Earnings Call Transcript - BCH Q3 2020

Operator, Operator

Good day everyone, and welcome to Banco de Chile’s Third Quarter 2020 results conference call. If you need a copy of the press release issued yesterday, 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 Daniel Galarce, Head of Financial Control. Before we begin, I would like to note that 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. Mr. Aravena, the floor is yours.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

Good afternoon, everyone. Thank you very much for attending this conference call today. In the first part of this webcast, I’ll present our view of recent developments in the business environment. Then, Pablo Mejia, our Head of Investor Relations, will go over strategic advances and financial results achieved by our bank during the third quarter. Let me start with our view of the economy. Several signs indicate that the bottom of the negative cycle was seen in the second quarter of this year. Chile’s activity is also improving when compared to most countries in the region, which is highly attributable to our sound fundamentals, strong policy responses, and the improvement in COVID-19 evolution. I’ll go into greater detail regarding factors later on in this presentation. The chart on the top left shows the magnitude of this recovery. After the 43% annualized drop in the second quarter, GDP increased 21% in the third quarter. Consequently, the activity reduced its annual decline rate from 14% to 9% during that period. This rebound has been explained by higher dynamism in several sectors related to domestic consumption, which have also been influenced by the withdrawal of personal savings from pension funds, as well as the implementation of other government support programs. This potential turning point in the economic cycle has increased domestic prices. The CPI went up by 0.6% in September, which was well above the market consensus and from levels observed in previous months. Consequently, the annual inflation rate rose to 3.1% in September, an increase of 60 basis points from August, as the chart on the upper right clearly shows. As seen in most countries, the labor market has suffered the main negative consequences from this pandemic. As a matter of fact, the unemployment rate rose sharply from 7% in February to 13% in July. This deterioration resulted from the 20% and 15% declines in employment and the labor force, respectively. Nevertheless, some potential Green Shoots are taking place in line with the gradual, but steady recovery of overall activity. This can be seen in the bottom right chart, where employment has been improving since August. These positive signs are highly attributable to the gradual lift of mobility restrictions due to the lower spread of COVID-19. I’d like to briefly refer to this factor, which has undoubtedly played a key role in this recovery. Please move to Slide number 4. In our previous conference call, we mentioned that Chile was under strict lockdowns since the second quarter of this year. As a result of these measures, we have seen a positive evolution in several indicators related to the pandemic, making it possible to ease mobility restrictions. The chart on the upper left shows the drop in active cases of COVID-19 in Chile, with an impressive pick-up in the number of recovered people. Additionally, the share of positive tests has remained at levels around 5%, well below other Latin American countries. Thanks to this, as you can see in the chart on the bottom left, local authorities have been reducing the number of areas in quarantine. While 54% of the population was under quarantine in July, this number went down to 19% in October. This change contributed to greater mobility in the country, as the bottom right chart suggests. The impact on activity was greater, as the proportion of GDP affected by the lockdown fell from 65% to 15% in the same period. This trend, together with strong fiscal and monetary policies and favorable copper prices, has been critical for this improvement. All these factors have led to better expectations for the future, which I’d like to discuss now. Please move to Slide number 5. We are aware of the unusual uncertainty that we face, not only in Chile but also in the world. That’s why, in this particular environment, I’d like to emphasize three main assumptions that we consider in our baseline scenario. First, we assume that social distance restrictions will remain for most of the next year, which is consistent with a gradual pace of recovery in both GDP and employment. Second, we also assume the absence of further domestic shocks as we experienced last year. Finally, we also assume that copper prices will continue providing support for the Chilean economy. This table summarizes our forecasts for this and the next year. We see a recovery in GDP to 4.5% in 2021, from a 5.3% drop this year, which positively compares with other countries in the region. The table on the right shows that, according to the IMF forecasts, Chile will have the best performance on average in Latin America. We expect an inflation rate to remain around 2.8% this and next year, still below the 3% target set by the Central Bank. Since banks are a perfect reflection of the economy, this new normal has had significant implications for the financial sector, as we will discuss in the next slide. Please move to page number 6. The Chilean banking industry has shown significant resilience in this pandemic. Despite the crisis, which was accompanied by lower inflation, employment, and interest rates, banks have been able to adapt their strategies to deal with this scenario. Total net income had slightly increased on a sequential basis to CLP 473 billion in the third quarter, adjusted by Itau figures. This result, however, was 19% below the same period of last year. Consequently, ROE fell from 12% in the third quarter to 9% in this period. In a broad sense, profitability was affected by the following factors: first, a weaker loan mix; second, higher cost of risk due to new criteria to account for government-guaranteed loans and additional provisions; and third, the negative impact of lower inflation and interest rates as well as the flatter yield curves. It’s also important to pay special attention to the evolution of delinquency rates, which have remained at very low levels, as the chart on the bottom left shows. Nevertheless, this should be a temporary situation since figures have been supported by specific factors. One of them is the impact of SME’s reprogrammed loans, which remain in the grace period. Another factor is the impact of the 10% withdrawal from pension funds since, according to the Central Bank, nearly 15% of these resources were spent on reducing past-due loans, as you can see in the chart on the bottom right. Therefore, it is reasonable to expect higher delinquency rates in the future after these effects end. Despite this complex environment, Banco de Chile was stable once again, accomplishing good results not only in financial terms but also in strategic advances. Please move to Slide 8. Banco de Chile has had a successful and proven track record of consistent and robust results. Since we aspire to continue being the most sustainable and profitable bank, we are continually reinforcing three key areas of our long-term strategy: digital transformation, efficiency and productivity, as well as sustainability. We firmly believe that strengthening these strategic areas will allow us to support long-term growth and help us in the future challenges that arise in the new business and social environment. Please move to Slide 9, where we begin to highlight some of our initiatives in Digital Banking. The pandemic has accelerated how we use technology in our daily lives. This has pushed us to work harder and faster on all of our digital banking solutions in order to provide our customers with the financial products and services they demand. We are proud to announce that in September we set a new standard for digital banking in Chile, officially launching our new digital 100% online onboarding bank account, called Cuenta FAN. This is a far superior product compared to what is available in Chile today. And thanks to this, our launch was a total success. In less than two months, we already have over 90,000 new FAN customers. The demand from customers opening Cuenta FAN accounts nearly doubled the amount reached by our main competitor, as you can see on the top right of this slide. For instance, we launched the product in the first half of this year and reached almost the same number of new customers, but in a much shorter timeframe. There are many advantages to our account that are driving this demand. Just to name a few, a Cuenta FAN customer becomes a Banco de Chile customer, allowing them to receive all discounts and benefits of a regular client. There are also no entrance or maintenance fees, and this account grows with the customer. It starts as a debit account and later, if the client qualifies and desires, it becomes a current account. As the FAN customer has additional financial needs, we can offer them other products, creating new cross-selling opportunities. Most of our new FAN customers are younger than 45 years old, and we are using this product to build closer relationships with people from these segments. Before moving to the next slide, I’d like to mention that the cost of this account is very low compared to a traditional account. At the origination, we don’t require costly credit checks and extensive customer background reviews that could affect delivery times. It’s also important to mention that ongoing costs for these accounts are marginal since we already have the installed capacity and back office processes. Please turn to Slide 10. As I mentioned in the previous slide, one of the main advantages of Cuenta FAN is that these clients have access to all discounts and benefits of a Banco de Chile customer. Our premium loyalty program includes exclusive discounts with the main delivery platforms such as Uber Eats, Pedidos Ya, and Rappi. We also have a unique program called Big Five, with discounts of up to 40% in big chains, including Starbucks, Papa Johns, and others. In addition to this, we have partnerships for the most demanded events in Chile and alliances with stores and services across a wide range of segments that go from technology, transport to telemedicine and leisure. This strong loyalty program is one of the fundamental drivers of the success of our Cuenta FAN and assists in increasing our relationships with customers to become their main bank account. Please turn to Slide 11. Cuenta FAN is only one part of our strategy to strengthen our digital experience at Banco de Chile. We are continually renewing, improving, and rethinking how we can deliver our products and services better through the channels our customers are demanding. For this reason, we have been updating many of our front-office digital platforms, bringing more agility and security to our channels. One of the latest advances is our new webpage that offers a superior customer experience and incorporates analytic tools. It is more modern, secure, and inclusive. We also integrated on our webpage a heat map, which provides us with valuable information to understand our customer preferences even better. In addition to this, we renewed our apps Mi Banco and Mi Pago, with new technologies that allow for faster, easier, and safer transactions. Behind our front-office improvements, we also had significant advances in our digital back-office operation. Undoubtedly, the pandemic accelerated our digitalization, as in a short period of time we had to deal with an important increase in the usage levels of our digital channels. To mention some numbers, we received 23% of the total pension fund withdrawal and processed 100% online over 400,000 loans in personal banking to support our customers’ liquidity needs. All these efforts are part of an ambitious digital roadmap that aims to make our institution the benchmark in digital banking in Chile. Now Pablo Mejia, our Head of Investor Relations, will continue to present the rest of our advances and Banco de Chile’s results.

Pablo Mejia, Head of Investor Relations

Thank you, Rodrigo. Please turn to Slide 12. The successful implementation of our strategy has provided our customers with the best experience in the industry. Even during this challenging time, we have continued to innovate and strengthen our brand, leading in many different indicators as you can see on this slide. For example, we continued to lead the industry in customer satisfaction, with a wide gap to our closest competitors. This solid track record of customer experience has been provided through our proven ability to not only have the best customer service but also to offer the best products through the channels our customers demand. I should mention that the surveys shown on this slide for customer satisfaction is a fairer representation of banking customers' opinion as a whole. These surveys use a more representative sample of banking customers and do not predominantly use our own customers. It’s also important to highlight that for a third year in a row, we were distinguished with the national award for customer satisfaction in 2020, as you can see on the right. Another relevant point I want to mention is the strength of our brand. In many surveys, we rank first. For example, we have posted once again the highest brand recognition in the Chilean industry. And we led with a very wide gap to our competitors in the survey where customers are asked if they were to switch to another bank, which bank they would choose, as shown on the charts on the left. We are also considered to be the safest bank in terms of security and solvency, as shown on the chart on the bottom. This leading position in both customer experience and brand is extremely valuable in light of new regulations, where it will be much easier for customers to switch from one bank to another. To date, we have more customers representing information on switching to our bank versus customers requesting a change to another bank. We are confident that these attributes should assist us in maintaining a low attrition rate, as you can see on the chart to the right. Please turn to the next slide, number 13. In our 127 years of history, we have accompanied the development of Chile and supported the country especially in more difficult times like today. Our commitment to be a sustainable bank is a fundamental pillar of our strategy. Along these lines, I would like to share some initiatives on this matter before moving to the quarterly results. Given our concern for our customers, we were the first bank to implement a national support plan for our retail banking and commercial clients. This plan included a series of special measures to support our customers so they could cover their most urgent financial needs. We are deeply committed to supporting Chile’s SMEs, as we believe they are the driving force of our economy. In this line, we launched the Fifth National Entrepreneur Challenge with more than 56,000 participants. Furthermore, we have also implemented many actions to mitigate the consequences of the pandemic for vulnerable groups in Chile. Some initiatives we would like to highlight is that we delivered essential products to almost 9,000 vulnerable families all over the country and held a campaign that raised over CLP 16 billion to benefit elderly people affected by the pandemic. All these efforts, among others, maintain our bank as the financial institution with the best performance in terms of the actions taken during this health crisis, as seen in the chart on the upper right. Our sustainable business model was also recognized once again by the European, in the Global Banking & Finance Awards 2020 in the categories of Best Bank of the Year, Innovative Digital Bank of the Year, and Best Bank for Financial Inclusion in Chile. These awards acknowledge the relevant progress we have made in digital transformation and its contribution to our business. In addition, Banco de Chile ranked first in the general ranking of Merco Talento 2020, which positions us as the best company in the country to attract and retain talent. Finally, we are honored to be recognized for our Outstanding Crisis Leadership by Global Finance. This clearly shows how we as a financial institution went above and beyond to assist customers, protect employees, and provide critical support to society at large. Please turn to Slide 15, to begin our discussion on our results for this quarter. We recorded a net income of CLP 88 billion with a return on average equity of almost 10%. Our lower bottom line was mainly the result of higher provisions, attributable to our prudent and conservative risk management approach that aimed at setting adequate levels of provisions. We continue this approach, which is particularly important today given the magnitude of the crisis we are facing globally. Net income was also affected by a decrease in NIM, which was a consequence of a combination of factors, including lower CPI and the sharp decline in interest rates and loan mix. This was partially offset by strong cost control. Despite this, it is important to highlight that we still posted the highest year-to-date net income in the Chilean Banking industry. And we have, by far, the highest level of coverage. Apart from having the highest profitability and the best credit risk indicators in the industry, we also outperform the banking system in terms of capitalization levels. Please turn to Slide 16. Operating revenues recorded a year-on-year decrease of 12%, principally due to unfavorable trends in inflation, interest rates, loan growth, and fees. Specifically, inflation dropped 0.5% when compared to the prior quarter impacting non-customer income. Also, given monetary policy actions taken by Central Banks, interest rates decreased sharply this year while yield curves flattened, which resulted in a lower contribution of our demand deposits to our funding and less chance to benefit from term gapping. Additionally, we had a reduction in high margin loan products as consumer loan demand shrank. Second, the main driver of loan growth during the second and third quarters of 2020 was focused on FOGAPE government guaranteed commercial loans which only carry a 3.5% interest rate. These effects were partly offset by better performance of our AFS and trading portfolios due to the shifts observed in interest rates. In this context, NIM fell from 4.1% last year to 3.1% this quarter, as you can see on the table on the bottom left. About one-third of this decrease was caused by the lower CPI we had this quarter. The remaining part is explained by the effect of the lower contribution of demand deposits to our cost of funding in terms of term gapping given sliding interest rates. It is worth mentioning that, as mentioned in previous calls, our net interest income has also been affected by the negative impact of mortgage loan renegotiations that took place in the second half of 2019, and the regulation regarding automatic payments of overdraft lines that went into effect in January 2020. The drop in NIM has also been explained by greater exposure to low margin and low risk cases such as the Central Bank short-term bonds used to comply with the reserve requirements linked to the strong increment posted by demand deposit balances. Also, since strict lockdown began to be lifted by mid-August, our fee income has been impacted during the last quarter, particularly revenues from transactional services such as checking accounts, credit cards, debit cards, and ATMs were down due to lower transactionality and spending. Similarly, fees linked to loan originations, such as insurance and brokerage also decreased, while fees related to assets under management dropped as a result of market volatility that led customers to switch from higher margin equity funds to fixed income. Nevertheless, the good news is that we have begun to see an improvement in different indicators across the bank that could imply the work for fee income generation is behind us. Before moving on to the next slide, I want to highlight that we continue to be a leading bank in the industry with a wide gap to our peers in fees and in net operating more, as you can see in the chart to the right. Please turn to Slide 17. Total loan growth reached CLP 31 trillion this quarter, increasing 6% year-on-year and up 1.5% quarter-on-quarter. Demand for loans, excluding COVID loans improved slightly in the third quarter from the weak levels reported in the previous one, in line with the third quarter 2020 Chilean Central Bank Credit Survey. This report showed that both demand and supply had improved slightly quarter-on-quarter for all retail loan products and that credit restrictions had been reduced for companies. Nevertheless, this was accompanied by weaker demand for loans from the later due partly to the high volume of COVID loans and the still uncertain outlook for the economy. For Banco de Chile, most of the dynamism in loan growth was created by the FOGAPE loan program, as shown on the diagram to the right. Specifically, total commercial loans grew CLP 2 trillion year-on-year, but CLP 1.8 trillion was related to these loans with government guarantees for companies with sales of up to $10 million per year. As a reminder, the COVID loans were part of the government’s stimulus package for companies that provided guarantees of up to 85% for working capital loans. We are pleased that we have assisted our customers and Chile by taking part in this program. Most of these loans were provided to small and medium-sized enterprises, which accounts for about 21% of the growth, as shown on the bottom of the slide for SMEs. On the other hand, personal banking loans only grew 1.3% year-on-year, and actually dropped 0.9% quarter-on-quarter, as you can see on the chart on the bottom right of this slide. This result is consistent with the subdued economic growth, which caused a reduction in household spending and less demand for both consumer and mortgage loans. We expect that the dynamism of personal banking loans should begin to improve gradually in the next months as the economy recovers. In this regard, data revealed by the national chamber of commerce shows that household consumption, for instance, would be showing some signs of modest recovery. Please turn to Slide 18. Our leading funding structure has been made possible through our ability to provide the best service experience that our customers value and ultimately establishes Banco de Chile as their primary bank account for both retail and wholesale customers. Over the past 12 months, our solid brand and soundness have provided us with a strong increase in demand deposits, which rose an impressive 45% year-on-year, and equally remarkable 11% on a quarterly sequential basis. Consequently, our funding structure has significantly changed year-over-year. Today, our demand deposits represent 32% of total funding, well above our peers, as shown on the bottom right chart. More importantly, DDAs held by non-financial counterparties, which are a stable source of financing, represent around 80% of the total amount. Also, we took advantage of the liquidity facilities provided by the Central Bank, from which we obtained mid-term funding denominated in pesos and bearing the monetary policy interest rate. These funding sources have mostly replaced time deposits held by financial counterparties, particularly in local currency. Our well-diversified funding base, as seen in the chart on the left, is undoubtedly an important competitive advantage for Banco de Chile. Finally, our strong Tier 1 capital base of 11.6%, together with our superior credit risk ratings, allows us to place debt with good conditions, giving us a leading level of cost of funding of only 1.6% in local currency. We are confident that we can take advantage of the opportunities that will be presented during this period to strengthen our relationships with our current customers, as well as continue increasing our share of wallet, especially through our digital contact channels. Likewise, initiatives like the FAN account should allow us to continue expanding our customer base while bolstering our market-leading position in core demand deposits. Before moving to the next slide, I’d like to mention that we are well prepared to face Basel III future phase-in requirements, which is in line with our historical guidance. Our solid track record of generating an attractive bottom line has been a result of our consistent and prudent risk policies that focus on growing responsibly and sustainably over time. Please turn to Slide 19. A key component of managing risk in Banco de Chile is the governance structure for this topic, in which the board of directors plays a vital role and actively participates in the whole process including assessment, strategies, and guidance of the bank for accepted risk levels, for developing and validating provision models, as well as to define additional provisions. As you can see on the chart on the left, cost of risk this quarter rose to CLP 113 billion, up from CLP 89 billion last year, but below the level posted of CLP 139 billion during the previous quarter. However, our NPL ratio continued to drop from 1.17% in the third quarter of 2019 and 1.33% in the prior quarter to a mere 0.98% this quarter. The year-on-year rise on loan loss provisions was due mostly to a recalibration of our internal provisioning models for group-based evaluated portfolios in order to incorporate new information in the context of COVID, with an impact of CLP 71 billion. This was partially offset by a release of additional provisions during the month of September for CLP 78 billion of the CLP 105 billion of additional allowances that we proactively recorded in the prior month this year. This was only a small portion of the total additional allowances we have booked on our balance sheet over the years, and as you can see on the chart to the right, we have by far the highest level of these reserves in the industry. It’s important to note that these allowances, even after this release, are three times larger than our main competitor. This figure of cost of risk also includes the full impact of loan growth in COVID FOGAPE loans, most of them granted during the third quarter, and the full adoption of the provisioning treatment set by the regulator for these types of loans. It’s important to note that we continue to see positive payment behavior from our customers and that this has translated into low levels of NPLs and a reduction of charge-offs. It is also important to note that we had a temporary rise in NPLs and charge-offs as a result of the weaker macro environment in Chile due to the social crisis that began in the fourth quarter of 2019. As a result of decisions that were undertaken during these events, our early overdue portfolio began to rise. Nevertheless, we adjusted our collection procedures and began an improving trend in overdue loans. Despite this change, some overdue loans were not recovered, and in line with the temporary rise in NPLs, we saw a brief rise in regulatory charge-offs that has now more than normalized. However, as we mentioned earlier in the presentation, we must pay close attention to how these indicators evolve, as they are benefiting from the financial assistance that customers received from both the government and banks as part of the measures taken during the crisis. We can’t rule out that, in the coming quarters, we see a rise in delinquencies as these payment holidays and other benefits come to an end. Nevertheless, our prudent risk policies have made Banco de Chile the most prepared bank to continue facing this weak cycle. All of what I’ve talked about demonstrates the quality of our portfolio and how our prudent risk management is very proactive during this difficult period. By having a consistent commercial and risk strategy, we have been able to grow our portfolio responsibly and profitably over the long run. We are confident that this risk approach should distinguish us among other banks in the coming quarters. Please turn to Slide 20. During this quarter, we continued our focus on cost control, as we believe that reaching efficiency in operations is even more relevant in this challenging scenario. As you can see on the chart on the left, total operating expenses grew 5.9% year-on-year, equivalent to CLP 13 billion of savings. The drop in the yearly cost was driven by lower salaries, as well as a reduction in administrative expenses as shown on the chart on the right. Particularly, we had a reduction in selling expenses related to lower severance indemnities from organizational restructuring that took place in 2019, as well as lower variable compensation as a result of the current situation. As for administrative expenses, the main savings were associated with higher expenses in 2019 that were associated with the development and implementation of internal projects to improve our efficiency and deploy digital transformation initiatives. Additionally, we introduced changes in our service models that allowed us to reduce costs in outsourced services. Likewise, the use of more effective channels for advertising and customer loyalty enabled us to reduce marketing expenses. Thanks to your cost control efforts, we reported a slight improvement in equity and efficiency ratio that reached 44.6%, clearly outperforming the average level posted by the industry that actually increased during the same period. We also recorded a positive indicator of expenses to total assets of about 1.86% this quarter versus the 2.33% recorded one year earlier. Please turn to Slide 21. Even though it’s difficult to predict how this pandemic will evolve, since some countries are evidencing increases in COVID cases and have returned to lockdown, we clearly see some signs suggesting that the worst is behind us. As you can see on these charts, we have begun to see a gradual increase in the origination for consumer mortgage loans, as well as a steady rise in terms of new current account openings. We’re also seeing a slight improvement in credit and debit card purchases. The low figure seen in prior months was due to the strict lockdowns and the low mobility in Chile, which caused a significant impact on credit origination as well as activity in our transactional products. We are pleased to see a gradual normalization in these figures, and this should translate into better income generation, as well as in the coming quarters. We are confident that these better perspectives for the economy, together with the superior competitive advantages will allow us to continue being the best long-term alternative for our investors. Thanks. And if you have any questions, we’d be happy to answer them.

Operator, Operator

Thank you, sir. The first question we have will come from Tito Labarta of Goldman Sachs. Please go ahead.

Tito Labarta, Analyst

Hi Rodrigo and Pablo. Thank you for the call. A couple of questions. I guess, first in terms of your margin, just understand how we should think about the margins going forward? Or maybe to start, like how much of your margin is impacted by the FOGAPE loans? And how long do you think that will continue to impact your margins? How should we think about margins for next year? Do you think that you can get some improvement in the margin or increase in the margin? And then the second question in terms of your provisioning and your cost of risk. Do you feel that – and I think you’ve mentioned provisions now for everything. Do you think your cost of risk next year can really begin to come down, or even in the fourth quarter? How do you feel about your provisioning versus kind of your expectations for asset quality going forward given that the real impacts on appeals, how long we have been going forward? Thanks.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

Hi, Tito. Okay. Well, in terms of NIM, we recorded this quarter a level of 2019. I think it’s important to go over a little bit where we’re coming from. So in 2019, NIM was around 4.2%. And year-to-date in 2020, we recorded 3.5%. And in the quarter 3.1%. It’s important to note that, if we look at the 2019 numbers, we have to take into consideration certain things that occurred. For example, there’s 20 basis points we have to reduce from the level from last year, the CLP 4.2 million because of the huge level of renegotiations of mortgage loans, because the interest rates were very low, and that took place in mid-2019 when customers began renegotiating. So this together with the implementation of a new regulation that obligates banks to pay off overdraft lines of credit when customers have funds in their accounts affects our NIM by about 20 basis points. So, in summary, for the 4.2% level that we recorded last year, reality based on the new market conditions and regulations, it’s closer to 4%. So it’s also important to mention some things that happened this year. So we have – due to the huge amount of demand deposits that we received, this affects our net interest margins as well because we have to price those fines – a portion of those funds in highly liquid assets. So that’s about 10 basis points. So for the 3.5% that we recorded this year, if we adjust – if we look at it on an adjusted basis, it should be close to around 3.6%. So we’re comparing 4% and 3.6%. So if we look going forward, there are some things that we should take into consideration. First, inflation should return to the levels of 3% at some point in the future. For every 100 basis points of change in inflation, that’s around 15 and 16 basis points in NIM based on current GAAP on our balance sheet. The low overnight rate of 0.5% is temporary. So after this crisis is over, it is reasonable to expect that the long-term rate should move back up to the level of 3% to 4%, which is positive for margins, especially for us because we have a huge amount of manageable liabilities. That under asset, maybe a 100 basis point change in the overnight rate in the long term, this is something around – when we say long-term three to five years, it should benefit the impact of around 30 basis points, everything else being equal. And third, loan mix is super important because in terms of the commercial loans, they have a low-interest rate. If you look at it in terms by segment, it brings down margins, but as a whole, for the commercial loan portfolio, it has a higher interest rate than the average interest rate of our commercial loan portfolio. So by segment, for SMEs, SMEs have a higher interest rate because they have a much higher level of risk for the entire commercial loan book, it’s actually positive for interest rates. So what’s happening, more than the commercial loans for the FOGAPE, what’s occurring negatively is that the high-margin products, such as consumer loans are decreasing around 12%, 13% for us in the industry. And also those SME loans that normally would grow aren’t growing because customers took advantage of the total loans. So when we look forward, we should think that we should be able to have a better growth in consumer loans high-margin products, such as the consumer loans I mentioned and the commercial SME loans. And that should, in the medium term, return us, maybe not – it should return us to levels higher than what we have today of the 3.5%, and the 4.2% would have to be other market conditions, long-term level with a different portfolio than we had before and regulations. In terms of risk, I think some things that are important to mention is that the environment that we’re facing is highly uncertain. It’s something very new to us in the world. This crisis doesn’t have an economic precedent. It’s impossible to anticipate the impact of the recession on asset quality. This is one of the reasons why it’s difficult for us to provide guidance for the future. However, there are some essential things to keep in mind. As we mentioned in the presentation, there’s a gradual recovery in the economy for 2021. This is an important after this significant contraction this year. So based on this, we recalibrated our risk models in order to reflect this better way to evaluate the current economic situation. So from a prudential point of view, it’s undoubtedly much better to have these models reflect the new normal economy. And that’s why we use a portion of this are being basically used a portion or reclassified a portion of these additional provisions that we had recorded throughout the year into this new model. So we actually didn’t release provisions. We reclassified these provisions and our actual provision levels are actually higher than they were before being lower. So the net effect is actually an increase in provisions this quarter. This change follows with other measures earlier in the year. For example, there is a significant increase in group provisions for companies that were exposed to sectors that were affected by this. So, the individual loan book portfolio, we are very conservative in terms of that portfolio, we increased the provisions there. This is part of our proactive management for risk approach. And finally, I think some things to consider is that we have the highest coverage ratio, a very diversified loan portfolio, and a proven track record of risk management. And we think that these will be key attributes that will allow us to better preserve the value of the bank in the long run.

Tito Labarta, Analyst

Okay. Thanks Pablo, that was pretty clear. But just I guess, on the cost of risk, and I know it’s uncertain, but how normalized in 2021 do you think maybe in the first half of the year, cost of risk needs to remain somewhat elevated in the second half? You can get back to normalized levels? I mean, I know it’s difficult to predict, but just to help a little bit in the modeling. Is that the right way to think about it, maybe higher in the first half and lower in the second half, getting back to normalized levels in the second half?

Pablo Mejia, Head of Investor Relations

I think it’s difficult to estimate for how this will evolve, especially since there are a lot of government aid and different things that have occurred in Chile, for example, the withdrawal of pension fund money, which has helped customers pay their loans. There are still payment holidays for the SME loan book, which comes due later on this year or beginning of next year. So there’s still a lot of uncertainty about what could happen, especially if we look at what’s happening in Europe and other areas. A second lockdown makes it difficult. So, probably before seeing an improvement, there will be still some uncertainty in the medium term before we get to normalized levels.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

I would like to add – we are not providing further guidance for the next year because of the very high uncertainty. So it’s not clear, for example, how will be the relation between the employment recovery relative to the GDP growth. So what we’ve seen is a positive sign in the Chilean economy. So, green shoots, as we mentioned in the presentation, and since we have a very high uncertainty, we think that the most responsible thing is not to provide further guidance for the next year.

Operator, Operator

And the next question we have will come from Neha Agarwala of HSBC.

Neha Agarwala, Analyst

Hi thank you for taking my question. My first question is regarding the repayment behavior. Could you give us some concern, what percentage of the loans that you had reprogrammed actually came due? And what is the payment behavior of those loans? And I’m still not quite sure what was the reason for releasing some of the additional provisions given that you feel that there’s a lot of uncertainty in the environment. So what maybe take a step like that? And then I’ll ask my second question.

Pablo Mejia, Head of Investor Relations

In terms of the additional provisions, I think it’s important to mention those provisions are used for uncertain times. And what we did is we updated the model to take into consideration more of these market aspects that were occurring today and the actual provisioning models. So we could use – so we’ve basically reclassified from one part of the book to another, but it really doesn’t have the net effect this quarter was higher provisions, higher coverage ratio. So it was just something that was evaluated on how we could implement this methodology. And this was how it was considered the best method to record allowances for the bank.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

It’s important to mention as well that we have a new macro scenario; perhaps we have a new normal with different parameters. So, it’s very hard to imagine, for example, that the probability of delinquency rate in the future is the same today related to the previous scenario. So what we are trying to do is reflect in a better way, the current economic situation, the current probability of default, for example, in the current economic model. So basically, the real goal is to adapt our models to the new normal in the economy. That’s our aim.

Pablo Mejia, Head of Investor Relations

In terms of the repayment behavior, we’ve had very good repayment behavior from the customers that have had their loans postponed. Today, most of the customers for the consumer loan book have already repaid. A portion of the mortgage loan book is repaid. And then we have the SME loans, which still have a little while to go for us and the industry because that program of FOGAPE, but it entailed is the customer that took a FOGAPE loan would have all other loans at that bank would get a six-month grace period. Since this happened during the second quarter of the year, probably by the end of this year, beginning of next year, we’ll have more information on how that evolves. But what we’re seeing today is our postponed book is performing embedded in the level of our total overdue loans of our average retail loan book prior to the COVID crisis.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

It’s very important to analyze how the economy will evolve in the future, given the uncertainty. So far, it’s been better than expected, but we have to be cautious about the evolution of the economy in the future.

Neha Agarwala, Analyst

Okay. My next questions are – first capital and payout. What is your expected impact on capital ratio from Basel III implementation next year? And do you expect any delays in implementation or should it happen early 2021? And what do you think about the payout ratio that you can maintain, given that you have the strongest level of capital? And my second question is more on the economy. We have the referendum recently. What impacts do you see from the constitution? Or how do you think this will – it’s a two-year process, but how do you think it will impact – the final impact would be on Chile? Thank you so much.

Daniel Galarce, Head of Financial Control

Hi. This is Daniel Galarce. As you know, we don’t have the old regulatory framework yet. I mean the clean regulator has published most of the specific regulations regarding Basel III, but we just know the final norms for more than five or six of them. So far, as we have mentioned in previous calls, the regulations are quite similar to our first estimate. So, we don’t see any significant deterioration regarding what we estimated in the past for the impact of Basel III on our capital ratios. Yet the regulator has imposed or has phased in the implementation of Basel III starting in December 2021 until December 2025. So we have some time in order to commend any need of reinforcing capital if we believe that it’s not enough. However, we are quite confident because we have taken steps in the past in order to bolster our capital base. As you know, in 2019, we issued subordinated bonds. And also, we need to know how the new regulation will evolve and how the market will evolve in terms of additional Tier 1 capital. So we still have a lot of room in order to prepare our capital base and us in order to address the new regulation. We don’t see significant deterioration in our capital ratios due to Basel III as long as the implementation is gradual.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

Neha, this is Rodrigo Aravena again. In terms of the impact of the potential new constitution, I think that it’s very important to say that it’s too early. I just want to see potential changes in the constitution, as well as in the economy scenes. It has to be discussed in the new body, and each article has to be approved by 2/3 of members of the elected body. Even though the uncertainty in the process, we are aware of the importance of preserving those critical assets that have been important in the development of Chile, but it has to be discussed in the next – during the next year. It’s important to keep in mind here that the ability to conduct this process with discussion based on a long-term view that takes into consideration fiscal events and also learns from international experience will possibly factor in the discussion and, of course, in the future development of Chile. For now, we think that the most prudent thing is to wait for the discussions to be held in the process during the next year. So, it’s more prudent to wait for discussions. How do you say that? I think that it’s very important to keep in mind that Chile has had a very positive recovery in the economy during this year relative to other countries. In fact, according to the IMF estimates, as well as the blue market consensus, activity, Chile is expected to have the best performance on average during this and the next year after. We sold off the solid fundamentals that we have, as well as the very active response from the central bank and the central governments as well. So we are aware of the potential increase in uncertainty, that it’s too early to anticipate any specific impacts coming from this discussion.

Neha Agarwala, Analyst

Very helpful. Anything on the payout ratio?

Pablo Mejia, Head of Investor Relations

We should maintain that. We’re giving them more lifts over the years as it has been very, very consistent over time.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

I think it’s important to mention, however, that this is something that’s taken the side of the level, and we don’t have information until January of this year on how this will evolve. So, it depends on many different market factors, but in the long-term, as Daniel mentioned, it should be similar to that level. But in the shorter term, we have to take into consideration what will happen in the short term and how our Board of Directors will decide to capitalize.

Neha Agarwala, Analyst

Thank you. So then it could be lower than 60%. That’s not decided yet.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

No, no. There’s no decision today for the dividend that will be paid in March 2021. It’s still something that’s being analyzed, under discussion, and it’s something that the Board of Directors will review.

Operator, Operator

And next, we have Claudia Benavente of Sandando. Please go ahead.

Claudia Benavente, Analyst

Hi. I have a question. Is it possible or fair to compare the changes that you made to the provisioning model to IFRS 9 that eventually Chilean banks will have to comply with? Do you believe that the important increase that you made on the consumer book reserves would be enough to comply with IFRS 9? Thank you.

Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations

The important increase in provisions, I think you have to take into consideration. It depends on the cycle and how this evolves and what point you're in. And the models in Chile don’t only use non-performing loans. So, generally speaking, there are different accounting reconciliations for the 20-F, for example. It is so large an impact like it is in other countries. So it’s reasonable to expect that this would bring us closer to those levels if we’ve had to apply IFRS 9 in Chile today. But the model is different. That είναι actually model on IFRS 9.

Pablo Mejia, Head of Investor Relations

Yes. So it’s – for IFRS 9 and the 20-F, for example, it’s around it’s around a similar level of the CLP 70 billion that we recorded. It’s a similar level. Now exact, but it’s similar. So in terms of compliance, if we had to apply and the reconciliation, it would be the impact wouldn’t be so significant anymore.

Claudia Benavente, Analyst

Perfect. Thank you.

Pablo Mejia, Head of Investor Relations

You’re welcome.

Operator, Operator

And next, we have Domingos Falavina of JPMorgan. Please go ahead.

Domingos Falavina, Analyst

Hello. Good morning everyone. Thanks for taking my question. Just want a quick recap. I know it changes based on your balance sheet in the quarter, but looking at your balance sheet today, 100 basis points of higher U.S. inflation, what impact would it have on either NIMs as well as on tax rate? And ballpark estimates – I’m sorry if you mentioned that before, I couldn’t join the phone call.

Pablo Mejia, Head of Investor Relations

In terms of the GAAP on the balance sheet, we have about CLP 5.8 trillion GAAP on the balance sheet. It runs between CLP 5 million and CLP 6 trillion. So for a 100 basis point change, that changes net interest income between CLP 50 billion and CLP 60 billion, which is around 15 basis points in net interest margin and how we cap rate it. So when you look at the effective tax rate, you have to look at two things. One is the offering because we have more assets in EURs than liabilities. We have a positive impact of higher inflation. But at the same time, the tax authorities use inflation accounting to calculate the practical rest. So you have to take the net non-monetary asset position. So we have more liabilities linked to the U.S. than our assets linked to the U.S., which are non-monetary. So you take basically acquisition, multiplied by the inflation for the period and as your price level restatement loss. So the calculation, generally, when it’s running around 3%, inflation generally, Banco de Chile should be around an effective tax rate of 23%, 24%, its bit closer.

Operator, Operator

Well, so no further questions at this time. We will conclude the question-and-answer section. I would now like to turn the floor back to Banco de Chile’s management team for closing remarks, gentlemen?

Pablo Mejia, Head of Investor Relations

Thank you for participating in this conference call. We look forward to speaking with you for our year-end results. Thanks.

Operator, Operator

Thank you, gentlemen. This concludes today’s presentation. At this time, you may disconnect your lines. Thank you again, everyone. Take care and have a great day.