Credicorp Ltd Q3 FY2020 Earnings Call

Good morning, everyone. I would like to welcome all of you to Credicorp Ltd Third Quarter 2020 Conference Call. We now have all of our speakers in conference. With us today is Mr. Walter Bayly, Chief Executive Officer; Mr. Gianfranco Ferrari, Deputy Chief Executive Officer; Mr. Reynaldo Llosa, Chief Risk Officer; and Mr. Cesar Rios, Chief Financial Officer. Now it is my pleasure to turn the conference over to Credicorp's Chief Financial Officer, Mr. Cesar Rios. Mr. Rios, you may begin.

Thank you. Good morning, and welcome to Credicorp's conference call on our earnings results for the third quarter of 2020. Since our previous conference call, the health situation in Peru has improved considerably, and the economy continues to rapidly recover. In fact, the evolution of both scenarios has exceeded expectations. Further, our weekly death tolls have registered significant improvement in recent months. Nevertheless, we remain vigilant to track any eventual second wave of COVID-19. In parallel, the Peruvian economy experienced a V-shaped recovery throughout the third quarter of 2020. The economic indicators have been encouraging over the past few months. According to the latest official data, economic activity in August was only 10% below the figure recorded for the same time last year. This compares favorably with the minus 40% registered for the year-on-year comparison in April. This V-shaped recovery has also been observed for several economic indicators. Real estate transactions, cement dispatches, and vehicle sales have recovered significantly in recent months. Reactivation is also evident in labor market data, including payrolls through BCP. Although the Peru GDP posted its steepest decline in the second quarter of 2020, it is rapidly regaining territory in Latin America. Moreover, market consensus has gradually improved its expectations for the Peru GDP growth in 2021. Peru is expected to lead economic recovery in Latin America towards 2021 as we leverage strong macroeconomic fundamentals, high commodity prices, and broad government stimulus packages. In our previous conference call, we expected the GDP to drop between 11% and 15% in 2020, and that the rebound in 2021 would situate between 6% and 10%. Our latest estimate suggests that GDP will contract around 12.5% in 2020, and will rebound between 9% and 12% in 2021. It is important to note that the series of elections, referendums, and constitutional changes are underway in the countries in which Credicorp operates. In Bolivia, Luis Arce from Evo Morales' party won the general election and will take office on November 8. In Chile, 78% of the population voted in favor of drafting a new constitution. The positive trend seen for economic data is mirrored in the evolution of data for the financial system. Transactions with debit cards of BCP have exceeded pre-COVID-19 levels. Nonetheless, credit card transactions are recovering at a slower pace. During the third quarter, the Reactiva Peru program continued to contribute to loan growth systemwide. According to data from the Central Bank, loan growth stood at 14.1% year-over-year at a constant exchange rate, supported by the effect of Reactiva loans. If we exclude the Reactiva loans effects, total loans declined 2% year-over-year. It is important to remember that Reactiva loans target businesses of different sizes. After the first phase of the Reactiva program was rolled out for PEN 30 million, a second tranche option with an additional PEN 25.3 billion was introduced. Disbursements of these second phases were primarily for small micro and medium-size businesses. We would like to mention several economic policy measures and regulatory actions that are in effect or under discussion. First, there has been further debate on additional economic stimulus. According to its last monthly policy statement, the Central Bank stands ready to expand the liquidity injections to a range of instruments. Second, Congress is currently discussing initiatives in several key areas. A proposal has been made by a special commission that contemplates a complete overhaul of the Peruvian pension fund system. If this deal becomes law, it could have a material impact on Prima. Given the scope and complexity of the measures, the commission has requested additional time for analysis. Third, early this week, a motion was approved to impeach the President. The President is expected to present his legal defense on Monday, November 9. Fourth, a number of bills on pension fund withdrawals have been in play since the first quarter. On November 2, another deal was passed giving pensioners the right to make withdrawals again in their funds. Fifth, a second program of monetary transfers began in October. These instruments, known as universal bonds, constitute direct monetary transfers from the government to mitigate the impact of the crisis. Sixth, the government recently approved a payroll subsidy program, through which private sector entities that fulfill specific requirements can access this facility. The program aims to bolster recovery in formal employment. Lastly, the government has rolled out a COVID-19 guarantee program, directed at individuals and SMEs. Under this initiative, the bank can offer reduced insurance rates in exchange for additional government loan coverage for very specific segments of clients. We will continue to closely monitor developments on the economic policy and regulatory fronts to evaluate the impact on Credicorp's operations. At Credicorp, we see clear signs of reactivation. The reprogrammed portfolio has stabilized, and there has been an increase in demand for financial products in the individual segment. Additionally, the pandemic has accelerated client migration to digital channels, which are driving a significant portion of the increase in transactions. Over the past few months, we have supported our clients as they adapt to new dynamics. We have actively offered debt reprogramming facilities to aid in recovery. Today, the reprogrammed portfolio represents 17.1% of Credicorp's total loans, with 11% related to the retail reprogrammed portfolio in Peru. The new COVID-19 guarantee program primarily targets a subset of this portfolio. To qualify, loans must meet specific term and amount caps, and the facility is only available to clients who have not received other government assistance. Given these restrictions, we do not anticipate a significant impact, but we continue to monitor our clients' needs to respond swiftly to changes. September marked a pivotal moment for loan origination and sales of insurance for retail and microfinance loans in October, with trends showing improvement. Our clients' adoption of digital channels, highlighted during the Investor Day presentation on our transformation strategy, continues to gain significant traction. All of these factors have helped Credicorp progress towards its goal of promoting a more inclusive economy. Going on to our third-quarter financial highlights results, it shows that the worst is behind us and Credicorp is on the road to recovery. It is important to note that there were several nonrecurring events this quarter. A summary of the results shows in a quarter-over-year analysis that the loan portfolio and deposit base grew more than 21% and 27% in quarter-end balances, driven mainly by loans from the government relief programs. After isolating the effect of these programs, Credicorp's structural loan portfolio fell in quarter-end balances. Net interest income resumed growth and increased 10.2% quarter-over-quarter, recovering from low-interest rate loan impairment. An analysis of the year-over-year evolution of adjusted interest income shows that adjusted interest income decreased 8.3%, driven by lower interest rates and a contraction in the structural loan partially offset by active investment portfolio management. While adjusted interest expenses fell 19.3% due to funding and structure optimization, in this context, adjusted net interest income contracted 4.3%. The cost of risk improved this quarter and situated at 3.84%. Forward-looking provision expenses fell compared to the previous quarter, reflecting an upward revision in the macroeconomic outlook and the fact that the probability of default has fallen in most segments, driven by improvements in client behavior. This quarter was marked by several nonrecurring charges that we will explain throughout the presentation for a total of PEN 185 million after taxes. In this context, Credicorp reported PEN 105 million in net income, which represents a return of equity of 1.8%. If we isolate nonrecurring charges, adjusted net income this quarter was PEN 289 million and adjusted ROE 4.9%. I will now explain the results of our main operating units. I will start by explaining BCP's standalone quarterly results. On a quarter-over-quarter basis, loan growth was driven mainly by the second tranche of the Reactiva program. Loans through this phase were disbursed primarily in the SME business and SME-Pyme segments. In this scenario, the total loan portfolio in both SME segments grew 34% while the total loan portfolio of BCP grew 4.5%. If we exclude Reactiva, BCP's structural portfolio contracted 4.9% this quarter, mainly driven by wholesale banking, where clients would pay liquidity facilities disbursed at the beginning of the crisis. Although the quarterly evolution of the structural loan portfolio in average daily balance contracted, it is important to note that loan origination in retail banking is gaining traction and is expected to reach pre-pandemic levels by year-end. The total loan and the structural loan portfolio posted 21.4% and 1.9% growth, respectively, in average daily balances year-over-year. BCP's funding structure has improved through active management. In the third quarter of 2020, total deposits grew 7% quarter-over-quarter, mainly driven by noninterest-bearing deposits and saving deposits, which increased 11% and 8%, respectively. In the year-over-year evolution, total deposits grew 30%. The year-over-year growth in deposits was led by noninterest-bearing demand deposits and saving deposits, which expanded 66% and 38%, respectively. In this context, BCP has been able to repay other sources of funding such as due to banks, repos, and senior bonds, which matured this quarter. Additionally, BCP executed a liability management transaction this quarter to extend subordinated bonds maturing in 2026 and 2027 at rates of 6.875% and 6.125%, respectively, for an $850 million subordinated bonds and 3.125% that matures in 2030 and is callable at 2025. Now I will comment on the evolution of payment behavior in retail banking at BCP and discuss the reprogrammed portfolio. In the third quarter, retail clients at BCP registered an improvement in payment behavior, hand-in-hand with the economic reactivation. On-time payment on structural retail loans due reached 94% at the end of September, improving from 72% in June. An analysis of payments performance shows that on-time payments on the structural retail loans due are different by subsegments. In the case of SMEs, the payment ratio for businesses that benefited from Reactiva loans was situated at 94% versus 88% for non-beneficiaries. In the case of individuals, the payment ratio is higher for BCP payroll clients who registered an on-time payment rate of 97% compared to 91% for non-payroll clients. By the end of September, 71% of the structural retail portfolio reported net current reprogramming facility. During the same month, BCP's reprogrammed retail portfolio situated at 23%, which is partly below the figure of 58% registered during the first wave of facilities. An analysis of the retail portfolio maturity profile reveals that high uncertainty portfolios are comprised of clients that are still within the grace period and have received at least one credit facility, or those that have overdue installments. Currently, 18% of BCP's structural retail portfolio falls within this category. As loans come due during the fourth quarter of this year, we will have more information to assess the performance and risk of these loans. The improvement in macroeconomic expectations and buying behavior indicators led provision expenses to drop this quarter. Nonetheless, asset quality began to deteriorate as grace periods expire and some clients were unable to service their debts. BCP's provision expenses decreased quarter-over-quarter due to improvement in expectations for GDP growth for 2021 and 2022, and fine-tuning of risk models and updating of client information to create a better picture of client situations. Provision expenses for the individual segment registered the highest decrease after significant provisioning in the second quarter this year. This quarter, provision expenses were mainly concentrated in SME-Pyme segments in the retail portfolio after delinquency levels rose among clients that benefited from more than one facility. Finally, wholesale banking provision expenses increased to cover a small number of clients in the energy and airline sectors. In this scenario, the structural cost of risk situated at 3.22% for the quarter and 5.33% year-to-date. Deterioration in structural loans was mainly concentrated in the consumer, credit cards, and SME-Pyme segments. Grace periods in the individual and SME segment will expire on average in October and December, respectively. As such, we expect overdue loans to increase in the individuals portfolio next quarter, particularly in the credit card and consumer segments, while overdue loans in the SME-Pyme are expected to rise in the first quarter of 2021. Credit card provision level and asset quality this quarter led to NPL coverage ratio to hit a record high of 157%. Finally, BCP's accumulated provisions represent 7.8% of the total structural portfolio. Next slide, please, going onto BCP's results. Net interest income initiated recovery and grew 10.2% quarter-over-quarter, recovering from low-interest rate loan impairment. An analysis of the adjusted net interest income evolution year-over-year shows that adjusted interest income decreased 8.2% due to a drop in market rates, which was partially offset by active investment portfolio management, and second, adjusted expenses fell 27% due to a drop in interest rates and funding optimization. In this context, adjusted net interest income fell 0.5% year-over-year. In contrast, NIM and structural NIM decreased due to several factors. First, BCP's structural NIM decreased 23 basis points quarter-over-quarter. The negative impact of lower interest rates was partially offset by active investment portfolio management, which increased term transformation while maintaining short-term liquidity positions and the optimization of the funding structure. Second, the loan mix was marked by a significant increase of Reactiva loans and a slight contraction in structural loans. And third, the decrease of 19 basis points in NIM due to nonrecurring expenses related to a liability management transaction conducted in July. Risk-adjusted NIM situated at 1.6% this quarter. In terms of nonfinancial income, core items increased 38% quarter-over-quarter, hand-in-hand with economic reactivation. The 50% quarter-over-quarter growth posted in Finco was driven by an upswing in transactions and an active reactivation fee waiver last quarter, in line with our client support plan. We expect our trend to continue in the coming months. Growth in noncore items was driven mainly by expansion in net gains and securities. Lastly, the efficiency rate of BCP improved quarter-over-quarter. Several short-term cost control measures have been applied, including reducing nonessential expenses and variable compensation. After adjusting operating income for the nonrecurring charges registered in the second and third quarter of this year, the adjusted efficiency ratio improved from 39.9% to 38.9% quarter-over-quarter. As explained during our Investor Day, BCP's transformation strategy is advancing, and we maintain our aspiration of becoming the most efficient bank in Latin America. In terms of nonfinancial income, core items increased 38% quarter-over-quarter, hand-in-hand with economic reactivation. The 50% quarter-over-quarter growth posted in Finco was driven by an upswing in transactions and an active reactivation fee waiver last quarter, in line with our client support plan. We expect our trend to continue in the coming months. With regard to microfinance, let me explain the dynamics of Mibanco's loan portfolio and deposit rate this quarter. Loan growth at Mibanco was attributable to government relief programs, mainly Reactiva. The second phase of Reactiva has qualifying requirements for micro and small businesses. As such, more of Mibanco's clients can tap into this facility. By the end of September, Mibanco had disbursed more than PEN 2.3 billion year-to-date under the Reactiva and FAE programs. The aforementioned led loans to grow 15.1% year-over-year measured in average daily balances. If we exclude government loans, the structural portfolio at Mibanco fell 3.4% year-over-year. In September, loan origination in Mibanco's structural portfolio began to recover, bolstered by new campaigns to support clients that are still within our risk appetite. Regarding Mibanco's funding structure, demand and saving deposits grew 26% quarter-over-quarter and 37% year-over-year. This evolution, coupled with an increase in funding from the Central Bank to finance disbursements of government loans, led the funding cost to fall 56 basis points quarter-over-quarter and 98 basis points year-over-year. Client payments at Mibanco are trending upwards, and the high uncertainty portfolio has considerably diminished. This quarter, Mibanco showed an increase in on-time payments and a drop in the facilities needed by its clients. By the end of September, the breakdown of our structural portfolio was as follows: 61% of loans were reprogrammed and up-to-date; 35% were non-reprogrammed up-to-date loans, and 4% were overdue loans. As mentioned previously, the high uncertainty portfolio is comprised of clients that are still within the grace period and have received at least one credit facility or those that are overdue. This portfolio has evolved positively at Mibanco as on-time payments increase. The COVID-19 environment continues to impact Mibanco's provision expenses. Growth in provisions was a result of the increase in the probability of default rate after client risk assessments were updated. This was partially offset by an improvement in the macroeconomic estimates of our forward-looking model. Expansion in provision expenses, coupled with a contraction in structural loan portfolio, led the structural cost of risk to situate at 6.1% on an annualized basis. In terms of portfolio quality, the structural NPL ratio rose to 9.3% in the third quarter. This was mainly attributable to an increase in refinancing for some clients that as of February 29, had less than 15 days overdue and delinquency among clients that did not utilize financial relief facilities. In this context, Mibanco's NPL coverage ratio increased and situated at 206.5%. Finally, Mibanco's accumulated provisions represented 19% of the total structural portfolio this quarter. Now let's look at Mibanco's performance. Net interest income and NIM were negatively impacted by the loan mix where low-margin government loans rather than structural loans drove growth. This negative effect was accentuated by accrued interest reversals after grace periods expired and some clients registered delinquency and a decrease in interest rates. If we exclude the effect of government programs, Mibanco's structural NIM is situated at 12%. This quarter, nonfinancial income began to recover, driven by an uptick in bancassurance, policies, and fees. Operating expenses decreased 7.3% year-over-year, which was attributable to cost-saving programs. Nonetheless, income decreased at a faster pace, leading to a deterioration in efficiency. Going forward, additional initiatives to improve efficiency include optimizing the network, centralizing processes, and improving the productivity of relationship managers through technology. In the bottom line, Mibanco generated a loss this quarter, which was mainly due to the contraction in net interest income and an increase in provision expenses. Now I will comment on the results of the insurance business. This quarter, Grupo Pacifico's net income was negative due to higher net claims in incurred but not reported provisions in the life business, especially for the credit life and disability and survivorship products, which were heavily impacted by the increase in mortality due to COVID-19. The property and casualty business results improved year-over-year due to a decrease in net claims, mainly in the car business due to mobility restrictions during the pandemic. In the quarter-over-quarter analysis, net premiums in the property and casualty business registered a recovery due to new sales and renewals, mainly in the car and medical assistance business. Results in the health insurance business improved year-over-year, driven by a drop in net claims after the demand for out-of-fashion services spurred during the pandemic. The health provider business registered a decrease in the demand for services due to occupancy limits at clinics and the fact that clients prefer to delay appointments in the COVID-19 context. Pacifico's regulatory capital coverage ratio increased from 1.3% at December 2019 to 1.33% as of September 2020, which was attributable to the earnings capitalization. Regarding the pension fund business, assets under management remained relatively stable quarter-over-quarter. Fund withdrawals and the government-mandated facilities were rarely offset by the combined effect of an increase in monthly contributions and growth in fund profitability. It is important to note that a bill passed on November 2 which allows additional withdrawals will impact assets under management by an estimated PEN 3 billion. Net income decreased quarter-over-quarter due to a decline in the profitability of the reserved funds, in line with the decrease in market profitability and nonrecurring expenses related to fee waivers and withdrawal facilities. This was partially offset by an increase in fees after fee waivers were lifted this quarter. In the year-over-year analysis, total fees decreased because a significant number of individuals in the affiliate base lost their jobs during the pandemic. Finally, a congressional commission is still evaluating comprehensive pension system reform. It is very difficult to predict how this will impact our business. Now to summarize the evolution of the main indicators. In line with improvement in payments and economic reactivation, provision expenses dropped quarter-over-quarter after achieving a peak in the second quarter. We expect this downward trend to continue. Asset quality deteriorated as grace periods expire and some remain unable to service their debts. Nonetheless, our coverage ratio increased year-over-year, situated at 169.9%. Net interest income increased 10.2% quarter-over-quarter. The analysis of adjusted net interest income on a year-over-year basis indicates that adjusted interest income decreased 8.3%, while adjusted interest expenses fell 19.3%. Consequently, adjusted net interest income contracted 4.3%. Credicorp's net interest margin this quarter situated at 4.05%. NIM was negatively impacted by a decrease in the structural NIM, the government programs' structural loan mix, and non-recurring charges related to bond exchange transactions. The structural NIM was situated at 4.46% for the quarter and 4.93% year-to-date. Finally, risk-adjusted NIM and structural risk-adjusted NIM situated at 1.6% and 1.87%, respectively. In this environment, we can offer a clearer picture of the medium term. We expect real GDP to grow between 9% and 12% in 2021. In terms of loan origination, our commercial activity is accelerating. By December of this year, we expect to return to pre-pandemic levels in the individual segments and achieve 75% to 85% of pre-pandemic levels in the SME and Microfinance segments. Regarding NIM, the negative impact of the government programs on NIM will level off, while structural NIM will benefit from a decrease in funding costs and active management of the investment portfolio. This, alongside property and casualty premiums, should continue to increase but will be partially offset by life claims. Provision expenses are expected to continue to follow a downward trend until 2021. We will continue to control expenses in 2020 and are fine-tuning BCP's operating models to determine the structural measures for the medium term. In Microfinance, measures are underway to optimize the branch network and improve the productivity of the sales force. Finally, we expect our ROE to return to the high teens by the second semester of 2022. With these comments, I would like to open the Q&A, please.

Our first question will come from Ernesto Gabilondo, Bank of America.

My first question is on provision charges. So we saw that they started to normalize to PEN 1.3 billion in the quarter. Is this a level we should continue to see during the last quarter? And then my second question is on your reprogrammed portfolio. As you mentioned in your presentation, retail banking reprogrammed portfolio is showing that 6% are value loans, while 12% fell in the grace period. I also noticed that you are presenting the same breakdown for individual, SME-Pyme, and SME business. So by any chance, if you look at the number of the reprogrammed portfolio at a consolidated basis indicating how much is overdue and how much will be resuming payments in the next months? Considering the overdue loans in each segment and the portfolio that will resume payments, do you think that the provisions created during the first half of the year will be enough to cover that portfolio? I just want to know if you have already created enough provisions, if you have achieved provisions or if they seem okay. And then my final question is on insurance revenues, which were affected by higher claims in life insurance due to the COVID-19. So I would like to hear your expectations for the insurance revenues in the next quarters.

Thank you, Ernesto. Regarding the questions on provisions, as we expected, we've seen quite an improvement in the levels of provisions during this third quarter compared to the second quarter. We expected to have a number closer to what we did in the first quarter. The cost difference, both in the macro environment as well as the performance of our clients, will make us feel quite positive towards the level of provision for the next quarter. We don't have a precise number today, but we see that positive trend continuing in the same direction. In terms of the reprogrammed portfolio, this is a long journey, and we've been helping our clients to reprogram their loans. Gradually, we've seen our clients, both SMEs and individual clients, starting to pay their loans at a better level than we expected initially. So in terms of whether we've done enough provisions, I mean, we are on the right trend towards provisioning what we need to do and that positive trend is expected to continue, especially during 2021.

Our next question will come from Jorge Kuri, Morgan Stanley.

Two questions, please. The first one is on your operating expenses. Your outlook slide said that operating model is being challenged to conduct structural medium-term measures. What exactly does that mean in terms of expense growth for 2021 and 2022? Your expense would have been, over the last 2 years, around 6% to 7%. If you may end up with around, I'm guessing, 7% to 8%, does that mean we are not going to see a slowdown in that level of growth for 2021 or 2022? Especially given the context of the very weak revenue growth, do you think that there's a chance for you to try to offset that by being more aggressive in cutting expenses, particularly next year?

What we aim for is to have income growing at a faster pace than expenses. These structural measures that we have mentioned are going to have a gradual impact in 2021 and be more visible in 2022. Short-term and continuous improvement measures have been taken in the last few years at the same time that we have spent more heavily on transformation. But these additional more structural measures are going to take time to mature.

So just to clarify, in terms of expense growth, does this mean your expenses will grow similar to the last 2 years, 7%, 8% or more than that?

We expect to be in this range, probably a little bit lower, in line with the increased level of activity in transactional activity and the offering of new and different products. What we try to manage more than the line itself is the ratio between fee income and expense growth.

Got it. My second question is on provisions. You built a very sensible amount of excess provisions given the NPL outlook and overall contraction in economic activity. At this point, do you think it’s possible to return to 1.5%, 1.6% cost of risk for the second half of 2021? I’m assuming you’re still going to have elevated costs of risk in the first half of the year, given that you’re going to start to see a wave of NPLs from the forbearance program rolling off. But again, given the significant amount of reserves that you have built, can we see that sort of like towards the second half of next year?

We are going to convert to more normal levels of provisions at the end of next year. But you also should consider that we are gradually changing the composition of the portfolio to a more retail one. So even with the same line-by-line, business-by-business level of provisions, the mix will lead to a slightly higher structural cost of risk due to the relative weights of the business.

And we understand what you're saying. So that, say, 2018 and 2019, your cost of risk was 1.5%, 1.6%. Given the mix composition shift, what would be the equivalent cost of risk?

I would say a little bit more than that at the end of next year. But it is going to be a gradual recovery, as Reynaldo mentioned. It’s not an on-off effect. You have a significant impact in the second quarter of this year. And after that, a gradual improvement.

So you think your cost of risk, say 2022, which hopefully, knock on wood, is a normal year is around 2%. Is that kind of like the way I’m reading through the lines?

We expect that, it's probably a little bit lower, yes.

It will depend on how we manage it. Please proceed.

I was mentioning that this figure is probably in the upper bounds for 2022. But it is going to be a gradual recovery.

Our next question will come from Thiago Batista, UBS.

Yes. I have one question on the margins. You already mentioned in the guidance that the government loans pressure your margin. So my question is, do you believe that when those programs end, the clients will be able to pay the same rates they used to pay before those government programs? So will they trend to return to the normal level once all those programs are ended? And the second question is about Mibanco. When do you believe Mibanco should achieve breakeven? And also, if you have any estimate on when the profitability of Mibanco should return to the high teens?

Okay. First, regarding the first question, I think when the government programs start to mature in the second part of next year, you are probably going to have declines of clients. Clients who have gone through the process, and they are starting to have normalized conditions. Clients that, even with this support, have become insolvent or unable to continue in business. Probably a third category are the clients who are going to need additional support, likely in the form of longer-term facilities. I think that all clients have understood that these are special conditions. When the facilities mature, they need to pay market rates based on the performance size on credit risk. That’s our belief. And for the second question, Mibanco is starting to recover as we mentioned. The difference is that the government programs and the reprogramming started a little bit later after BCP. In fact, government programs favor the Mibanco clients, mainly in the second wave. In the first wave, there were very few clients who could apply to that. So the recovery is going to happen and it’s a little bit after the case of BCP. We expect to have a much more positive year next year, of course. But the delay is going to be — the recovery is going to be slightly delayed in the case of Mibanco for the reasons I already mentioned.

Our next question will come from Tito Labarta, Goldman Sachs.

First question, following up on your margin. I would have expected a bigger increase in your margin. Just if I remember last quarter, you had some frozen installments. That had about a 70 basis points impact if I remember correctly. But your margin didn't really recover that much this quarter. Is that mostly because of more Reactiva loans? Or just to understand the dynamics here. Maybe another way to think about it, if you exclude Reactiva, what would your margin have been without the Reactiva loans?

Actually, I think the margin has panned out as we expected and we provided guidance. I will differentiate two different things. One is the NIM and another is the net interest margin as a figure, as a number. In terms of NIM, the figure is significantly diluted by the huge amount of Reactiva that has almost 0 margins or very low margins and was designed as such because it was a relief program. This is one part of the equation. But thinking about the net interest margin, it has been impacted and is recovering and the dynamics were explained. You had a sudden shock of lower reference rates, more than 200 basis points were a significant part of the cure, impacting your short-term facilities, and you also have smaller portfolios. Once we start to originate at a faster pace, a process that has already begun, we are starting to recover volumes with higher margins, and the NIM is going to expand. Another positive impact this quarter was the reduction in interest expenses, and the effect of this reduction will be carried out in the next quarters as a significant part of the process has already been done throughout the semester. I don't know if this helps.

Yes, no, very helpful, sir. So then maybe leading to my second question. To get back to the high teens ROE that you expect by 2022, what's going to be the main driver of that? Is it — are your margins normalizing? How dependent will that be on higher interest rates, on the Reactiva loans coming off your books? I know there are a lot of moving parts but then also provisions normalizing, maybe cost-cutting, just to get a sense of what it will take to — what do you think will be required to get to that high teens ROE by 2022?

Yes, but I would like to emphasize that it's in the second half of 2022, not for the whole of 2022. That’s an important point. The effects are going to be three-pronged, I would say. The markets will be recovering in line with the factors we have discussed. The provisions are going to be much more normalized and in line with the new portfolio composition. We are starting to gain efficiencies due to the execution of several initiatives. It should be noted that the general profitability is impacted in BCP, Mibanco, and all banks globally due to slower or lower interest rates. This impact is compensated by several measures, but it makes a difference on our books. Our assumption is that the interest rates are still going to be lower in 2022, both locally and internationally. So we expect to regain profitability levels, but with underlying, less profitable basic margins in several businesses due to lower reference rates.

Great. That’s helpful. So just to clarify on that last point, you can get back to the high teens ROE with interest rates where they are today. Is that correct or do you need interest rates to increase?

I think we can achieve that with lower interest rates, but applying those three levels that I have mentioned, we see our portfolio composition and higher efficiencies.

Our next question will come from Jason Mollin, Scotiabank.

You've addressed my questions on margins, provisions, costs. But maybe I can ask a general question on the outlook and the risk to that outlook of 9% to 12% real GDP growth and everything that follows on there. I mean, you've been seeing the reactivation. It's been impressive but from very low levels. What could derail this recovery? I guess, is it a second wave of COVID and lockdown? What are the risks to this outlook, I guess? If you could help frame that. And how is the group preparing for this kind of scenario, a negative scenario?

Okay. One significant risk, and I think not only for Credicorp, but globally, is a second wave, not only in terms of infections but also mortality, that will lead to some kind of shutdowns, severely impacting business activity and economic activity in general. This is one risk we are monitoring. One encouraging sign, but we take very prudently, is that the level of infections in Peru is very high. Different studies conducted using various statistical methods suggest that the level of infection in Peru can be as high as 50%. So even if we have a second wave, probably the impact in total infections and mortality should be attenuated. But this is a significant risk. The other potential risk is changes in regulation. We will have the elections next year. So far, it's not absolutely clear who is going to be the winner. We need probably much more time to have a clear picture. We don’t expect significant changes, but the risk is already there. The best protection for our business is to have a very strong balance sheet, a solid capitalized business, prudent risk management, and efficiency that allows us to operate even in less favorable environments, and we are working in this direction.

Mr. Correa.

Okay. Thank you. There was a question related to projections in insurance, and it's important to note that Peru has one of the highest infection or contagion rates in the world. This fact has two sides. On one side, the high number of deaths, as you have seen, has had a direct impact on our life portfolio. We have an important portfolio in Peru. It includes individual life, mortgage protection insurance, credit life insurance in general, for credit cards and small business owners across all socioeconomic segments. But on the other side, with that high contagion rate, we expect to be reaching a growth of regular rates in a few months. For example, during July and August, we had the highest levels of deaths in our country, more than 2.5 times compared to others. During October, the number of deaths was similar and even lower than the numbers we had in March, the first month of the pandemic in Peru. So we expect this trend to continue.

And for the net loss, we can see that there are no reductions in the life loss rate. In the P&C business, the situation has been the opposite, where lower economic activity and important parts of our clients working at home decreased the claims' frequency and reduced the loss rate.

Our next question will come from Geoffrey Elliott, Autonomous.

Can you help us a little bit more on net interest income? When is that expected to start inflecting and moving up on a recurring basis? Is that going to happen soon or do we have to wait a little bit longer?

So I couldn't hear the first part of the question very clearly.

Net interest income, when is that expected to start increasing again on a recurring basis once we've taken out the one-offs?

Actually, the process has begun in line with what we already explained. What’s happening is that this is starting to gain traction, but at a lower base due to the reduction in reference rates.

So just to be clear, so even though originations are going to be lower than they were pre-COVID, you still think that the 4Q recurring NII can be higher than the 3Q recurring NII?

Just because you start with a lower base of the case, at the level of origination that we are increasing the structural portfolio in BCP and in Mibanco. So it’s starting from a lower base. I repeat this point, we are expecting to build up the structural portfolio at this moment.

Our next question will come from Brian Flores at Citi.

I want to know how you are thinking about structural NPLs going forward, particularly in the second half of 2022.

Well, we'll probably see in the following quarters an increase in the NPL levels because actual problems in loans will appear in all segments, especially in SME and individual clients. But on the other side, we'll see an increase in the level of write-offs. Remember during the first half of the year, due to regulatory constraints, we didn't make the adequate levels of write-offs. The net effect, given the number of clients impacted, will show a shift to higher NPLs. But in general, it will be adequate levels compared to what we are expecting today.

And just as a quick follow-up, is there any particular segment of your portfolio concerning you based on the trends you are observing right now?

There are no surprises this quarter. We don't expect further surprises in the following quarters. I mean we see constant trends in both the SME and credit card segments of our portfolio. But there are no important shifts from what we've seen as of today.

Our next question will come from Carlos Gomez-Lopez, HSBC.

I wonder if you could comment on the legislative initiatives that could impose either lower fees or capital interest rates at the Peruvian banks. We know that a proposal was proposed at the committee level. What do you think are the chances of this happening and the potential impact on your numbers? And a small follow-up, do you have any additional processes for Madoff at AFP? Is that a one-off? Or are there any outstanding contingencies that we might still see in the future?

Regarding the first question, there are some initiatives at the commission level in Congress. It's too soon to tell if any of these initiatives will go to discussion in Congress, and if so, if they're approved and what the impact would be. Our vision is that what Peru needs in the financial system is small financial inclusion, and any of these initiatives would generate financial exclusion, which is exactly the opposite impact. As I mentioned before, it's too soon to tell if any of these initiatives will become law and if so, what the impact would be.

Regarding Madoff, we have made a provision because there was a recent ruling by the Supreme Court that did not go in our favor. So we decided to make this provision, and we think that this is the end of it.

Our next question will come from Piedad Alessandri, Credicorp Capital.

I want to know regarding the corporate cases that were announced. If you could give us a bit more detail on those cases you announced in the energy and airline sector, did you see any segment behaving riskier?

As you probably know, we don't get into specific details in terms of the specific cases of our clients in the corporate world. However, we can confirm that we have established all the necessary provisions to cover the expected losses in those two cases. We don’t expect any new big cases in the near term.

Our next question will come from Andres Soto, Santander.

My question is related to the deal that was approved one month ago regarding reprogramming and guarantees for retail loans, including SMEs. I understand you’ve already mentioned you don’t expect material impact from that. By that, I understand that when you refer to impact, you mean that on the balance, it will be a negative one considering that it reduces your net interest income versus the reduction that you will get via the guarantee in your cost of risk. So I would like to confirm that, is it the case you are expecting that on the balance to be a negative one, even if it is small? And in the end, this will depend on the level of adoption or the enrollment that you guys take up in your client portfolio? I’m also curious about the rate of adoption you are assuming to expect this to have a marginal impact.

We expect to have, as we previously mentioned, a moderate impact. It’s difficult to say exactly what because it depends on the level of adoption and the specific type of clients that will access the facility. But I would like to emphasize that you are going to capture the costs and benefits in different lines and probably at different moments in time. What do I mean? You are going to have an immediate reduction in margins, but a deferred benefit in the cost of risk.

Just to complement what Cesar just mentioned, due to the amount that was assigned, we don’t see — these are two programs, sir. Because of the amount assigned, we don’t see this going to be a massive program. What's assigned by the government, I mean, on one hand. On the other hand, we basically restructured all of our portfolio, all of our clients that needed restructuring. So we don't see a large demand from our client base. Having said that, we are going to work proactively in helping the clients that need it and obviously trying to balance that with demand from other relatively smaller financial institutions that have not been as proactive as BCP in restructuring their clients' loans before.

Our next question will come from Yuri Fernandes, JPMorgan.

I have two. The first one is a follow-up on the margins. I understood the message that you should kind of stabilize or even improve a little bit from the current levels. But I have some doubt here regarding first, the overdue loans have increased, as I said, right, like the nonaccrual loans only pay for the increase. In the next quarter, in pricing, it’s probably in 2021, in the first quarter in 2021. And you also have a new government program that I understood may be super vocal in the program because, again, you have a lot of renegotiations already. The size of the guarantee is not that big. But should that be a headwind on margins? Yes, I just would like to confirm that, yes, margins should move slightly up from the current levels and that we are taking consideration through all moving parts, the nonaccrual loans and also the renegotiated program.

Yes, in our calculations, we are considering the nonaccrual of the delinquent loans. This is going to negatively impact the margins; however, it’s part of the assumptions we have when we provide this guidance. The process is going to be gradual because in accounting terms, you accrue and when you have the actual default, you reverse the accrual, which diminishes the income. This is going to happen gradually as we have seen happening in the last quarter. I think that answers your question.

Yes, and in terms of allowances for bad loans, as we have been mentioning throughout the call, the values have been positive, and the trends have been better than we initially expected. However, there's still at BCP, what we call an 18% high uncertainty portfolio. These are clients that haven’t started paying their debts yet. They are in their grace period. In Mibanco, that figure starts around 43%. So the reversions will depend on the performance of those high uncertainty portfolios in COVID situations.

To add to Reynaldo's response, for example, in the case of BCP in September, we had uncertain portfolio of around PEN 42 billion. Out of them, PEN 34 billion already had the obligation to make a payment during the month. For that reason, we talk about an uncertain portfolio because not every client has the obligation to pay due to the reprogramming process.

Our next question will come from Sergey Dubin, Harding Loevner.

Yes, two questions from my side. The first one, just a clarification. You mentioned something about capital ratios calculated according to Peruvian standards versus capital ratios calculated to IFRS, I guess, or some other standards. So can you clarify exactly what the differences are and what's the impact on these ratios?

The difference is that in normal times, the difference between incurred losses and forward-looking provisions is very small, so we don’t make any difference. To give you an idea, in the case of BCP, at the end of September, the difference between local and international accounting in terms of provisions is PEN 1.2 billion, out of PEN 7.7 billion. So in local accounting, you have lower provisions and a higher profit. And this impacts the level of capital. I can be probably accurate, but the difference can be around 50, 60 basis points. In the case of Mibanco, the relative difference is slightly higher. The difference is PEN 500 million out of PEN 1.8 billion in provisions. So you have more than 300 basis points difference when you consider local and international accounting.

Right. So what you show on your presentation in Slide 30, basically, these graphs show that BCP's stand-alone CET1 is 11.5% and Mibanco CET1 is 16.5%. Are these numbers calculated according to IFRS or according to Peruvian local standards?

No. It's local accounting. It’s local standards. So the IFRS number is going to be lower.

Right. So for Peruvian, that’s what you show. For IFRS, it would be 11.5% minus 60 bps. And for Mibanco it would be 16.5% minus 300 bps, correct?

Yes, more or less.

Okay. Okay. That’s helpful. My second question is on Madoff. Again, this is one of those issues where I’d like to have some more clarity. It looks like you have 71.9% legal contingency. How did this contingency arise? The Madoff scandal happened 12 years ago. Why are you just showing this now? Can you give some background, some color around this whole issue?

This relates to Mr. Picard, who is the court-appointed liquidator, and us trying to articulate clawback initiatives against some of the investors, I guess there are about 400 of them. Recent rulings by the Supreme Court of the United States are not favorable to the utilization of the extra-territoriality arguments. So we found it prudent to create provisions just to cover potential claims.

So does it mean that you will be liable? Like you think that in a worst-case scenario, you could be liable to pay PEN 72 million to this court-appointed trustee for the Madoff case? Is that correct?

Well, we hope not, but we thought it was prudent to create the provision.

Okay. Okay. Now that you said that’s very clear, but before, it was very vague. So now that you clarified it, it’s good. My last question is about the assets under management in your fund management business. You said that it could be something like PEN 3 billion withdrawal. Can you give some more color around that particular issue?

We are talking about Prima. Prima is a private pension fund manager. A new legislation allows clients to withdraw funds. The estimated amount of the new funds that will be withdrawn according to this legislation is PEN 3 billion.

And is that, again, a worst-case scenario that if everyone who can withdraw chooses to withdraw? Or is that your estimate of a realistic scenario?

It's our best guess. It’s our best estimate based on previous withdrawal authorization processes. It’s not the first one.

I think it's about 7% of the total assets under management. Just an additional clarification, please refer to the 20F where all this Madoff stuff is fully disclosed, and you can get a lot more information there if you need to.

And now I would like to turn the conference back to Mr. Walter Bayly, Chief Executive Officer, for closing remarks.

Thank you, Shantal. Thank you to all of you. This has been a very encouraging and important quarter for us. We now have shown the market evidence of what we have been perceiving in the last couple of months, mainly that we are past the inflection point on several fronts. On the health side, the numbers reported are very encouraging, and hopefully, they will continue this way. The economic activity and the second front is coming back to normal levels. On several fronts, we are already there and we estimate that by year-end or the first quarter of next year at the latest, we will be substantially on pre-COVID levels on a monthly basis. The third and last inflection point refers to the impact of this very severe downturn in our portfolio. The numbers we have shown for this last quarter clearly indicate this inflection point, and we continue to see improvements week by week. We are emerging from the most severe economic crisis in the last 100 years. We think it is unrealistic to expect the situation to normalize in 1 or 2 quarters. The recovery path is laid out. And as we have indicated in our guidelines, we expect to be back to returns on equity in the high teens in the second half of 2022. Our franchises continue to be strong. The path to change and evolve our business models and distribution to digital technologies has accelerated and continues to be a key element of our strategy. We thank you very much for your continued support. And with this, I conclude our quarterly phone call. Thank you very much.

Thank you very much, ladies and gentlemen. This now concludes today's presentation. You may now disconnect your phones, and have a great weekend. Thank you.