BAP Q1 2023: Insurance ROE Surges to 36.5% as Retail Risk, Provisions Rise

May 8, 2023 | By EarningsIQ Research

Credit Corp (BAP) delivered robust headline profitability in Q1 2023, propelled by an outsized insurance result and resilient core banking, despite Peru’s economic contraction and mounting retail credit risk. Management held firm on full-year guidance, but flagged that cost of risk and efficiency metrics will trend toward the upper end of the range amid social unrest, climate disruption, and a deliberate mix shift toward higher-yield, higher-risk retail loans. Strategic focus is shifting to stable, fee-generating businesses and digital ecosystems as legacy segments and macro headwinds persist.

Summary

• Insurance Outperformance: Q1 insurance ROE reached an exceptional high, but normalization is expected.
• Retail Risk Creep: Loan mix shift and social unrest are driving higher provisions and cost of risk.
• Strategic Refocus: Leadership is pivoting toward stable fee businesses and digital payments for future growth.

Business Overview

Credit Corp (BAP) is a leading financial services group in Latin America, anchored in Peru, with operations across universal banking, microfinance, insurance, and wealth management. The company’s primary revenue streams derive from net interest income (NII) on loans, insurance underwriting, and fee-based asset management. Major business segments include BCP (universal banking), MiBanco (microfinance), Grupo Pacifico (insurance), and investment banking and wealth management. The group also invests in digital payments platforms such as Yape, digital wallet, and disruptive fintech initiatives like Tempo in Chile.

Performance Analysis

BAP posted strong consolidated net income growth and an 18.7% ROE, led by universal banking and a standout quarter in insurance. Net interest income rose sharply, driven by higher rates and structural loan growth, particularly in retail banking at BCP and MiBanco. However, the operating environment was turbulent, as Peru’s GDP contracted due to social unrest and Cyclone Yaku, pressuring asset quality and raising provisions to pre-pandemic levels. Retail and microfinance segments saw the largest impact, with MiBanco profitability notably weak.

Cost of risk increased to 2.1%, at the upper end of guidance, reflecting both planned portfolio risk-taking and exogenous shocks. Operating expenses grew double digits, reflecting investments in digital transformation and disruptive initiatives, while efficiency ratios improved on higher income but are expected to normalize. Loan growth guidance was moderated, with management now expecting expansion at the lower end of the 6% to 10% range.

• Insurance ROE Spike: Grupo Pacifico’s ROE hit 36.5%, driven by life and pension product strength, though management expects a return to high teens/low 20s.
• Retail Loan Growth: BCP retail banking loans rose 14.1%, but this mix shift contributed to higher provisions and cost of risk.
• Digital Payments Traction: Yape active users grew from 5.1 million to 8.8 million YoY, with monthly transaction volume more than doubling, but remains short of breakeven.

While headline profitability was strong, underlying risk and cost dynamics point to a more challenging forward environment as BAP absorbs higher risk for higher yield in retail and microfinance, and as insurance results normalize.

Executive Commentary

Strategic Positioning

1. Fee-Based and Stable Business Emphasis

BAP is refocusing its investment banking and wealth management strategy toward stable, fee-generating businesses such as wealth and asset management, and capital markets transactional services, while scaling back volatile investment banking and trading activities. This pivot aims to deliver more predictable earnings and optimize capital allocation as regional macro volatility persists.

2. Digital Ecosystem Expansion

Digital platforms are a core pillar of future growth, with Yape now commanding 75% to 80% of Peru’s digital wallet market. The platform’s user and transaction growth is robust, and management reiterated its path to breakeven in 2024. Disruptive fintech initiatives like Tempo in Chile are earlier stage, with revenue generation underway but profitability still distant.

3. Risk Management and Balance Sheet Discipline

Leadership stressed conservative balance sheet management, prudent risk appetite, and robust liquidity controls. Stress testing and internal capital and liquidity coverage ratios (LCRs) exceed regulatory requirements, with a high-quality, liquid investment portfolio. However, the deliberate shift to higher-risk retail lending raises the importance of ongoing risk monitoring and provisioning discipline.

4. Microfinance Strategy Under Review

MiBanco’s profitability was hit by social unrest and climate events, with management tightening origination standards and risk appetite. While MiBanco Colombia faces margin compression from regulatory rate caps and inflation, BAP is taking a “wait and see” approach to further expansion or acquisitions in the segment for now.

5. Governance, ESG, and Sustainability Integration

BAP advanced its ESG agenda, strengthening board diversity and launching a corporate environmental strategy. The group’s sustainability initiatives are increasingly embedded in core business planning, with a focus on carbon footprint measurement, transition financing, and stakeholder engagement.

Key Considerations

This quarter underscores a deliberate shift in BAP’s risk-return calculus and a strategic recalibration toward digital and fee-based businesses amid macro and regulatory uncertainty.

Key Considerations:

• Insurance Normalization: The outsized insurance ROE in Q1 is not expected to persist, with management guiding for a return to previous levels.
• Retail Credit Risk: Exposure to higher-risk segments, especially in consumer and microfinance, will keep provisions and cost of risk elevated.
• Digital Monetization Path: Yape’s scale is impressive, but profitability remains a future event, with continued investment required.
• Efficiency Ratio Volatility: Q1 efficiency gains reflect seasonality and one-off drivers, with ratios likely to rise in subsequent quarters.
• Capital Allocation Discipline: Dividend policy remains tied to capital needs for organic and potential inorganic growth, with a payout ratio in the 50% range absent acquisitions.

Risks

BAP faces elevated credit risk from its retail loan mix, with social unrest, climate events, and potential El Niño impacts posing further asset quality threats. Regulatory changes, especially in Colombia (rate caps, funding costs), could compress margins in microfinance. Political stability in Peru has improved, but remains fragile, and insurance outperformance is unlikely to recur. Management’s forward guidance remains subject to macro shocks and normalization of one-off tailwinds.

Forward Outlook

For Q2 2023, BAP guided to:

• Cost of risk at the upper end of the guided range, reflecting ongoing macro and portfolio risk.
• Efficiency ratio normalization, rising from Q1’s low due to seasonality and insurance outperformance.

For full-year 2023, management maintained guidance:

• ROE around 17.5% (vs Q1’s 18.7%)
• Structural loan growth above the lower end of 6% to 10% range
• Efficiency ratio restated to 47% to 49% under IFRS 17

Management highlighted that insurance ROE will revert to sustainable levels, retail credit risk will remain elevated, and digital initiatives will continue to require investment before achieving profitability.

• Macro and climate risks are closely monitored, especially El Niño probabilities.
• Capital allocation remains conservative, with dividend payout flexed for growth and M&A.

Takeaways

BAP’s Q1 headline strength masks a more complex risk and cost environment as the group leans into higher-yield, higher-risk retail and digital growth while macro headwinds persist.

• Insurance Windfall Not Sustainable: Q1’s insurance result is a one-off; normalization will pressure consolidated ROE in coming quarters.
• Retail and Microfinance Risk Rising: Provisions and cost of risk will remain a key swing factor as BAP pursues growth in riskier segments.
• Digital and Fee Focus: The group’s strategic pivot toward digital payments and stable fee income is prudent, but will take time to materially impact earnings and risk profile.

Conclusion

BAP’s Q1 2023 results showcase resilience and strategic adaptation, but forward returns will be tested by higher retail risk, normalization of insurance earnings, and continued investment in digital transformation. Investors should monitor cost of risk, digital monetization, and macro shocks as key levers for the remainder of the year.

Industry Read-Through

BAP’s experience this quarter highlights the dual challenge for Latin American banks of managing macro volatility and asset quality while investing in digital platforms for long-term growth. The group’s shift toward fee-based and digital businesses is a signal for peers facing similar margin and credit risk pressures. Microfinance operators should note the vulnerability to social and climate shocks, while insurance outperformance in a volatile environment is unlikely to be replicated sector-wide. The normalization of cost of risk and efficiency ratios is a likely theme for regional banks as pandemic-era credit trends fade and risk appetite recalibrates. BAP’s digital wallet penetration illustrates the potential for rapid scale, but also the long runway to profitability for fintech disruptors in cash-heavy economies.

BAP Financials Banking Digital Insurance Microfinance Fee Income Provisions