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Morningstar | Banco de Chile Sits Atop the Chilean Banking Food Chain

Banco de Chile sits atop the food chain of Chile’s banking industry, allowing the firm a cheaper source of deposits. This funding advantage has helped the company to generate impressive returns on equity nearing 20% in each of the past five years. While we anticipate continued profitability, we do expect returns to decline. While Banco de Chile has shrugged off recent slowdowns in the country’s economy, we believe a slowing Chilean economy, along with pressure on loan spreads, will result in lower margins. We’ll note that Banco de Chile’s impressive returns were generated during a time of impressive economic expansion that has correlated with China’s demand for natural resources. As the world’s largest producer of copper, the Chilean economy has benefited greatly from this. During this impressive economic expansion, Banco de Chile’s loan book has increasingly tilted toward mortgages and consumers. Since 2009, spreads on mortgages have decreased significantly. We believe Banco de Chile has been able to originate mortgages at continually decreasing spreads as a result of credit losses that continually outperformed lender expectations. In 2017, charge-offs on mortgages were a minuscule 7 basis points, while charge-offs for the entire bank rose 14 basis points to 1.25%. Since a more normal rate of charge-offs is closer to 30 basis points, this leads us to believe that we are at or near peak credit performance and credit losses will put some pressure on overall performance. Despite strong growth in mortgages, commercial loans still account for more than half of the bank’s loan portfolio. Spreads in this segment have been under pressure since 2008. We believe this is partly attributable to growth in foreign trade loans, which provide short-term financing for purchases of Chilean exports and decreasing margins. As with mortgages, we believe it’d be challenging for charge-offs on commercial loans to get any lower. In 2017, charge-offs on commercial loans were only 41 basis points. We believe a more sustainable level of commercial charge-offs to be closer to 60 basis points, or about 50% higher.