Earnings Call Transcript - BCH Q2 2020

Operator, Operator

Hello, everyone, and welcome to Banco de Chile's 2Q '20 Financial Results Conference Call. If you need a copy of the press release, it is available on the company's website. Today with us we have Mr. Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations; Mr. Pablo Mejia, Head of Investor Relations; and Mr. Daniel Galarce, Head of Financial Control. Before we begin, I would like to remind you that this call is being recorded and that the information discussed today may include forward-looking statements regarding the Company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the Company's press release regarding forward-looking statements. I will now turn the call over to Mr. Rodrigo Aravena. You may please proceed.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

Good afternoon, everyone. Thank you very much for joining us on this conference call. Today, we'd like to present our analysis of three main areas. First, the evolution of the macro environment with a special emphasis on the role of economic policies and excellent fundamentals, as key factors in the potential recovery in the future. Then, we will present the main advances in critical strategic areas of our bank. Finally, before moving to the Q&A section, we will go over our financial results for the second quarter of 2020. I'd like to start with an overview of recent developments on the macro side. Please move to Slide 3. Chile has been experiencing an ongoing contraction since March, in line with the trend observed in most countries. This downturn has mostly been explained by the strict social distancing measures which aim to reduce the spread of COVID-19. This has led to a sharp drop of 14% in the GDP during the second quarter as seen in the chart on the left. The breakdown shows a significant deterioration in sectors more intensive in social activities, such as hotels, restaurants, and transportation. On the other hand, the positive growth posted by mining production has offset the sharp decline in the rate of the economy. The overall CPI has also been falling. As seen on the other right chart, CPI went down to 2.6% in June, from 3.9% in February before the pandemic. This trend has been driven by the slight growth reflected in the lower non-tradable operation and stability in the Chilean peso which has reduced tradable prices. The labor market has also been affected by subdued growth. The bottom left chart shows the increase in the unemployment rate to 12.2% in June, led by the annual decline of 20% in total employment and a 15% drop in the labor force. I'm aware that this scenario described so far is not entirely encouraging. However, we are optimistic about the future especially relative to other countries in the region. In fact, the lower depreciation of the Chilean currency as shown in the chart on the bottom right confirms the better outlook for Chile. Therefore, the next question is what is behind this positive view? Let me try to answer this question on the next slide. Several factors support the positive view of Chile in the future. One of them is the existence of sound fundamentals, which make Chile the strongest economy in Latin America. Apart from having the highest per capita GDP, and the most stable economy, we also have a unique combination: the lowest vulnerability and the most significant room to implement countercyclical policies. As the table shows, Chile has the best country risk reflected in the lowest sovereign credit default swap among peers. Thanks to these, the government has issued bonds in foreign markets with very favorable conditions. Additionally, Chile has important buffers that made possible the implementation of further fiscal and monetary measures. Resources available from the Central Bank, including international reserves and the credit line with the IMF, are nearly 20% of GDP while the net fiscal debt was only 14% at the end of 2019 due to $22 billion held in sovereign wealth funds. Chile is also less vulnerable to external shocks. According to the statistics released by the IMF for investors, they represent only 10% of the local equity market, due to the strong base of domestic institutional investors. Consequently, Chile would experience a lower impact if there were capital outflows from emerging countries. That's why typically the Chilean markets have been more resilient in negative cycles. These fundamentals are even more relevant when they are supplemented by strong countercyclical policies as we've seen in Chile. The magnitude of the fiscal policy can be seen in the significant right in the fiscal deficit as the left chart shows. Chile can implement these policies because of the solid position it had before the pandemic, as shown in the chart on the right due to the low public debt relative to most countries in the world. The improvement in GDP growth will likely take place in the short term. Let me explain why on Slide 5. Chile is easing the social distancing measures adopted in this pandemic as a result of the improvement in the number of active cases of COVID-19. The other chart shows the continuous downturn of them while the number of recovered people has risen significantly. Based on these positive trends, the government reduced zones in quarantine making possible the beginning of gradual normalization. This follows a period marked by very strict social distancing measures where, as the chart on the bottom shows, more than half of the population was under quarantine. In fact, the Curency Index, which is released by Oxford University, confirms that Chile applied its strict measures due to the temporary suspension in schools and commerce as well as constraints to their mobility. These changes should be augmented by the economic measures adopted in this crisis. As we mentioned in the previous conference call, Chile has been recognized for having a coordinated, timely, and robust response from different economic authorities, as demonstrated in the table on the right. The government has announced measures equivalent to nearly 11% of GDP, including a fund of $12 billion to finance transfers to vulnerable people and public investment for next year. These results supplemented the measures announced before to set up the capitalization of both FOGAPE and the unemployment fund. The Central Bank has even expanded the monetary policy in addition to the interest rate cut to 0.5%. The Board implemented forward guidance anticipating that the interest rate will likely remain at 0.5% for the next couple of years and also announced an expansion of the FCIC program by a further $16 billion, and asset purchases in the open market by $8 billion. Finally, congress approved a bill that allows withdrawal of up to 10% of personal savings held in pension funds. Despite the long-term impact, this measure will contribute to an increase in private consumption this year. Additionally, they will discuss changes in the constitution that will allow the Central Bank to buy and sell treasury bonds in the open market, providing an additional tool to stabilize liquidity in the challenging scenarios. All in all, we expect a recovery for next year, which I'd like to discuss in the next slide. Please go to Slide 6. This table summarizes our macroeconomic forecast. We predict the GDP will decline by 6% this year since the GDP plummeted by 14% in the second quarter; this estimate is consistent with better growth ahead, which is more likely after the recent easing in social distancing measures announced by the government. In this environment, we estimate a 4% growth in 2021 as a result of expansionary policies, the better outlook for the global economy and favorable corporate prices. Nevertheless, we are aware of the unusual uncertainty, mainly related to the future evolution of the pandemic, as well as internal factors. We expect the CPI to be at 2% this year and 2.2% next year due to this growth and the stable currency. These changes in the macro conditions have had a direct impact on the banking sector. Please move to Slide 7 to analyze them. Undoubtedly, sluggish growth, weaker employment, and lower inflation have affected the results of the banking industry. Total net income adjusted was CLP 457 billion in the second quarter, which is 7% lower than the previous quarter and almost 50% down relative to the same period last year. This decrease is mainly explained by the pickup in provisions, lower dynamism in loans and, to a lesser extent, the lower NIM due to reduced CDI. As shown in the chart on the right, there was lower nominal growth in loans, mainly in those related to the more profitable product, as reflected by consumer loans declining 6.8%. In the case of mortgage loans, quarter-on-quarter growth slowed to 1.4% during the quarter. The changes are explained mainly by lower disposable income and lower consumer confidence. On the other hand, commercial loans maintained the pace of growth, increasing 3.7% quarter-on-quarter as a result of the implementation of COVID loans program. Total provisions increased, doubling the level observed in the same period last year. This increase is mostly attributable to the considerable deterioration in commercial loans, affecting commercial sectors due to the pandemic and the weak employment outlook, resulting in banks recording an important level of additional provisions during the quarter. Due to this, the cost of risk for the industry increased to 2% from 1.15% last year. It is essential to keep in mind that these figures do not reflect the total impact of the weaker economy on asset quality, particularly for loans evaluated on a group basis, due to the deferral of housing and consumer loan installments that had been implemented during the crisis. Therefore, as part of the deterioration over the next month is likely for these types of loans, the cost of risk for individually evaluated loans should have already been part of the outlook for the economic sector in which those companies participate. I would like to finalize this part by highlighting the important role that the banking industry plays in the current crisis. We know about the positive correlation between GDP and total loans, which tend to be higher in the case of commercial loans. This means that in a positive cycle, loans to companies grow even faster than the overall economy while in a negative cycle, we see a contraction, as was the case in 2009. The chart on the bottom shows the strong relationship between them. However, to date, the story is different despite the fall of 14% in GDP during the second quarter, commercial loans increased by 3.7%. This recovery has been attributable to the pickup in loans with a big guarantee, mainly to SMEs, known as COVID Loans. This confirms the strong countercyclical role that our authorities and the banking sector are planning in this crisis, which will contribute to a faster and healthier recovery after the pandemic. It's important to highlight this has been possible, thanks to the solid position of Chile as well as the robust position of Chilean banks, especially in terms of capital. Now we would like to move to our advances in key pillars and the financial results posted in the last quarter. Please flip to Slide 9.

Pablo Mejia, Head of Investor Relations

Thanks Rodrigo. Please move to Slide 10, where we will highlight some of our initiatives in digital banking. The pandemic we are facing is changing the way we live, especially in terms of using technology to fulfill our needs. In this sense, the digital initiatives that we have implemented in the last few years have allowed us to understand our customers' behavior further and have built a solid basis to provide 100% online solutions for most of the requirements during the sanitary crisis. Even though we already had robust platforms, we recognize that the pandemic challenged us to accelerate our digital transformation as we provided an essential service and the role is critical to support our clients' financial activities. As you can see in the timeline, we have innovated in our digital experience for our customers in several fields, focusing on delivering the best customer experience through the incorporation of business intelligence, data mining, analytics, and digitalization of our processing branches. In order to continue to provide the best customer service for our customers, we're working on launching a new digital onboarding platform that will give us significant improvement with the possibility of opening a new account 100% online at a very low cost for us. This will also allow us to gain a greater number of customers, particularly within the younger segments, as we promote financial inclusion. Another recent advancement in our front office digital platforms is our new webpage that offers an improved customer experience and incorporates analytic tools. It's more modern, secure, and intuitive, and has inclusive features for the visually impaired. We also included a heat map that will provide us with valuable information to understand even better customers' preferences. Those efforts contributed to establish the best digital bank in Chile, as well as having the best online platforms according to Global Finance. All the investments we have made in the previous years allowed us to undertake high digital demands of Financial Services in the current crisis. During the pandemic, we processed over six times the number of loans pre-COVID. Using robotics and through agile developments, we were the first bank in the market to provide a facility to postpone installments for personal banking customers 100% online and to offer COVID loans to SMEs through our digital channels. On the other hand, we also noticed that usage rates at digital channels have been intensifying significantly. As we can see on the bottom of the slide, online consumer loan originations increased from 37% during the first half of 2016 to 46% of total operations in the first half of this year. On the right side, the activities done through our online platforms continued growing and now represent 88% of total monetary transactions. An important rise in mobile transactions represented an increase of 16% year-on-year. Although we acknowledge that the lockdown mostly explains a higher preference for digital channels, we believe that this trend will continue after the pandemic has finished. Please turn to Slide 11. The successful implementation of our digital transformation has played a critical role in providing the best experience to our customers. Despite this challenging period, we've continued to show excellent indicators. As you can see, we posted once again the highest brand recognition in the Chilean Industry and are top of mind for the higher income segment with a very wide gap with our closest competitors. Along with our superior brand recognition, we are also the leader in customer satisfaction, as measured by net promoter score. It is important to note that we have historically been recognized as the bank with the best customer experience levels according to many different sources. We attribute the success to the quality of our services and products, which have helped to generate stronger, long-lasting relationships with customers. These figures are reinforced by the recognition we received for a distinguished National Award for customer satisfaction in 2019. Another relevant point I want to mention is the strength of our brand. In one survey, customers were asked if they were to switch to another bank, which bank would they choose? As you can see on the chart in the middle, we are the most preferred bank in Chile. Another key aspect we highlight relates to security and solvency, where we lead the perception with a large gap when compared to the next main competitor. This position in survey is especially relevant in the context of new regulations, where it will be much easier for customers to switch from one bank to another. This customer satisfaction is most clearly demonstrated by our low attrition rate, which has remained historically low in the chart on the bottom left, which we believe is one of the best in the Chilean banking industry. Please turn to Slide 12. Another aspect of our long-term strategy is efficiency and productivity. Our combined focus on digitalizing the bank by implementing technologies that increase productivity and streamline processes, together with identifying savings areas and implementing better cost controls, has begun to bear fruit. In addition to these improvements, in 2019, we started a process of optimizing our branch network which includes a new service model that has resulted in a decrease in branches. We have reduced our network to 336 branches, almost 50 less compared to a year earlier. The new office model should not only permit further improvements in efficiency but also increased client experience, which is even more important in this context. We have implemented, for instance, new intelligence self-service machines to provide more services that traditionally had to be executed by service carriers. Another measure that contributes to reduce cost is our purchasing desk, which has shown excellent results due to the reduction in expenses in areas such as acquisitions and services hired. Through all of these initiatives, we have been able to show consistent and significant improvements in our productivity as measured by loans per employee and total assets to expenses, as seen on these charts. We expect that through these projects, we continue improving our productivity and delivering a better customer experience. We strongly believe that through the greater use of technology across our business, we should continue to see improvements in efficiency in the long term. Please turn to Slide 13. The final aspect I would like to share before moving on to our second quarter results is the advances we have made in our commitments to sustainability. Today we are witnessing an unprecedented health crisis, and it is still impossible to quantify the effects that it will have in the long term. We are aware of our role in supporting the recovery of economic and social development, especially in challenging times, and now is no exception. During the pandemic, we strengthened our commitment to society and implemented a National Support Plan. We took several measures to support our customers, apart from being the first bank to offer the option of reprogramming loans 100% online. We are the first bank to offer SME customers COVID Loans. For this segment, we went beyond providing liquidity and hosted, for the fourth time, our national entrepreneurial challenge, where we achieved a record of 56,000 applications and promoted a virtual fair for 60 entrepreneurs where they were able to exhibit their products. Furthermore, we have also implemented many actions that aim to reduce the consequences of the pandemic for vulnerable groups in Chile. We delivered packages with essential groceries for people with disabilities and their families, offering food and medicine and telemedicine services to senior adults as well. All of these efforts rewarded our bank by being recognized as the financial institution that did the best job in taking actions during this health crisis, as seen on the chart on the right. Please turn to Slide 15 to begin a discussion of this second quarter. During this quarter, we recorded a bottom line of CLP 112 billion with an ROE of 12.5%, a level we consider reasonable given the magnitude of the crisis we are facing globally and the low level of inflation for the period. We also outperformed our peers, apart from having the highest profitability indicators and coverage ratio; we maintain the best capitalization level as shown on the chart on the right. We are confident that our prudent risk management approach, strong capitalization, and our consistent strategy will allow us to continue delivering sustainable and superior profitability for our shareholders. Please turn to Slide 16. Operating revenues dropped 6% year-on-year due to the fall of inflation from 1.2% to 0.%, impacting non-customer income and, to a lesser extent, a slight decline in customer income, which even though remains strong when taking into consideration the weaker environment. In this context, NIM fell from 4.5% last year to 3.5% this year, as you can see on the table on the bottom left. About 50% of this decrease was caused by lower CPI we had this quarter and the effect of the lower contribution of demand deposits to our cost of funds, given the sliding interest rates. To a lesser extent, these factors coupled with the negative impacts of mortgage loan rate renegotiations at lower rates in the second half of 2019 and the new regulation regarding automatic payments of overdraft lines, which became effective in January 2020, were only partly offset by higher income from loans. The rest of the decrease in NIM is explained by higher exposure to low-margin and low-risk assets, such as the Central Bank short-term borrowings used to comply with the reserve requirements linked to boost in demand deposit balances. As the chart on the upper right shows, customer income remained relatively stable as a result of opposite forces. The lower overnight interest rates sharply reduced the contribution from deposits, even with the impressive growth and balances seen during the last month. On the other hand, as mentioned, there were positive contributions from the increase in commercial loans, higher sales in the distribution desk from the Treasury Division, and higher fee income. Most of the rise in fees was associated with a 9.3 billion increase in insurance brokerage linked to the partnership with an international insurance company. Unfortunately, this was partly offset by a substantial decrease in economic activity amid the strict lockdowns that lowered transactional fee income from other sources such as cards. Market volatility also affected revenues from mutual fund and stock brokerage business due to customers moving to their AUMs, the fixed income funds that generate lower fees, and as well as lower transactions in stock trading. I think it's also important to note that our fee business is chiefly related to the retail segments. Although we had some drawbacks this quarter as a result of the weak activity that exceeded the aggregate demand from customers and therefore transactionality, we believe that this is temporary. Despite this impact, we continue leading the industry in net operating income and fee margin. As you can see on the charts on the right, our margin as a percentage of average interest-earning assets reached 3.8% and 1.2%, well above the average level of our peers. Please turn to Slide 17. Total loans reached almost CLP 31 trillion in this quarter, increasing 7% year-on-year, and remained basically flat quarter-on-quarter. Demand, except for COVID loans, was weak across all segments this quarter. In the wholesale segment, we posted a year-on-year growth of 5%, but quarter-on-quarter, it dropped by 3%. There was a similar trend in personal banking loans, increasing 5% year-on-year but following with almost 2% quarter-on-quarter. The annual rise was mainly due to residential mortgage loans that grew 8%, while in contrast, consumer loans during the same 12-month period decreased by 6%. On a quarterly basis, mortgage loans remained flat, and consumer loans actually dropped by 6%. These results were attributable to strict lockdowns and the weaker economy, as we discussed at the beginning of this call. This resulted in reduced household spending as well as lower demand for home sales. In fact, the expectation of the National Chamber of Construction is that new home sales will actually drop by 40% in 2020, and this sector will only return to normal business levels by mid-2021. We expect that the dynamism of personal banking should continue weak throughout the remainder of the year. These results were almost completely offset during the quarter by the strong growth we experienced in COVID loans for the SME book, which grew 19% year-on-year and then an impressive 14% quarter-on-quarter. Please turn to Slide 18. As mentioned, a strong result in the segment was attributable to the government stimulus package for companies that provided guarantees of up to 85% for working capital loans. We are proud that we have been able to assist our customers and the country by taking part in this program. We placed during the quarter over CLP 1 trillion equivalent to 3.7% of total loans as of June 30th. Most of these loans were directed to provide liquidity for small and medium-sized enterprises, and as of July 2nd, we granted almost 25,000 loans with a market share of 18%, which is similar to our market in the sector and aligns with our risk appetite. In terms of total loans reprogrammed, and taking into consideration the total value of the loan, we are the bank with the lowest proportion of the total loans among our peers, as shown on the chart on the bottom right. Finally, if we only look at the installments that have been reprogrammed and of the loans granted, this reaches CLP 495 billion or 1.6% of total loans, as the chart on the top right side of this chart demonstrates. I think it's very important also to highlight that the banking industry has made an important effort to assist those customers. We believe that the efforts combined with all of the programs that the government has provided should make a difference during the economic recovery post-COVID. Please turn to Slide 19. We continue to have the best funding structure in Chile. This has been possible thanks to our customers using us as their primary bank account. This is clearly demonstrated by the strong increase we had in demand deposits, which rose 37% year-on-year and 11% on a quarterly basis. It is also important to note the significant change in the rise of DDAs for our funding structure. Today our demand deposits represent 28.5% of total funding, up from last year, 25.7% and significantly higher than our peers, as shown on the bottom right chart. More importantly, approximately 75% of our DDAs come from non-financial counterparties, which represents a stable source of financing. Aligned with this, we have been able to replace time deposits from financial counterparties with DDAs. We also have a well-diversified funding base which is very relevant today, and this makes it another positive difference for Banco de Chile. All in all, our brand coupled with our leading risk indicators and a strong Tier 1 capital base of 10.9% allows us to place debt at favorable conditions and have permitted us to maintain a leading level of cost of funding of only 2% in the local currency. We are confident that this crisis will open new opportunities to strengthen our already solid relationship with our customers and continue to increase in our share of the wallet. Our long history of prudent risk policies and very reasonable growth have been fundamental to our sustainability over time leading into claims toward long-term strategy. Please turn to Slide 20. Managing risk globally across all levels of the corporation is a key component to our consistent and attractive results. Our Board of Directors plays a vital role actively participating in establishing policies and guidelines for acceptable risk levels, for developing and validating provision models, as well as to define additional provisions. Management is responsible for controlling compliance with the mandate of the board, especially in terms of control of different types of risks. As you can see on the chart on the right, the cost of risk this quarter jumped to CLP 139 billion, up from only CLP 68 billion last year and CLP 126 billion from the first quarter. However, our NPL ratio dropped from 1.4% in the first quarter of 2020 to 1.3%. This combination of higher costs but lower NPLs was principally due to two factors. Please take a look at the chart on the bottom right. First, CLP 70 billion of the CLP 139 billion posted in the second quarter was due to additional provisions. These provisions were recorded to protect the bank against unforeseeable economic fluctuations. The pandemic has brought forth many uncertainties such as citywide lockdowns, deterioration in employment, and financial stress on companies. These uncertainties have made it extremely difficult for traditional risk models to properly gauge credit risk, and as a result, our board approved the establishment of these general provisions. It's important to note that these allowances are not for any specific segment, sector, or customer but for the entire portfolio, implemented under different circumstances such as the one we are facing today. Second, the remainder of the quarterly provisions was chiefly due to the impact of COVID-19 on the financial position of certain large customers, which have suffered a deterioration in their business environment and income-generating capacity. As a reminder, large companies are evaluated on an individual basis for provisioning purposes, using a forward-looking approach. In terms of the retail book, the retail book composed of consumer mortgage and commercial loans evaluated on a group basis, delinquency levels have remained relatively stable. Nevertheless, this was mainly due to the support measures we provided in this segment which included grace periods, loans at preferential rates, and government-backed COVID commercial loans for SMEs. In addition, as a way to promote lending and assistance to banking customers, the local regulator gave special treatment to rescheduled loans in terms of provisioning, which had a positive effect on cost of risk compared to normal periods, even though we expect deterioration in the portfolio in the next few months. In this regard, we are confident that our prudent risk policies have made us one of the most preferred banks facing negative cycles, as shown on the next Slide 21. As you can see, our coverage ratio reached 235% as of June 30th, significantly higher than our peers, and we recorded the lowest delinquency ratio of 1.3%. Our prudent risk culture has also contributed to creating the highest level of additional provisions in the industry, reaching CLP 283 billion, as you can see on the chart on the bottom right. All of these figures demonstrate the soundness and quality of our portfolio and our prudent management when it comes to risks. Our consistent and successful strategy has been sensitive to grow our portfolio responsibly, and this has allowed us to portray a solid track record of dependable results. As shown on the following Slide 22, a well-diversified portfolio with lower overall exposure to risk factors also contributed to these results. Our portfolio is highly diversified and concentrated in lower risk segments. Despite this, we are the most profitable bank in Chile, because our customers choose to use us as their primary account, and this provides many additional benefits that we believe you are all aware of. As you can see on the chart on the top left, the retail segment represents 63% of our portfolio, which is divided into three main areas. First, consumer loans to middle and upper-income individuals, as well as mortgages, our focus is on low risk individuals. We have the highest market share among high-income individuals, which are low-risk in nature. Second, our exposure to consumer finance through our Credit Chile brand is only 2% to date, significantly lower than the level we had in 2009 during the subprime crisis, which represented nearly 7%. And lastly, our SME book is a very high-quality portfolio that historically has had low levels of cost of risk and is closely related to our upper-income individuals. We may not have the largest market share in this segment, but we assume we have the best portfolio in the industry. The remaining portion of the portfolio is the wholesale book that represents 37% of total loans. We work with the largest companies and multinational corporations in Chile, and by nature, this segment is at lower risk. For this reason, we are proud that we have historically solid performance when it comes to wholesale risk. The pie chart on the bottom of this slide shows our exposure to different sectors in Chile, as you can see our penetration is lower than our peer group. In retail, hotels, and restaurants, we have an exposure of 9%, versus our peers at 11%; in construction, our exposure is 7% versus the competition at 10%. Lastly, we compare peers in transportation but it's important to note that we don't have any significant loans to the airline industry. We are confident that our prudent approach to risk management should set us apart in the coming months when banks have more information regarding the quality of portfolios and how this will translate into costs of risk. Please turn to Slide 23. More important than ever is our focus on managing costs. As you can see on this chart on the left, we managed to maintain total operating expenses basically flat quarter-on-quarter and decreased 4.4% year-on-year. The yearly drop in expenses was driven by lower salaries and other expenses, as shown on the chart on the right. Specifically, we were able to increase our business activity without significantly increasing our salary expenses and also had a reduction in severance payments and loan loss provisions on cross-border loans due to higher depreciation of the Chilean peso; this compared to the second quarter of 2019. In addition to this, we lowered our outsourced sales force services by observing these functions internally during the second half of last year and we lowered marketing expenses by reducing media expenses, market research, and adjusted loyalty programs. These reductions were also partially offset by higher IT expenses related to software licensing as we adjusted the bank quickly in this environment. Additionally, we incurred higher expenses linked to fixed asset maintenance related to sanitation, new safety measures related to the pandemic, as well as costs associated with updating our branches to the new service model, among others. On a year-to-date basis, we recorded an improvement in efficiency, as shown on the chart on the bottom right, reaching 43.6%. Please turn to Slide 24. Before moving on to questions, I would like to highlight the favorable comparison of our stock versus our main peers in Latin America. As you can clearly see, the technical difficulties aside, our stock price has been the most resilient in this crisis. We have recovered part of the drop from pre-COVID levels; this is clearly a result of the market understanding that we're not only the most profitable bank in Latin America, as shown on the chart in the bottom left, but this is accomplished in a dependable manner through all the cycles. So, it is also important to mention that we may have recovered the post or near-post COVID level, but we still have multiples where we are very well below the levels that we've had in the past. Despite the current economic environment, we are confident that the better prospects for the economy coupled with our strong fundamentals and strengthening of the key aspects of our long-term strategy will allow us to continue being the best long-term alternative for investors. Thanks for listening, and if you have any questions, we'd be happy to answer them.

Operator, Operator

Our first question will come from Ernesto Gabilondo with Bank of America. Please go ahead.

Ernesto Gabilondo, Analyst

Hi, Rodrigo and Pablo. Thanks for taking questions. My first question is on the reprogramming portfolio and the FOGAPE program. Can you give us some details on how much both the reprogramming and FOGAPE represented of your total loan portfolio? And why you're seeing the percentage of the reprogrammed portfolio seems significantly lower when compared to Santander Chile? And then my second question is on credit provisions. Considering that you have created additional provisions of CLP 70 billion during the quarter, do you think this was a peak in provisions or do you continue to see higher provisions by year-end once you start to see NPL showing up after ending the relief programs or from the exposure to high-risk economic sectors? Thank you.

Daniel Galarce, Head of Financial Control

Thanks. Well, if we look at the participation in the most recent information, we have similar levels of COVID loans as our competition. Our bank approved a significant amount of the loans today in dollars; we have, as of July 24th, about $1.9 billion issued to companies, a large proportion of those to SME customers and that represents somewhere close to 30,000 customers today.

Pablo Mejia, Head of Investor Relations

In terms of that, I think our levels are very similar to what our main peers have issued. If we move to the levels of provisions, it's difficult to have a clear understanding of how the economy will recover and the current position of our customers. What we can see today is that the portfolio is in relatively good shape. But we have a limited amount of information, but we do know, and we've seen good payment behavior in the recent information. But we can't rule out that in the future months, there could be levels of provisions similar to what we've seen in the previous months and quarters.

Daniel Galarce, Head of Financial Control

Okay, thank you, Pablo. And then just a follow-up on the reprogram portfolio. When looking at Santander Chile, you mentioned that close to 30% of the loan book was reprogrammed, including the FOGAPE loans. Do you see the same proportion in your loan book?

Operator, Operator

Ladies and gentlemen, it appears we have lost connection to our main speaker line again. So please standby, while we reconnect.

Pablo Mejia, Head of Investor Relations

Sorry about that again. So, again just finished nothing in terms of the provision. One of the important things to mention is Ernesto, are you there?

Ernesto Gabilondo, Analyst

Yes, I'm here.

Daniel Galarce, Head of Financial Control

Okay. So I think another important thing to mention is that what we've seen in the month of July is the payment behavior of the customers taking on these reprogramming of loans. So a large proportion of the customers were reprogrammed in April, and what we've seen on the payment behavior is a positive result, but we cannot confirm that this will continue in the future.

Pablo Mejia, Head of Investor Relations

And I would like to add one thing here. This is a key point, and it’s important to remember that there are likely factors that will affect this, such as the potential increase in the unemployment rate. So basically, we've seen an increase of unemployment rate from 7% to 12% in that month. So we cannot rule out that it will increase further. But more importantly, we have a very significant uncertainty in terms of the final impact of this crisis on the economy; we don't know how the recession will proceed, and more importantly, we don't know when the economy will start to grow again, and that's why we are not providing more guidance in terms of the cost of risk for the future. And maybe a follow-up on the first question. So the market share in loans, we have 18.4%, but the information as of this month is worth mentioning. This level of market share is actually higher than the market share in commercial loans. So it makes sense this level of market share for our customer base.

Ernesto Gabilondo, Analyst

And I was looking through your presentation on Slide 18, and I was looking at the volume of loans reprogrammed and as of July, and you mentioned you have around 35%, right? And I'm looking that Santander has around 41%. So what do you think will be the difference with your competition having a higher market share than yours?

Pablo Mejia, Head of Investor Relations

The market share in terms of the loans reprogrammed, it's important to mention one very particular thing—this issue pertains to the banking industry. The reprogramming of these loans isn't a leading indicator of the cost of risk. Some of these loans obviously could become more problematic, we've seen this positive result in the first month. But it's not a lead indicator because there are certain characteristics that customers had to comply with in order to be able to have these loans reprogrammed at Banco de Chile and many other banks. One of the requirements was not a requirement if customers had a loss of income. They could be good customers who are paying on time and, due to that reason, it’s not a good lead to the cost of risk. So what I would say is that this indicator is not a lead indicator for banks, and the lead indicator for the cost of risk holds more relevance when we see months of positive results post-reprogramming.

Ernesto Gabilondo, Analyst

Okay, understood. Perfect. And then considering the additional provisions that you created in this quarter, it seems that it was the quarter with the highest provisions. Do you think this was the peak of provisions, including these additional provisions, or do you think we should continue to potentially have another one like this one by year-end or in the next year, once we finish the reprogramming of the portfolios?

Pablo Mejia, Head of Investor Relations

It really depends on the evolution of the economy and how the economy begins to open and the impacts on companies and individuals and employment. That will be a key area that we need to see. Today, what we're seeing is starting to get better information regarding the virus in Chile, which could be positive. But we maintain the expectation and prediction that more provisions might be needed as the future unfolds. We made judgments based on the foresight but in order to have a clearer understanding that this is likely the worst month and if the impacts of the economy continue could worsen.

Daniel Galarce, Head of Financial Control

So basically, we can't rule out more provisions for example, if the economy gets worse. So, it's very important to keep in mind that this crisis is different from any other crisis we faced. So, that's why it's very important to highlight our very robust position in terms of our coverage ratio. As we mentioned in the call, we are the bank that sells more during cycles. So we tend to allow for more provisions if the economy remains weak.

Claudia Benavente, Analyst

I have two questions. The first is, how much should we expect to be provisioned for the COVID loans deductibles? Have you started to provision this or if not, when should we expect this impact? The second question is maybe a little bit of a follow-up to what you were saying. Within the clients that have reprogrammed loans, can you provide some color on how much actually reprogram belongs to a necessity versus those that are potentially taking it as an opportunity? Probably you have many of those customers that have current accounts with Banco de Chile, so you might have a better idea of who are the most troubled versus those who could be taking it as an opportunity. Thank you.

Pablo Mejia, Head of Investor Relations

Regarding the provisions for the COVID loans, basically, what happened is that for regular product loans that were FOGAPE guaranteed, the regulator indicated detailed instructions regarding the constitution of provisions related to the deductibles of the COVID guaranteed loans. Specifically, according to the current regulation, customers provision in deductible loans that were originated at the time the guarantee is exercised. So specifically what the regulator says is, when the expected loss excluding the FOGAPE guaranteed loan is lower or equal to the deductibles, the provisions should be determined without the guarantee. When the expected loss excluding the FOGAPE guarantee is greater than the deductibles, that provision should be determined based on the aggregate of the deductible plans and expected losses related to the FOGAPE guarantee. So therefore, we expect that there should be more provisions in the banking sector beginning in September. We're currently calculating the impact of this change and will be recorded in our books from September 2020. So, that's all I can say regarding that. And in terms of the installments of the reprogram, like I mentioned, most banks did not request customers to send us information regarding income. So, it’s not clear what percentage of the customers needed these grace periods. But I think it's very important to mention that the level of deposits in Banco de Chile had grown by over 30%—around 35% for individuals. So our individuals have more deposits in their accounts, which can have many different reasons. But that’s something very important to note. Our customers are high-income individuals who are a little less susceptible to the volatility in the economic cycle, and what we've seen today in terms of payment behavior in the first month has been very positive.

Claudia Benavente, Analyst

Is it possible to have an idea of maybe within the reprogrammed loans how many of the customers have taken accounts with Banco de Chile?

Pablo Mejia, Head of Investor Relations

Basically, when the customer enters Banco de Chile, they have a package, and most of our customers use Banco de Chile as their primary account. So it's very uncommon that a customer would have a product without having a current account with us.

Claudia Benavente, Analyst

But basically for the consumer group then, you can identify that those who have seen their salaries at least reduced. So therefore, you can see maybe the proportion of those that may have a higher probability of having a hold?

Pablo Mejia, Head of Investor Relations

Again, not necessarily, since you can add more than one bank account. So it's not clear that you would have the savings in one versus another. So the information that we have is not public, but what I can say is that the first month of reprogram that we did was in April, and that was due in July, and we had very good levels of payment behavior.

Sebastián Gallego, Analyst

Hi, thank you for the presentation. I have three questions. The first one is a follow-up on the asset quality. I just want to get a sense of when should the benefits provided to customers start to fade and actually if you are providing more extensions to those benefits that will be the first question. The second question is regarding the pension fund withdrawal in Chile. I would like to know if you can comment on the behavior of clients, or whether you can comment if those clients are repaying debt or not. How are you seeing those clients so far with the information we have as of now? And third, considering that Rodriguez is in the call, I just want to have his perspective on the upcoming events for the new constitution in Chile and how this will play out going forward. Should we expect more of the same that we saw in October last year or should we expect a more balanced and stable outlook in terms of the social crisis? Thank you.

Pablo Mejia, Head of Investor Relations

In terms of asset closure for the consumer, most of that is coming in July. April is the most important month for consumer loans. But what we have seen is that, in the overall of these customers who took on this grace period, a very good level of payment behavior was observed. This was very positive information that we've seen so far. In terms of whether there are more benefits, we announced for the mortgage loan book three additional months that customers could postpone. Again, the reprogramming of loans allows customers to take these benefits as they need or see it as attractive. So there are certain characteristics that customers must comply with, such as being current on time with their loans, etc., and then they can take this offer. So that's a lead indicator in terms of the book, and there are two ways to analyze this. One way is publicly available, and we can analyze all the banks in total volume of the loans that had some relation of an installment reprogram, which is available on the website of the CMS, or what we showed on Slide 18, which is only the installment of these three programs. These three installments represent today CLP 490 billion, which is 1.6% of total loans. It's not a very significant amount for installments that has a new loan associated with it. In terms of the 10% of the pension funds, I guess that would be the main new benefit. Currently, we have three more months, six months since they took the SME COVID loans. So we should see a gradual payment as of now and the end of this year and the beginning of next year among the first volume of consumer loans, mortgage loans, and then commercial loans for SMEs. For the 10% of ASP, it's something that's been heavily discussed with the group. But the funds haven't been issued, so it's hard to know which customers will take those funds. One important thing to note is that Banco de Chile has been very strong in the past regarding getting customers to use their primary bank accounts. Generally, customers work with Banco de Chile as their primary bank account.

Daniel Galarce, Head of Financial Control

Yes, I’d like to add one idea to that, Pablo, that the 10% of the withdrawal from pension funds will likely contribute to an increase in the short term private consumption. So that's why we are taking a bigger role in loans as well by the end of this year because the increase in private consumption will come as a result of this withdrawal from pension funds. This highlight under consideration, this is one additional factor supporting a better outlook for the future, especially impacting consumption in the short term. With respect to your third question, it's too early to provide a more accurate estimate in terms of the potential changes in constitution and what would be the impact on the economy further. We are aware that the main challenge in the short term for the economy is to recover economic growth. So that's why there is an important discussion in Chile in terms of the main policy. The government has been, for example, very active in terms of implementing a strong stimulus. It will compare Chile related to other countries that would be more aggressive in the future stimulus in order to recover economic growth. So that's why, when you compare the GDP estimate for 2021 in Latin America, Chile should have one of the best economic growth rates for next year. After the recovery, we expect by the end of this year, there will be several discussions on the political side. We know that we will likely have a discussion about the constitution and we will likely have fresh elections for next year. We are aware of the potential impact on economic growth. But all in all, we are positive for the future in Chile. We are confident that the second quarter was the bottom of this cycle. We are facing positive growth on a sequential basis for the fourth quarter of this year and all in all are expecting nearly 4% economic growth for the next year.

Neha Agarwala, Analyst

Following up on Claudia's previous question on the deductibles for the FOGAPE loans, I understand that you will start making these provisions in September, but could you give us a sense of the magnitude of these provisions that might be needed? CLP 30 billion to CLP 40 billion does that sound reasonable or should be more or less? And related to that is, there was a change in the treatment of FOGAPE loan guarantees for the capital calculation. What would be the impact on your Tier 1 ratio from that? Is it already included in the numbers that were presented, or would that change in fact your 3Q capital levels?

Pablo Mejia, Head of Investor Relations

So in terms of Claudia's question, what we can say is that the FOGAPE contribution essentially is calculated when the expected loss excluding that FOGAPE guarantee is lower or equal to the deductible, and the provisions should be determined without the guarantee. On the cases where the expected loss excluding the FOGAPE guarantee is greater than the deductible, the provision should be determined based on the aggregate of the deductible and expected loss using the FOGAPE guarantee. We expect more provisions in the banking sector, beginning in September. We're currently calculating the potential impact of this change, and the details will be in our books when we report in September 2020.

Daniel Galarce, Head of Financial Control

Hi, this is Daniel Galarce speaking. The impact for us is not relevant. We actually don’t have any impact due to this new treatment for that amount. This is just a change in the risk-weighted assets due to capital-weighted assets, so it's not a big change for us, and it is not further down at all.

Neha Agarwala, Analyst

Perfect. Then the next question is on the trend that we can expect in terms of NPL ratio and cost of risk. I believe you – stated today we don't have a very aggressive charge-off policy. So should we expect the NPL ratio once it starts increasing to remain at relatively high levels for a few quarters and gradual write-off, or will you be more aggressive in writing off loans as you learn about the quality of the portfolio? And in terms of cost of risk, should we expect the bulk of it to be in 2020, or more evenly distributed between 2020 and 2021, and any particular quarter in which you think the cost of risk should peak? My second question is on additional provisions. You showed that you have a very high level of additional provisions versus your peers. But you mentioned in the previous calls that you probably would not be using it in the current crisis. So haven’t you changed, and do you think that you would probably trigger the use of these provisions if required in the coming quarter or would you like to just maintain them at these levels? Thank you so much.

Daniel Galarce, Head of Financial Control

In terms of write-offs, there are regulations that determine when a loan should be written off—when there are certain characteristics, such as for consumer loans lasting six months, and mortgage loans have longer periods of time required. There are conditions that you can write off loans before that. Probably what we should see today is something in the normal write-off period, and there could be an additional decision, we can't rule it out, because it is still closer to write-off, but it's not something that we could provide guidance on at this time. Regarding the cost of risk, it should be the same; in this year, obviously, the peak of the pandemic should be effective for the banking industry and for next year it's difficult to determine a number because it's not clear about the economic outlook of the pandemic.

Pablo Mejia, Head of Investor Relations

We don't know when a vaccine or medicine will be made available, or if another wave of the pandemic will occur. I think that's the biggest uncertainty and the reason why we can't provide guidance for 2021. That's right, Neha. In the case that the economy grows 6% this year, for example, and if the economy grows by 4% for example next year, this should be consistent with an unemployment rate and that would last until 2022, for instance. So that's why it's very, very hard to make any comparison with base prices because this time is really defensive, and that's why we don't know the length of this crisis. We will know what the actual impact will be in terms of the output of the economic cycle. Therefore, we don't have an accurate guideline regarding cost of risk.

Daniel Galarce, Head of Financial Control

Also, I think it's important to emphasize that we can’t roll out the additional constitution of additional provisions or releasing provisions, because it's not clear regarding the outlook. So we have to see how this evolves. So it's not clear on how or when these provisions can be utilized.

Alonso Garcia, Analyst

My first question is actually just a follow-up on the requirement for clients to adhere to reprogramming. I guess it’s true that you asked for documentation to prove that they had an impact on their income from the pandemic, or if you did not ask for such documentation. My second question is on Basel III implementation. Recently, the regulator put out for consultation details for the risk weighting factors for market risk? So I just wanted to hear your thoughts if based on that new information, what is your new expectation for Basel III impact on your capital ratios? Thank you.

Daniel Galarce, Head of Financial Control

So, I think it's important to give a clear understanding of the reprogramming of loans. So basically in Chile, what happened, different from other countries, is that most of the large banks in Chile did not provide extensive documentation required in certain cases when they offered reprogramming of loan without understanding or requesting that customers send us information regarding if they faced a significant income impact. It was an opportunity to build stronger relationships with our customers. We used digital estimates to quickly online offer these products, preventing them from having to come to branches directly. So regardless of whether customers experienced a loss of income or not, they had an opportunity to be reprogrammed.

Pablo Mejia, Head of Investor Relations

Just to clarify regarding Basel III implementation, we believe the introduction of Basel III accelerated the new methodology on market risk-weighted assets. We're currently analyzing this and estimate that the impact on our capital ratios will be similar to prior disclosures, though we believe that the overall impact will be between 80 and 100 basis points on the capital ratio, according to this new method for market risk-weighted assets.

Operator, Operator

This concludes our question-and-answer session. At this time, I would like to turn the floor back to Banco de Chile for any closing remarks.

Pablo Mejia, Head of Investor Relations

Okay, thank you for your attention. We appreciate your participation and we look forward to continuing our dialogue. Thank you for joining us today.

Operator, Operator

Thank you, this concludes today's presentation. You may now disconnect your line at this time and have a nice day.