Grupo Cibest S.A. Q3 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to Bancolombia's Third Quarter 2020 Earnings Conference Call. My name is Vanessa, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. Please note that this conference is being recorded. Please note that this conference call will include forward-looking statements, including statements related to our future performance, capital position, credit-related expenses and credit losses. All forward-looking statements that are made in this conference call and future filings and press releases or verbally address matters that involve risks and uncertainty. Consequently, there are factors that could cause actual results to differ materially from those indicated in such statements, including changes in general economic and business conditions, changes in currency, exchange rates and interest rates, introduction of competing products by other companies, lack of acceptance to new products or services by our targeted clients, changes in business strategy and various other factors that we describe in our reports filed with SEC. With us today, Mr. Juan Carlos Mora, Chief Executive Officer; Mr. Mauricio Rosillo, Chief Corporate Officer; Mr. José Humberto Acosta, Chief Financial Officer; Mr. Rodrigo Prieto, Chief Risk Officer; Mr. Jorge Humberto Hernandez, Chief Account Officer; Mr. Carlos Baene, Investor Relations Director; and Mr. Juan Pablo Espinosa, Chief Economist. I will now turn the call over to Mr. Juan Carlos Mora, Chief Executive Officer of Bancolombia. Mr. Juan Carlos, you may begin.

Good morning, everybody, and welcome to our conference call for the third quarter 2020. I hope all of you and your families are safe and healthy. During the third quarter, Colombia ended the mandatory preventive isolation. The country is now facing the double challenge of containing the second peak of infections while at the same time, gradually reopening the economy. The data have shown that September was the best month since the start of the health crisis, reflecting a better performance of agriculture and mining sectors, complemented by the reactivation of retail and construction, activities that have benefited from more freedom of movement in the main urban centers. While we are still in a very uncertain environment, during the third quarter, Bancolombia performed better than the previous one. The net income for this quarter was COP280 billion. Before getting to the details of the results, I want to mention two key topics. First, regarding credit risk, we recorded 31% less provision charges compared to the second quarter of this year as a reflection of better economic activity and the increase of mobility in the main cities of the country. The cost of risk decreased during the quarter, but it still reflects a weak economic outlook related to the pandemic. This provisioning level and the lag in non-performing loans formation results in a coverage ratio of 232% for the quarter. The second point is regarding our digital strategy for Bancolombia. Digital transformation is a continuous process and a medium to generate solutions that meet the needs of people and companies. This has a higher goal to promote sustainable economic development to achieve well-being for everyone. We started this strategy three years ago and now it is showing very positive results. The actual health crisis has made it possible to see the preparation of the bank in terms of digitalization. From the moment that preventive isolation measures led us to limit physical operations, we were able to redirect most of our clients' needs to digital channels. Today, we have more than 12 million digital clients. At this point, I want to turn the presentation to Juan Pablo Espinosa, who will further elaborate on the performance of the Colombian economy.

Thank you, Juan Carlos. During the past few months, the Colombian economy has rebounded from the low teens in April and May as lockdowns came to an end. To do a gradual resumption of activities in most sectors and higher mobility within the country, GDP variation went from minus 15.7% year-on-year during the second quarter to an estimate of minus 9.7% in the third quarter. Moreover, initial data suggests that at the start of the fourth quarter, the pace of contraction has adjusted further to around 9.6% year-on-year. This recent recovery trend is consistent with our full year probably adjusted projection of minus 8.1%. Going forward, uncertainty and risks remain significant, especially due to the possibility of rising COVID-19 cases that might force authorities to impose new containment measures. Nevertheless, we think that the negative impact on the economy of such a scenario would not be as large as we saw in the first half of this year. The relevant risks are the second round effects of the shocks that have taken place since March, including permanent job losses, the reduction of disposable income and increase in poverty. However, moving into 2021, we also identified several factors that will promote economic growth: Low interest rates and stimulus programs led by the government in sectors such as infrastructure and housing will combine with a more positive global context and higher terms of trade. As a result, next year, we project that GDP will recover at a probably adjusted rate of 5.2%. Consistent with this, we anticipate a mild improvement in the labor market. We expect that the urban unemployment rate will average 19.3% in 2020 and will adjust to 17.3% in 2021. Regarding inflation, given the ample negative output gap as well as an abundant supply of food, we think that downward pressures will continue to determine the performance of CPI leading its annual variation to close this year near 1.5%. Inflation will only start to accelerate gradually in the second half of 2021. And by then, activity will start to gain traction and some relief measures taken during the pandemic are reversed. Hence, by the end of next year, annual CPI change will go back to the lower half of the target range. Against this backdrop, we predict a long period of low and stable interest rates. We expect that the reference rate will be at its current level of 1.75% at least until the second half of 2021 when the Central Bank will do some upward fine-tuning in order to keep inflation expectations in check. Finally, a factor that will drive the performance of the Colombian economy during the next two years will be the adjustment of the central government's deficit. After its large widening during the pandemic, our scenario suggests that peso fiscal consolidation will probably be more gradual than initially estimated by authorities. However, implementing actions that lead to a stabilization of public debt will be key to maintain the country's investment-grade and keep access to external financing. Now I want to turn the presentation back to Juan Carlos.

Thank you, Juan Pablo. I want to continue this presentation by walking you through our digital strategy. At Bancolombia, we decided to develop a strategy focused on a holistic relationship with our clients to solve their needs with financial and non-financial solutions. We have studied the context of our clients from life cycles for individuals to production chains for companies seeking to be relevant in their daily lives. In accordance with these analyses, we have decided to evolve our value proposition towards a business model based on ecosystems, developing a value proposition in which clients and financial and non-financial solutions are in one place. So we are working on orchestrating the demand and supply of certain ecosystems such as housing and mobility through our digital channels. In this way, our more than 1.8 million SMEs and corporate clients have been able to offer their services and products to our more than 15 million clients in Colombia. Through this strategy, we will keep adding new clients, approving digital loans and capturing new data sources to enhance risk models. Moving to Slide 5. We can see some figures of this strategy. Bancolombia's QR code as a model to connect formal and informal retailers with more than 8 million digital clients through our digital channels has reached close to 450,000 merchants throughout the country in less than two years. This service allows small businesses to sell digitally and physically, receiving the money from their customer purchases directly to their savings, checking Bancolombia a la Mano or Nequi accounts. With the transaction data of QRs, we have already pre-approved credit lines of more than COP430 billion to clients who have not had access to credit from the financial system before. We launched in alliance with Suramericana a platform that will be available in our digital channels, and its purpose is to strengthen independent workers, who represent about 50% of the workforce in Colombia. We aim to connect 600,000 independent workers in the country with the more than 15 million clients of Bancolombia to accompany them in their growth through the formalization and access to digital credit, thanks to the new data sources that the bank will have. Each independent worker will have a digital account, such as Nequi or Bancolombia a la Mano and QR codes to receive payments for services. In the upcoming weeks, our clients will be able to find personal finance assistance in our app that will help them to manage their day-to-day finances and bring them closer to their housing or mobility goals through financial planning. Additionally, Bancolombia, aligned with its purpose of orchestrating supply and demand to fully serve the needs of our clients, will launch the housing and mobility solutions, two marketplaces for our clients to find their next home, their next vehicle with financing and rental solutions in one place. During the first nine months of the year, Bancolombia distributed more than 2.3 million products through digital channels, which represents 45% of total products sold. Sales through digital channels as of September 2020 have increased by 79% when compared to the same period of 2019. The digital sales have maintained a steady evolution on a monthly basis despite the reactivation of the physical channels during the reopening of the economy in the third quarter. This performance indicates that the customer experience evolution has accelerated during 2020 towards the permanent adoption of digital channels by many of our clients. The balance of digital time deposits reached by September, COP4.5 trillion coming from COP363 billion in January, showing an important growth throughout the year. Digital sales continue to gain relevance towards reducing the operational expenses. On average, the distribution of products through digital channels represents only 36% of the cost of selling it via physical channels. The digital competitive environment in Colombia is getting tougher. New players are entering the market, but we have been preparing for this during the last three years. We have a robust client base, products and services, coupled with access to very competitive funding that give us size and cost advantage. Now I want to turn the presentation to José Acosta.

Thank you, Juan Carlos. Now turning on Slide 7, I want to walk you through the evolution of the relief program in our loan book. Trade reliefs have decreased from June to September by 30%, coming from 44% to 14% on a consolidated basis. Out of total loans under relief, corporate loans represent 46%, consumer represents 22%; mortgages 19% and SMEs, 12%. This trend shows the evolution in the first wave of relief across the board. In Colombia, 10% of total loans are still under relief. However, this percentage should come down to 4% in October, 3% in November and less than 1% by December. Regarding Central America, the relief program is as follows: in Banco Agromercantil, we have 1% of the total loan book under relief. In Banco Agrícola in El Salvador, we have 21%, which should come down to zero by December. And finally, in Banistmo, we have 45% of the total loan book under relief. This proportion may vary until December because of the moratorium law in Panama. Even though the moratorium law is until December 2020, the regulator in Panama gave an extension of the terms of the law until June 2021. On Slide 8, we present the breakdown of the first wave reliefs and the PAT program in Colombia. Regarding credit reliefs in Colombia, we want to point out that the first wave of reliefs is almost done and now represents 6.9% of total loans as of September. It is important to highlight that 88% of loans after the relief ended are performing. 8% of the loans have been canceled and 4% are 30-day past due, which is a very positive indicator of improvement in the payment capacity of our clients. Regarding PAT, remember that this program began in August and will end in December 2020, and we have to offer different alternatives of payment for our clients. It is important to highlight that those alternatives are by demand. Structural solutions of medium and long-term will be granted according to the individual client condition. The PAT program accounts for 3.1% of total loans as of September. Out of the total program, 43% are structural solutions for corporates, 34% for consumers and mortgages and 23% for SMEs. The solutions are basically three: grace periods, deferred payments, and tenure extensions. On Slide 9, we present the breakdown of provisions during the quarter. As we did the previous quarter, we want to explain the provisions breakdown. First, provisions associated with the update of macro scenarios and COVID-19 represented 37% of the total provision expenses as of September. We want to highlight that the expectations for macro variables deteriorated from the second quarter to the third quarter of this year in most of the geographies, reflecting the still uncertain economic environment in which the bank operates. Second, regarding provision charges associated with consumer loans, we must mention that these correspond to a normal pace of deterioration and represent 32% of the total provisions as of September. Moving to Slide 10, we give you a snapshot of the composition by stages and their coverage. Regarding the composition by stages during the quarter, we can see that there was an important increase in stage 2. This increase was explained by three aspects: first, clients in which the relief ended did not get a structural solution and did not have the capacity to pay yet. Therefore, they became 30-day past due. Second, the number of clients in the watch list increased; and third, the output of the risk assessment of our expert models resulted in higher risk. On the other hand, the client increase in Stage 3 was due to a higher number of clients in watch list and a higher deterioration in loans that were not part of the relief programs and that surpassed the 90-day threshold. Coverage by stages shows a strong protection of the balance sheet. Our levels of coverage are aligned with the average of the financial system. Slide 11, represents provision charges and allowances. Cost of risk for the quarter — for the last 12 months was 3.4%. Cost of risk without COVID-19 effect was 2.3% for the quarter and 2.4% for the last 12 months. As a result of our provisioning models, the level of allowances has increased as a proportion of the total loan portfolio, protecting the balance sheet in an environment that is still uncertain. It is important to mention that even though the provision level was lower than the one reported in the second quarter, we expect that provision charges to increase for the fourth quarter because of the end of the first wave reliefs, worsening of macro variables in Central America, and increase of structural solutions under the PAT program. The next slide shows the past due loan formation and coverage. New passing loans during the quarter increased mainly due to higher non-performing loan formation related to the end of the reliefs. Therefore, some clients became past due mainly in credit cards, personal loans, and mortgages. Also, there was a corporate client related to biofuel production that defaulted during the quarter. This client is highly provisioned with a coverage of 84%. The coverage ratio rose to 232%, explained by the provisions based on expert models, clients in the watch list, and past due loan requirements. Also, bear in mind that our risk provision models are based on expected losses under IFRS 9. On Slide 13, we present the capital situation of Bancolombia and subsidiaries. The total service ratio stands at a level of 14.8%, while CET1 at 11.4% for the third quarter, well above the minimum regulatory requirements. These levels leave the bank in the high range of our solvency target. This increase in the capital ratios is explained by the reclassification of existing resources from the occasional reserve to the bank's legal reserve, approved by the extraordinary shareholders meeting last July. This is a remarkable fact; having a strong capital position is a fundamental pillar to face the new future. The adoption of Basel III in Colombia is scheduled to start its implementation in January of 2021. The effect of the accounting reclassification we did anticipated most of the Basel III impact. So we are not expecting a material change in the ratios for January, but because of foreign exchange volatility and uncertainty regarding year-end results ratios may vary. On Slide 14, we present the liquidity position of the bank. On a consolidated basis, we are expecting high liquidity levels to maintain for this year due to low demand in the loan portfolio and low dynamics in withdrawals from savings and checking accounts. Savings and checking accounts have consolidated as the main funding vehicle with a 50% share of the total funding. I want to highlight that throughout the year, we have achieved a continuous decrease in the funding cost, reducing 64 basis points in the last 12 months. In addition to the increase in savings and checking accounts, this improvement is explained by the following reasons: first, the liability management transactions we executed last year and in January this year, allowing us to exchange all bonds with high coupons for more cost and capital-efficient ones. And second, the decrease in credit lines with financial institutions. On Slide 15, we present a snapshot of our stand-alone operations. In general terms, the trend throughout the different geographies operated by Bancolombia is similar. Margins under pressure, fees recovering as economies are starting to reactivate, non- or slightly growth of the loan book, and a solid position in terms of capital and liquidity. In the same way, coverage ratios have been one of the key indicators in Colombia and in the Central American subsidiaries, sustaining a level of 232% on a consolidated basis. Amid the main challenges ahead, I would like to point out the positive evolution in terms of efficiency to bring down the cost-to-income ratios consistently in the four operations such as a coordinated effort that contributed gradually to profitability ratios. On Slide 16, we see the evolution of margins and net interest income. Lending margins continue under pressure during the third quarter, explained by several reasons. First, the increase in Stage 3 clients under IFRS 9 that generates fewer interest income. Second, during this year in Colombia, the cut of rates by the Central Bank has reached already 250 basis points. We don't expect further cost cuts for this year. Third, the mix between consumer and corporate loans will continue to impact the margin. The driver for growth will be in corporate loans. Finally, the loans under reliefs and PAT program will return a lower interest rate because of the structural solutions of grace periods, deferred payments, and tenure extensions. On the other hand, it is important to note that the decrease in cost of funds has added receivings and partially offset the compression to our lending margins, which ended the quarter at a level of 5.5%. We are expecting NIM at around 5% area for the year-end. Slide 17 shows the evolution of expenses and efficiency. The trends in cost efficiency for the bank continued to show an encouraging outlook. During the first nine months of 2020, total operating expenses have contracted already more than 1% when compared to the same period of 2019. General expenses have remained relatively stable, growing less than 1%, below inflation rates, reflecting the management actions to maintain strong cost control. Moreover, personnel expenses have significantly contributed to the improvement of operational burden, dropping more than 7%, mainly attributed to bonus plans related to employee benefits. Our cost-to-income ratio stands at a level of 49.7% for the third quarter of this year. The depreciation of the local currency had an impact on efficiency when excluding the foreign exchange impact and cumulative figures; the reduction in operational expenses for the first three quarters of the year we have reached more than 4%. For 2020, we are expecting to report aberration between 0% and 2% of our operating expenses. Regarding income tax, the figure shows a recovery of COP11 billion, mainly explained by the Colombian operation. Such a boon refers to the tax impact related to fiscal concepts such as tax discounts, liability management operations, and tax shields resulting from the second quarter net losses. Slide number 18 shows the evolution of fees. Fees have been receding during 2020. During this quarter, they grew 12% when compared to the second quarter of 2020 and decreased 2% when compared to the third quarter of last year. Lines such as debit and credit cards, bancassurance, trust, brokerage, and investment banking have contributed to the performance of fees during the year. In bancassurance, we have grown 20% for the year. We expect these products will continue leading the growth next year. Now I want to turn the presentation to Juan Carlos for the closing remarks.

Thank you, José. In summary, I would like to highlight several elements of the third quarter results. The balance sheet structure remains solid. We are expecting the loan portfolio to remain stable or could even have a single low-digit growth for the end of the year. The funding composition shows high liquidity levels, diversification, and cost reduction, and solvency levels are more than enough to face this economic cycle. This year has higher levels of uncertainty. We think that the fourth quarter will reflect more accurately the performance of our clients in terms of their payment capacity, and therefore, we could know what will happen in terms of risk. Bancolombia is well prepared to face the new normal. We have a stronger capital and liquidity position, a better cost structure, and a more diversified portfolio of products and services leveraged by a robust digital strategy with a positive evolution of digital platforms that have allowed us to gain over 4 million new clients during the year. After elaborating on these key topics, I want to open the line for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Thiago Batista. Your line is open.

I have one question about asset quality. So if you can comment on how fast do you believe that the cost of risk in Colombia will normalize? So to be more specific, in 2021, next year, do you have any sense on the level of cost of risk? And if it's possible to see, let's say, kind of still high levels of provisions in the first half and then some normalization in the second half? So if you can talk a little bit. I know that is a tough question, but on how you can see the dynamics of cost of risk going forward? And another one, very briefly one and linked with this cost of risk is how fast will the normalization of the bank's return on equity be? So if you can comment on what we can expect for next year if it's high single digit, close to 10%, above that. So only a big number or a big indication on how fast would be the recovery of the bank's results.

We are expecting, maybe, as we mentioned in the script, a certain level, the same level of provisions or either a little bit more this next quarter this year. What we expect next year? We are expecting the first half maybe to maintain a certain level of provisioning because of two factors. First, because of the PAT program, which means there will be more clients restructuring that will require provisions. And the second factor, that will be because of the Banistmo operation in Panama, they will finish partially the relief program. So we are going to see the same effect that we are seeing here in Colombia during the second half of the year. So those are the two reasons why we believe that this first half of the year, the provisions will maintain a certain level. When we are going to reach the new normal in terms of cost of risk, a new normal meaning in between 2% area. Maybe in two years, and this is basically because of the effects of COVID-19. Regarding your second question regarding return on equity, obviously, because this is highly correlated with the cost of risk. We believe that in the next two years, the return on equity will be single-digit, and we will go back to the double-digit return on equity in two years, I mean beginning in 2023.

Our next question comes from Ernesto Gabilondo from BoA.

My first question is on the deferred portfolio. Can you walk us through the first and second rounds of the deferred loans? I believe that initially, 50% of the portfolio was integrated by deferred loans. And as of today, it's only 14%. So can you repeat how much of the first round is current, restructured, and delayed? And for the second round, how much do you expect to be restructured and delayed? And when do you expect to communicate the payment behavior of the second round? And very quickly, a second question in terms of taxes. I believe you have a couple of quarters with no taxes. So how should we think about the effective tax rate during the last quarter and for the year?

Thank you, Ernesto. Let me elaborate on your question related to the deferred part of the portfolio. Currently, in Colombia, we have around 10% of the total portfolio with some kind of relief, 14% in total on a consolidated basis. The total portfolio is performing. That part of the portfolio is performing, close to 90% are current. So the other part was canceled. So just 4% is 30-day past due loans. So that behavior we think it's a good behavior. It shows that the payment capacity of the clients was affected, but still, they have cash flow to serve their portfolios. Related taxes, you are right. We had lower taxes because of some tax shields and some particularly the quarters, but we expect the tax rate on a consolidated basis to be between 10% and 15%. So there are going to be some tax charges at the end of the year related to how we are going to behave. And I want to refer to Thiago's question since I was not able to answer. Definitely, 2021 will be a transition year. It's going to be a better year than 2020, but it's not going to be a normal one, definitely. So cost of risk is going to move towards a mid-term normalized figure, but still, it's going to be above that level. We find that our cost of risk, midterm cost of risk should be around 1.7%, 1.9%. And definitely, next year, will be, as I said, better, but not on that range. And related to ROE, again, transition year, where we think that ROEs should be around the top of a single-digit figure, but we will see how it's going to perform. The performance of the portfolio is encouraging. We think that it's performing better than we expected, but we need to wait and see how '21 will develop. I want to pass to José Humberto Acosta to see if we want to add something to these topics.

No, Juan, I think the answer is complete. So I have no comments.

Our next question comes from Sebastián Gallego.

My question today will focus on Central America. We observed a varied performance across different regions. I would like to delve deeper into certain trends, especially considering the net losses in Guatemala alongside the strong performance in El Salvador, while also taking into account the situation in Panama. Can you provide more insights on the expectations for this region, especially given the high levels of confidence you mentioned in your remarks? Additionally, my second question pertains to capital. You noted that Basel III should not significantly impact the capital ratios. Initially, banks in Colombia anticipated a positive effect from the implementation of Basel III. Are you still not expecting that positive effect?

Thank you, Sébastian. Regarding our operations in Central America, I'll break it down by the three countries we are involved in. Starting with El Salvador, Banco Agrícola is performing quite well. The bank's non-performing loans are managing well, demonstrating strong profitability and solid operational ratios. Remittances, which play a crucial role in the Salvadoran economy, are also doing very well. The same applies to Guatemala. This isn't just limited to Salvadorans; it reflects the Central American community in the U.S. Remittances are performing positively. Our operations in El Salvador are stable, and Guatemala's economy is also doing well. However, we are experiencing losses due to some extraordinary provisions, which we are working to normalize. By normalization, I mean aligning with our standards for coverage ratios regarding provisioning. We're making progress in Guatemala, and I am optimistic about the economy's performance and that of Banco Agromercantil. Yet, some adjustments are still needed, which will influence Banco Agromercantil's performance in the near term. Overall, I would describe both banks' performances as good. The situation in Panama is somewhat different. As Juan previously mentioned, we are still under certain moratoriums that prevent us from accurately assessing asset quality, and this will continue for a while. We have to wait to see how the economy performs, and currently, we don't have much information. We are actively engaging with our clients and providing tailored solutions for their specific situations, but in Panama, we should hold off until the moratorium concludes to understand the true asset quality. Regarding capital, we had a significant shareholders meeting at the end of July, where we transitioned new reserves to become permanent. This change improved our capital ratios. However, with the upcoming implementation of Basel III starting next year in Colombia, we anticipate some positive effects on our capital ratios. The asset density will improve, which should positively impact our ratios. We will need to include additional buffers for operational and systemic risk, but overall, we expect to benefit from the Basel III implementation in terms of capital ratios.

Our next question comes from Jason Mollin.

My question is a follow-up on the payments being made by the first wave of rescheduled loans. I think you showed almost 88% in the presentation, I think you were saying almost 90%. Can you give us that evolution? What was that in the second quarter? I think it was not nearly as good. So I wanted to understand better that evolution. And then as a follow-up on capital, but more so on the movement in shareholders' equity in the quarter, we saw a boost above the net income generated. And I believe a portion also came from translating the dollar capital or equity you have in Central America. If you can give us some specifics on what is the dollar equity that you have? And how did that impact it? And if there was any other impact? Because it seems like it was larger, a larger impact than just that FX movement.

Thank you, Jason. Let me take your first question, and I will pass the second one to José Humberto. During the second quarter, around 44% of our portfolio was under some kind of relief. So during that period, indicators actually improved. The non-performing loans were down, but that was because of that particular situation that a lot of our portfolio was under some kind of relief. So the second quarter is not a quarter from which we can have good information about the performance. Even though we keep doing provisions, coverage ratios improved, the third quarter now that the first wave of reliefs ended, as we mentioned. And now we enter in a different phase, which is a more structural phase of restructuring the loans of our clients, it's much clearer how the loan portfolio is performing. And as I mentioned before, it's performing well. Let me say that, even though there are in general, the economy is affected, and of course, some payment capacity of some clients is affected, but it's performing well. So the second quarter was, for me, was a quarter in which we didn't get much information on the actual quality. The third quarter gives us more information, and we are confident that what we are seeing is good. Let me say that economic activity in Colombia in September and October has been good. We see much more activity around sectors that were very affected and are encouraging. But still, as we mentioned in our presentation, there is still a lot of uncertainty around if these trends are going to consolidate or not. But what we are seeing at this moment, with the information that we have is that the loan portfolios are performing according to what we were expecting, or even a little bit better. Let me pass your question around capital to José Humberto.

Thank you, Jason. Yes. The equity, it is improving and it's increasing because of a combination of three factors. The first one, as you mentioned, Mollin, today, we have more than 30% of our equities in U.S. dollars, and you have to take into consideration that the valuation of the currency is 12%. So that is the first reason why the equity is increasing. The second one is the net income cumulative, we are having COP0.5 billion in net income in September. So it is reflected also on the equity side. And the third reason is we announced the complete acquisition of Banco Agromercantil that was 40% of the operation; that also reflects on the equity. And going back to the point of solvency ratio, the impact of moving some reserves from occasional to legal reserves, the real impact was in terms of solvency ratio at around 200 basis points.

Our next question comes from Carlos Gomez.

It's also a clarification of what you said before; you were very clear guidance in terms of taxes for this year, but I don't think you gave guidance for 2021. And also, you referred to more provisions in the fourth quarter. I mean, the profitability of the group was already reduced to 4% ROE this quarter. So should we expect a loss in the last quarter of the year? And again, related to this and given your capital position, do you have any expectations for dividends for next year?

Thank you, Carlos. I will address your second and third comments and refer the first one to José Humberto. Looking ahead to the fourth quarter, we are moving towards a more normalized situation. This means that loan portfolio performance will be more indicative of the current economic conditions. As I mentioned earlier, the second quarter was focused on relief measures, while the third quarter offers a clearer picture of the economy's state, and the fourth quarter will provide further insights. We anticipate that provisions may increase in the fourth quarter due to uncertainty regarding client payment performances, particularly for those still receiving some form of relief. On the positive side, some sectors are performing better than expected, and the unemployment rate has shown some recovery, though we need to monitor if this trend holds. To summarize, we could see higher provisions in the fourth quarter, but the economic outlook appears slightly better than we anticipated. Regarding losses, we are hopeful that our income performance and expense management will lead to a quarter without losses, but this remains uncertain. There is still some ambiguity about how the final quarter will unfold. As for dividends, that will depend on the end-of-year net income. Currently, we are in a positive position in the third quarter, which ties into your inquiry about the fourth quarter. Personally, I am optimistic about the fourth quarter’s performance, but we must acknowledge the ongoing uncertainty. Now, I will pass your remaining question to José Humberto.

Thank you, Juan. Carlos, yes, what happened till September, as we mentioned on the credits, because of the net losses that we registered in the second quarter, we have this tax recovery. And remember that we had the liability management exercise exchanging sub-debt and also they gave us a tax shield. So that's the reason why we have right now a tax recovery. What is going to happen at the end of the year is maybe some operations we have net income. And in those operations, the statutory tax will be in between 35% to 36%. That's the reason why our guidance computed tax at the end of the year will be in the range of 10% to 15%, as Juan mentioned. Next year, we are going to see the performance of the different operations that we are having. Remember that our statutory tax in Colombia will be 36%; Salvador, 35%; the other two operations in Guatemala and Panama, 25%. So if you blend a combined, maybe our taxation of our tax rate, effective tax rate next year will be in the range of 25% area. But again, it depends on the performance of the cost of risk, depends on the recovery of the economies in which we operate, depends on the loan growth that we are going to see maybe in the second half of this year.

Our next question comes from Alonso Garcia.

I wanted to discuss the operating expenses. This year, over the past two quarters, operating expenses have been unexpectedly favorable. I'm curious about how much of this positive outcome is due to the significantly reduced activity this year because of the pandemic. Additionally, how many of these cost savings are likely to continue? After experiencing 0% to 2% growth in operating expenses this year, what can we anticipate for next year and the years ahead? Should we expect this growth to align with inflation going forward? Also, how do you view your efficiency ratio from a midterm perspective?

Let me provide some insights, and then I will turn your question over to José Humberto for further comments. Regarding the structural measures we are implementing related to operating expenses, some actions we are taking are specific to this year and the unique circumstances we are facing. For example, bonuses are one element that is particular to this year, and we anticipate that this will normalize in the future. However, beyond that, we are focused on structural changes that will be lasting. Our goal for efficiency is to continue to enhance it, which has two main components: managing operating expenses and planning for next year. We expect some genuine growth, but we believe our cost control initiatives will yield positive results in 2020. Therefore, we foresee growth in 2021 as we need to sustain our investments and equip the bank with the necessary tools to remain competitive. We anticipate a recovery in income, leading to an improved efficiency ratio next year, but we don't expect a constant improvement in this ratio going forward. With that, I will now hand your question over to José Humberto for additional insights.

Alonso, if you check the numbers of each operation individually, all of them are growing negative in terms of expenses. We have been doing our job, as Juan mentioned. Just to give you a couple of examples. In terms of headcount, we have almost maintained the same number of headcount that a year ago, we have been doing some efforts in different geographies. In terms of branches, this year, we have been reducing 17 branches, 1-7 in some operations in Panama, in Colombia, and also in El Salvador. So at the end of the day, we are creating the foundation of the new way to do business, a new way to distribute our products. So again, you have to take into consideration that there was an inflation in Colombia of a foreign exchange depreciation of the currency of 11.7%. If you discount that, the negative growth could be around minus 4% in expenses. So we are doing our job. And as Juan mentioned, we are expecting to maintain this OpEx under control in the next coming two years.

Our next question comes from Yuri Fernandes.

I had a very quick one on margins. I heard on your presentation, you're saying like the outlook is challenging because of the mix, the rate pressure, the PAT program, and you mentioned a number around 5% by year-end. And I just want to check what does this 5% mean because if we look at the total margins now, this quarter, I think it was 4.9%. So this is an improvement, like of 10 bps? Or when you say around 5%, are you talking about the margins on loans that were 5.5%. So an additional 50 bps pressure for the fourth Q. So I just want to understand a little bit more the dynamic of the margins for the 4Q and as a result, for 2021. And if I may, a second one on provisions. We see Bancolombia doing more provisions than peers overall and we know that all the banks in Colombia, at least the way we look here, right, they are under IFRS 9, and they should provision as expected losses. But still, we see a very big difference between you and some of your peers. And I know it's hard to talk about peers, but what are things happening here? Like you think Bancolombia had worse underwriting? It's a different mix or maybe peers are having different assumptions on the expected losses model. How do you address this big discrepancy of you building a lot of losses on the loans and some peers not doing as much as you are?

Thank you, Yuri, for your question. I'll address your second question and pass your first one about NIMs to José Humberto. It’s challenging to compare ourselves with peers, but we can focus on our own approach. We are carefully assessing credit risk, aiming to be conservative. As you noted, we're managing an expected loss scenario, but how we handle provisioning plays a significant role. Specifically, when you factor in the weighted expected economic performance in your models, the difference between forecasting a 6% decline versus an 8% decline in 2020 will impact your provisions. The inputs banks use can vary, even if we're operating under similar conditions. Regarding your question about whether our underwriting process is worse than others, I don't believe that's the case, and the numbers support this. The performance indicators show no substantial differences in non-performing loans or the transition of credits from 30 days past due to 90 days past due among various banks. Ultimately, it boils down to how you incorporate your outlook for the future, whether you're proactive or taking a wait-and-see approach.

Thank you, Yuri. Yes, you are right. There are a combination of factors that had a big pressure on the NIM. But just to give you an idea what's going to happen in the 4Q. What is happening right now in Q3 is there is an increase in Stage 2 credits. Because now people are increasing the level of past due for 30 days to 90 days. In the next quarter, we are going to see an increase of the 90-day past due, and when you get the 90-day past due, you have to increase the provisioning, but also you don't have to interest. So that will impact the NII for the fourth quarter basically because of the Stage 3 incremental. The other reason is we did our job reducing our funding cost. And you see that the numbers have dropped 69 basis points the whole year. We did our job. And marginally, we are not seeing more space to reduce the funding cost on the same trend. That's the reason why we are expecting a 5.1%, 5.2% area NIM at the end of the year, and we are expecting to maintain the 5% for the whole year 2021.

José, Yuri was asking about NIMs. Could you give some information about what we are expecting? We mentioned during the remarks that we are expecting by year end a NIM around 5%. We reported 4.9%. We still need to see how interest rates will evolve. But please, José, give Yuri some more information about the new.

Yes, I'm sorry about that. Yes. We were talking about the lending NIM of the loan portfolio. If you combine the 5.5% of the lending portfolio NIM with the securities portfolio mean that is 1.7%. That's the reason why it is right now at a level of 4.9%. For us, it's very complex to realize how will be or which number will be at the end of the year, the combined NIM. We are just referring to the NIM of the lending portfolio that currently is 5.5%, and at the end of the year, that will be 5.2% and the whole NIM will depend on the performance of the security portfolio.

Our last question comes from Andres Soto.

My question is related to digital strategy. When we look at your numbers, it's really impressive what you have achieved in terms of digital adoption and increasing clients via digital. So my question is related to what is your target in terms of digital strategy? Meaning, are you looking at this either as a way to increase your market share in consumer loans? Are you looking at this as a way to improve your efficiency; therefore, you should have a reduction in expenses, shutting down branches, or is it just this defensive strategy and this connected to your medium-term guidance where you say that you don't expect returning to double-digit ROE until 2023, which implies that based on the cost of risk assumption, that basically implies that your margin is not going to expand that much. So I don't see that much of a mix benefit in there. You are expecting and expenses will need to continue increasing in nominal terms year after year. So I don't see that being reflected as efficiency. So I'm kind of puzzled how we can incorporate the results of digital in terms of profitability.

Thank you, Andres, for your question. The digital strategy is intended to act as a defense mechanism, but that isn't its primary purpose. We have been rolling out various initiatives for over three years to establish ourselves as a digital player in our markets. During this health crisis, we've seen a significant boost in this strategy, with adoption rates among our clients being exceptionally high. We are preparing for the upcoming launch, and we are pleased with the numbers reflecting how our clients are embracing new ways to interact with the bank and access our products. This includes not just financial products, but also how we integrate more into our customers' daily lives. Currently, we are adding about 300,000 new customers each month. Despite the option for clients to visit branches, we have observed continuous growth in digital sales. We are definitely gaining market share and are confident in our ability to continue doing so as we are equipped to meet the evolving expectations of our clients. It's more about how clients embrace what we offer than our readiness to provide various digital options. Our presence is strong, and we are witnessing this growth period. While there are many discussions regarding fintechs, we believe we can match their offerings since we have been developing our capabilities for a while now. Our strategy is yielding positive results. This will also impact our expenses. As you know, a significant cost for banks is related to the branch network. As we shift towards a digital approach and enhance our customer relationships, branches will adapt, potentially altering these costs. Consequently, this strategy should improve our cost performance. Ultimately, it's a midterm strategy aimed at increasing market share and being an active player, which will affect operating expenses and solidify our position against new market entrants.

There are no further questions. I'll turn the call over to Juan Carlos Mora, CEO, for closing remarks.

I want to thank you all of you for your participation in this call and your interest in the Bancolombia results. We think that the fourth quarter is going to show us how is the real situation of the economy and related to that to our clients. I am positive that what we are seeing is good. We will see that next year when we are together to present the full year results conference call in which we will expect you to be with us. So thank you very much again for your interest, and have a good day.

This concludes today's conference. Thank you for participating. You may now disconnect.