Company Alert. Rating Hold. Industry Banks. Juan Dominguez +(571) ext

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1 USD mn Colombia, Equities Grupo Aval Relative valuation is playing against fundamentals; maintaining our Hold We are keeping our neutral view after adjusting our TP to COP 1,090 (-14% compared to our previous update). On one hand, a strong, value-oriented management team, conservative risk management, expertise in infrastructure and the leading position in Colombia and Central America may prove supportive for share performance. On the other hand, valuation seems stretched, closer to that observed in the more profitable Chilean banks in terms of P/E, and the group seems to have a higher exposure to the O&G sector compared to peers. Fundamentally speaking, Aval is still the most interesting asset in the Colombian banking sector. Value-oriented management, conservative risk taking, healthy LTDs, leading position in NIB deposits, expertise in the infrastructure sector, the best asset in Central America, are among the positives we see in Aval, that reflect into a superior long-term ROAE (17%). We note that efficiency surprised negatively in 3Q15. This is important, as the effective cost-control strategy of the group has been one of the main points of our constructive long-term view on Aval. Nonetheless, we believe management has the expertise to lower cost-to-income to 46%-47% in the long-term. Depreciation is heavy on capital at main subsidiary - Banco de Bogota. Expected appreciation of the COP and plowback of USD-denominated earnings from BAC should ease pressures. Valuation is stretched. Aval is trading at P/E multiples that are closer to Chile than Colombian peers. A premium makes sense, but today it just seems too much. To account for the better quality of Aval compared to peers, the assumed Ke (13.6% in COP) is materially lower than that of Davivienda (14.5%) and Bancolombia (13.9%), yet upside seems lower. Multiples E 2016E 2017E P / E 15.1x 14.6x 13.4x 10.7x 9.5x P / B 2.2x 2.1x 1.8x 1.6x 1.5x EPS growth 3.0% 3.4% -6.9% 21.1% 12.9% Div. Yield 4.0% 4.4% 5.4% 5.5% 5.5% Sources: Company Reports and Credicorp Capital; E Credicorp Capital Estimates; 2014 onwards under IFRS February 8 th, 2016 Company Alert Rating Hold Industry Banks Stock Data Ticker ADTV and Performance Source: Bloomberg, Credicorp Capital pfaval cb / aval us Price (COP) 1,060 LTM Range (COP) 990-1,285 Target 1,090 (loc) / 6.5 (ADR) Total Return 8% Market Cap (USD mn) 7,085 Shares Outstanding 22,281 Free Float 21% ADTV (USD mn) Feb-15 Jun-15 Oct-15 Feb-16 PfAval COLCAP CREDICORP CAPITAL EQUITY RESEARCH Juan Dominguez +(571) ext jcdominguez@credicorpcapital.com Cesar Cuervo, CFA +(571) ext ccuervo@credicorpcapital.com 5 Credicorp Capital may do or seek to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 17 to 22. Analyst Certification on Page 17. Additional disclosures on page 19.

2 Grupo Aval Sector: Banks Rating: HOLD Target Price: COP 1,090 (loc) / USD 6.5 (ADR) Stock Data Ticker pfaval cb Company Description Price (COP) 1,060 Positives Concerns LTM Range 990-1,285 Market Cap (USD mn) 7,085 Shares Outstanding (mn) 22,281 Free Float 21% ADTV (USD mn) 2.4 Loans by segment (as of Sep-15) Valuation Summary E 2016E 2017E P/E P/BV ROAE 15.4% 15.7% 13.5% 15.6% 16.4% ROAA 1.9% 1.8% 1.5% 1.5% 1.6% EPS growth 3.0% 3.4% -6.9% 21.1% 12.9% Div. Yield 4.0% 4.4% 5.4% 5.5% 5.5% Income Statement COP bn E 2016E 2017E Net interest income 6,981 7,413 8,369 10,049 10,954 Ownership Structure Net fee income 2,815 2,850 3,547 3,924 4,120 Free-float 21% Mortgages 9% Consumer 29% Commercial 62% Luis Carlos Sarmiento Angulo (directly and indirectly ) 79% Grupo Aval is the leading financial conglomerate in Colombia through its 4 banks (Banco de Bogotá, Banco de Occidente, Banco Popular and Banco AVVillas), developing a multi-brand strategy. It is also leader in the pension fund management and merchant bank businesses through AFP Porvenir and Corficolombiana respectively. Through BAC Credomatic, it is the leader in the Central American banking industry. - Leading position in both Colombia and Central America. - Strong management, with focus on profitability, efficiency and robust credit risk management. Operating income 11,113 12,924 14,430 16,505 17,768 Provision expenses -1,294-1,475-1,863-2,507-2,580 Operating expenses -6,028-6,627-7,696-8,249-8,567 Net income 1,601 1,839 1,817 2,200 2,484 EPS (COP / share) Balance Sheet - The benefits of a multi-brand strategy are not easily observable as synergies (headcount/cost of funding) could be captured through mergers. - High valuation and depreciation hitting capital COP bn E 2016E 2017E Cash & interbank loans 16,097 19,374 23,625 24,659 26,578 Investments 27,299 28,082 30,683 34,825 39,167 Gross loans 96, , , , ,142 Management Total assets 154, , , , ,056 Deposits 101, , , , ,809 Chairman BoD: Luis Carlos Sarmiento Angulo Financial obligations 28,257 36,073 49,735 50,972 54,667 CEO: Luis Carlos Sarmiento Gutiérrez Total liabilities 136, , , , ,816 CFO: Diego Solano Minority Interest 6,472 7,700 7,982 8,732 9,546 IR Manager: Tatiana Uribe Shareholders Equity 11,728 13,332 13,630 14,520 15,694 Total Liabilities + Equity 154, , , , ,056 ratios. Tangible ratio 8.9% 7.5% 5.4% 6.6% 7.1% Sources: Company Reports, Bloomberg and Credicorp Capital; E Credicorp Capital Estimates; 2014 onw ards under IFRS 2

3 Investment Thesis: too pricey despite sound fundamentals We remain constructive on the long-term, but efficiency is facing pressures; hefty valuation leads us to remain neutral despite sound management. The Group has work to do to regain its competitive advantage in efficiency. What once was a jewel in terms of profitability is facing challenges in one of its main advantages: its efficiency. In fact, the opex (excluding D&A) to assets ratio will increase in 2015 compared to 2014, an event not seen since the consolidation of BAC Credomatic ( ). We still think that Grupo Aval has the expertise in managing costs, but the standardization of processes within the banks in Colombia is taking longer than expected, and cost control in the cross-country operation in BAC is challenging. ROAE should remain relatively stronger, but gap to peers has closed. Despite the challenges, we still expect efficiency to improve to a long-term cost-to-income ratio of around 46%-47%. In fact, the strong EPS growth forecasted for the next two years (21% for 2016) depends on a modest growth in opex, just at the pace of minimum wage. Thus, ROAE should improve to 17.0% in the long-term. Even though ROAE remains relatively stronger than peers, the difference has closed significantly. One of the main reasons behind this lower ROAE ( average lied at 20%) is the tax inefficiencies of BAC s operation in the consolidated statements, despite the 20% average ROAE of this subsidiary; hence, we are assuming a long-term effective tax rate at 43%, the highest in our Colombian sample (the tax reform to be presented in 2H16 could imply changes to our long term assumptions). Depreciation is hurting capital adequacy. The strong depreciation of the COP following the sharp drop in terms of trade has been positive for the income statement, but has been heavy on capital. Grupo Aval s tangible capital ratio has fallen from 7.7% in 3Q14 (after the share issuance in the NYSE) to 5.7% in 4Q15, but at the holding level, it is not subject to regulatory capital standards. However, its main asset, Banco de Bogota, has seen its Tier 1 ratio drop to 7.5%. Management is exploring ways to optimize both capital and risk weighted assets to tackle this issue. As we are expecting an appreciation of the COP in the next couple of years, and as Banco de Bogota will plowback earnings in USD from BAC Credomatic, the ratio should improve in Despite headwinds, Grupo Aval remains a sound fundamental play within Colombian banks. Sound risk management practices and ample liquidity (the most attractive LTD ratio with a leadership in NIB deposits) support a positive long-term outlook, and should shield the investment thesis in the current scenario. Furthermore, the management of Aval shines as the best in our coverage of Colombian banks. Multiples seem stretched. PFAVAL trades at 10.7x 2016E P/E and 9.5x 2017E P/E, which looks closer to Chilean banks than to Colombian peers. 2016E P/B at 1.6x also seems high given an expected ROAE at 16% on average in the next 2 years, and a 13.6% Ke (fair multiple is estimated at <1.5x). Leading position, strong management, sound risk policies and ample liquidity may explain why investors may pay a premium. Therefore, we remain neutral as management is in our view, the strongest within Colombian banks, but we note that poor delivery in profitability could deteriorate our outlook. Finally, the 5.5% dividend yield seems appealing, but current payout is not sustainable in our view, and DPS could remain close to current levels in the mid-term. Risks to our thesis. i) our EPS outlook depends heavily in better efficiency; if management fails to deliver in this front, investors may eliminate the premium paid against Bancolombia and Davivienda; ii) depreciation is pressuring capital adequacy at Banco de Bogota, which could potentially trigger ECM activity; iii) a weaker than expected macro environment could increase cost of credit; iv) the conglomerate seems more directly exposed to the O&G sector than Davivienda and Bancolombia; a worsening on the fundamentals of these companies could deteriorate cost of credit. 3

4 What has changed in our forecasts? Loan growth is adjusted to incorporate our expectations of a weaker macro backdrop in Colombia (2.3% GDP growth expected for 2016) and our estimate of appreciation of the COP by year end. Loan growth in Colombia is assumed at 9.5% y/y in 2016 driven by commercial lending and mortgages; in Central America we are assuming a ~10% y/y growth in USD fostered by a stable macro backdrop, but our estimate of appreciation (we expect and exit FX of COP 2,800 in 2016), drives consolidated loan growth down to 4.6% y/y in COP. NII is adjusted to the upside despite the lower loan volume during the year, as the tightening of monetary policy in Colombia should expand yield on loans. We are forecasting another weak year for the fixed-income portfolio, normalizing in Net fee income has surprised us positively in recent quarters, but lower business volumes should contract it starting in Following our conversations with Grupo Aval and considering that we are expecting a slower loan growth, we decrease slightly provision expenses for 2016; however, as we are now forecasting a slower convergence to potential GDP growth, cost of credit should remain relatively high in Opex is adjusted slightly to the upside incorporating the surprise in 3Q15. Cost-toincome converges to 46%-47% in the long-term. The end result is slightly lower EPS for However, lower loan volume should contract estimates in the long term, and we are expecting a 17% sustainable ROAE compared to our previous 17.5%. We forecast that Grupo Aval will post its lowest ROAE at 13.5% in 2015, improving to 15.6% in Our forecasts for are around 2% below consensus. Grupo Aval Model Update COP bn Upd. Prev. Diff. Upd. Prev. Diff. Upd. Prev. Diff. Upd. Prev. Diff. NII 7,413 8,369 8, % 10,049 9, % 10,954 10, % 11,830 11, % Net fee income 2,850 3,547 3, % 3,924 3, % 4,120 4, % 4,435 4, % Operating income 12,924 14,430 14, % 16,505 16, % 17,768 18, % 19,166 19, % Provision expenses -1,475-1,863-2, % -2,507-2, % -2,580-2, % -2,615-2, % Operating expenses -6,627-7,696-7, % -8,249-8, % -8,567-8, % -9,115-9, % Net profits 1,839 1,817 1, % 2,200 2, % 2,484 2, % 2,775 2, % EPS % % % % ROAA 1.8% 1.5% 1.6% 1.5% 1.6% 1.6% 1.6% 1.6% 1.7% ROAE 15.7% 13.5% 13.6% 15.6% 15.1% 16.4% 16.5% 16.9% 17.7% Loan growth 19.3% 25.5% 22.6% 4.6% 9.7% 7.9% 9.5% 11.0% 10.3% Source: Credicorp Capital; Previous update released on October 22nd, 2015 (refer to our Andean Equities Guide 2016) 4

5 Valuation Despite the strong management and fundamental story, shares seem pricey; we are maintaining our Hold with an adjusted 2016E TP at COP 1,090. Our 2016E TP is based on a 10-year residual income model using a Ke of 13.6% in COP. A relatively lower Ke (13.6% in COP) compared to Bancolombia (13.9%) and Davivienda (14.5%) reflects a lower assumed beta reflecting our positive view on management and the diversification of Grupo Aval to low-beta regulated natural monopolies through Corficolombiana. Our 2016E TP at COP 1,090 implies 11.0x 2016E P/E, 9.8x 2017E P/E and 1.7x 2016E P/B. Target multiples imply 13% and 23% premiums compared to Bancolombia and Davivienda respectively, but target valuation is still well below Chilean banks, reflecting the higher country risk. Shares are trading at 10.7x 2016E P/E and 9.5x 2017E P/E, low compared to L5Y averages, but stretched compared to Bancolombia and Davivienda. In fact, 2016E P/E multiples are more in line with the Chilean banks, which have higher ROAE and lower Ke. Adjusting P/B for value generation (i.e ROAE - Ke), Grupo Aval seems also pricey, trading at 1.6x 2016E P/B; according to numbers, it should trade at <1.5x P/B given the expected ROAE for However, despite the relatively high valuation of Aval, we are maintaining our neutral stance, as strong fundamentals, conservative risk management and sound management may prove supportive for share performance under the current scenario. Grupo Aval Target Price Derivation Assumptions PFAVAL CB Target Price PFAVAL CB Risk-free rate 1.8% 2016E target price 1,090 Beta E dividend yield 5.5% Equity risk premium 6.0% 2016E expected return 8.4% Country risk spread 3.7% Target 2016E P/B 1.7 Ke (USD) 12.5% Target 2016E P/E 11.0 Ke (COP) 13.6% Target 2017E P/B 1.5 Long-term ROAE 17.1% Target 2017E P/E 9.8 Long-term growth rate 5.5% Discount vs fundamental value 0% Residual income model (COP / share) Forward looking multiples 2016E book value E P/B 1.6 Discounted residual income E P/E 10.7 Discounted perpetuity E P/B E fundamental value 1, E P/E 9.5 Grupo Aval: Forward (N12M) P/E Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Grupo Aval: Forward (N12M) P/B Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Source: Bloomberg, company reports, Credicorp Capital 5

6 Financial Statements Income Statement COP bn E 2016E 2017E Interest income 10,783 11,911 14,175 17,841 18,385 Interest ex penses -3,802-4,498-5,807-7,792-7,431 Net interest income 6,981 7,413 8,369 10,049 10,954 Net fee income 2,815 2,850 3,547 3,924 4,120 Other operating income 1,317 2,662 2,515 2,532 2,694 Total operating revenue 11,113 12,924 14,430 16,505 17,768 Prov ision ex penses -1,294-1,475-1,863-2,507-2,580 Operating ex penes -6,028-6,627-7,696-8,249-8,567 Operating income 3,791 4,823 4,872 5,750 6,621 Operating margin 34.1% 37.3% 33.8% 34.8% 37.3% Non operating result Earnings before tax es 4,027 4,823 4,872 5,750 6,621 Tax es -1,415-1,750-1,920-2,300-2,781 Minority interest -1,011-1,234-1,134-1,250-1,356 Net income 1,601 1,839 1,817 2,200 2,484 Net margin 14.4% 14.2% 12.6% 13.3% 14.0% EPS (COP / share) Balance Sheet COP bn E 2016E 2017E Cash and interbank loans 16,097 19,374 23,625 24,659 26,578 Inv estments 27,299 28,082 30,683 34,825 39,167 Gross loans 96, , , , ,142 (-) Allow ances -3,073-3,158-3,659-4,252-4,800 Net loans 93, , , , ,341 Fix ed assets 2,593 5,887 6,570 6,719 7,097 Other assets 14,858 14,640 18,952 17,802 17,872 Total Assets 154, , , , ,056 Deposits 101, , , , ,809 Bonds 11,180 14,134 17,209 17,956 19,350 Financial debt 17,078 18,647 28,379 28,689 30,654 Other liabilities 6,639 12,710 16,010 16,705 18,002 Total Liabilities 136, , , , ,816 Shareholders Equity 11,728 13,332 13,630 14,520 15,694 Minority Interest 6,472 7,700 7,982 8,732 9,546 Total Equity and Liabilities 154, , , , ,056 Sources: Company Reports and Credicorp Capital; E Credicorp Capital Estimates; 2014 onw ards under IFRS 6

7 Ratios E 2016E 2017E Profitability NIM (inc. interbank loans) 6.3% 5.7% 5.4% 5.7% 5.8% Prov ision ex penses / Av rg loans -1.5% -1.4% -1.4% -1.7% -1.6% Fee ratio 25.3% 22.0% 24.6% 23.8% 23.2% Opex / Rev enue -54.2% -51.3% -53.3% -50.0% -48.2% Opex / Av rg assets -4.3% -4.1% -3.8% -3.7% -3.6% ROAE 15.4% 15.7% 13.5% 15.6% 16.4% ROAA 1.9% 1.8% 1.5% 1.5% 1.6% Asset quality NPL ratio 1.8% 1.8% 1.7% 1.7% 1.7% NPL cov erage -179% -151% -151% -163% -177% Capital adequacy Equity + Min. Int. / Assets 11.8% 11.7% 9.8% 10.1% 10.1% Tangible ratio 8.9% 7.5% 5.4% 6.6% 7.1% ROAE Decomposition E 2016E 2017E (1) Net income to shareholders / Net income 61.3% 59.8% 61.6% 63.8% 64.7% (2) Tax burden = (1 - (3)) 64.9% 63.7% 60.6% 60.0% 58.0% (3) Effectiv e tax rate -35.1% -36.3% -39.4% -40.0% -42.0% (4) Pretax earning / Operating income 106.2% 100.0% 100.0% 100.0% 100.0% (5) Operating margin (1 - (6) - (7)) 34.1% 37.3% 33.8% 34.8% 37.3% (6) Efficiency -54.2% -51.3% -53.3% -50.0% -48.2% (7) Prov ision ex penses / Rev enue -11.6% -11.4% -12.9% -15.2% -14.5% (8) Net profit margin = (1) x (2) x (4) x (5) 14.4% 14.2% 12.6% 13.3% 14.0% (9) Net interest income / Av rg assets (10) x (11) 5.0% 4.4% 4.2% 4.5% 4.6% (10) NIM 6.3% 5.7% 5.4% 5.7% 5.8% (11) Av rg interest assets / Av rg assets 78.7% 77.2% 77.0% 77.6% 78.3% (12) Fees / Av rg assets 2.0% 1.7% 1.8% 1.7% 1.7% (13) Other operating rev enue / Av rg assets 0.9% 1.6% 1.3% 1.1% 1.1% (14) Asset turnover = (9) + (12) + (13) 7.9% 7.7% 7.2% 7.3% 7.4% ROAA = (8) x (14) 1.1% 1.1% 0.9% 1.0% 1.0% ROAA including minority interest 1.9% 1.8% 1.5% 1.5% 1.6% Leverage = Avrg assets / Avrg equity 13.5x 14.4x 14.9x 16.0x 15.9x ROAE = ROAA x Leverage 15.4% 15.7% 13.5% 15.6% 16.4% Multiples E 2016E 2017E Price (COP / share) 1,275 1,280 1,090 1,060 1,060 Shares outstanding (mn) 20,178 22,281 22,281 22,281 22,281 P / E 15.1x 14.6x 13.4x 10.7x 9.5x P / B 2.2x 2.1x 1.8x 1.6x 1.5x EPS grow th 3.0% 3.4% -6.9% 21.1% 12.9% Div. Yield 4.0% 4.4% 5.4% 5.5% 5.5% Sources: Company Reports and Credicorp Capital; E Credicorp Capital Estimates; 2014 onw ards under IFRS 7

8 Last Px / B 2015E Relative Valuation Credicorp Capital Coverage Universe Price Market Cap CC CC Last P/E PEG P/B Dvd Yield ROAE (local) (USD mn) Rating T.P. Update 2015E 2016E 2017E Ratio* 2015E 2016E 2016E E 2016E 2017E Banks Banco de Chile ,815 HOLD /01/ % 24.5% 21.2% 20.1% 20.7% Corpbanca ,614 BUY /01/ % 15.9% 17.0% 13.5% 10.8% Santander ,035 BUY /01/ % 22.3% 16.8% 17.5% 18.0% Chile Median 6, % 22.3% 17.0% 17.5% 18.0% Bancolombia 24,740 6,949 HOLD 26,300 08/02/ % 16.0% 13.1% 12.5% 13.3% Dav iv ienda 23,400 3,118 BUY 26,900 08/02/ % 13.6% 15.9% 14.9% 15.7% Grupo Av al 1,060 8,556 HOLD 1,090 08/02/ % 15.7% 13.5% 15.6% 16.4% Colombian Median 6, % 15.7% 13.5% 14.9% 15.7% IFS ,248 BUY /10/ % 24.0% 26.2% 22.8% 23.0% Peru Median 2, % 24.0% 26.2% 22.8% 23.0% Non-banks Corficolombiana 36,980 2,452 BUY 43,000 22/10/ n.a % 11.5% 12.5% 11.2% 10.8% Grupo Sura 34,980 6,128 HOLD 41,600 22/10/ % 3.1% 6.3% 6.6% 7.4% SMChile B 185 3,183 HOLD /01/ % 11.3% 9.1% 9.5% 10.3% * (LTM P/E) / (Avrg EPSg 2016E-2018E) Latam Relative Valuation Covered Not covered y = x R² = Compartamos Bancolombia* Inbursa Itaú Grupo Aval* Banorte Santander México Banregio Santander Chile* Credicorp Banco de Chile* Crédito Real IFS* 1.0 Santander Brasil Bradesco Davivienda* 0.5 Banco do Brasil Corpbanca* Banrisul % -5% 0% 5% 10% 15% [ ROAE - Ke ] 2016E * Based on Credicorp Capital estimates Source: Bloomberg, company reports, Credicorp Capital; market data updated on February 5 th,

9 Our forecast on credit quality for We expect cost of credit to surge on the back of lower economic activity and higher unemployment. Despite the strong growth of the industry after the crisis, the increase in penetration seems moderate. More than one year after the strong drop in terms of trade began, asset quality in Colombia has been resilient. NPLs and cost of credit have been surprisingly resilient despite the adjustment of the Colombian economy to its new reality of lower oil prices. However, we are exploring the outlook for cost of credit considering that we are expecting a further deceleration of the economy to 2.3% y/y in 2016, and a slight uptick on unemployment. In our view, the cost of credit should increase during 2016, with possibly a tougher environment in commercial lending; in the retail segment we expect some deterioration on the back of higher unemployment, shielded by the low LTVs in the mortgage portfolio, and the higher concentration of consumer loans in less risky payroll loans. Nonetheless, the increase in average maturity of the consumer portfolio and an increasing financial burden of households should prevent retail lending from recording the dynamism of previous years, especially within consumer lines. How stretched is the banking penetration in Colombia after almost two decades of high growth? Following the emerging markets crisis of , banking penetration in Colombia has doubled from its low in 2000, and according to the World Bank, it has reached 43% of GDP. The risks posed by this kind of trend in banks in emerging markets at the end of the commodity boom were widely discussed in a Dec-15 article in The Economist titled Stressful times: The problems of banks in the developing world are more chronic than acute. However, examining the trends across emerging economies, the increases in banking penetration since 1998 are in our view less alarming, and as a consequence, these economies could be resilient in relative terms. For instance, banking penetration in Colombia in 2014 is 1.23x that of The same exercise in Brazil, India, Russia and Turkey throws 2.3x, 2.2x, 3.8x, and 4.1x respectively. Banking penetration in emerging economies (1 = 1998) Brazil Mexico China India Russia Turkey Chile Peru Colombia Source: World Bank, Credicorp Capital 9

10 Our macro framework for Colombia: lower economic growth on sharp drop of terms of trade Colombia: Macroeconomic forecasts E 2016E 2017E Real GDP growth (y/y) 4.0% 4.9% 4.6% 3.0% 2.3% 3.2% CPI inflation (eop) 2.4% 1.9% 3.5% 6.7% 4.5% 3.2% CPI inflation (aop) 3.2% 2.0% 2.9% 5.0% 6.6% 3.2% Unemployment rate 9.6% 8.4% 8.0% 8.3% 8.6% 8.7% Nominal loan growth (y/y) 15.2% 13.6% 15.5% 17.5% 9.2% 10.0% Policy rate (eop) 4.25% 3.25% 4.50% 5.75% 5.50% 5.00% Exchange rate (eop) 1,767 1,932 2,377 3,200 2,800 2,600 Exchange rate (aop) 1,797 1,869 2,002 2,760 3,150 2,700 Source: BCCh, INEI, SBIF, DANE, BanRep, Credicorp Capital We expect 2.3% y/y GDP growth, and interest rate hikes up to 6.5% by the BanRep. The economy should slowdown to 2.3% y/y in A relevant adjustment in public spending and additional deceleration of private consumption will drag growth, partially offset by 4G infrastructure projects, Reficar, housing programs and a gradual recovery of external demand. We expect unemployment to deteriorate slightly during the year. Depreciation and El Niño will keep inflation high during 1H16. However, we expect temporary factors to fade in 2H16, allowing inflation to reach 4.5% by year end, still above the target range of the Central Bank. We believe the BanRep will continue to hike its repo rate to 6.5% in 1Q16 to tackle heightened inflation expectations. Challenges in fiscal and external accounts subsist. Even though we expect the government to record a fiscal deficit of 3.6%-4.0% of GDP in 2016, complying with the fiscal rule, a structural tax reform is strongly required for the long-term in a scenario of persistently lower crude oil prices; this reform will likely be discussed during the year. External accounts are expected to improve, with a current account deficit of 5.5% in 2016, a figure that still seems relatively high. Diversification in Central America is supportive Central America should grow at a more stable rate. Despite our criticism on the M&A activity of some banks in Colombia, the foray in Central America seems supportive on diversification. According to the IMF, the region is expected to grow at a more stable rate of around 4%, favored by their oil-imports driven economies. Nonetheless, we note that the political context in the region and the strong violence wave of some of the countries in which Colombian banks have operations could hurt business confidence and credit demand. 10

11 Risks in the commercial loan book have risen; a recovery of exports in nonextractive industries could be supportive, but it could take time Total exposure to the O&G sector represents around 17%-27% of Tier 1 capital for the industry. To what extent is the Colombian banking industry exposed to commodities? According to guidance of the different banks we cover and our own forecasts, the industry is not severely exposed to the O&G sector in a direct way as it represents only 0.8% of total loans, and the sector is not labor intensive. However, we extended the exercise to include the rest of the O&G value chain (the O&G classification that is used by the Financial regulator - SFC only includes E&P) and other extractive industries (i.e. mining). Adding up O&G E&P, refining, services, and mining, the exposure increases to 1.5% of total loans, which still seems not worrisome: as a percentage of Tier 1 capital (as a measure of the potential impact of a severe trouble in the sector in banks capital adequacy), the extended sector weighs 11% for the industry; Grupo Aval is relatively more exposed to the sector, concentrating 2.3% of its loans in Colombia in O&G, equivalent to 19% of its tangible capital. Nonetheless, the effect of the O&G sector s context in the transportation industry is more difficult to assess. According to the sector classification used by the SFC, transportation adds ground freight services and pipelines, and therefore, the definition seems too broad and could be inaccurate. We explored the debt of oil pipelines using Ecopetrol s annual filings, and we found that their banking debt in Colombia amounts to 0.7% of total loans in the industry. Nonetheless, using this number underestimates the effect, as it does not include fuel truck services (ground transportation). Hence, we estimate that a broader exposure to commodities could range between 2.2%-3.5% of total loans, or equivalent, between 17%-27% of Tier 1 capital for the industry. Total NPL ratio in Colombia (industry) 16% 14% 12% 10% 8% 6% 4% 2% 0% Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 Consumer NPL ratio in Colombia (industry) 14% 12% 10% 8% 6% 4% 2% 0% Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 Commercial NPL ratio in Colombia (industry) 12% 10% 8% 6% 4% 2% 0% Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 Mortgage NPL ratio in Colombia (industry) 30% 25% 20% 15% 10% 5% 0% Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 Source: SFC, Credicorp Capital 11

12 As alarming as it may seem, parts of the O&G value chain should be resilient. Main shock to cost of credit may come from COP depreciation; we rule out a crisis-like event. However, parts of the value chain of the O&G sector should not be affected by the context. For example, refining actually benefits from low crude prices, and pipeline transportation is somewhat shielded due to the nature of the contracts and the possibility of changing the use of the pipeline to oil derivatives. Further, fees charged by pipelines are usually USD-denominated. Thus, we see unlikely that a strong risk event could jeopardize the banking industry directly via its exposure to the O&G sector. The major exposure of the industry is through the indirect depreciation effect. Depreciation of the COP is one of the main drivers behind the strong increase in the private debt to GDP ratio to 44.5%. The Central Bank ran some numbers on the exposure of the banking industry to the strong depreciation of the COP via impairments in asset quality. Those companies defined by the BanRep as potentially vulnerable include net importers (companies with an imports-to-operating-revenue ratio greater than 10%) and debtors in foreign currency that are not oriented towards international trade. According to the BanRep s exercise, in the event of a 40% depreciation, 428 companies face a decrease in their shareholders equity greater than 30%, representing 3.2% of total private sector s lending. Finally, the Central Bank also estimated the industry s exposure to fragile companies, as measured through interest coverage ratios (<2x), at 10.7% of total commercial loans. These numbers suggest a material increase in the risk profile of the corporate segment in 2016 (via higher cost of credit), but a crisis-like blow to the industry is ruled out in our base scenario. Colombian banks: Estimated exposure to extractive industries (as of Sep-15) Sector Bancolombia Grupo Aval * Davivienda COP mn % Total COP mn % Total COP mn % Total COP mn % Total Coal ex traction 285, % 51, % 76, % 93, % O&G (E&P) 2,785, % 125, % 1,419, % 361, % Metal mining 355, % 112, % 126, % 4, % Other mining 285, % 48, % 26, % 50, % Serv ices to mining & O&G 1,268, % 286, % 505, % 61, % Oil refining and fuels 380, % 80, % 58, % 106, % Total O&G & mining 5,362, % 704, % 2,211, % 678, % Ground and pipeline transportation 7,442, % 2,555, % 2,852, % 958, % OBC + ODL 2,747, % n.a. n.a. n.a. n.a. n.a. n.a. O&G, mining and oil pipelines 8,109, % n.a. n.a. n.a. n.a. n.a. n.a. O&G, mining and ground/pipeline transportation 12,805, % 3,260, % 5,063, % 1,636, % Total loans in Colombia (SFC) 367,571,588 91,310,189 96,379,122 46,459,361 Tier 1 47,280,974 11,998,961 11,396,134 5,079,136 % of O&G & mining in Tier 1 11% 6% 19% 13% % of O&G, mining and transportation in Tier 1 27% 27% 44% 32% * Capital adequacy analysis is based on tangible capital for Grupo Aval Source: SFC, Ecopetrol, Credicorp Capital 12

13 Conalvias should not be a systemic event, but it is turning banks more selective in infrastructure. Conalvias, a micro-driven credit event. One of the main blows to sentiment on financial shares during 2015 was related to the bankruptcy filing of Conalvias, one of the largest infrastructure companies in Colombia (noting the low concentration of this sector). The reasons behind the meltdown of Conalvias are apparently linked to an aggressive and unsustainable growth strategy in the region, and according to our conversations with the banks, it is not a sector-wide issue (however, we do note that there are other smaller players in infrastructure with rumors of insolvency). The Conalvías issue should increase the selectivity of banks in infrastructure, but they are not stepping down from the 4G boom. After this event, banks are turning more cautious on the business models of the road concessions, and that will most likely be translated into higher loan rates in the construction stage. However, projects will likely refinance loans at lower rates once the concessions enter their operating stage (in this stage, concessions become pretty much sovereign risk), lowering interest expenses, and thus, we still think that projects make financial sense. El Niño is another source of risk in the utilities and agriculture sectors. El Niño phenomenon is another source of credit risk. The strong drought that the country is currently facing could last until April, and some sectors are feeling the pressures. Thermal generators such as Termocandelaria and Termovalle are facing marginal costs that are well above the electricity scarcity price set by law. Also, agriculture weights 5.7% of total commercial loans, and losses in crops due to the acute weather conditions cannot be ruled out. Finally, the recent outbreak of the Zika virus could dampen the outlook for hospitality and tourism (1.3% of commercial loans), as some countries have issued travel warnings to the region. Commercial loan breakdown by sector PDL ratio by sector Agriculture 5.7% Other services 6.9% Utilities 5.0% Mining 2.0% Restaurants & hospitality 1.3% Retail 21.4% Agriculture Mining Retail Real estate Construction 7.5% 5.2% 3.7% 2.8% 2.8% Transportation 2.6% Transportation 10.1% Industry 2.5% Restaurants & hospitality 2.2% Other services 1.8% Real estate 10.6% Construction 15.6% Industry 21.4% Utilities 0.1% Source: BanRep, Credicorp Capital 13

14 Retail lending seems well prepared to withstand the cycle, but loan growth could be affected several years Households are more indebted, but growth in the consumer segment has come from safer payroll loans. The financial burden of the Colombian household has increased in According to the Central Bank, the burden has increased to 9.5% of disposable income, which is now close to the pre-crisis levels observed in the late 90s. Under the methodology used by Asobancaria (banking guild) and Cifin (credit bureau), which only includes those households with debt, the burden has increased to 21.8% in These trends create uncertainty in a world of lower economic activity and likely increases in unemployment. Product breakdown of consumer loans in Colombia However, the double-digit growth in consumer loans since 2008 is greatly explained by payrolls. In Jun-08 payroll loans weighed 19.4% of total consumer loans; in Oct-15 this figure was 36.7%. The increase in the participation of payroll loans has come at the expense of free-investment loans and revolving lines, while credit card lending has been stable at around 21% of total consumer loans (although it has decelerated over the last two years). How do payroll loans work? Simply put, a payroll loan is a free-investment loan that has the employee s salary as collateral. Usually, banks disbursed payroll loans up to a maximum of 12 monthly salaries, depending on the total debt burden of the employee. Hence, the main risk of the product comes from swings in the labor market: an increase in unemployment could increase past-due-loans; nonetheless, when an employee is fired, the compensation and severance amounts are first destined to pay the outstanding debt in the payroll loan (this also means that the payroll loan is senior to other debts), implying that this consumer product is relatively safer even when employees lose their job. For instance, in the aftermath of the global financial crisis, the unemployment rate in Colombia increased from 11.2% in 2007 to 12.0% in 2009; during this period, PDL loans in payrolls increased to a peak of 2.6% in 1Q19, compared to 8.9% and 10.9% in credit cards and free-investment loans, respectively, in the same quarter. COP mn Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Sep-15 Payroll loans 11,766,426 15,249,732 18,957,044 23,198,999 27,595,566 32,100,174 35,596,426 Share on consumer loans 28.4% 31.7% 31.5% 32.8% 34.9% 35.9% 36.7% PDL ratio 2.1% 2.0% 2.0% 2.1% 2.0% 1.8% 2.0% Credit cards 9,166,393 10,679,633 13,343,111 15,770,209 17,526,958 19,536,167 20,276,517 Share on consumer loans 22.1% 22.2% 22.1% 22.3% 22.2% 21.9% 20.9% PDL ratio 6.7% 4.8% 4.9% 5.7% 5.1% 5.3% 5.8% Free-investment loans 11,086,605 11,288,502 14,409,750 16,643,874 17,836,898 19,973,752 21,691,118 Share on consumer loans 26.8% 23.4% 23.9% 23.6% 22.6% 22.3% 22.4% PDL ratio 10.0% 6.5% 5.6% 6.8% 6.3% 6.4% 6.4% Car loans 5,158,058 5,889,884 7,500,336 8,540,844 9,059,866 10,372,880 11,133,237 Share on total consumer loans 12.5% 12.2% 12.4% 12.1% 11.5% 11.6% 11.5% PDL ratio 7.0% 4.7% 4.3% 5.3% 5.4% 5.2% 5.6% Total consumer loans 41,394,731 48,179,916 60,252,314 70,647,863 79,083,145 89,392,722 97,017,958 PDL ratio 6.5% 4.4% 4.2% 4.8% 4.5% 4.4% 4.6% Source: SFC, Credicorp Capital 14

15 * The increase in maturity in consumer loans could limit recovery in growth. We are not expecting major risks from mortgages given low LTVs. This gives stability to the sector, but also could imply a lower future dynamism. The lower sensitivity of PDLs to unemployment of payroll loans compared to credit cards and free-investment loans implies that the industry could be more resilient today to a tightening of the labor market. Nonetheless, the maturities of these loans are longer: according to the Central Bank, the average maturity of the outstanding consumer loans has increased to above 4 years. In a scenario of slower economic growth, this implies that the consumer segment could take longer than expected to reactivate its previously high growth rates. Mortgage lending seems resilient. The industry learned from the mistakes of the past that led to the mortgage crisis of LTVs at origination are at a maximum of 70% for traditional housing (80% for social interest programs), and according to the Central Bank, current LTVs are at 49% for traditional housing and at 61% for social interest programs, which implies that the banking industry is well prepared to withstand a drop in price of housing units. Moreover, in the event of an above-expected surge in unemployment we highlight that i) individuals normally get past-due in their consumer loans and not in their mortgage loans, which are in most cases their major source of wealth; ii) the share of mortgage lending in GDP remains low at just 5%-6%, including housing leases and securitizations. Mortgage lending penetration (loans to GDP), still well below pre-crisis levels 12% 10% 8% 6% 4% 2% 0% * Starting in 2015, mortgage credit includes housing leases, previously recognized as commercial loans under ColGAAP Source: SFC, DANE, Credicorp Capital 15

16 Scenario Analysis Pessimistic scenario. The macro picture worsens, with GDP decreasing 1.0% in 2016, and a long-term potential GDP of 3.5%. The BanRep rapidly cuts rates to 5.0%. Under such a scenario, we expect a sharp increase in cost of credit throughout the year. Perpetuity growth is decreased to a nominal 5%. Management fails to deliver in efficiency, and investors eliminate the premium paid for Aval; under this scenario we are valuating with the same Ke we use for Bancolombia (13.9% in COP). Optimistic scenario. We expect the industry to maintain a 2.1x elasticity against real GDP growth. Cost of credit is lower than in our base case scenario. Perpetuity growth is increased to 6.0% in nominal terms. Grupo Aval: Valuation Scenarios COP bn 2014A 2015E 2016E 2017E 2018E Long-term Base (2016E TP COP 1,090; expected return +8.4%) Net income 1,839 1,817 2,200 2,484 2,775 EPS (COP) EPS growth 3.4% -6.9% 21.1% 12.9% 11.7% ROAE 15.7% 13.5% 15.6% 16.4% 16.9% 17.1% Pessimistic (2016E TP COP 910; expected return -8.6%) Net income 1,839 1,817 1,768 2,045 2,455 EPS (COP) EPS growth 3.4% -6.9% -2.7% 15.7% 20.0% ROAE 15.7% 13.5% 12.8% 14.1% 15.9% 16.5% Optimistic (2016E TP COP 1,240; expected return +22.5%) Net income 1,839 1,817 2,253 2,555 2,849 EPS (COP) EPS growth 3.4% -6.9% 24.0% 13.4% 11.5% ROAE 15.7% 13.5% 16.0% 16.8% 17.2% 18.5% Source: Company reports, Credicorp Capital 16

17 Important Disclosures This research report was prepared by Credicorp Capital Peru S.A and/or Credicorp Capital Colombia Sociedad Comisionista de Bolsa and/or Credicorp Capital S.A. Corredores de Bolsa, companies authorized to engage in securities activities in Peru, Colombia and Chile, respectively and indirect subsidiaries of Credicorp Capital Ltd. (jointly referred to as Credicorp Capital ). None of the companies jointly referred to as Credicorp Capital are registered as broker-dealers in the United States and, therefore, they are not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution only to major U.S. institutional investors in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the Exchange Act ). Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or related financial instruments based on the information provided in this research report can do so only through Credicorp Capital Securities Inc., a registered broker-dealer in the United States. Under no circumstances may a U.S. recipient of this research report effect any transaction to buy or sell securities or related financial instruments directly through Credicorp Capital. Credicorp Capital Securities Inc. accepts responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor. Any analyst whose name appears on this research report is not registered or qualified as a research analyst with the Financial Industry Regulatory Authority ( FINRA ) and is not a registered representative of Credicorp Capital Securities Inc. and, therefore, is not subject to applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account. A. Analyst Disclosures The functional job title of the person(s) responsible for the recommendations contained in this report is Equity Research Analyst unless otherwise stated on the cover. Regulation AC - Analyst Certification: Each Equity Research Analyst listed on the front-page of this report is principally responsible for the preparation and content of all or any identified portion of this research report and hereby certifies that with respect to each issuer or security or any identified portion of the report with respect to an issuer or security that the Equity Research Analyst covers in this research report, all of the views expressed in this research report accurately reflect their personal views about those issuer(s) or securities. Each Equity Research Analyst also certifies that no part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendation(s) or view(s) expressed by that Equity Research Analyst in this research report. Each Equity Research Analyst certifies that he or she is acting independently and impartially from the referenced company/shareholders, directors and is not affected by any current or potential conflict of interest that may arise from any of the companies activities. Analyst Compensation: The research analyst(s) primarily responsible for the preparation of the content of this research report attest(s) that no part of his or her compensation was, is or will be, directly or indirectly, related to the specific recommendations that he or she expressed in the research report. Registration of non-us Analysts: Unless otherwise noted, the non-us analysts listed on the front of this report are employees of one of the companies jointly referred as Credicorp Capital, which are non-us affiliates of Credicorp Capital Securities Inc., a SEC registered and FINRA member broker-dealer. Equity Research Analysts employed by the companies jointly referred as Credicorp Capital, are not registered/ qualified as research analysts under FINRA/NYSE rules, are not registered representatives of Credicorp Capital Securities Inc. and may not be subject to NASD Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Please refer to for further information relating to research and conflict of interest management. 17

18 B. Ownership and Material Conflicts of Interest Neither Credicorp Capital Securities Inc. or its affiliates beneficially own, as determined in accordance with Section 13(d) of the Exchange Act, 1% or more of the equity securities of any of the companies referenced in this report. Credicorp Capital Securities Inc., its affiliates and/or their respective officers, directors or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein. C. Compensation and Investment Banking Activities Neither Credicorp Capital Securities Inc. or any of its affiliates have managed or co-managed a public offering of securities for any of the subject companies in the past 12 months. Within the last 12 months, Credicorp Capital Securities Inc. or its affiliates have received compensation for investment banking services from: Cencosud. Neither Credicorp Capital Securities Inc. nor its affiliates expect to receive or intend to seek compensation for investment banking services from any of the subject companies in the next 3 months. D. Market Making Credicorp Capital Securities Inc. is not a market maker in any of the companies referenced in this report. E. Rating System Stock ratings are based on the analyst s expectation of the stock s total return during the twelve to eighteen months following assignment of the rating. This view is based on the target price, set as described below, and on the analyst s opinion, general market conditions and economic developments. Buy: Expected returns of 5 percentage points or more in excess over the expected return of the local index, over the next months. Hold: Expected returns of +/- 5% in excess/below the expected return of the local index over the next months. Underperform: Expected to underperform the local index by 5 percentage points or more over the next months. Under Review: Company coverage is under review. The IPSA, COLCAP and IGBVL indexes are the selective equity indexes calculated by the Bolsa de Comercio de Santiago, the Bolsa de Valores de Colombia, and the Bolsa de Valores de Lima, respectively. In making a recommendation, the analyst compares the target price with the actual share price, and compares the resulting expected return for the IPSA, the COLCAP, and/or the IGBVL indexes, as estimated by Credicorp Capital S.A. Corredores de Bolsa, Credicorp Capital Colombia Sociedad Comisionista de Bolsa, and/or CredicorpCapital Peru S.A, and then makes a recommendation derived from the difference in upside potential between the shares and the respective index. F. Distribution of Ratings Buy Hold Underperform Restricted Companies covered with this rating 36% 42% 19% 4% Compensation for investment banking services in the past 12 months* 30% 29% 0% 67% *Percentage of investment banking clients in each rating category. 18

19 G. Price Target Unless otherwise stated in the text of this report, target prices in this report are based on either a discounted cash flow valuation or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst s views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company s products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, in fashion. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. Investment in overseas markets and instruments such as ADRs can result in increased risk from factors such as exchange rates, exchange controls, taxation, and political and social conditions. This discussion of valuation methods and risk factors is not comprehensive further information is available upon request. H. Price Chart GRUPOAVAL (pfaval cb) 1,400 1,350 1,300 1,250 H 1,400 H 1,270 Date Rating Price (COP) T.P. (COP) 23/10/2014 Hold 1,325 1,530 09/02/2015 Hold 1,260 1,400 1,200 22/10/2015 Hold 1,205 1,270 1,150 1,100 H 1,090 08/02/2016 Hold 1,060 1,090 1,050 1, Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Source: Bloomberg and Credicorp Capital Credicorp Capital ratings: B = Buy, H = Hold, U = Underperform II.ADDITIONAL DISCLOSURES This product is not for retail clients or private individuals. The information contained in this publication was obtained from various publicly available sources believed to be reliable, but has not been independently verified by the companies jointly referred as Credicorp Capital, therefore they do not warrant the completeness or accuracy of such information and does not accept any liability with respect to the accuracy or completeness of such information, except to the extent required by applicable law. This publication is a brief summary and does not purport to contain all available information on the subjects covered. Further information may be available on request. This report may not be reproduced for further publication unless the source is quoted. This publication is for information purposes only and shall not be construed as an offer or solicitation for the subscription or purchase or sale of any securities, or as an invitation, inducement or intermediation for the sale, subscription or purchase of any securities, or for engaging in any other transaction. This publication is not for private individuals. 19