Earnings Call
Credicorp Ltd (BAP)
Earnings Call Transcript - BAP Q4 2020
Operator, Operator
Good morning, everyone. I would like to welcome you all to the Credicorp Ltd Fourth Quarter 2020 Conference Call. We now have all of our speakers in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of today's presentation we will open the floor for questions and at that time instructions will be given as to the procedure to follow if you would like to ask a question. With us today is Mr. Walter Bayly, Chief Executive Officer; Mr. Gianfranco Ferrari, Deputy Chief Executive Officer; Mr. Alvaro Correa, Deputy Chief Executive Officer; Mr. Reynaldo Llosa, Chief Risk Officer; Mr. Cesar Rios, Chief Financial Officer and; Milagros Cigüeñas, Investor Relations Officer. And now it is my pleasure to turn the conference over to Credicorp's Chief Financial Officer, Mr. Cesar Rios. Mr. Rios, you may now begin.
Cesar Rios, CFO
Thank you. Good morning and welcome to Credicorp's conference call on our revenue results for the fourth quarter of 2020. Since our previous conference call, economic reactivation in Peru has continued at a very unexpected pace. In seasonally adjusted terms, GDP in the last quarter of 2020 stands around 3% below the pre-pandemic levels. Our estimates suggest GDP decline around 11.3% in 2020 due to the COVID-19 pandemic, which is better than initially forecast. The job market has also continued to recover as indicated by data on payrolls managed through the banking sector. The external sector has also provided favorably, as copper prices have reached levels not seen in almost eight years. We expect the GDP to rebound between 8% and 10% in 2021, underpinned by high copper prices, capital inflows to emerging markets, and expansive monetary or fiscal policies on the local front. Next slide please. Two significant factors are driving uncertainty in the core economics. First, the sanitary situation generated by COVID-19 has deteriorated in developed and emerging countries over the last few weeks. The Peru's data on excess mortality reflects this reality. The government has established restriction measures based on the severity of COVID-19 indicators, which include high, very high, and extremely risky levels. On January 28, the government ordered a new focused lockdown from January 31 to February 14 in regions that registered extreme risk levels of COVID-19 indicators, including Metropolitan Lima. The effect of these restrictions will slow down the recovery in the government and service sectors, but other sectors such as mining, fishing, manufacturing, and construction will continue to produce. Downside risk to our current GDP growth forecast of 8% to 10% might revise if the sanitary situation deteriorates further and more restrictive lockdowns are mandated. However, vaccine doses will arrive in Peru in February and the vaccination process will begin immediately. Second, Peru will hold general elections from April 11, 2021. The latest survey shows candidate George Forsyth leading voters' preferences with 17% of total votes, followed by Keiko Fujimori, Julio Guzman, Verónika Mendoza, and Yhony Lescano, who are neck and neck for second place as of the date of the poll. It is still early to predict outcomes. The political landscape continues to be marked by the uncertainty that will play out in the coming months. It is important to note that according to the latest surveys, 25% of voters are undecided, intend to leave their vote blank, or will invalidate their ballots. The second round of the presidential election is set to be held on June 6, 2021. Other relevant events in countries in which Credicorp operates include a law passed in Bolivia in January 2021, which leaves eligible borrowers the option of a six-month grace period. This facility is in addition to the loan deferrals implemented in 2020, resulting in both interest reversals and zero interest rate impairment charges in December 2020. We are closely monitoring the impact of these measures on our business at BCP Bolivia. In Chile, elections will be held on April 11 to elect members of the Constitutional Assembly, Regional Governors, Mayors, and Councilmen. General elections are set for November 2021. Next slide please. The Peruvian financial system has evolved favorably hand in hand with economic recovery in the last quarter of 2020. According to data from the Central Bank, loan growth in December stood at 12.3% year-over-year at a constant exchange rate, the highest growth rate since 2013, underpinned by the effects of Reactiva loans. If we include the effects of Reactiva loans, total loans—sorry, if we exclude the effects of Reactiva loans, total loans declined 4.6% year-over-year. Importantly, there are signals of recovery in loan originations in the retail segment, which includes consumer and mortgage loans. In this context, Peru boasted one of the highest loan growth rates in the region in 2020. For 2021, we expect total financial system loans in Peru to grow around 3% as the effect of Reactiva loans starts to recede. Lastly, I would like to comment on recent events regarding economic policy and regulatory fronts in Peru. The Central Bank recently announced monetary measures to expand long-term credit. This technical difficulty—I’m not sure if you see. At the end of December 2020, Congress passed a law for an interest rate ceiling. These ceilings will be set by the Central Bank, which will also set limits on charges for certain fees in the financial system. On February 2, the executive branch announced its intention to take the matter to the constitutional court if Congress insists on passing these measures. Additionally, the Minister of Finance has approved a decree that enables SUNAT, the National Superintendency of Tax Administration, to gain access to client deposit information if balances exceed PEN30,800. Lastly, on January 28, 2021, the government announced the COVID-19 government guarantees program directed toward individual SMEs, which will be extended until March 21, 2021. As explained in our last call, under this initiative, banks can also reduce the interest rate on reprogramming facilities in exchange for additional government loan progress for very specific segments of clients. We will continue to closely monitor these developments to evaluate their impact on Credicorp's operations. Next slide please. Economic reactivation described earlier is evident at Credicorp's end market by a significant uptick in the use of digital channels. Demand for financial goals in individual segments continues to reactivate. Some products such as Mortgages and Bancassurance registered a significant recovery in the fourth quarter of 2020. Digital sales in particular accelerated this quarter and on a full year basis grew 72% in 2020. This expansion took place in the context of growth in the adoption of digital channels due to immobilization measures and social distancing. Bancassurance and advance of wages are the products that reported the highest growth in sales this quarter costing expansion above 400% with respect to general estimates. Analyzing the full year transactional trends we found, first, average monthly number of transactions grew 51.5%, led by VISA transactions that grew 91.5%. Second, digital transactions have contributed to 77.7% of total transactions this quarter. The largest increase in shares of transactions was registered by Yape, which represents 19% of total transactions this quarter compared to 5% in the first quarter this year. This expansion was driven by our new product Yapecard, which allows BCP and non-BCP clients to execute transactions. This new product generated more than 1 million new Yape accounts in 2020 and banked almost 400,000 people during the same period. Next slide please. Now I will comment on the highlights of Credicorp's performance in the fourth quarter and the full year 2020. Results show a quarterly recovery in line with economic reactivation. A summary of results shows a year-over-year analysis, the loan portfolio grew more than 19% in quarter-end balances, driven mainly by loans on the government relief programs. After isolating the effect of these programs, Credicorp's structured loan portfolio trailed 2.2% in quarter-end balances. On a quarterly basis, net interest income registered a contraction of 4.3% due to the impact of non-recurring events and zero-interest rate loan impairment charges in Bolivia in particular. If we isolate non-recurring events, adjusted net income fell by 0.8%. On a full year basis, adjusted net interest income contracted 1%. This evolution was fueled by lower interest rates and a less profitable asset mix, which was partially offset by the reduction in interest expenses generated by a lower cost funding structure. In this context, the full-year structural NIM situated at 4.78%. Non-financial income was boosted this quarter by fee income, which increased 20.7% quarter-over-quarter, in line with more transactional activity and expiration of fee waivers. In full-year results, non-financial income dropped 10% due to a decrease in transactional activity throughout the year. Full year insurance underwriting results were impacted by COVID-19 related incurred but not reported claims in the life business, which was partially offset by a decrease in property and casualty claims. Provision expenses fell considerably this quarter; better economic expectations and improvements in client behavior led to a structural cost of risk of 2.44% this quarter. In full-year terms, the structural cost of risk was 5.07% in 2020. In this context, Credicorp reported PEN653 million in net income this quarter, which represents a return on equity of 10.8%. On a full year basis, Credicorp generated PEN347 million. If we isolate non-recurring events, adjusted net income for 2020 situates at PEN725 million and adjusted ROE at 3.5%. I'll now explain the results of our main operating units. Next slide please. I will begin by explaining BCP's standalone evolution. In 2020, the total loans portfolio in year-end balances grew 18.8%, driven by the Reactiva loans, while the structural loan portfolio decreased 4.1%. Now let me explain in further detail the evolution of average daily balances, which are major drivers of margins. On a quarter-over-quarter basis, loans in average daily balances grew 1.4%, driven by Reactiva loans, while the structural portfolio dropped 2.5% due to a contraction in the wholesale and SME segments. On a full year basis, total loan growth in average daily balances of 17.1% was mainly driven by the Reactiva program, which provided loans primarily to the middle market, SME-Business, and SME-Pyme segments. If we exclude the Reactiva program, BCP's structural loan portfolio in average daily balances grew 4.1% in 2020, mainly driven by corporate banking, mortgages, and consumer loans, which expanded 7.5%, 7.2%, and 13.1%, respectively. BCP's funding structure has improved due to active liability management and the increase of savings and demand deposits. On a full year basis, total deposits grew 30% led by low-cost deposits. In 2020, BCP materially reduced its funding costs. It has been able to repay more expensive sources of funding, such as due to bank, Repos, and Senior bonds, and has seized opportunities in the context of low interest rates to implement a timely liability management strategy. Next slide please. Regarding payment behavior under the reprogram portfolio in retail banking at BCP, in the fourth quarter, retail clients registered an improvement in the payment behavior in line with economic reactivation. On-time payments on the structured retail loans reached 96% at the end of December, improving from 94% in September. By the end of the year, only 20% of the retail portfolio was under reprogramming facilities compared to 23% in September. Finally, our high uncertainty portfolio, which is comprised of loans that are within a grace period or those that have overdue installments currently, represents 9% of the structural loan compared to 18% last quarter. In this portfolio, at the end of the fourth quarter of 2020, only 3% of the structural loans were still within a grace period and 6% were overdue. Next slide please. Now let me explain the evolution of cost of risk and asset quality indicators. On a quarter-over-quarter basis, the decrease in provision expenses is attributable to an improvement in macroeconomic expectations and updates in the probability of default of the specific segments based on the latest assessments of transactional and payment behavior. On a full-year basis, provision expenses growth was mainly concentrated in the individual segments, specifically consumer. In addition, higher wholesale banking provision expenses were driven by the evolution of specific clients in the Airline, Tourism, Transportation, and Energy sectors, which have been highly impacted in the COVID-19 context. In this scenario, the structural cost of risk situated at 2.73% for the quarter and 4.74% for the full year. As anticipated in our last call, figures for asset quality show deterioration quarter-over-quarter, particularly in structural loans in the individual segment, given that credit card and consumer grace periods have expired. This was partially offset by a rebooting of write-offs, which initiated in September after a legislative mandate to freeze the counting of days of delinquency expired. We expect further deterioration in the first half of 2020, particularly in the SME segment as grace periods in this segment will expire. In the aforementioned context, the NPL coverage ratio situated at 145.1%. Finally, this accumulated provisions represent 7.92% of the total structural portfolio. Next slide please. Going on to BCP results, net interest income continues to follow an upward trend and rose 5.9% quarter-over-quarter. In full-year figures, net interest income declined 2.4%, impacted by non-recurring events throughout the year. If we exclude non-recurring events, the full year adjusted net income analysis shows, first, a decreasing adjusted interest income of 4.2% due to a drop in market rates and a change in the asset mix, which was partially offset by active investment portfolio management. Second, adjusted interest expenses fell by 18.2% due to a drop in interest rates and funding structural improvements. In this context, adjusted net interest income rose by 0.8% in 2020. In terms of NIM, the full-year contraction of 87 basis points was attributable to the aforementioned variations and to the dilution effects of Reactiva loans, which generate negligible NIM. Risk adjusted NIM situated at 2.28% this quarter, and 1.03% in 2020. Regarding non-financial income, in terms of the quarterly evolution, core items grew by 13.2% unencumbered by economic reactivation. This was the first full quarter free of the exceptions, and as a result, fee income expanded 12%. Additionally, alongside an uptick in transactions gained, NIM-based transactions grew by 18.1%. On a full-year basis, non-financial income fell 11%, mainly driven by fee income and gains on FX transactions, which declined by 12.1% and 11%, respectively, due to a decrease in transactional activity over the year. Next slide please. BCP's efficiency ratio improved year-over-year after cost control measures were implemented in 2020, including reduced non-essential expenses and variable compensation. In full-year terms, although operating income contracted 5.4%, BCP's adjusted efficiency ratio remained stable at 14.9%. This evolution was a result of our efforts to speed up the process of implementing BCP's transformation strategy, which focuses on improving the client experience and efficiency levels. The table in this slide shows our progress and the rising efficiency drivers to move forward on our journey to optimize our cost-to-income ratio. First, we accelerated our IT investments to enhance digitalization; the share of digital transactions grew by 16 percentage points, and also 55% of our clients are digital. We were able to close 20 branches this year. Next slide please. With regard to microfinance, let me explain the dynamics of Mibanco's loan portfolio and funding base. In 2020, the total loan portfolio in year-end balances grew by 20.5%, while the structural loan portfolio decreased by 6%. The structural portfolio construction is explained by the severe impact of the pandemic on the micro businesses segment, and the fact that liquidity was provided by clients to the government programs. Now let me explain in detail the evolution of average daily balances, which are major drivers of margins. On a quarter-over-quarter basis, loans in average daily balances grew by 9.4%, driven by the launch of government programs, while the structural portfolio grew 1.4%. On a full-year basis, the total loan portfolio grew by 13.4% in average daily balances, driven by government programs, while the structural loan portfolio grew by 1%. With the onset of economic reactivation during the second semester of 2020, origination levels for Mibanco's structural portfolio began to recover in segments that are still within our risk appetite. Regarding the evolution of funding at Mibanco, demand and saving deposits grew 37% year-over-year, which allowed us to reduce the share of more expensive funding sources in total funding. All these factors led to a structural funding cost falling from 4.2% in 2019 to 3.3% in 2020. Next slide please. Client payments at Mibanco continued to follow our upward trend, and the high uncertainty portfolio has shrunk considerably. Mibanco's client payment performance showed substantial improvement, and there was a drop in requests for new reprogramming facilities as grace periods expired in a context of economic reactivation. Moreover, overdue payments remained stable this quarter. Analyzing the structural portfolio reprogramming figures, we note, first, non-recurring up-to-date loans increased this quarter to represent 49% of the structural loans at the end of December. Second, the overdue portfolio has slightly increased this quarter as planning facilities start and reached 6% for the structural loans. Finally, the high uncertainty portfolio, which is comprised of loans that are within a grace period or those that have overdue installments, currently represents 24% of the structural loans compared to 43% last quarter in this portfolio. At the end of the fourth quarter of 2020, 18% of the structural loans were still within a grace period. The majority of these periods will end by June 2021 and the remainder by the end of 2021. Next slide please. Regarding asset quality indicators, provision expenses decreased quarter-over-quarter due to adjustments in our credit risk model after better-than-expected trends in client behavior were registered in a context of economic reactivation. This improvement was partially offset by an increase in delinquency as grace periods expired. This evolution coupled with the expansion of the structural loan portfolio led the structural cost of risk to situate at 4.7% this quarter. In full-year terms, this structural cost of risk stood at 10.6% in 2020. In terms of portfolio quality, the structural NPL ratio rose to 10.2% in 2020. Delinquency showed an uptick as grace periods expired and some clients were unable to make payments. The increase in NPLs was partially attenuated by a reboot of charge-offs. In this context, Mibanco's NPL coverage ratio increased to 117% in 2020. Next slide please. Now let's look at Mibanco's results. Net interest income fell by 6.4% quarter-over-quarter after being hit by accrual interest reversal and grace periods expiring as some clients registered delinquency. In full-year figures, net interest income declined by 18.4%, impacted by, first, a contraction in the structural portfolio and the influence of the government program loans. The context of lower interest rates and the interest rate figures is due to an increase in delinquency situations. In terms of NIM, the full-year contraction of 400 basis points was attributable to the aforementioned variations and partially offset by an improvement in the funding structure. In this context, NIM stood at 3.2% in 2020. Regarding efficiency, full-year operating expenses decreased by 6.3% due to cost-control initiatives, including a reduction in headcount, non-core expenses, variable compensation, among others. Although non-financial income reflected an uptick in bank assurance fees for quality assurance to our current portfolio, operating income dropped at a faster pace than operating expenses, leading to a deterioration in efficiency. Next slide please. Now I will comment on the results of the Insurance business. On a full-year basis, net income decreased due to growth in provisions related to excess mortality for COVID-19. This was partially offset by lower claims in the P&C business. The decrease in claims in the P&C business was attributable to a drop in cases, mainly in the cost line and personal line, after movements were restricted to combat contagion. Life net premiums increased through the alliance channel and due to an increase in sales in the Bancassurance channel. An analysis of the evolution of provisions this quarter indicates that there was a decrease in incurred but not reported provisions in the life insurance business after fewer COVID-19 related cases were reported. On a year-over-year basis, however, claims increased by 59.8%, mainly due to the impact of COVID-19. On a quarterly basis, corporate health insurance and medical services registered an increase in net income. This evolution is explained by lower claims at the corporate health insurance business and higher demand for medical services. On a full-year basis, net income increased due to a drop in net claims in corporate health insurance, which was attenuated by a decrease in medical service income due to lower demand. Next slide please. Regarding the pension fund business, assets under management and the fiscal level dropped year-over-year due to higher withdrawals under the government-mandated facilities. In the case of Prima, total fund withdrawals amounted to PEN7.5 billion, which represents 70% of the fund that was available for withdrawal. The law, which is under consideration by the executive in November, could lead to traditional withdrawals in the first quarter of 2021 for approximately PEN3.4 billion. Net income increased quarter-over-quarter due to a recovery in the profitability of the reserve funds in line with market performance. Nonetheless, it was partially offset by a decrease in income due to a decrease in affiliate contributions. On a full-year basis, total fees decreased due to, first, higher unemployment, which reduced the level of contributions; second, contribution exemptions granted by the government in April; and finally, a decrease in assets under management levels after funds were withdrawn under government-mandated facilities. Next slide please. Regarding our investment banking and wealth management businesses, total assets under management posted an increase of 34.5% over the year, impacted by the exchange rate and driven by the asset management businesses in general and the subscription of the third-party funds from institutional buyers in particular. On a quarterly basis, recurring income grew by 4.1%, mainly driven by asset management and corporate finance businesses. In full-year terms, the decrease in the earnings contribution was mainly associated with growth in recurring expenses, which was internally driven by transformation in the operating model and by one-off expenses from new subsidiaries. This was partially offset by growth in recurring income mainly due to capital markets and asset management businesses. Non-recurring results also contributed to gains of 24 million in a context in which non-recurring income outweighed non-recurring expenses. Next slide please. Now, I will summarize Credicorp's consolidated performance. An analysis of the balance sheet structure shows that Credicorp's interest-earning assets increased by 29% in 2020, driven by both the loan and the investment portfolio. We increased the size and duration of the investment portfolio while maintaining interest rate risk and solid short-term liquidity. In 2020, Credicorp's loan portfolio in year-end balances grew by 19.1%, driven by government programs, while the structural loan portfolio decreased by 2.2%. On average daily balances on a full-year basis, the loan portfolio grew by 15.8% while the structural loan portfolio grew by 4%. As explained throughout our lines of businesses, these assets have been financed mainly through low-cost funding sources. Additionally, we executed our inaugural international bond issuance at the holding company level this year to increase our liquidity portfolio. Next slide, please. Now, to summarize the evolution of the main risk indicator, there was a significant quarter-over-quarter drop in provision expenses, which was attributable to an improvement in expectations for 2021 and to an improvement in client statements this April. On a full-year basis, work in provision expenses reflected the impact of COVID-19, which led to a structural cost of risk of 5.07%. Regarding asset quality, NPL increased quarter-over-quarter as grace periods expired. Our coverage ratio increased year-over-year and is situated at 156.1%. It is important to note that NIM this quarter was impacted by a zero-interest rate loan impairment charge of PEN148 million in a context of regulatory changes in Bolivia. On a full-year basis, NIM contracted and is situated at 4.3% due to new construction structurally, the impact of government programs, and zero-interest rate impairments. Next page, please. In terms of full-year efficiency, the cost-to-income ratio is situated at 46.3%, deterioration was driven by lower income and non-recurring events in most of our lines of businesses. The deterioration attributed to microfinance was driven by a decrease in income from Mibanco Peru under the consolidation of Mibanco Columbia. Common equity Tier 1 level for both BCP and Mibanco remain above our internal target, situated at 11.4% and 18.1%, respectively. It is important to mention that the capital ratio of Mibanco increased due to a capital contribution of PEN400 million executed in December. As mentioned previously, our core equity Tier 1 ratios are calculated under the Peruvian GAAP accounting charge, using local net income figures. Next slide please. Credicorp generated PEN653 million in net income this quarter, which represents a 10.8% ROE. If we isolate non-recurring events registered this quarter, adjusted net income is PEN725 million, while the adjusted ROE is situated at 12%. It is important to mention that this year, non-recurring events refer to impacts on income and expenses that were registered in our P&L but are not part of our recurring business channel. We are not expected to recur on a consistent basis going forward. It is important to note that some variable costs such as variable compensation payments and that withholding provisions this year due to the crisis and a drop in income. We expect that going forward, these variable costs will reactivate in a context of ongoing. To review our expectations, let's go on to guidance. Next page, please. In a context with uncertainties remaining, our expectations for 2021 assume that the lockdown will be lesser and shorter than those imposed last year. As one of the economies that was hardest hit by the pandemic in 2020, we expect Peru's GDP to recover in 2021 and grow between 8% and 10%. In terms of loan origination, we expect our commercial transactions to continue on our trend into 2021. As such, we project growth between 4% and 8% in our balances. For the total portfolio, this will be driven mainly by the retained statement at BCP and alone and by new banks. Regarding NIM, we expect interest rates to remain low in 2021, and our loan portfolio will continue to be impacted by the presence of low-interest-rate government loans. Accordingly, we expect NIM to sit between 3.9% and 4.4%. As macroeconomic expectations continue to improve, provision for loan losses are expected to continue following a downward trend, bringing the cost of risk levels between 1.8% and 2.3%. We expect to recover our capacity to generate income this year and believe that 2021 will be a year of transition in terms of efficiency. In this context, we expect some variable costs such as variable compensation and recall to reactivate alongside higher income. Additionally, in 2021, we will continue investing in digital channels and in transforming our operating volume to boost efficiency in coming years. In this scenario, the efficiency ratio is expected to situate between 44% and 46% this year. Finally, we expect our ROE to reduce to a lower double-digit level this year, first time between 10% and 14%. With these comments, I would like to open the Q&A, please.
Operator, Operator
Thank you. Our first question comes from Ernesto Gabilondo with Bank of America.
Ernesto Gabilondo, Analyst
Hi, good morning, Walter, Alvaro, Gianfranco, Reynaldo, and Cesar. Franco, my first question is from the regulatory outlook. So the observation of President, I ask you the government is a potential deal of interest rate cuts and also any observations continuing too much on alliance private pension funds. However, we have seen that Congress is expected to continue to pressure on both deals in the next couple of days. So what is the probability that you're seeing on the back and can you share with us which percentage of your loan portfolio if your interest rates above 80%? Thank you.
Gianfranco Ferrari, Deputy CEO
Ernesto, thank you for your questions; I'll try to tackle some of the questions that you posted. I think certainly we have some recent horizon. The law that put caps on commissions and interest rates is still going to be—I'd say probably a lengthy period of discussion. It's probably too early to have an exact assessment. But if this law rolls and passes through all the processes and debate, it is probably going to impact more severely institutions that operate in the very high-interest-rate segments, particularly specialized institutions, and probably have a less severe impact on the universal banking institutions in the country. Nevertheless, it's going to damage access to credit and reduce access to credit for a significant number of Peruvians.
Ernesto Gabilondo, Analyst
So you can share with us what percentage of your loan portfolio is going to reap above 50% if you haven't—
Gianfranco Ferrari, Deputy CEO
Excuse me, I couldn't understand the question very well.
Ernesto Gabilondo, Analyst
Yes. Can you share what is your percentage of your loan portfolio with interest rates above 50%?
Gianfranco Ferrari, Deputy CEO
I don't have the figures on hand. We can come back with some general guidance further on.
Reynaldo Llosa, CRO
Ernesto, this is Reynaldo. Good morning. What is the question? How come—how did you come up with a 50% threshold?
Ernesto Gabilondo, Analyst
Yeah, I believe that. Yeah. So I believe that it is a percentage of the loan portfolio. So if you have interest rates above 50%.
Reynaldo Llosa, CRO
So yeah, I understand the question. But my question is why 50%, not 40 or 75?
Ernesto Gabilondo, Analyst
I was thinking that high-interest rates we've seen in other countries just gives you that number.
Reynaldo Llosa, CRO
But I'm trying to make a point because unfortunately, if this law is passed, what is going to happen is it will have a huge impact on financial inclusion, and it will actually generate a lot of financial exclusion. If you understand the dynamics of how financial inclusion on the asset side works in Peru, it is basically very, very tiny loans of less than $100 at high rates that are mostly driven by Mibanco and institutions like that, and those guys move forward and we're going for the rate—the amount of loans are larger and very smaller amounts. I'm afraid you made a point of 50%. That is if there is a 50% gap, the whole microfinance industry maybe something that microfinance industry is very healthy.
Ernesto Gabilondo, Analyst
Okay, thank you. Thank you for addressing this. Then just my second question is from the political front. We have seen that Verónika Mendoza appears in the second position in recent polls. Also, we saw that unfortunately, the potential successor of the President of the Central Bank passed away, so this is creating uncertainty about who will be his successor. So I wanted to read all your thoughts from these events.
Gianfranco Ferrari, Deputy CEO
Yeah, go ahead, Cesar, if you want.
Cesar Rios, CFO
I think, Ferrari, my first reaction is that we are in Peru, and it's very early to tell. We have several surveys, several polls, some of them—actually, Verónika Mendoza are in the top position cycle five, depending on the polls, but I will say that it's very early to tell at this point. Probably, we need to have clearer proposals to go down the road and see how the proposals and the mash of the candidates consolidate in the next month.
Gianfranco Ferrari, Deputy CEO
Just to add on that, the temperature on the election is very cool. The focus of the population, I would say, was more on the pandemic rather than on elections. And statistically, there are like seven number two candidates who are within the margin of error. So as Cesar mentioned, it is really too soon to tell, and I do believe that we will have to wait at least one more month to have more clarity on possible outcomes of the election.
Ernesto Gabilondo, Analyst
Right. Thank you very much for your thoughts.
Operator, Operator
Thank you. Our next question comes from James Mollin with Scotiabank.
Jason Mollin, Analyst
Hi, this is Jason Mollin. On the question of medium- and longer-term asset and earnings growth versus capital optimization and dividend, Walter, you had provided some thoughts at the end of the third quarter call where you spoke about the potential that shareholder returns going forward could shift more to dividends with slower earnings growth versus what—in the future versus what we've seen in the past. Have recent trends given you more conviction that this is what will drive future shareholder returns?
Walter Bayly, CEO
Yes, good morning, Jason. This is Walter. Yes, we have to take out of the equation this year. This year is somewhat unusual. We are rebuilding our profitability. And we do not expect—we haven't made a final decision from the board. But this is not a year in which I would have people waiting for a lot of dividends. We want to rebuild a little bit our capital base. But going forward, yes, the long-term dynamic is that the country will grow less while Credicorp continues to generate around a 17% return on equity, which will be a lower rate than what our risk assets will grow. But we will be spinning off excess capital regularly to our shareholders. That is the dynamic that I think should come back next year, not this year.
Jason Mollin, Analyst
Thank you very much.
Operator, Operator
Thank you. Our next question comes from Tito Labarta with Goldman Sachs.
Tito Labarta, Analyst
Hi, good morning, everyone. Thank you for the call and taking my question. My question is also, I guess, on the longer term, looking at your credit guidance for this year and eventually getting back to 16%, 17% as you mentioned, Walter, I think we saw a nice improvement in the cost of risk, but net interest margin continues to be under pressure. I mean, I guess partly due to Reactiva loans. I think previously, you've guided for maybe the second half of 2022. Is that how long you think it will take, and is it mostly a function of getting your margin back to where it was before? And for the margins to get back to where it was before, is it just the Reactiva loans coming off the loan book? Do you need interest rates to go back to normalized levels to get to that 17% ROE? Just to try to get a sense of the drivers to be able to get back to that long-term ROE. Thank you.
Cesar Rios, CFO
Probably if we consider that the asset base growth at high single digits we can obtain, as mentioned before, ROEs of high double-digit. This growth is going to be driven by a country that is going to grow, let's say, three plus percent. The financial sector usually grows 1.5 times the nominal figure. In terms of margins, what we should expect is that we are going to have at least a couple of years of very low interest rates that affect our overall profitability. At the same time, we are going to come down with a relative rate of Reactiva loans that are scheduled to have 2.5 years more standing if there are no additional changes. So we are going to have, I would say, a couple of years in which we are still going to have very low interest rates and the presence of Reactiva loans on the book. At the same time, we expect during this period to have a higher proportion of retail loans in our book that carry higher margins with some more risk also. The risk should come down at the segment level to pre-pandemic levels, adjusted by the change in compensation because of more retail loans than wholesale loans down the road. The fee income probably is going to grow less than the assets due to the digitalization that will put some pressure on fees. At the same time, we are going to start gaining efficiency within the benefits of the vehicle transformation that we have embarked on in all the companies of the group. The combination of these factors will lay down a sustainable ROE in the high double digits as mentioned. Walter mentioned previously, this is the basic dynamic. I don't know if you want some clarification on this specific topic.
Tito Labarta, Analyst
Yeah, thank you, Cesar, that's helpful. I guess, maybe just a follow-up on the margin side, given just the impact of Reactiva, do you know, if you guide—with the guidance you've provided 3.9 to 4.4. Do you know what that will look like if you exclude the Reactiva loans? Just trying to get a sense of, I guess, the normalized margin excluding that? And then—and it sounds like you would need for interest rates to get back to maybe more normalized levels to get that margin up higher and to get that ROE up higher, is that correct?
Cesar Rios, CFO
Yes, but I would say Reactiva post probably 80 basis points of the margin that is—the slowdown is going to be progressive. And the interest rates also impact because we have a very low funding base that is less valuable in relative terms now. This process I mentioned is going to last at least two or three years; when all these two factors dissipate, what we are going to have probably is higher margins driven by these factors, but no more competition. We wouldn't expect to reap the full benefits of these two factors due to the competition, but we are going to still remain profitable with stronger NIMs than now.
Walter Bayly, CEO
But let me add something; this is Walter, just to be very concrete. We do not need interest rates to go up to achieve the return on equity that we have been accustomed to. We can achieve it without an increase, a general increase in interest rates. This is the year in which we will be rebuilding our profitability. And we should see the results quarter after quarter until reaching this last quarter, which will give us good results still below, but close to sustainable levels.
Tito Labarta, Analyst
Okay, that's very helpful. Thank you, Walter and Cesar. And just one final question just to confirm, the 17% I think you had previously mentioned you could probably get there in the second half of 2022. Is that the correct timing? How do we think about just the timing to get back in?
Walter Bayly, CEO
Definitely not this year. As I said last quarter, this year we'll be close to those levels, but still below.
Tito Labarta, Analyst
Okay, so sometime next year, fair. Thank you, Walter.
Operator, Operator
Thank you. Our next question comes from Jorg Friedemann with Citibank.
Jorg Friedemann, Analyst
Thank you very much for the opportunity to make questions. Good morning, everyone. My question is regarding asset quality. If you could give us some thoughts about when you think that NPLs will peak; we have started seeing the deterioration due to the expiration of grace periods. But I was even more interested in reconciling this with your cost of risk guidance, which is still above 2019 levels. So just wondering if you think this is a new normal or just the cumulative effects of the pandemic, and we should have some normalization in 2022 afterwards. Thank you.
Reynaldo Llosa, CRO
Yes, there are two questions. In terms of the expectations on the increase in the NPL loans, we expect them to peak, as Cesar mentioned, by the end of the first semester—by the end of the second quarter, basically because we'll see a low performance in the SME and consumer markets where all the grace periods expire. In terms of the projections, I mean, there's still some uncertainty in the market. The health issues are not over in Peru. We have elections. So we provide, I would say—truly forecasted what we feel the range would be. That's why you have a range between 1.8 and 2.3 because there are still some clouds in the sky. And we are not sure what will happen during this year, especially during the first two quarters.
Jorg Friedemann, Analyst
Perfect. And if you allow me just to follow up there, because now you have more than 10% of your portfolio in government programs that have lower risk, and those according to what I understood in the call are still expected to last for 2.5 years. So would it be reasonable to expect the cost of risk to evolve in 2020 to levels below those observed in 2019? Thank you.
Reynaldo Llosa, CRO
I wouldn't expect them to go below what we had in 2019. Probably—remember there is that changing mix, and more important growth in the retail market, I mean, the wholesale market. So we'll probably see numbers somewhere below what our guidance for 2021 has been.
Operator, Operator
Thank you. Our next question comes from Geoffrey Elliott with Autonomous.
Geoffrey Elliott, Analyst
Hello, good morning. Thank you for taking the question. Can you help us a little bit on the net interest income? I guess you've given the guide on net interest margin, but the balance sheet size has clearly been pretty volatile during 2020 due to the pandemic and due to Reactiva Peru. So can you help us either on the net interest income or on the size of interest-earning assets? How that's going to evolve, so we can get a clearer idea of what you're expecting on NII?
Cesar Rios, CFO
We have been explaining the basic dynamic. Could you clarify your question, please?
Geoffrey Elliott, Analyst
Yeah, so you've given us an outlook on net interest margin. But the balance sheet size, the interest-earning asset base that you're calculating that on has been very volatile because of the pandemic and because of Reactive Peru. So I'm trying to get a clearer idea of how you're expecting that to evolve so we can get a better picture of what you're expecting on net interest income from here? I mean, maybe a better way of putting it is, how do you expect net interest income to evolve off the 4Q '20 base once we've adjusted for the one-off that you had in Bolivia this quarter?
Cesar Rios, CFO
The NIM this year has been affected. I am going to summarize by the reduced interest rates that impact our liquidity and investment income. We have managed the portfolio to increase the long-term income. There was also a reduction in the mix due to Reactiva. As I mentioned previously, these factors are going to wind down. And the other factor is going to be the change in the composition of the portfolio towards retail. In terms of the cost of funds, we have already made significant liability management, and the costs are not going to be reduced significantly. So the improvement is going to come from the relatively less weight of Reactiva and the higher proportion of retail loans in our book, and after some time, the increase in general interest rate in the market. But this is going to take a while.
Geoffrey Elliott, Analyst
Okay, thank you.
Cesar Rios, CFO
The size of the book has increased—the size of the book has grown significantly this year due to I will say three factors. Reactiva loans, a significant influence of deposits that we have invested in liquidity and in medium and long-term bonds, but this stunning increase is not going to repeat in 2021.
Geoffrey Elliott, Analyst
Understood. Just a follow-up on that, in 2020, you had really huge growth in deposits, up 27% year-on-year. How do you think deposit balances are going to evolve in '21?
Cesar Rios, CFO
They are going to come down to more historical levels close to the growth of the loans. The significant increase in deposits in 2020 was due to the liquidity provided by Reactiva and the withdrawals from the pension funds. This is one or a couple of one-off events. In 2021, the trend is going to be similar to the growth of loans, with probably an upward lease due to additional liquidity measures provided by the Central Bank, but probably not to the same magnitude as in 2020.
Operator, Operator
Thank you. Our next question comes from Andres Soto with Santander Bank.
Andres Soto, Analyst
Good morning. Thank you for the presentation. Maybe a follow-up on interest earnings. I would like to—based on your guidance, I understand that you are expecting NIM for 2021 to be at the same level as your structural or total NIM before adjustments in the fourth quarter of 2020. So I would like to understand in terms of the new originations that you are seeing, especially in the SME portfolio. What are the trends that you are seeing? Is it being difficult to get rates a bit close to historical levels, given the potential anchoring effect of the Reactiva loans?
Cesar Rios, CFO
My initial response is that no. The clients understand the difference, and the volume was driven more by capacity to pay and need. Probably Gianfranco will give better color, but was not an anchoring effect of Reactiva. The clients understand that this is a different program.
Gianfranco Ferrari, Deputy CEO
Yes, thank you, Cesar. Exactly, and we already have a lot of clients where clients ask for financing. Reactiva loans during May to September of last year have already driven new loans with normal conditions. They completely understand the difference between normal rates and market competitive rates and the subsidized rates given by Reactiva. So that's not an issue for us today. Going forward, what happens and we have a lot of conversations right now. There are some specific sectors of the economy that have been hit very hard. An example is tourism. So the Reactiva program may get extended for some specific segments. There's nothing concrete right now. But something like that may come in the next couple of months.
Andres Soto, Analyst
Perfect. Thank you, Gianfranco. And previously, you guys mentioned competition as another source of pressure to your margins. Which specific segments are you seeing the strongest competitive environment in revenue base?
Gianfranco Ferrari, Deputy CEO
Well, there's a lot of competition. So let me go a step back. There are some sectors in which—some parts in which we are back on track to pre-COVID level, and those are the sectors where there's very harsh competition. Strategically, mortgages are very competitive now, and in the other sectors, the whole corporate, I mean the midsize companies or the large midsize companies, there's not much—there's not too much activity and/or investments where the usual suspects are providing or offering financing facilities to the same clients. And there's also a very strong competition from the top corporates and large market companies. The competition is across all the segments or the entire culture in those two segments.
Andres Soto, Analyst
Perfect. Thank you, Gianfranco and Cesar.
Operator, Operator
Thank you. Our next question comes from Alonso Garcia with Credit Suisse.
Alonso Garcia, Analyst
Good morning, everyone. And thank you for taking my question. So let's touch base again, on the regulatory front. I mean, you already provided some color on the interest cap bill, but could you please share your thoughts on the pension system reform? I mean, what probability do you see of it being approved in Congress? Does the current government support this bill or not? The timing, and also, would the AFPs as we know them right now play a role under this new model or not at all? Any color would be appreciated. Thank you.
Alvaro Correa, Deputy CEO
Okay. Hi, this is Alvaro Correa. The question is difficult to answer. There's a lot of uncertainty to date. There is a new law that is being drafted as we speak, and there is a proposal from a specific commission, a special commission that was created last year. That specific new regulation is a real transformation of the pension system. However, it is difficult to say that it has strong support from all parties. There's still discussions in Congress about that, and the timeframe for that is also uncertain. Some people say it's going to come with a final decision in the next, let's say, 30 to 60 days; other people talk about leaving this to the next government and the next Congress. That means that should be discussed in about six to eight months from now. So a lot of uncertainties and it goes through. It's definitely— it will have an impact on Prima AFP for sure because the model changes. The funds will be auctioned in an international auction, and we can participate. But it's not for sure that everything will stay as it is today. I mean, it's surely not going to stay as it is today, so a lot of uncertainty. We should have more color on that in the next call for sure. Thank you.
Alonso Garcia, Analyst
Thank you. And lastly, on the expense side, could you please discuss the allocation of OpEx and CapEx this year related to your transformation strategy? I mean, by subsidiary or which specific initiatives you are currently working on? Thank you.
Cesar Rios, CFO
All the companies in Credicorp are undergoing a transformation process in relative terms, or the BCP share is bigger due to the relative size and the evolution of the company. I would say in terms of transformation probably two-thirds are OpEx. A little bit more than that, one-third is CapEx, and the increase from 2020 to 2021 is going to be significant, probably more than 20%, 30%. Out of this total, BCP is going to be more than 50% of the total of the entire corporation. But I would like to emphasize that all the companies, subject to the reality of each one, are undergoing a significant process of investment and digital transformation suited to the specific needs of the specific segments that they serve.
Alonso Garcia, Analyst
Understood. Thank you very much.
Operator, Operator
Thank you. Hearing no follow-up, we'll move to our next question from Piedad Alessandri with Credicorp Capital.
Piedad Alessandri, Analyst
Hi, thank you very much for allowing questions. I had a question regarding the other expenses. In the MD&A, you mentioned all the salaries, the administrative expenses, but other expenses—that's a significant point of the increase in total expenses year-over-year. It's not detailed. If you could give us a bit more view regarding the other expenses within 2020 and its development for 2021, I would be really grateful.
Cesar Rios, CFO
Yes, usually in other expenses, we record special taxes that are not income taxes that can be contributions to several institutions operational with related expenses. In the year 2020, we had significant operating expenses relating to two items. One was donations; BCP made a PEN100 million donation at the beginning of the crisis. Mibanco also made a significant donation. Credicorp Capital recorded this as a significant expense this year that is not recurrent and is of course included. We are also recording in this item the expenses related to the management of direct expenses to COVID-19. We are talking about specific safety measures, health measures, protective equipment. The sink of these two items has been significant this year. And we also had some relative uptick in fraud at the end of the year, but not to the magnitude of the first two accounts I mentioned.
Piedad Alessandri, Analyst
Okay, so we could expect other expenses to—
Cesar Rios, CFO
Of these two expenses—sorry, I would like to clarify something. Down the road for 2021, we still expect to include COVID-19 related expenses, probably for the first half of the year due to the lockdowns and all the security measures that are mandated to protect our team.
Operator, Operator
Thank you. Hearing no follow-up, we'll move to our next question from Carlos Gomez with HSBC.
Carlos Gomez, Analyst
Hello, good morning. My question refers to the lessons that you have learned from the last year. Obviously, that is a big shock for most companies. They say that this has been an acceleration of the change. But have you seen anything that makes you think about a structural change at the company? In the future, would you like perhaps to be more in the insurance—or less in insurance? More abroad or less abroad? Has the strategy changed in any way as a result of the pandemic in the year 2020? And I shouldn't ask this, but can you also tell us why your tax rate was so low this quarter? Thank you.
Walter Bayly, CEO
Cesar, can you tackle the tax rate and I'll answer the strategy.
Cesar Rios, CFO
Okay.
Walter Bayly, CEO
Okay, go ahead.
Cesar Rios, CFO
Relating to the tax rate, we calculate the tax rate based on local accounting figures. And in local accounting figures, we have, I'd say, two significant factors. One is that we have increased for the year the size of the investment portfolio, and we have been tax-exempt securities. Particularly in the last quarter, we have also recorded significant provisions in local accounting. So the combining effect of these two factors has led to a drop in income tax.
Carlos Gomez, Analyst
That's clear, thank you.
Walter Bayly, CEO
Carlos, yeah. To answer the second part of your question, actually, that was my last closing comment. In my remarks at the end, we have not modified our strategies. But undoubtedly, we have accelerated several initiatives, as you all mentioned, because of the accelerated use of digital channels. So what this means is that we will probably deteriorate our short-term efficiency ratios. But we think this is a smart thing to do for long-term results and competitiveness. We have had very extensive reviews of all our strategies in all our business units, and nothing has dramatically changed. The plans that have been laid off have, in essence, just accelerated. And I think that the lesson is that—I personally take from this is that why do you feel that you're on the right path? Maybe do it faster, but that's my own personal thoughts, Carlos.
Carlos Gomez, Analyst
Thank you very much.
Operator, Operator
Thank you. Our next question comes from Jason Mollin with Scotiabank.
Jason Mollin, Analyst
Hi, as the second question, and maybe a follow-up to what Carlos was asking. On the earnings mix at Credicorp, considering its banking, insurance, pension, and investment banking and wealth management businesses, in general terms, do you see a change in the earnings growth rate from the different segments that would alter your view of the composition of Credicorp's earnings going forward?
Walter Bayly, CEO
Okay, let me take this from Jason. This is Walter. We have several dynamics. I think that within Credicorp, BCP will obviously continue to be by far the largest contributor, and we still have a lot of room to grow in Peru through BCP and through Mibanco. Of course, this is a year to rebuild the profitability that will grow a lot. But we think that due to the continued low levels of penetration of the Peruvian population in the banking system, there continues to be a lot of opportunities there. So where would we grow more than vehicle-by-vehicle? I would say that the segment in which we will grow will be in the SMEs and at the low end of the consumer side. There continue to be opportunities both on the transactional side on setting up platforms as well as on the lending side. And that will continue to be the segments in which we will grow more in Peru for obvious reasons, because the upper end of the consumer and in all this talks we're seeing corporates and middle market companies are fully banked. To complement that, we have wealth management; we've continued to have nice opportunities, both in Peru, in Chile, and in Colombia. And we have this initiative that we have for microfinance in Colombia, which we'll slowly try to see if we can capture the growth. But in summary, where will Credicorp grow? In the unbanked segments of the population, which are consumers and SMEs, particularly in Peru.
Jason Mollin, Analyst
And how does insurance fit into that outlook, Walter?
Walter Bayly, CEO
It fits quite nicely. We are developing every day, and we get better at it at insurance products precisely for those segments of the population. We've been very successful with our oncological insurance. And we think that there are more insurance products that we can take to those segments of the population. Of course, recognizing that at insurance, there's still a lot more room to grow, but it's much more difficult than in banking. The penetration of insurance in Peru continues to be very low, even at some of the higher end levels of the consumer population, so insurance complements quite nicely there.
Jason Mollin, Analyst
And is the outlook for pension growth with the changes, I mean with potential changes or reforms. Is that something you think could grow slower in the new context or faster than you've been seeing growth?
Walter Bayly, CEO
I think that one of the potential—I mean, the potential outcome from the industry will change dramatically. So I would expect pensions to become a very, very small contributor to Credicorp going forward.
Jason Mollin, Analyst
I really appreciate your views. Thank you all very much.
Walter Bayly, CEO
You're welcome.
Operator, Operator
Thank you. I would now like to turn the conference back to Mr. Walter Bayly, Chief Executive Officer, for closing remarks.
Walter Bayly, CEO
Thank you. We are very pleased to have left 2020 behind. It undoubtedly was a very remarkable year with Peru having been impacted by the most severe recession in our modern history. We were always very confident about the strength of our balance sheet, which we felt was more than enough to take us through this severe downturn. This position of strength led us to try to the extent possible and with the assistance of our risk group, to fully acknowledge and recognize in our results the expected credit losses in the most vulnerable portions of our portfolio. This was the idea to leave the loss of the mainframe behind and focus management's attention on the task of rebuilding our profitability while accelerating our delivery of our products via digital channels. Due to our conservative nature, we took the precaution of issuing $500 million in five-year bonds at the holding company level, which is still sitting on our books. We believe that this low-rate environment allowed us, at a minimal negative carry, to have a certain level of insurance, which has not been utilized. Looking forward, there continue to be two elements of uncertainty. As was mentioned, the second wave of contagion, which is currently taking place. We believe that as a country, we have learned lessons from the first wave and that given the vaccines are already arriving, we expect the second wave to be less severe. But definitely, we will know for certain in the next 30 to 60 days. The second element of uncertainty is related to the political situation and elections. The political scenarios continue to be a source of uncertainty, but we will try to navigate those waters, as we have had in the past. On the business front, this is the year, as I mentioned, to rebuild our profitability. This resilience should happen throughout this year, and we should start to see the results quarter after quarter until reaching, as I mentioned before, the last quarter; results and returns still below, but close to sustainable levels. We have not modified our strategies. But undoubtedly, we have accelerated several initiatives, which probably will deteriorate somewhat our short-term efficiency risks. But we are confident that these decisions are the smart ones, the best for long-term results and competitiveness. Before we finish this call, I would like to announce that we will be publishing our annual sustainability report prior to the end of the first quarter. During the first half of last year, to further strengthen our long-term performance and competitiveness in the markets we operate in, we launched the project to develop a strategy aimed at integrating sustainability more deeply and consistently into our business strategies, as well as in our day-to-day activities. We worked for five months with a dedicated commitment of more than 30 leaders across six of our largest operating companies to identify sustainability-related risks and opportunities that could create strategic or financial value growth while generating a positive impact in society for each of our businesses. As a result, we redefined our vision, purpose, and values, which are now better aligned with our current role in society and businesses and established our 2020 and 2025 commitments to sustainability products. We will introduce this plan to you in our upcoming 2020 sustainability report. We look forward to hearing your comments and further expanding on our program in the future. Thank you, everyone, for your attention on today's call. As always, the team is available to meet and talk with you more about our performance, operating environments, and strategy. Thank you all very much.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.