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Morningstar | Banco de Chile's Loan Growth Accelerates in Fourth Quarter Though Macro Risks Remain

Narrow-moat Banco de Chile reported a 3.3% increase in year-over-year net income, slightly below our expectations. Excluding the impact of accounting changes in the third quarter, credit provisions as a percentage of total loans increased slightly to 0.90%, from 0.85%. On a yearly basis, credit provisions remained stable at 0.93%. The Chilean economy experienced strong GDP growth of 4% in 2018 as the economy continued its rebound from the sub-2.0% growth in the two years prior. For now, we'll be maintaining our fair value estimate at $20.50 as we take into account full-year results and management's updated guidance.

Loan demand is being driven by a strong Chilean economy, notwithstanding headwinds from falling copper prices. During the fourth quarter, Banco de Chile achieved impressive sequential loan growth of 3.2%, with total yearly loan growth of 9.7%. Consumer loans continue to drive loan growth, with growth in the segment up 3.5% compared with the third quarter. Over the past decade, the correlation between Chilean GDP and bank loan growth has been about 2 times. Chilean GDP growth is expected to reach about 3.5% in 2019, which sets an industry loan growth baseline of 7% for the year, before inflation. Given macroeconomic risks, we view 7% growth as somewhat aggressive, though we don’t see any immediate risks to the Chilean economy.

Improved underwriting technology launched earlier in the year has contributed to the growth of consumer loans, and we expect the bank to realize efficiency gains in the coming years as this technology is expanded. The bank leverages a model to pre-approve clients for loans, reducing required resources and potentially improving loss outcomes. On the earnings call, management announced that more than half of consumer loans were granted online. We have a positive view of these loan approval changes, while noting the inherent risk in expanding the loan portfolio with less human oversight.

Banco de Chile has been able to maintain consistent and industry-leading net interest margins and cost of funding over the past year, at 4.4% and 2.7%, respectively. This funding advantage, along with switching costs from a sticky deposit base, are the primary sources for Banco de Chile’s narrow moat. In late January, the bank announced a 15-year partnership with Chubb, a Swiss insurer. Per the agreement, Chubb will distribute its insurance products exclusively through Banco de Chile. We think the terms are favorable to Banco de Chile, with the agreement providing a consistent source of revenue and more cross-selling opportunities.

The Central Bank of Chile increased interest rates last quarter to 2.75% from 2.50%, the first increase since December 2015. This rate increase was implemented to keep inflation below 3% in the medium term, as it had reached 3.1% in September 2018. Banco de Chile expects further increases to the overnight rate in the coming quarters as the Central Bank continues to target a neutral rate. While overall GDP growth is still positive, annualized GDP growth has cooled somewhat, and was below 3% in the second and third quarters. While Chile plans to diversify its economy in the long run, copper is still the top export and the country has high exposure to the ongoing volatility in copper prices.