juan Recalde: That's helpful. And then I have a follow-up on NIM.

I think that Pablo mentioned -- made a comment on the NIM expectation in the long-term. Can you comment on what level of NIM do you expect for 2024, and please repeat the long-term expectation for NIM? Thank you.

Pablo Mejia: So with the -- NIM really depends on many factors. There's many factors at play. So you have today inflation that's coming down.

We're expecting around 4%, and for the next year, inflation is expected to be at around 3%. That's something important to be considered. So for every 100 basis point change in inflation, with the gap that we have today on the balance sheet is about 68 -- is about -- between CLP60 billion and CLP70 billion change in net interest income so something like 15 basis points. So we have that. We also have the different factors and the assets that are coming due, loans are coming due and our insurance coming due, which will be at higher rates.

This is a positive impact to growth in terms of more profitable products with a stronger economy should be possible as well. So probably in the ranges of around 4% is reasonable or slightly higher than 4%. And we're expecting for this year, 4.3% so next year, slightly lower than that, 4.2% is reasonable to expect in this scenario. Obviously, this depends on the baseline scenario of what you saw in terms of rates and inflation. This could have a change in also on expectations that Chile returns to grow in next year and -- which should increase the demand for loan growth.

Rodrigo Aravena: One other important thing to consider here is that, for the future, we're expecting a neutral interest rate that will likely be a bit higher than we used compared to the rate that we used to see in the past. So for example, before the pandemic, the neutral interest rate in Chile used to be around 3.5%. Now we're expecting for the long run an interest rate a little bit higher than 4% in an environment where the potential growth probably will be 2% or slightly lower. So that's important to consider the different opposite forces that there will be in the future.

Pablo Mejia: All right.

Pandemic net interest margins on average were around 4.5%. We should be in similar levels.

Juan Recalde: Got it. Thanks for the comments.

Rodrigo Aravena: In the medium.

Pablo Mejia: In the medium term, obviously.

Juan Recalde: I understood. Thank you for the comments.

Operator: Okay. Thank you very much.

Our next question comes from Mr. Tito Labarta from Goldman Sachs. Please go ahead, sir. Your line is open.

Tito Labarta: Hi, Rodrigo and Pablo.

Thank you for the call and for taking my question. A couple of questions also. Just to think about your profitability going forward, just given all the moving parts. You know, you're coming from a high level of ROE, how quickly does that normalize? As inflation comes down, as interest rates come down and cost of risk kind of gradually going up, just to think about that gradual sort of evolution in ROE and thinking about sustainable levels, I think in the past 18% or so. Is that sort of where should we expect ROE to be next year? Or any color you can give on the ROE trajectory from here.

And then my second question, I guess, somewhat following up on the dividend question, but from a different perspective. You have a very high capital ratio as you've highlighted. What is the optimal capital ratio? I mean, I don't think you need to sustain a 13% core Tier 1, or do you think you do? Or what should that optimal capital level be in a normalized environment? Thank you.

Pablo Mejia: Thanks for your question. In terms of ROE, there's a lot of moving parts.

So for this year, around 22% is reasonable. For next year, around 18% in this baseline scenario which is our long-term level. There is many moving parts because of the pandemic. So on the assets, we've had lower rates than normal because of different products that were originated during this time period and liabilities as well. There's different moving parts.

So this makes it challenging to analyze the banking industry today. However, when we take into consideration all these moving parts that have benefits and negative impacts on the balance sheet, we should expect gradually returning to the 18% today. We have had higher rates for longer than we're expecting and with a little bit lower inflation. But this is meant that we have a very strong net interest margin for the year. For next year, this should begin to normalize and we should have levels of around 18% of ROE which is in line with our long-term level.

In terms of the capital, the capital is, today we're very comfortable with the level of capital that we have. So we're very comfortable, but we are aware that we have to use our capital efficiently. And for this reason and in the future we have to analyze how much capital is required for the growth that we're anticipating. Today the growth in Chile is very slow. As Rodrigo mentioned, the term rate GDP growth is around the 2% level with elasticity today being closer to 1%, 1.3% around there versus the higher levels in the past.

So this is something that has to be taken into consideration and the Basel III requirements Pillar 2, which is possible to be implemented. We just recently had an increase in the requirements for the counter-cyclical buffer of 0.5%. So all this has to be taken into consideration. But we can't rule out a change in similar to what we've had in the past in terms of how much we pay out.

Tito Labarta: Okay.

Thanks, Pablo. But I guess just to think -- I mean, 13.5% core Tier 1, is there an optimal level? I mean -- because 18% ROE, even loan growth picking up, maybe you grow loans 10% a year, you would still be generating capital over time. And also you're well above the minimums even with the counter-cyclical buffer.

Daniel Galarce: Hi. This is Daniel Galarce.

Regarding capital and core capital, of course, we have today 13.5% ratio. We have, of course, some internal buffers, very important there, and also we basically want to see how it's going evolve the implementation of Basel III in Chile. Today, we don't have, for instance, for any of the banking players Pillar 2 charges, you know, so we have to see what's going to happen in the next years. And additionally, in terms of a target ratio, we don't have a specific figure, but of course, we want to hover in the future two or -- at least two percentage points over the regulatory limits and also our internal buffers as well.

Tito Labarta: Okay.

That's helpful. Thank you very much for the color.

Operator: Thank you very much. Our next question comes from Mr. Ernesto Gabilondo from Bank of America.

Please go ahead sir.

Ernesto Gabilondo: Hi. Good morning. Rodrigo and Pablo. Thanks for taking my call.

My first question is also a follow-up on NIMs. In the past, you have said that NIMs benefited from higher rates. So considering that rates are starting to go down, what should be the impact for NIMs? And can you remind us the sensitivity to rates for every change of 100 basis points? Then my second question is on expenses. We saw them growing at double-digit this quarter. So how should we think about OpEx growth for the full year and next year? And then my last question is on your effective tax rate.

Considering lower inflation levels, where do you see the effective tax rate normalizing? Thank you.

Pablo Mejia: Hi. Thanks for the question. So in terms of NIM, at NIM, there's a lot of moving parts. So we have different events that occurred during the last years, which are coming due all at once so it's very difficult to analyze.

So we have a negative impact, some positive impact. So we have, for example, today rates coming down and it's lower inflation, but we also have positive impacts of higher rates on loans being originated during this time of higher rates. And they'll stay higher because of different levels of interest rates that we're seeing today, as Rodrigo mentioned. So it's very difficult to isolate one factor from another. So it's true, the lower rates will have a negative effect, but we also have positive effects that are occurring at the same time.

And for this reason, this is the reason why we don't expect a large change from the guidance of this year of 2022 of 4.3%, and next year, which should be around similar levels of around 4.2% because we have different factors that are impacting us negatively, but also positively. So the change of -- at end you have to take into consideration that the rates went up very quickly over a very short period of time and we're already seeing reductions. So not the entire loan book is in price setting very high rates. So today we have a lot of loans at are very low rates, so there's -- it makes the calculation more difficult. So for 100 basis point change, if you think of an average rate of the total loan book of 100 basis points, it would be something like 30 basis points over a three-year period and that's about one-third of that impact per year, but it's a calculation that's very complicated to take into consideration because of the quick changes that we've had in the overnight rate.

In terms of expenses, if you see the expenses in real terms, our expenses only grew around 1%. So we've been very good at managing our expenses and implementing changes in order to control expenses quickly. Remember that all salaries in Banco de Chile index inflation and adjusted at least twice per year, and basically almost all contracts in Chile are indexed to inflation. So it's reasonable to expect that inflation plays a major role. We have already implemented a large change in the footprint of Banco de Chile, and we already -- we made changes in the past, which we have been -- we already made some large changes that some of the competition is currently doing.

If we look at -- for the future, we should think of costs in around inflation and we should think of the efficiency ratio have been as we showed in the press release and the conference call, we mentioned less than 42%. And in terms of taxes, with our baseline scenario of 3% inflation, we should think of around 23%.

Ernesto Gabilondo: Perfect. Thank you very much, Pablo. Just a follow-up in terms of the expenses.

Now, you said that cost growth should be in line with inflation next year, but thinking about this year that you mentioned has been pressured of salaries linked to inflation, how should we think about the OpEx growth for this year?

Pablo Mejia: It should be around the [Technical Difficulty]. So, for next year, in line with inflation.

Ernesto Gabilondo: And for this year?

Pablo Mejia: It should be around the high single-digits growth.

Ernesto Gabilondo: Perfect. Thank you very much.

Operator: Thank you very much. Our final question for today comes from Neha Agarwala from HSBC Global Research. Please go ahead, ma'am.

Neha Agarwala: Hi. Thank you for taking my question, and congratulation on the solid quarter.

For this year, if I'm not wrong, you expect about 22% ROE, which means a meaningful deceleration in the second half of the year. Are you just being conservative, for instance, in your provisioning guidance? Or do you expect a meaningful slowdown in your margins or any other aspect of the business? And my second question is, for next year, the decline in the ROE is mostly coming from the NIM, but we should see an improvement in the other indicators like fee income and provisions should continue to remain stable? Is that right? Thank you.

Pablo Mejia: Thanks. So for the remainder of the year, we have to think that we have a reduction in the interest rates and inflation that will be impacting the bottom line for the remainder of the year. That's the main impact that we see.

In terms of the second question, can you repeat?

Neha Agarwala: For next year, the decline in the ROE would be mostly driven by the top line, the NIM. How should -- the OpEx -- and fee income should improve and OpEx should remain under control and provisions should also be stable. Is that the trends that you expect or is there any divergence? Thank you.

Pablo Mejia: Provisions should normalize to levels of around 1.2% versus this year which should be around the 1%. That would the only difference in the lower inflation and lower rates.

Yeah.

Neha Agarwala: And a slightly higher tax rate.

Pablo Mejia: Sorry?

Neha Agarwala: And slightly higher rate for next year.

Pablo Mejia: Tax rate, yeah, because of the lower inflation.

Neha Agarwala: Okay.

Perfect. Thank you so much.

Pablo Mejia: Thank you.

Operator: Okay. Thank you very much.

We see no further questions. I would like to apologize once again for the technical issue that interrupted today's presentation. And I'll pass the line back to the management team for the concluding remarks.

Pablo Mejia: Thank you for listening and we will see you again in the next quarter results. Thanks.

Operator: Thank you. This concludes today's conference call. We'll now be closing all the lines. Thank you and goodbye.