August 14, 2012 7:41 pm
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ECB is right to ask for more eurozone action
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The European Central Bank has been widely criticised for announcing that while it stands ready to buy sovereign bonds, this is conditional upon countries asking for support from eurozone bailout programmes and acceptingstrict and effective conditionality”. Bond purchases could buy time. But a bond buying programme that does not require policy changes would contribute nothing to addressing the eurozone crisis and would pose risks, including digging deeper debt, growth and banking holes.





The eurozone’s elected leaders and parliamentarians have been slow to act since the start of the crisis, causing great hardship for millions of Europeans. The issues facing these leaders are complex. But sheltering them from pressure to act only increases the likelihood of continuing failure to do what is needed. And the longer the crises go on, the deeper the holes, the stronger the measures ultimately required, the harder it is to regain confidence and the higher the probability of failure in some form. In the words of a major money manager, “the cost of doing nothing is not nothing”. Of course, as an American commenting on the eurozone, I should acknowledge that this point applies to the US as well, in its failure to address effectively the fiscal, public investment and reform issues critical to our future. (And in full disclosure, Mario Draghi, the ECB president, is a close personal friend.)




The effect of ECB financial support without adequate policy is exemplified by the ECB’s longer-term refinancing operations to eurozone banks, which used the money in part to buy sovereign debt. Many analysts thought that LTROs would buy at least a year, without focusing on how that time would be used. When political leaders continued their inadequate crisis response, markets noticed and crisis conditions recurred more quickly than expected.





Some argue that the ECB could stave off crises in bond markets indefinitely: by buying all bonds in the secondary market and those issued for rollovers and new financing. However, in the 1990s, when the international community addressed serious financial and economic crises in Mexico, Asia and Russia, we concluded that money without policy simply would not work, and that if there is broad-based capital flight, no amount of money is enough.




Today, capital flight could include all forms of eurozone credit assets sovereigns, private sector debt, bank deposits, bank wholesale funding and so onsold in what would become a vicious cycle. It could include a sharp depreciation of the euro against other major currencies not as a policy measure to increase exports, but rather as a reinforcing part of the crisis. And that raises another risk of ECB credit extension without policy conditionality: the spectre of debt monetisation and the loss of ECB credibility. That could create fear of longer-term inflation, through future inflationary expectations and increased money supply. (There is virtually no realistic likelihood of short-run inflation.) That fear, the ECB’s loss of credibility, and continued policy failings could spur a capital market crisis at some unpredictable point.




An effort by the ECB to keep pace with capital flight would in time lead to ruinous inflation and an even more massive crisis. No serious central bank would carry monetary expansion to that level. More broadly, the loss of central bank credibility with respect to long-run inflation is a matter of paramount importance for any financial system.




Eurozone reform programmes are often criticised for involving a level of austerity that undermines growth. But that ignores the necessity for sufficient deficit reduction to win market confidence and thereby avoid crippling interest rates. An effective reform plan for the pressing crises would involve enough deficit reduction to win market confidence, but limited enough to allow for growth. That programme should also include measures that apply now to sustain fiscal discipline, strengthen banks and promote growth, for example by increasing domestic demand in Germany to expand that market for eurozone countries. Such a programme is critical and would enhance economic confidence.




A workable fiscal balance could have been struck earlier in the crisis countries, except Greece. The question is whether, after so much delay, with rising bond yields, worsening economies, and declining market confidence, that can still be done. If not, the policy challenges would be enormously difficult and hugely consequential, since additional writedowns in major economies could easily have destructive contagion effects.




In the long run, the eurozone will require big structural change: eurozone bonds, fiscal union and other measures. But this would take a long time to accomplish and should not be confused with measures to address today’s threats.




None of this analysis applies to the different question of conventional short-term ECB funding to banks against good collateral for purposes analogous to the Federal Reserve’s actions to affect overnight interest rates. These operations do not reduce pressure on elected officials, affect bond markets in stressful times, or threaten ECB credibility.




The only effective way forward is exactly the proposal that the ECB has now made: a combination of supportive funding combined with policy to address the eurozone’s deeply threatening crises.





The writer is a former US Treasury secretary


Copyright The Financial Times Limited 2012.




The Sinai Powder Keg

Itamar Rabinovich

13 August 2012




TEL AVIVThe crisis in the Sinai Peninsula seems to have been dwarfed by Sunday’s drama in Cairo. But Egyptian President Mohamed Morsi’s civilian coup, in which he dismissed General Mohamed Hussein Tantawi, the leader of the army’s supreme command, has not diminished the importance of the trouble there.


 

Earlier this month, jihadi terrorists ambushed an Egyptian military base in Sinai, killing 16 Egyptian soldiers. They then hijacked two armored personnel carriers and sped toward the frontier with Israel.



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One vehicle failed to break through the border crossing; the other penetrated Israeli territory, before being stopped by the Israel Defense Forces (IDF). In response, Egypt’s military and security forces launched an offensive against Bedouin militants in Sinai, while Morsi forced the General Intelligence Service’s director to retire and dismissed the governor of Northern Sinai.



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These episodes highlight the complexity of the Middle East’s changing geopolitical landscape, the fragility of Egypt’s post-Mubarak political order, and the explosive potential of Sinai, which, though sparsely populated, includes Egypt’s borders with Israel and the Palestinian enclave of Gaza. Indeed, since Hosni Mubarak’s ouster last year, security in Sinai has deteriorated, and the region has become fertile ground for Islamic extremism.



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The 1979 Egypt-Israel Peace Treaty mandated that Sinai be largely demilitarized in order to serve as a buffer zone between the two former enemies. Tourism and natural-gas pipelines linking the two countries provided economic resources for the local Bedouin.


 
 
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But, as Mubarak’s regime declined, so did the government’s control over the Bedouin. Palestinian militants from Gaza – an active arena of Israeli-Palestinian confrontation since Hamas gained control in 2007 – and jihadi terrorists affiliated with Al Qaeda and the largerglobal jihadnetwork penetrated Sinai, exploiting the government’s neglect of the region and inflaming the local population’s feelings of disenfranchisement.



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Israelis complained about Mubarak’scold peace,” but they appreciated that he adhered to the treaty’s fundamental provisions. Now the behavior of his successors from the military and the Muslim Brotherhood has revived security challenges and raised difficult questions about the region’s future.




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For example, in August 2011, a jihadi group from Gaza seized control of an Egyptian outpost on Israel’s border and killed eight Israeli civilians. Their objective was to damage further the Israeli-Egyptian relationship, which is already more fragile than ever, and they succeeded: the IDF accidentally killed several Egyptian soldiers during the incident. The Egyptian security forces’ subsequent failure to prevent demonstrators from storming Israel’s embassy in Cairo brought matters to the brink of calamity.




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The uncertainty and disorder that have plagued Egypt for the last 18 months are fueling increasing lawlessness in Sinai. Last month, a pipeline carrying Egyptian natural gas to Israel and Jordan was bombed – the 15th such attack since Mubarak’s regime was toppled – and remains out of commission.




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There are four principal actors in this arena: Israel, Egypt, Hamas, and the Sinai jihadis. Israel wants, first and foremost, peace and stability. To this end, Israeli leaders expect Egypt’s government to reestablish its authority in Sinai, and, despite the peace treaty’s provisions, have agreed to Egyptian requests to increase its military presence in the region.




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Moreover, Israel has practically abandoned any hope of receiving agreed gas supplies from Egypt, and has not pressed its demand that Egypt block the passage of sophisticated weapons to Gaza. Israel is determined not to act against terrorist groups and infrastructure on Egypt’s territory. And, in view of Hamas’s close links with Egypt’s Muslim Brotherhood, whose political party backed Morsi’s successful presidential run, Israel has restrained its response to terrorist and rocket attacks from Gaza.



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But Egypt’s divided government has not established a correspondingly coherent policy. Relations with Israel are managed by the defense minister, now Lieutenant General Abdul Fattah al-Sisi, and the military security establishment, whose leaders are determined to maintain a peaceful relationship with Israel and to secure Egyptian sovereignty in the Sinai. For them, the lawless Bedouin, the Sinai jihadis, and Hamas and other groups in Gaza threaten Egypt’s national security. But their will and ability to translate this view into policy are limited.



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Meanwhile, Morsi and the Muslim Brotherhood are playing a double game. While Morsi denounced the recent violence (particularly the deliberate killing of Egyptian policemen) and issued an implicit threat against Hamas, the Brotherhood published a statement accusing Israel’s Mossad of perpetrating the attack – a claim that Hamas’s Prime Minister of Gaza, Ismael Haniyeh, has repeated.


 

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In fact, Hamas, too, is playing a double game. Having lost Syrian backing, it is hoping that the Egyptian Brothers will provide its kindred movement with political and logistical support. Yet it allows radical Palestinians and jihadi groups in Gaza to conduct operations in Sinai.




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The fourth actor, the Sinai jihadis, comprises primarily Bedouins, whose distinct origins and long-time marginalization have led some to identify with radical Islamist groups (often while working in the Arabian Peninsula). While this group’s primary goal is to undermine Israel-Egypt relations, they do not shy away from operating directly against the Egyptian state. Given their strategic location, Sinai jihadis could easily be used by larger terrorist networks to target strategically vital locations, such as the Suez Canal.



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Egypt’s government was humiliated and incensed by the recent terrorist provocation. But it is too early to tell whether its security crackdown in Sinai is a one-time operation, intended to placate angry citizens, or the beginning of a serious effort to address the interconnected problems in Sinai and Gaza. It is also too early to tell whether Morsi’s shakeup in Cairo was related to, or expedited by, the Sinai events. But Sinai’s explosive potential clearly has been increased by the Muslim Brotherhood’s takeover.




Israel’s longstanding channel of communication with Egypt through the military has disappeared, and may or may not be replaced by a similar channel. Hamas and the Bedouins in Sinai have most likely been emboldened by the latest developments in Cairo. But, as Egypt’s domestic politics take their course, Israel, which has had to tread softly in its relationship with Egypt and in Sinai since January 2011, will have to behave with even greater sensitivity in the days ahead.





Itamar Rabinovich, a former ambassador of Israel to the United States (1993-1996), is currently based at Tel Aviv University, New York University, and the Brookings Institution.


Copyright Project Syndicate - www.project-syndicate.org



Why I Continue To Like Peru's Credicorp

August 13, 2012

by: Caiman Valores


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For investors seeking exposure to banking and financial stocks, Latin America offers some of the best opportunities, with many of the region's economies still growing rapidly despite the current global headwinds. One opportunity that I believe stands out is Peru's Credicorp (BAP). Not only does the bank operate in one of the region's fastest-growing economies, but also it has a track record of strong management and conservative credit and risk management. This has placed it in a firm position to capitalize on the growth the opportunities that exist in one of Latin America's most under-banked but fastest-growing economies.
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Strong financial performance



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Credicorp is growing from a position of strength; already the bank has around a third of Peru's loan market, a fifth of the credit card market and more than one-third of the country's deposit market. This strong market share has been a key factor in the bank's success.





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Credicorp's second quarter 2012 financial results were on initial appearances somewhat disappointing in comparison to the previous quarter. Despite revenue being up by 6% to $394 million, net income fell by 9% to $172 million. The bank's balance sheet also weakened, with cash and cash equivalents falling by 12% to $5.5 billion and deposits and other obligations rising by 2.5% to $21.7 billion.




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However, the fall in net income can be attributed to Credicorp setting aside further funds for provisions in accordance with their conservative risk management policy and Peruvian government requests. This saw provisions for non-performing loans increase by 59% to $111 million, yet the value of non-performing loans only increased by 12.5% to $449.4 million. A significant portion of the substantial increase in provisions can be attributed to Credicorp adopting a more conservative provisioning methodology rather than due to a material deterioration in loan quality.
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Conservative risk management




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One of the reasons I like Credicorp is that it consistently delivers strong financial performance while utilizing a relatively conservative risk management framework, particularly with regard to its core business of lending money. This has seen Credicorp build a growing high-quality loan portfolio that is not experiencing the same issues as many of its peers with regard to credit quality.





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An important metric for measuring the quality of a bank's loan portfolio is its non-performing loan ('NPL') ratio. This represents the portion of total loans under management ('LUM'), which are overdue by 90 days or more. Typically, an acceptable NPL ratio is seen as being anything under 5%.






As the chart below shows, Credicorp despite seeing its NPL ratio rise by 13 basis points from the previous quarter, has a very low NPL ratio of 2.34%. For the same period, Credicorp's past due loan ratio (PDL), which measures those loans where payments are overdue by up to 60 days, remained
steady at 1.7%.
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Source data: Credicorp financial filings Q1 2011 to Q2 2012




Furthermore, despite the bank's loan loss provisions increasing, all of these indicators are within acceptable parameters and emphasize the quality of its loan portfolio.
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The product lines that make-up the highest proportion of Credicorp's non-performing loans are those which are typically high risk being cash flow lending to small to medium enterprise ('SME') and credit cards. These loans are for smaller amounts than mortgages and pose less risk to the bank's solvency. But regardless, past due loans ratio ('PDL'), which represents the portion of loans in arrears, is still within acceptable levels, as the chart illustrates.



Source data: Credicorp 2Q 2012 Earnings Release

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For all of these reasons, it is clear that Credicorp has a high-quality lending portfolio, with all risk indicators well within acceptable parameters. In fact, Credicorp's non-performing loan ratio is substantially superior to many of its regional peers, including Banco Santander Brasil (BSBR), Banco Bradesco (BBD) and Banco Bilbao Vizcaya Argentaria (BBVA) as illustrated by the chart below.

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Source data: Credicorp, Banco Santander Brasil, Banco Bradesco, BBVA financial filings Q1 2011 to Q2 2012

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Credicorp's potential losses from non-performing loans are well covered with the bank having a solid coverage ratio of 139%. Although as the chart shows, this has fallen slightly over the previous five quarters.


Source data: Credicorp financial filings Q1 2011 to Q2 2012




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I expect Credicorp's credit risk indicators to remain well within acceptable parameters primarily as a result of the bank's conservative credit policy and high levels of liquidity.
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Attractive levels of liquidity




After Credicorp's high-quality credit portfolio, the next aspect that is particularly attractive is the bank's relatively low degree of leverage and high levels of liquidity. Currently, Credicorp has a debt to equity ratio of 188%, which is low for a bank and well below the industry average of 216%.





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The bank also has solid liquidity indicators. It has a tier 1 capital ratio of 11%, which over the last year has declined as the bank has increased its provisions.


Source data: Credicorp financial filings Q1 2011 to Q2 2012




However, Credicorp's tier 1 capital ratio is not as high as many of its competitors' as the chart shows, and while adequate, particularly in light of the banks solid risk indicators, it would be a bonus to see the bank increase its tier 1 capital.
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Source data: Credicorp, Banco Santander Brasil, Banco Bradesco, BBVA financial filings Q1 2011 to Q2 2012

* Banco Santander Brasil includes 'goodwill' in its Tier 1 calculation




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Credicorp has a healthy loan-to-deposit ratio of 91%, which is well within the recommended range of 85% to 105%. This is seen as the optimal band that allows a bank to retain sufficient liquidity, while maximizing the revenues derived from deposits through lending. Credicorp has consistently maintained an efficient loan-to-deposit ratio for some time as the chart shows, This is an example of the conservative approach taken by management and the sustainability of the bank's operations.
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Source data: Credicorp financial filings Q1 2011 to Q2 2012



However, as the chart shows, Credicorp's loan-to-deposit ratio has increased in the last quarter. This can be attributed to ongoing robust growth in the bank's loan portfolio, which expanded by 6.3% for the second quarter in comparison to deposits, which only grew 2.3%. But this has still left Credicorp with an optimal loan-to-deposit ratio, which is superior to its peers as the chart shows.
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Source data: Credicorp, Banco Santander Brasil, Banco Bradesco, BBVA financial filings Q1 2011 to Q2 2012



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As a whole, Credicorp has a high-quality loan portfolio, a strong deposit base and conservative credit management practices, which have left it with enviable risk indicators that are well within acceptable parameters and superior to many of its peers.



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Performance metrics



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Credicorp is one of the strongest performing and well managed banks in Latin America. Despite the current global economic headwinds, management has been able to continue expanding the business and maintain a solid return on equity of 21% with moderate leverage and a solid efficiency ratio of 49.8%. These compare favorably to its peers as the chart illustrates.
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Source data: Credicorp, Banco Santander Brasil, Banco Bradesco, BBVA financial filings Q1 2011 to Q2 2012





For these reasons along with the bank's conservative risk and liquidity levels, Credicorp is well placed to take advantage of the opportunities present in Peru, which is one of the fastest expanding economies in Latin America.




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Macro environment and market outlook




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In 2011, Peru saw its economy expand by 6.9%, well ahead of Brazil's anemic 1.89%, and this strong growth has continued into 2012 despite growing global headwinds. For the first quarter of 2012, Peru's economy expanded by 6% and is expected to grow by 5.8% for the full year. Much of this is on the back of growing foreign investment in the mining sector and growing domestic consumption, which has seen increased demand for traditional banking products and credit.

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Peru is also one of Latin America's most under-banked economies with a penetration rate of around 30%, which means the majority of the Peruvian population doesn't use the formal banking system.
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This can be attributed to a conservative approach to money management with an inherent distrust of financial institutions combined with over 30% of the population living in extreme poverty. But these attitudes, along with the country's growing wealth and emerging middle-class, are changing.




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Furthermore, according to the World Bank, total private sector loans in Peru's financial system represent only 26% of the country's GDP, which is well under the Latin American regional average of around 50%. It is also substantially lower than the more economically developed countries like Brazil and Chile with ratios of 61% and 90%, respectively. This indicates that there is significant potential for growth in Peru's credit market, and with many Peruvians losing their traditional distrust of financial institutions, the demand for credit can only rise.





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All of this indicates that there are tremendous growth opportunities for Credicorp in its core business of traditional retail banking. As a result, I expect to see Credicorp maintain the growth trajectory of its loan book, which for the last six quarters, has continued to grow by an average of 5% per quarter. The bank has also been able to grow its deposits over the last year by 17% and has been averaging quarterly growth of 3% per quarter.
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Source data: Credicorp financial filings Q1 2011 to Q2 2012




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I also expect to see Credicorp grow revenues from higher margin wealth management, capital markets and insurance products over the long term as the Peruvian economy continues to expand and mature.
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Risks




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Obviously investing in a Peruvian bank is not risk-free and the level of risk associated with investing in Latin America is higher than that associated with U.S.-based companies. The key risks are:


  • Growing political risk, with evidence of increased government intervention in the region. In addition, Peru has been experiencing increased domestic unrest concerning the operations of foreign mining companies in the country.

  • Increased regulatory risk as governments and central banks seek to increase regulation of the banking sector globally, as part of broad based policy responses to recent banking crises. This has brought banking regulation in Latin America to the forefront as regional governments reform their regulatory frameworks to meet global requirements.

  • Investors should recognize that historically Latin American governments have had a habit of using regulatory frameworks as political levers.


  • Worsening global headwinds originating in Europe, which with Latin America's close trade ties to Europe, may see economic growth slow.

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While any investment in Latin America brings greater country risk for investors, Peru has recently demonstrated a more hands off and less interventionist approach to the economy. Furthermore, the majority of political risk in the country is related to issues of resource nationalism and control of national assets and not the financial or consumer sectors of the economy.




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A history of steadily growing dividends




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Credicorp commenced paying a dividend in 1996, and since 2001, these payments have increased year on year except in 2008 and 2009, as the chart illustrates. Dividends are paid annually and the last payment was $2.30 per share. The ex-dividend date was April 16, 2012, and it gives Credicorp a dividend yield of 2%, with a low payout ratio of 21%. This dividend, while not representing a monster yield, provides investors with a consistently growing source of income with a sustainable payout ratio.

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Source data: Credicorp




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Credicorp's dividend has grown along with the business since it went public on the NYSE and Lima Stock Exchange in October 1995. This dividend will continue to grow as the bank takes advantage of the opportunities present in Peru, expanding its operations and diversifying its markets.
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Future outlook and valuation
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Credicorp is currently trading with a price-to-earnings ratio of 12, which would indicate that at its current price, it is fairly valued. But this is in the same range of many of its peers such as BBVA with a P/E of 12 and Banco Bradesco with a P/E of 11. But in comparison to these peers, Credicorp has a far higher quality loan portfolio.





Furthermore, Credicorp has a strong history of growth as the table below illustrates. Both net interest income and earnings per share have grown in value at an average annual growth rate of 12% over the past five years. The bank's dividend has also increased in value at an average annual rate of almost 13%.







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I believe that Credicorp will be able to maintain this growth trajectory over the long term because there is still considerable room to grow in Peru's banking and finance market. In addition, across Latin America there is growing demand for banking and financial services, and Credicorp is well positioned to enter other regional markets and exploit this growing demand. This has recently seen Credicorp conclude the acquisition of a controlling interest in the Chilean investment bank Inversiones IM Trust.





Bottom line





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Credicorp has a solid business model combined with a culture of conservative and disciplined management. This has allowed the bank to build a high quality loan book, which has seen it avoid or significantly mitigate many of the credit quality issues and related financial impacts being experienced by its peers. As a result, Credicorp is well positioned to expand in Peru and more importantly throughout Latin America to take advantage of high economic growth rates and low banking and financial product penetration. All of which should see Credicorp continue to experience significant long-term growth and continue to deliver value for investors through both a growing dividend and share price.