Credicorp Q2 Earnings: A Well-Run House In A Tricky Neighborhood (NYSE:BAP)

I’ve long been a fan of Credicorp (NYSE:BAP), a well-run leading Peruvian bank, and I’ve been impressed with the company’s ability to navigate challenges in the political and macroeconomic environment of Peru, while continuing to maintain good lending share and investing in growth drivers like digital banking. I haven’t been as big of a fan of operating conditions in Peru, though, and I’m not altogether surprised that Credicorp’s shares are about 20% lower than at my last write-up, as the macroeconomic situation in Peru has gotten more challenging.

It’s easier to be bullish on Credicorp at this lower valuation, though I still see economic and political risk as major factors in the investment analysis. Weak business confidence and low real wage growth aren’t great underlying trends for the near term, nor is a 20% approval rating for the president or a significant increase in the price of credit default swaps for Peru since the start of the year. All in all, I like the double-digit prospective returns here, but investors need to go in with their eyes open with respect to the above-average risks and volatility here.

A Minor Miss On Core Earnings

Credicorp’s second quarter was more “okay” than “good”, with positive loan and interest margin trends offset by some shortfalls in fee-based lines and higher expenses.

Revenue rose 21% year over year and 4% quarter over quarter, with net interest income up 19% yoy and 8% qoq on a stronger-than-expected 46bp qoq improvement in net interest margin (to 46bp). While Credicorp isn’t an especially asset-sensitive bank, rate hikes have exceeded earlier expectations. Fee-based income rose 7% yoy and 3% qoq.

Operating expenses rose 10% yoy and 5% qoq, and this was a notable contributor to a modest miss on the pre-provision line. Expenses were driven significantly by ongoing investments in IT (including digital banking) and customer loyalty initiatives – both of which are think are worth upfront investment in pursuit of improved long-term efficiency.

Pre-provision profits rose 35% yoy and 3% qoq, but missed by about 1% – not a big deal, but you’d still rather see a beat. Provisioning expense was a fair bit higher than the sell-side expected, driven in large part by management caution regarding a deteriorating macro outlook, though underlying loss formation trends aren’t concerning at this point.

Loan Growth Despite Macro Challenges

Credicorp posted 15% yoy and 4% qoq adjusted constant-currency loan growth in the second quarter, which was solid relative to management and sell-side expectations. Mibanco, a segment of Credicorp that focuses on microfinance transactions, saw 20% yoy and 8% qoq loan growth, while Pyme (small-to-medium-sized business loans) saw 22% and 8% qoq loan growth. Corporate loan growth was also healthy (up 16.5% yoy and 3%), with middle-market (up 21% yoy and 3% qoq) standing out a bit.

Mortgage loan demand was softer (up 8% yoy and 2.5% qoq), and the Bolivian segment saw loans contract more than 1% yoy (flattish qoq). Reactiva loans (a program in Peru very roughly akin to the U.S. PPP program remain about 10% of loan balances).

Credit quality is somewhat mixed. The 90-day non-performing loan ratio was down both annually (down 65bp) and sequentially (18bp) to 4.9%, but the cost of risk is trending toward the high end of management’s expectations and the bank is seeing some moderate NPL formation within small/medium-sized business working capital lending. At the same time, Mibanco credit quality is trending positively, with the NPL ratio down 570bp yoy and 60bp qoq to 6.1%.

Healthy loan demand and improving credit quality are coming despite some notable challenges in the macro environment. While the Peruvian economy has been helped by higher commodity prices, copper prices are already about 25% off their high, and business confidence in Peru is fairly low at around 34 in July – down from close to 45 at the start of the year (numbers above 50 indicate positive feelings about the near-term outlook for Peruvian economy). At the same time, Peru remains stuck with low real wage growth and real GDP growth is only expected to be in the neighborhood of 2.5% to 3% over the next couple of years.

The political situation also remains volatile. There have been ongoing clashes between the legislative and executive branches, and President Castillo’s approval rating is currently hovering around 20%.

Between macro challenges and the risk of new rounds of political turmoil, the cost of 5-year credit default swaps for Peru have risen from around 75 at the start of the year to over 131 recently.

The Outlook

It’s tough for a bank to dramatically outperform its home economy, particularly when it’s a bank with roughly 30%-33% loan and deposit shares. Still, I don’t ignore the ongoing improvements at Credicorp and the efforts to drive better long-term returns. The bank continues to see growth in the number of clients using its digital banking services (and declines in per-unit transaction costs), and business ventures like Yape (a digital wallet) continue to grow, with a 95% yoy increase in active users and a 227% yoy increase in monthly transactions.

I’m still cautious on the near-term economic situation in Peru, but I also still believe that Credicorp can generate long-term core earnings growth in the neighborhood of 8%-9% (from pre-pandemic levels). I likewise believe the bank can and will maintain mid-to-high-teens ROEs, with past digital investments offering the possibility of improved operating leverage.

The Bottom Line

Between discounted long-term core earnings and nearer-term ROE-driven P/BV, I believe fair value for Credicorp ADRs is in the $150s, with the shares also priced for long-term annualized total returns in the low-to-mid-teens. That’s an attractive potential return from what I believe to be a well-run bank with low execution risk, but I would again caution investors not to ignore the macro risks. While Credicorp has been a well-run bank for some time, the stock price chart highlights how that’s not always enough to prevent significant pullbacks.