Earnings Call Transcript - CIB Q2 2020

Operator, Operator

Good morning, ladies and gentlemen, and welcome to Bancolombia's Second Quarter 2020 Earnings Conference Call. My name is Tanya. I'll be your operator for today's call. 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, whether made in this conference call, in future filings and press releases or verbally, address matters that involve risks and uncertainties. Consequently, these 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 substance of new products or services by our targeted clients, changes in business strategy and various other factors that we describe in our reports filed with the SEC. With us today is 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 Accounting 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.

Juan Carlos Mora, CEO

Good morning and welcome to our conference call for the second quarter of 2020. I hope all of you and your families are safe and healthy. The second quarter of the year absorbed the significant impact of the pandemic, not only in Colombia but also on a global scale. We are living under a new challenging environment, which has led us to quickly adapt as a bank and as individuals to face this new reality. In Bancolombia, we are fully committed to support our clients and take care of our employees. The net income for the first half of 2020 was COP263 billion, mainly because of a net loss of COP73 billion for the second quarter. I want to start by giving you an overview of 4 key points. The first is about our solid liquidity position and robust capitalization levels. We have diversified funding sources with our resilient deposit base. Since the first quarter, we have experienced a material increase in our deposits that have remained throughout this quarter, and this has allowed us to sustain high-quality liquid assets. On the capital front, our Tier 1 ratio reported for the first quarter is 9.3% and will increase after the extraordinary shareholders' meeting approval by which we reclassified COP4.12 trillion from occasional reserve to legal reserve on a consolidated basis. The second point is that we have increased our provisions by 76% compared to the first quarter of this year as a reflection of the weaker economic outlook related to the pandemic. This provisioning level results in a coverage ratio of 208% for the quarter. The third point is regarding our digital strategy. We have been a leading bank in Colombia supporting the government with the distribution of subsidies. We rapidly implemented an operating model that allowed us to distribute more than COP442 billion throughout our digital platforms, Bancolombia a la mano and Nequi, successfully adding over 2 million new clients. And finally, the last point is about the macroeconomic environment. Since the gradual reopening of economic activity in April, we have seen a slow recovery, but the uncertainty around the impact of COVID-19 and the overall performance of the economy in the second half remains significant. At this point, I want to turn the presentation to Juan Pablo Espinosa who will further elaborate on the performance of the Colombian economy.

Juan Pablo Espinosa, Chief Economist

Thank you, Juan Carlos. Let me start by saying that following a trend seen in many countries as a result of the lockdown measures taken to contain the advance of the pandemic during the second quarter of 2020, the Colombian economy experienced the largest contraction in several decades. According to our estimates, year-on-year variation of GDP in this period was around 16%, which is close to the upper bound of our forecast range. The decision of Colombian authorities to gradually restart activities in key sectors, such as manufacturing, construction, and retail, has led to a correction in the pace of contraction. As a result, monthly figures of economic activity moved from 20.5% in April to 16.6% in May and 11.3% in June. Despite this small improvement, we think that for the second half of 2020, the risks to growth are biased to the downside. In fact, as containment measures keep limiting the operation of several industries and uncertainty regarding the advance of COVID-19 remains, activity will be affected. This perspective is incorporated in our view of GDP contracting between 6% and 9% for the full year 2020. It is also important to mention that the negative effects of the pandemic have also translated to the labor market as the unemployment rate has soared to the highest levels seen since the recession of 1999. We foresee that in the short term, the urban unemployment rate will continue to increase, albeit at a lower pace than that seen in April and May. Regarding prices, during the past few months, consumer inflation has moderated markedly, thanks to several actions taken by the government aimed at reducing the burden of utility payments to households as well as a better performance of food prices and low pass-through of depreciation. Going forward, we anticipate that inflation will further correct due to lower pressures on the main components of the CPI. Hence, year-on-year variation will likely close the year below the floor of the Central Bank target range we see, which is 12.2%. In terms of monetary policy, the Colombian Central Bank has reacted proactively to the challenges arising from the pandemic and the reduction in oil prices. In addition to the increase in liquidity provision and asset purchases, it has cut its benchmark rate to 2.25%, the minimum level since the introduction of the inflation targeting regime. Due to the risk to growth, employment, and the deceleration of prices, further cuts are likely. However, future decisions will be contingent on new data, and we think that BanRep will continue to act cautiously. Finally, it is worth mentioning that over the past few months, conditions in global financial markets have improved. As a consequence, oil prices have recovered faster than initially expected, and the Colombian peso has gained some ground beyond our previous expectations. Moreover, given that we expect an additional inflow of dollars due to foreign debt disbursements, the local currency can sustain its recent gains. I want to turn the presentation back to Juan Carlos.

Juan Carlos Mora, CEO

Thank you, Juan Pablo. I want to continue this presentation by sharing with you what has been Bancolombia's response to the COVID-19 pandemic. Regarding our employees, we have focused on 3 main tasks: First, deploying resources to assist our employees in terms of mental and physical health; second, establishing remote work schemes for the majority of our workforce for safeguarding purposes; and third, adopting the opening model so that we can run the business without significant disruptions, designing specific return plans to the corporate buildings under strict protocols supported by analytics to optimize schedules and the use of workplaces. As of today, 58% of the group of employees are working from home. On the other hand, Bancolombia has adopted the support of communities as a priority during the pandemic. We have assisted the government in delivering subsidies under its different support programs, benefiting more than 857,000 people and more than 55,000 businesses. Over 1.7 million employees benefited from the subsidies distributed by the bank. Now turning to Slide 5, I want to walk you through the details of the impacts of the relief program in our loan book. We have taken several actions to help our customers over the last months on different fronts. First, we granted a 3-month grace period to personal loans and up to a 6-month grace period to mortgage loans. Whereas for SMEs and corporate loans, we granted this on a case-by-case basis based on the situation of each client. You may see in the slide, on average, the total relief program has represented around 50% of the total loan book, except in Banco Agromercantil de Guatemala, where it represents 31%. In the case of Bancolombia, 50% of the total relief is related to retail, 20% to SMEs, and 30% for corporate loans. Moving to Slide 6, we can see one positive aspect of the current situation, which is the growth in the adoption of digital banking. The number of clients and transactions has increased substantially over the year. Nequi and Bancolombia a la Mano have almost doubled since 2019 and are now reaching an aggregate of 6.6 million users. Nequi has grown over 300% in transactions over the last year, and Bancolombia a la Mano has increased almost by 3x the number of remittances during the second quarter of 2020 compared to the same period of 2019. This trend accelerated during the second quarter as Nequi showed a 45% growth in the number of users and 60% in the number of transactions, while Bancolombia a la Mano grew 55% in the number of users and distributed over 1 million payrolls as of June with an annual growth of 20%. We expect these trends to continue during the second half of 2020, although not all at the same pace. On Slide 7, we present the current status of our distribution channel in Colombia. The key point I want to emphasize is the rapid adoption of digital channels. During the second quarter, total transactions conducted through digital channels represented 87%. In this quarter, transactions performed through digital channels have grown 60% when compared to the second quarter of last year. I wanted to highlight 2 important facts. First, 70% of our clients use at least one of our digital channels; and second, the significant growth in digital sales, this year it represents close to 43% of the total number of products sold. This is more than double the figure of 2019. Now I want to turn the presentation to José Acosta. José?

José Humberto Acosta, CFO

Thank you, Juan Carlos. On Slide 8, we present the breakdown of provisions during the quarter. As we did the previous quarter, we want to explain the provisions breakdown. First, the provisions associated with the update of macro scenarios with a more negative forward-looking outlook and COVID-19, which represented 49% of the total provision expenses during the quarter. We want to highlight that the expectations for macro variables changed significantly from the first quarter to the second quarter of this year across the board. For example, expectations of GDP in the case of Colombia are minus 6%, coming from minus 0.8% in the first quarter of this year. Second, regarding provision charges associated with consumer loans, we must mention that these correspond to a normal pace of deterioration explained by the 17% nominal growth of the consumer loan portfolio between June of this year and June of last year. This growth occurred mainly in personal loans. Finally, we did the specific provisions for corporate clients in Colombia that also impacted the number. Moving to Slide #9, we give you a snapshot of what we are doing with our clients in terms of risk categorization. Because of the relief programs, we have been working on the risk assessment front, using internal data and developing models to determine the level of risk of the loan portfolio so that we can estimate NPL formation and the provisioning level of each group of risks. Assuming, for the retail segment that represents 34% of the total loan book, we identified that 68% is in loan risk, which means that those clients will be able to pay their obligations on time in the coming months. The 19% is in medium risk, which means those clients will need some type of solution to pay their obligations, and the 13% is in high risk, which means those clients are highly affected and might need a restructuring of their conditions in the coming months. SMEs represent 13% of the total loan book, and corporate represents 52%. As the SME segment has been the most impacted by COVID-19 and the economy's lockdown measures, the portion with high risk is at a 37% level. It is worth mentioning that during the first wave of reliefs in the corporate book, we developed a contingency of internal bundles of short-term solutions for each client depending on the type of support they needed. For the second wave of relief solutions, medium and long-term will be granted according to the individual client condition. Regarding SMEs and individuals, in the first wave of relief, SMEs had a similar treatment to the corporate book, but individuals got an automatic program of grace periods that ended in July for personal loans and will end in September for mortgages. It is important to highlight that this automatic program of grace periods intended to help clients comply with the national regulations regarding payment reliefs during COVID-19 lockdowns. As a result of this, the relief program represents around 51% of the total loan portfolio in Colombia. One implication of the grace periods is that past due loans did not increase. It is also that, to recognize the risk of the loans that received the grace periods, we used expert models that helped us to keep the same levels of provisions historically observed, and therefore, to better estimate provisions expenses. On the other hand, for the second wave of reliefs, which began in July and ends in December of this year, we have to offer different alternatives of payment for our clients. Some of them are mandatory by regulation and others are optional. It is important to highlight that those alternatives are by demand, which means that our clients must ask for the solution and must show evidence that they need it. Some of the options that we will offer to our clients are: self-managed solutions through our digital channels to extend, for example, the tenure of loans; specialized channels such as BPOs and audio banking to request solutions that are suitable for each client depending on their needs; and banking sales representatives for SMEs and corporates to develop the best solution to help these segments. Regarding the composition by stages, during the second quarter of this year, we can see that there was an increase in stage 2 and stage 3. The increase in stage 2 was explained by 2 aspects: First, the number of clients on the watch list increased; and second, the output of the risk assessment of our expert models resulted in higher risk, both due to the COVID-19 pandemic. On the other hand, the increase in stage 3 was also due to a higher number of clients on the watch list and a higher deterioration in loans that were not part of the relief programs and that passed the 90-day threshold. Finally, we expect to see a high deterioration of the loan portfolio in the second half of the year as the economy continues to suffer the impact of the lockdown. In this highly uncertain economic environment, estimated NPL formation is quite challenging, which makes it difficult to have an estimation of the provision charges and portfolio quality metrics for 2020. On Slide 10, we present provision charges and allowances. The cost of risk for the quarter was 4.8% and 3% for the last 12 months. The cost of risk, without the COVID-19 effect, was 2.4% for the quarter and 2.2% 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. The next slide shows the past due loan formation and coverage. New past due loans during the quarter decreased mainly due to the relief programs that began in March 2020. We also maintained the pace of charge-off loans during the quarter, restructured some clients, and there is some recovery of loans. Therefore, the behavior of the NPLs is negative, which means that they are being reduced. The coverage ratio rose to 208%, mainly explained by the provisions based on expert models that help us estimate the possible deterioration of the loan book, and therefore, the provisions necessary to cover those NPLs. Also, bear in mind that our risk provisioning models are based on expected losses under IFRS 9. On Slide 12, we present the liquidity position of the bank. The second quarter has shown a sustained trend in high liquidity levels in the consolidated figures and in the 4 geographies balance sheet in which the bank operates. And it's worth mentioning that we have an optimal funding structure with an important level of stable retail deposits, thanks to a strong customer base. The flight to quality effect seen in the first quarter continues to be reflected on the liability side and has contributed to the high liquidity levels. This has allowed us to withstand the grace periods we have granted to our clients. During the first semester of this year, the balance on checking and savings accounts has increased by 19% and represents 49% of the total funding. Such growth has been consistent in all 4 geographies. The output of the mix with a lower share from time deposits has permitted us to improve the cost of deposits quarter-by-quarter. I want to highlight that in the last week of July, we successfully executed the second international senior bond issuance for Banistmo for $400 million. The use of proceeds from the transaction is to establish a stable and diversified funding base. These liquidity levels should be maintained for this year due to the lower demand in the loan portfolio and low dynamics in withdrawals from savings and checking accounts. On Slide 13, we present the current capital situation of Bancolombia and subsidiaries. The total solvency ratio stands at a level of 12.64%, while CET1 totaled 9.3% for the second quarter, well above the minimum regulatory requirements, which signals a solid position to face the upcoming challenges. The bank has been in recent years accumulating capital, thanks to its earnings retention policy. According to the stress test performance under stressed conditions in terms of credit quality and considering the current environment and our portfolio growth outlook, the capital ratios are comfortable to comply with the regulatory thresholds. Last week, as Juan mentioned, it was approved by the extraordinary shareholders' meeting to reclassify existing results in the occasional reserve to the bank's legal reserve. Under the current Colombian regulation, the only reserve that is shareholders' equity considered as a basic solvency is the legal reserve. Similar measures were taken in Banistmo and Bancolombia for a total value of COP4.12 trillion. This action aims to increase the bank's solvency levels, while the shareholders' equity would not suffer any particular change. As a result, this accounting movement will increase the regulatory capital position and under a pro forma exercise with June numbers, we estimate a core equity Tier 1 ratio of 11.2% on a consolidated basis, which leaves the bank in the high range of our solvency target. This is a remarkable fact because under the current circumstances, having a strong capital position is a fundamental pillar to face the near future. The adoption of Basel III is scheduled to start its implementation in 2021. Our pro forma analysis suggests that we will increase our capital levels again. On Slide 14, we present a snapshot of our stand-alone operations. Through the different geographies operated by the Bancolombia Group, it is important to highlight the solid position of the stand-alone banks in terms of capital and liquidity as one of the priorities to operate reliably in the current uncertain environment. In the same way, coverage ratios have been key indicators in Colombia and the Central American subsidiaries, sustaining a level of 208% on a consolidated basis. Awaiting many challenges ahead, we would like to point out the positive evolution in terms of efficiency to bring down the cost-to-income ratios consistently in the 4 operations as a coordinated effort to contribute gradually to profitability ratios. On Slide 15, we see the evolution of margins at the net interest income. Lending margins were under pressure during the quarter, mainly explained by 2 reasons: First, the impact on stage 3 clients under IFRS 9 that generates fewer interest income; and second, during this year in Colombia, the reduction undertaken by the Central Bank has reached already 200 basis points, and it's expected that the cut rates will further continue through the year. On the other hand, it is important to note that the decrease in the cost of funds has added resilience and partially offset the compression of our lending margins, which ended the quarter at a level of 5.1%. Core deposits continue with the positive evolution shown at the beginning of this year during this quarter. However, we expect a NIM at around 5% at the end of this year. Finally, a steady balance in the loan portfolio and the sustained accrual of interest from clients under relief programs during the recent months explain the stability in NII for the second quarter of this year. Slide 16 shows the evolution of expenses and efficiency. Our focus on cost efficiency has delivered positive results. During the second quarter of 2020, the bank has managed to decrease total operating expenses by 15% when compared to the first quarter of this year and by 8% when compared to the second quarter of last year. In general, the first semester presents a positive performance driven mainly by lower personnel expenses and partially offset by higher administration and general expenses. During the first 6 months of this year, personnel expenses grew 0.8% on a yearly basis. But excluding the FX impact, we would have experienced negative valuations of 2.5%. For 2020, we expect to increase our operating expenses between 2% and 4%. Regarding income tax, the decrease during the quarter was mainly explained by the Colombian operation. One of the main aspects that explain the decrease is the higher level of provisions related to loans that generate deferred taxes. Now I want to turn the presentation to Juan Carlos for the closing remarks.

Juan Carlos Mora, CEO

Thank you, José Humberto. As a summary, I would like to highlight 3 main elements of the second-quarter results. The balance sheet structure remains solid. The loan portfolio will not grow as expected; it could be around minus 2% 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. The digital development of the bank has allowed us to connect the government support and the most vulnerable population to provide banking services to our clients without leaving their homes and to expand the client base through Nequi and Bancolombia a la Mano. This year definitely has high levels of uncertainty. We think that the fourth quarter of the year will reflect more accurately the behavior of our clients in terms of their payment capacity. Therefore, we could know what will happen in terms of risk. After elaborating on these key topics, I want to open the line for questions.

Operator, Operator

Our first question comes from Andres Soto from Santander.

Andres Soto, Analyst

I would like to zoom in on the process of provisioning in this quarter. I understand half of the provisions are related to general COVID-19 update. I would like to understand how do you break that down between a general, let's say, a general model update versus the exercise that you presented in Slide 9, where you classify that risk level for every of your segments? And to that point, I would like to understand a little bit better. I was kind of surprised that you considered that only 13% of your retail portfolio as high risk; I would like to understand what assumption is behind that, and why are you confident in this number? Or might we see this number deteriorate once this loan rescheduling plan phases out and you start asking your customers to pay back?

Juan Carlos Mora, CEO

Thank you, Andres, for your question. Let me take the second one, and I will pass the third one to José Humberto. We started doing a very deep analysis of the behavior of our clients in April. So we are running models to assess how they are in the economic development. We are confident that this assessment is giving us enough information to classify the clients into different categories that I mentioned. So the numbers that we are showing are based on that deep analysis, and we are confident. It's possible that the situation of the customers during the second half of the year changes. So we will continue assessing that situation. So with the information that we have today, that is a very good estimate of the situation of our customers, but that situation could develop in the future. José, could you take the first, Andres' question, please?

José Humberto Acosta, CFO

Thank you, Juan Carlos. Yes, half of the provisions are related to the updates on the debt parameters and COVID. Essentially, we created an expert model using historical data from customers who received the grace period, factoring in the various sectors they operate in and an additional capacity payment. Based on this, I would say that out of the 50% of that provision, 70% is attributable to the expert models and 30% is due to the different parameters we applied under the expected losses model. For example, we had to revise the GDP growth from minus 0.8% in March to minus 6% in June. Thus, the split is 70% due to the expert models developed for those clients while adapting to their risk profiles, and 30% from the updated models. The remaining 50% is primarily due to consumer deterioration, with additional contributions from SMEs and corporate deterioration.

Operator, Operator

And our next question comes from Ernesto Gabilondo from Bank of America.

Ernesto Gabilondo, Analyst

The first question is on the political side. We have seen the former President Alvaro Uribe was placed under house arrest. So given that he is well-known in Colombia and an important member of the right center and the one that chose President Duque, in your opinion, do you think this political noise can give some empowerment to Petro? And when do you have presidential elections? Then my second question is a follow-up in the NPLs and the provision charges. I believe the low NPLs were explained by the relief programs, and that they represented roughly COP60 trillion or 30% of your consolidated loan book. And I believe you have created COP1.2 trillion from your expected losses models due to this COVID-19 impact. However, I believe there is a second round of relief programs taking place. So I would like to know how much of your portfolio is in the second phase? When should we think NPLs will show up, will be the first one by year-end and the second phase at the beginning of next year? How should we think about the level of provisions that you have created in the second quarter and the cost of risk of this quarter? Should we think it will maintain the same levels during the next quarters? Any color on this will be appreciated.

Juan Carlos Mora, CEO

Thank you for your questions. I will address the first question and then provide some comments on the second one, with José Humberto giving you additional insights on that topic. Regarding Alvaro Uribe's situation, Colombia has robust institutions and a history of upholding them, so I believe this situation will strengthen those institutions and won't negatively impact the economy. As for the elections, Colombia will have presidential elections in 2022, meaning President Duque's administration is currently halfway through its term, with two more years remaining. Concerning your second question, as you noted, we provided relief to our customers in the first four months following the pandemic. We are now entering phase two. Thanks to these relief measures, non-performing loans (NPLs) are lower than they were at the beginning of the year, but we anticipate that NPLs will deteriorate. We are evaluating each client individually, assessing their risk levels, and collaborating with them on tailored solutions. NPLs will definitely worsen. Predicting the cost of risk at this point is challenging. We initially estimated a cost of around 1.7% to 1.8% for the year, but it has now exceeded 4% for the quarter. The cost of risk will remain high, contingent on the progression of lockdowns, the economic landscape, and the duration of relief provided to customers. I will now turn the question over to José Humberto for more details. Just a moment while I wait for him to reconnect. In this context, we are forecasting provisions based on expected losses, and we expect the remainder of the year to reflect a high cost of risk. I believe that next year we will start to see an improvement, as this year's peak will be followed by better conditions moving forward.

Operator, Operator

And our next question comes from Tito Labarta from Goldman Sachs.

Tito Labarta, Analyst

I want to discuss your expenses. We noticed some effective cost management, with operating expenses down around 8% year-over-year. You mentioned expecting growth of 2% to 4% for the year, but beyond that, where else can you manage costs? Is the transition to digital providing any advantages? How significant is that impact? Additionally, how should we view your branch network? Could you provide more details on your cost control efforts and any strategies you're employing to further reduce expenses?

Juan Carlos Mora, CEO

Thank you, Tito. Thank you for your question. Expenses is a focus of our job now. We are working very hard on how to control or be very productive as well. We were working on the physical side. We are optimizing our buildings, new office spaces, so we will optimize and it comes to tell you something that is going to last with new ways of working. So there is a sort of optimization. Then on the labor cost, we keep optimizing the cost. We are optimistic that we can do a good job on contract expenses during the year, and efficiency is going to improve. Let me pass this question to José Humberto and also, if you want to add something to the answer, like I do to Ernesto, please go ahead.

José Humberto Acosta, CFO

Thank you, Juan Carlos. Regarding expenses, there was a one-time reduction in the second quarter. As Juan mentioned, we adjusted the bonus plan due to the bank’s performance being different from our initial forecast. This is the main reason for the change. Additionally, if we consider the foreign exchange impact, without that, expenses increased by about 2.5%. Our cost structure is approximately 85% fixed, making it quite challenging to reduce costs. Therefore, we expect our cost growth by year-end to be between 2% and 4%. However, as Juan mentioned, we are contemplating a new approach regarding the branch structure and digital channels, which may lead to a restructuring of our costs. Our guidance remains at 2% to 4% largely due to the significant weight of our fixed costs. In response to Ernesto’s questions, I want to clarify that we provided COP70 billion in relief during the first wave, which accounted for 51% of the total loans. On a consolidated basis, this was COP90 billion, representing 44% of the loan book. For the second wave, based on our analysis of clients' cash flow, we believe that around 60% of clients will pay normally, while 20% to 25% may require additional relief or extended obligations. A small percentage, about 10% to 15%, will likely need more time for restructuring. For example, in the case of mortgages, we note that the 15% of loans in this group may struggle to meet their obligations.

Juan Carlos Mora, CEO

Let me add that regarding Tito's question, we are seeing room for branch optimization. It's something that we will do over the midterm period. The increase in digital construction is showing us that we can move many activities from the branches to digital. So definitely, we see room for improvement on the branch network. So you will see there is room for improving our expenditure.

Operator, Operator

And our next question comes from Gabriel Nóbrega from Citigroup.

Gabriel Nóbrega, Analyst

My first question is in relation to asset quality. Are you seeing any specific sector that is being more affected than you expected from the pandemic? And if you could also elaborate on how is your exposure to this sector and how you are managing risk. And then my other question is actually a follow-up on the question from expenses. During the quarter, we did, in fact, see a rationalization in other administrative expenses. But at the same time, we saw you adding 1 million clients in Nequi and 1 million clients in Bancolombia a la Mano. So my question here is, do you believe that you would have to continue increasing your IT investments? Or are you already able to collect fruits from your digital banking initiatives, especially that we have almost more than 6 million clients in both of these platforms? Also, as I believe, during COVID, people are using more and more digital channels.

Juan Carlos Mora, CEO

Thank you, Gabriel. I have some difficulty hearing you. So I'm going only to try to answer what I catch from your questions. Regarding the digital channels, we are now benefiting from the investments we have made. We have been investing in digital for, I don't know, 3 or 4 years ago. We were creating basically 2 platforms, Bancolombia a la Mano and Nequi. And now we are benefiting from those platforms. The numbers are impressive. As we mentioned, the growth in new customers...

Operator, Operator

We lost our speaker. Someone else can take over the question, please.

José Humberto Acosta, CFO

Okay. Yes. As Juan mentioned, we allocated around $100 million to $150 million on an annual basis for digital projects. So no matter if we are trying to reduce expenses, the allocation of expenses in terms of investing in IT is key for us. You know that one of the pillars during this second quarter is the growth in the customers of digital banking. So we are now planning to change the other way around. We want to invest more to get more potential in order to operate because the level of transactionality is growing. And regarding your first question regarding sectors, we have a well-diversified loan structure in terms of sector. Our huge exposure today could be commerce, where we have around 15%. We have consumer services at 35%. So we are well-diversified. Obviously, we have concerns about construction, for example, in which we have 11%. Just to give you an idea, in terms of airlines, we don't have exposure. In terms of Ecopetrol, we have a small portion of Bioenergy, that is also almost 82% to 83% fully provisioned. So again, concerns regarding all the macroeconomic outlook. But in particular, we don't have any specific sector in which we believe will have a huge impact.

Operator, Operator

Our next question comes from Sebastián Gallego from CreditCorp Capital.

Sebastián Gallego, Analyst

I have three questions. First, could you provide more details on the specific cases you provisioned during the second quarter and how they have developed? Second, can you discuss the trends you have noticed in your Central American operations regarding potential provisions and the need for extraordinary provisions going forward? Lastly, could you address a potential worst-case scenario that you are currently considering in relation to provisions and the impact this might have on the bank's capital position?

José Humberto Acosta, CFO

Thank you, Sebastián. Regarding special cases, we have a specific situation with Bioenergy, where our exposure is approximately $120 million to $130 million, which is fully provisioned with an 84% provision, more than sufficient. As for your second question, the trends we see in other regions mirror what we are experiencing in Colombia. In terms of provisioning, Banistmo will also feel the impact as the economy is heavily affected by COVID-19. In El Salvador, the trends are similar to those in Colombia. Guatemala, however, is seeing the lowest levels, primarily for two reasons: the agricultural nature of its economy means it is less affected compared to other countries, and the remittance levels provide a degree of liquidity for clients. For instance, 31% of the total loan portfolio in Guatemala is under grace periods, which is quite positive. So, in geographical terms, the trends are consistent with Colombia. Regarding a potential worst-case scenario, we decided to hold a general assembly to strengthen the solvency ratio by transitioning some accounts from occasional reserves to legal reserves. Our calculations suggest that, if we assume the worst-case scenario could be three times our provisions from last year, we will still maintain more than double the minimum Tier 1 ratio at the end of December. Therefore, we do not have any specific concerns, and by July, we anticipate a Tier 1 ratio of around 11.2%.

Operator, Operator

And our next question comes from Jason Mollin from Scotiabank.

Jason Mollin, Analyst

My question is about the asset quality of the portfolio, particularly regarding the customer breakdown by risk level. You mentioned that 13% of retail is classified as high risk, 37% for SMEs, and 16% for corporate. Can you explain what high risk entails? Do these clients have collateral? Additionally, could you discuss the collateral and guarantees by segment? I understand the mortgage portfolio represents about 13% of the total and has a higher rate of deferrals. Can you share what you're observing in that area? Are any clients making payments even though they had the option to defer? Moreover, I found it interesting that in the second wave of deferrals, you estimate that 60% will likely resume normal payments. What factors are you considering to make that estimate? Are you looking at their cash flows, bill payments, or something else? Any information you can provide would be appreciated.

Juan Carlos Mora, CEO

Thank you, Jason. I will provide some general information, and then José Humberto will share more details. We are evaluating our customers based on their financial movements, how funds are flowing through their accounts, and our observations of various sectors. From this assessment, we have identified that a significant number of small and medium-sized enterprises are facing higher risks. While we are monitoring customer behavior and making projections, the actual payment behavior is proving to be better than we anticipated. We continue to evaluate our clients' situations and gather more information to better understand their circumstances. Now, I will hand over your question to José Humberto for further details.

José Humberto Acosta, CFO

Thank you, Juan. I think it's a very clear answer, and I want to summarize your second question. The 60% is because of the data that we collect; we know that they have the capacity of payment because they have liquidity on their checking and savings accounts or maybe time deposits, and we compare that with the level of debt. That's the reason why we believe that these 60% have the capacity to pay. Regarding your first question, as Juan mentioned, it's in 3 phases. First, because of the historical behavior. We analyzed what happened in the previous months with every single client. Second, because of the sector they belong to. No matter if you are very well-behaved, but you work in a hotel, for example, we know that because of the sector, we will need to put it at risk. And third, again, because of the cash flow.

Operator, Operator

Our next question comes from Yuri Fernandes from JPMorgan.

Yuri Fernandes, Analyst

I have one question about net interest income. It's well-known that Colombian banks are sensitive to asset fluctuations and may face challenges due to lower interest rates. My question is about stage 3 loans. We have concerns regarding risky loans, especially since 50% of our loans are under forbearance. When we look at the stage 3, or nonaccrual loans, they haven't increased significantly; they represent about 7.6% of your total loans. My worry is that stage 3 loans could spike, creating a troubling situation. Given the asset sensitivity and the stagnation in your loan growth, as you mentioned, and the anticipated slowdown in loan volumes for the latter half of the year, I’m curious about your expectations for net interest income and margins. It seems likely that provisions will rise in 2020, as you've indicated, but perhaps they will taper off in 2021. However, net interest income might remain weak moving forward. What are your thoughts on stage 3 loans and your outlook for net interest income?

Juan Carlos Mora, CEO

Thank you, Yuri. Yes, you are right. I mean we will see that the margins are going to decrease. Interest rates are going to be low, lower than the ones that we have now. We are working on the cost of funds, and we have some room there, but we are foreseeing some margin compressions. Regarding your question about how we are seeing the behavior of the portfolio regarding stage 3 loans, we are seeing that the stage 3 is around 7% of our loan portfolio, and it will increase, but we are incorporating all of that into our provisions. So we will have some pressure from margins and will increase provisions regarding stage 3, but we are taking into consideration both aspects in our projections. I don't know, José Humberto, if you have something to add to Yuri's question.

José Humberto Acosta, CFO

No, Juan. That is very clear.

Operator, Operator

And our next question comes from Thiago Batista from UBS.

Thiago Batista, Analyst

I have two brief follow-up questions. First, regarding expenses, you mentioned an increase of 2% to 4% this year. Can you clarify whether this is an increase or a decline? Second, could you provide details on the size of the relief program, particularly pertaining to mortgages? This seems to be a significant aspect, so any information you can share about the mortgage component would be appreciated.

Juan Carlos Mora, CEO

Thank you, Thiago. Regarding expenses, we are experiencing a 2% to 4% increase, but we are diligently working to improve upon that, and I believe we can achieve better results. This year, as we noted, the variable component of salaries will not be included, which could represent around 20% or more of our total labor expenses. Additionally, we are taking measures related to office space, and as you can imagine, we are not increasing our headcount. With these initiatives, I am optimistic that we can perform better than initially anticipated. Now, I will pass your second question to José Humberto.

José Humberto Acosta, CFO

Okay. Regarding your second question, Thiago, the mortgage composition in the loan portfolio is around 11%. At around 70% to 75% of those mortgages were on the relief program, and we offered them 6 months. So we will see the second round beginning in September of relief.

Operator, Operator

Thank you, ladies and gentlemen. I'll now turn back the presentation to Mr. Mora, Chief Executive Officer of Bancolombia, for final remarks.

Juan Carlos Mora, CEO

I want to thank you all for joining us on this call. I hope this situation in the world improves soon. Please take care and stay healthy. We hope to see you at our conference for the third quarter of 2020. Thank you very much.

Operator, Operator

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