Earnings Call Transcript - CIB Q4 2020

Operator, Operator

Good morning, ladies and gentlemen, and welcome to Bancolombia's Fourth Quarter 2020 Earnings Conference Call. My name is Hector, and I will 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, whether made in this conference call, in future filings, in press releases or verbally, address matters that involve risk 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 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. Carlos Raad, 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. Mr. Juan Carlos, you may begin.

Juan Carlos Mora, CEO

Good morning and welcome to our conference call for the fourth quarter of 2020. I hope all of you and your families are safe and healthy. The fourth quarter confirmed that the Colombian economy is moving forward. It has rebounded from the lows observed in April and May of 2020. The fourth quarter GDP posted an annual negative variation of 3.6% and a full year contraction of 6.8%. This result shows that economic activity underwent a process of clear improvement with better-than-expected results. As we look at 2021, these results confirm that the worst of the impact generated by COVID-19 has been overcome, but also reveal that the recovery is very sensitive to the evolution of the pandemic. After a very challenging year, the net income for 2020 was COP 276 billion. Before getting to the details of the results, I want to highlight some key topics. During 2020, Bancolombia became stronger. We remained closer to our clients during the pandemic, offering them better, safer, and more reliable digital solutions. We improved our transactional portfolio with new digital services tailored to our clients' needs, leveraging self-managed options. We have a strong balance sheet with our diversified funding base, driven by the growth of retail deposits. Allowances for loans for the year-end were COP 16.6 trillion, growing 52% when compared to 2019, representing 8.1% of total loans. We made an early adoption of a full Basel III capital standards, reporting a Tier 1 level of 11.24% that represents an increase of 167 basis points when compared with the Tier 1 reported at the end of 2019. This is aligned with the guidance we have been giving in the last couple of years. Finally, despite high provision charges during the year due to COVID-19, Bancolombia continues to have a resilient result. The provisioning level takes the bank to a coverage ratio of 213% for the quarter. We expect the cost of risk to slow down in 2021, but returning to normalized levels shouldn't only take place in the upcoming years. 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?

Juan Pablo Espinosa, Chief Economist

Thank you, Juan Carlos. Now please go to slide number three in the presentation. At the end of 2020, the Colombian economy continued to rebound. In fact, in year-on-year terms, GDP decreased from minus 15.8% in the second quarter to minus 8.5% in the third quarter and minus 3.6% in the fourth quarter. As a result, full year GDP variation was minus 6.8%. This result not only beat our expectations, but also implies that almost 8% of the decrease in economic activity that took place during the lockdown was reversed in the second half of the year. Despite this positive trend, at the start of 2021, the economy took a hit as a result of the second wave of COVID contagions and the restrictions that local authorities imposed. Consistent with this, our real-time data point to a 5% year-on-year decrease in economic activity in January. However, this negative trend has receded quickly in the first weeks of February. Taking this into account, we estimate that during the first quarter year-on-year GDP variation will be around minus 3%. For the remainder of the year, there is a risk regarding the evolution of the pandemic and the effectiveness of the vaccination plan. However, we expect GDP to grow 4.7% in 2021 due to the combination of several factors. Globally, we expect higher oil prices in terms of trade, as well as a stronger recovery of export demand. Locally, low interest rates will combine with the stimulus program executed by the government in sectors such as infrastructure and housing. Regarding inflation, after a historic low print of 1.6% in December 2020, we anticipate that in the short term the CPI change will remain below 2%. These expectations rely on the fact that the economy is still running well below potential and risks arising from supply shocks are contained. The end of temporary relief measures taken at the start of the pandemic and the mild increase in the core component will take overall inflation to close 2021 around 2.5%. Against this backdrop, we continue to predict that for a long period, low-end and stable interest rates will prevail. We anticipate that the reference rate in Colombia 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, it is important to mention that in 2021 the implementation of initiatives related to fiscal adjustment will be key to rating agency decisions regarding Colombia. Officials have stated recently that this semester the government will submit to Congress a revenue tax reform amounting to around 1.5% of GDP starting in 2022. In addition, legal amendments to allow spending reductions could also be proposed. In our opinion, adjustments to the fiscal rule are also necessary to allow its reinstatement next year. After this economic overview, I will turn the presentation back to Juan Carlos and José Humberto Acosta.

Juan Carlos Mora, CEO

Thank you, Juan Pablo. Moving to slide 4, I want to continue this presentation by explaining our digital strategy. It is based on three pillars: new digital business development, digital experiences, and process digitalization. These pillars aim to increase income generation, reach new market opportunities, improve the digital experience of our clients, and accomplish greater efficiency. These goals are achieved through digital enablers, such as analytics and big data, accelerated adoption of cloud technologies, artificial intelligence, strengthening cybersecurity among others. In digital business, we highlight Nequi and Bancolombia a la Mano. During 2020, we reached 9.4 million clients between both, more than doubling the number of users from 2019. Nequi, with 4.0 million clients, averaged deposits over COP 400 billion, and 186,000 Visa card users had excellent results last year. On the other hand, Bancolombia a la Mano exceeded expectations with 4.6 million clients and a 123% growth in fees. We improved materially the digital experience of our clients, getting closer to them, reaching 8.4 million digitally active clients among retail, SMEs, and corporate apps; 71% of digital adoption; 44% digital sales over total sales; and 63,000 new personal loans digitally disbursed in 2020. We built up strategic alliances to escalate results. Wompi, our payment gateway, registered more than 38,000 merchants. Tributi, which offers online tax preparations to our clients, processed more than 27,000 tax forms. Using robotics and artificial intelligence, we automated 29 different processes to support the credit relief programs for our clients and the distribution of government subsidies to alleviate the pandemic. The branch networks automated 16 processes during 2020. This allowed us to serve almost one million requests from our clients, increasing productivity and improving service and customer experience. I want to share with you something very important for Bancolombia - that consolidated the bank's digital and innovation strategy. We have decided to migrate our applications to the cloud with our strategic partner, Amazon Web Services. This is going to allow us to take advantage of other value-added services that AWS offers and provide the business with the tools to be able to transform and innovate at the speed that the market requires. Moving to slide 5. I'm going to elaborate on our value proposition. Ecosystems are a fundamental component of the evolution of our digital strategy. Through this, we are solving end-to-end needs of our clients. We have decided to be relevant in mobility and housing. Think of Bancolombia as an orchestrator of financial and non-financial solutions. For example, in the housing and mobility ecosystems, we connect the supply and demand for housing and vehicles through our marketplace. At the same time, we offer credit leasing and rental solutions across an integrated digital experience. On the other hand, we are transforming financial inclusion using QR codes, where we connect more than nine million of our digital clients through Bancolombia a la Mano, Nequi, and the Bancolombia app with more than 400,000 small businesses, reaching 10 million transactions. Ecosystem solutions are interconnected with each other and complemented by third-party capabilities, allowing us to develop a value proposal beyond our industry to solve our clients' needs. On slide 6, we present our ESG framework. First, I want to share with you something that makes us very proud at Bancolombia. We were recognized with the gold medal of the Sustainability Yearbook 2021 developed by S&P Global, which highlights the companies with the best sustainability performance around the world. As the most sustainable bank of all the organizations analyzed, our purpose is to promote sustainable economic development to achieve well-being for everyone. We reached this purpose by developing four key points: financial inclusion, empowering more than nine million people financially through Nequi and Bancolombia a la Mano; sustainable finance, issuing COP 1.3 trillion in sustainable bonds and COP 1 trillion disbursed under a sustainable credit line in 2020; gender equality, as in 2020 for the first time we had a woman as a Board member and we designed a special credit line to support women with disbursement of COP 23 billion during the year; and climate change, with 26% of used energy in the year being auto-generated with renewable energy. We invested during 2020 COP 225 million in energy efficiency projects for our internal carbon travel tax. Now, I want to turn the presentation to José Humberto. José?

José Humberto Acosta, CFO

Thank you, Juan Carlos. Now turning to slide 7, I want to walk you through the evolution of the relief program. Credit reliefs have decreased throughout 2020, reaching the peak in the second quarter with 44% of the consolidated loan book under relief, and closing the year with a 15% level. It is important to highlight that this 15% includes structural solutions that we are providing to our clients in Colombia and in El Salvador. This figure is lower than expected due to the fewer structural solutions for SMEs and corporate clients. In Colombia, 12% of the loans are still under relief, out of which 11% are under the PAD program. Remember that the PAD program began in August and was initially meant to end in December 2020, but it was extended by the regulator until June of this year. In our operation in Panama, Banistmo, we kept 45% of the total loan book under relief. This proportion may remain high until June because of the extension of the moratorium laws in Panama. In slide 8, we present the breakdown of provisions during the quarter. Provision charges for the fourth quarter were COP 2 trillion. As we did in previous quarters, we want to explain the breakdown. Provisions associated with the update of macro scenarios and COVID-19 explained most of the quarter charges, 82%. We want to highlight that the expectations for macro variables deteriorated from the third to the fourth quarter of the year, especially in Central America. Just to give you an example, the GDP for Panama went from minus 3.3% in the third quarter to minus 15.2% in the fourth, reflecting the still uncertain economic environment in which the bank operates. Moving to slide 9, we give you a snapshot of the composition by stages and their coverage. During the quarter, we can see there was an important increase in Stages 2 and 3. This increase was explained by three aspects: first, clients for whom the relief ended at the final part of the third quarter and during the fourth quarter. Some of these clients did not receive a structural solution and did not have the capacity to pay yet, so they reached 30-day past due. Second, some clients that became 30 days past due since the third quarter deteriorated further and ended up 90 days past due. And third, the output of the risk assessment resulted in higher risk, and the number of clients on the watchlist increased. At the right side of the slide, you can observe the total balance in Stage 2 and 3 and the percentage covered by the allowances. This shows that depending on how the pandemic and economic recovery evolve, there is still space for provision charges in 2021. In slide 10, we present provision charges and allowances. The cost of risk for the quarter was 4.2%, and for the last 12 months was 3.9%. The cost of risk without the COVID-19 effect was 0.7% for the quarter and 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, protecting the balance sheet in an environment that is still uncertain. By the end of 2020, allowances for loan losses represented 8.1% of total loans. As we mentioned before, the recovery path is going to be slow. Returning to a normalized level of cost of risk will take until the end of 2022. This is going to be a transition year. Still with a lot of uncertainty, we expect to close 2021 with a cost of risk in the 3% area, moving closer to the 2% area at the end of 2022. Slide 11 shows the past due loan formation and coverage. New past due loans during the quarter decreased because of the reliefs and the structural solutions offered to clients whose reliefs ended. We expect charge-offs to increase during the first half of the year, as clients continue to deteriorate after the end of the reliefs. As reliefs continue to expire, asset quality metrics will continue to deteriorate at a faster pace. During the quarter, 90-day past due loans began showing deterioration because of clients that became 30-days past due during the third quarter and deteriorated further. The coverage ratio dropped to 213%, but remains high because of the increased provisions based on COVID-19 provision strategies, clients on the watchlist, and past due loan requirements. On Slide 12, we present the capital adequacy for Bancolombia. In December 2020, Bancolombia adopted the Basel III standard for capital adequacy. This was done in advance of a compulsory date of adoption. Remember that by regulation, all Colombian banks must comply with the new rules since January of this year, but we reported 2020 Tier and solvency ratios under Basel III. The total solvency ratio on Basel III stands at a level of 14.7%, while CET1 is at a level of 11.24%, well above the minimum regulatory requirements. Keep in mind that even though we have a phasing period of four years to fulfill the new levels and buffers of Basel III, we almost comply with the total solvency ratio with just our Tier 1 current ratio. We did serve the adoption in two steps: first, the reclassification of existing resources in the occasional reserves to the bank's legal reserve approved by the extraordinary shareholders' meeting last July. And second, during this last quarter, complying with the new regulation regarding risk-weighted assets, goodwill deduction, operational risk among others. As we have been saying in the last couple of years, the impact of the adoption of Basel III is positive for Bancolombia, showing an increase of 167 basis points year-to-year. On Slide 13, we present the liquidity position of the bank. On a consolidated basis, we expect liquidity levels to maintain at least for the first half of this year and stable interest rates at least until the third quarter. The material increase during the year of deposits was driven by savings accounts, especially in retail and SME clients whose balance increased in COP 13 trillion. As of December 2020, savings accounts represented 40% of the total deposits, mainly from retail clients. This makes our deposit base more stable and granular and has also boosted the decrease in funding cost, reducing 92 basis points in the last 12 months. On Slide 14, we present a snapshot of our standalone operations. In general terms, the trend throughout the different geographies operated by Bancolombia during 2020 was similar: margins under pressure, fees recovering as the economies started to reactivate, gliding growth of the loan book, positive evolution of efficiency, and a solid position in terms of capital and liquidity. I want to give you a quick overview of each of the Central American countries, which we where we operate. Let's start with BAM in Guatemala. The provision charges for the quarter were negative because of some change in the expected loss models with respect to the macro variables as the new economic forecast for the country is better than the previous one. Banco Agrícola in El Salvador had a good performance over the year with positive operational metrics. During the quarter, provision charges increased due to the update of macro variables and because the model recognized that the gradual termination of the reliefs will reflect an increase in the loan book deterioration. Finally, Banistmo, in mid-October, the bank regulator modified the moratorium law, so that bank extended this program up until June 2021. This time banks are in the position to decide how and until when they will provide these reliefs. The objective of this extension is to find solutions for clients that are still being affected somehow by the pandemic. In this sense, financial reliefs could go from extending loan maturities to partial payments to grace periods according to the client's current situation. These results observed in the third quarter significantly deteriorated, which implied updating the expected loss model, generating a higher requirement for provisions. Provision charges grew 211% when compared with the third quarter, explained by three points: macro variables update, increasing coverage of personal loans, and the deterioration in corporate loans. On Slide 15, we see the evolution of margins and net interest income. In line with the trends observed in the first three quarters, the net interest margin compressed for the full year figures. The reference rate cuts by the Colombian Central Bank continued to hit the lending margin in the second half of the year. The longer tenors granted on credit relief programs implied a reduction in charges and therefore lower interest, affecting revenues and the lending margin. Coupled with that, the increase of bucket three clients as a result of the deterioration in asset quality had an impact on their consolidated margins. As a positive outcome, we highlight the sustained reduction of the cost of funding attributed to the growth in deposits and efficient liability management transactions offsetting the compression of margins. For 2021, in all four geographies where we operate, we expect to continue reducing the funding cost in time deposits repriced at a lower rate. In 2021, the group's net interest margin is expected to remain relatively stable within the 5% area, foreseeing an environment of low interest rates in the local financial system and an increase in stage 3. Slide 16 shows the evolution of expenses and efficiency. Facing a difficult year, the bank shows a contraction rate at that 3% during 2020. Personnel expenses, which represent almost 40% of the whole operational burden, had nearly an important contribution to the positive performance, mainly explained by the cut of employees' bonus plans. On the administrative side, a growth of 1% is more remarkable when analyzing a variety of challenges experienced during the pandemic. Among them, increased expenses related to insurance policies and the depreciation of the local currency, which impacts several components of the bank's cost structure. In the same way, we must highlight the decrease in expenses associated with the daily operation of the business, such as our cash transportation, payment methods, and the distribution network. For 2021, we must expect a higher growth in expenses in line with our greater dynamism of the business and a faster economic activity added with a low base effect. Investments in digital transformation will continue to be an important element of our structure, understanding the business environment and the market opportunities ahead. The slide 17 shows the evolution of fees. Net fees were one of the most resilient lines during 2020. In the first half of the year, fees were impacted by the lockdown measures, but since September with the end of these, they quickly recovered to pre-COVID levels, posting a year-to-year increase of 0.4% and 3.8% during the quarter. We expect fees to have a better performance for 2021 with a growth between 5% and 8% driven by a higher volume of transactions. Lines such as debit and credit cards will lead the growth during the year. Finally, slide number 18 shows the profitability metrics. 2020 was a year of low profitability. We expect the bank to gradually recover. 2021 will be a transition period. Our guidance suggests a return on equity in between 4% to 5% for the present year, below pre-pandemic levels to eventually reach a target area in between 12% to 14% for 2023. Several factors would support this goal, such as loan growth, returning cost of risk levels at around 2% area, better cost-to-income ratios maintaining the cost strategy, higher payments due to a different interest rate environment, and the continuous recovery of fee income. Now, I want to turn the presentation back to Juan Carlos for the closing remarks. Juan Carlos?

Juan Carlos Mora, CEO

Thank you, José Humberto. 2020 was one of the most challenging years in recent history. But it was a year where we also learned a lot. At Bancolombia, we are creating the bank of the future. We have a strong balance, a better cost structure, a more diversified portfolio of products and services leveraged by a robust digital strategy with a positive evolution of digital platforms. 2021 began with uncertainty. The main challenges that we will have to face during the year will be; first, a demanding scenario from a risk management perspective; and second, relevant investments in digital and modernization projects to stay ahead in a highly competitive environment. After elaborating on these key topics, we want to open the line for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of Ernesto Gabilondo with Bank of America. Please proceed with your question.

Ernesto Gabilondo, Analyst

Hi. Good morning, Juan Carlos and José Humberto, and good morning to all of your team and to everyone. Thanks for the opportunity. I have a couple of questions. The first one is on asset quality. Can you share with us what is the percentage of deferred loans as of fourth quarter at a consolidated level? And how much is delayed with 30 days? And what was the amount of additional provisions built in 2020? And then my second question is on operating expenses. Considering that you have been doing important efforts to control expenses in the last years, how much additional room do you see to maintain low OpEx growth, or do you think that digital transformation should make OpEx to grow above mid-single digit this year? Thank you.

Juan Carlos Mora, CEO

Thank you, Ernesto. I’ll address your two questions and then turn it over to José Humberto for further details. Regarding asset quality, when the pandemic started, there was significant uncertainty, and we decided to release some consumer credits. As the year progressed, the situation became clearer. We concluded the year with 15% of our total loan portfolio undergoing some form of relief or restructuring. Currently, the situation is quite different. In Colombia, nearly the entire portfolio is under a restructuring program. In Panama, a substantial part of the loan book still receives relief, a situation we expect to continue until mid-year. With a clearer view of the portfolio now, we are better positioned to evaluate asset quality and understand the current landscape. On your second question about operating expenses, we believe that 2021 will be a year focused on investment in digital transformation and enhancing our capabilities. We will maintain our digitalization efforts and improve our abilities. Additionally, we are transitioning aggressively to the cloud, which will necessitate some investments but will yield significant returns. To directly address your questions, we expect 2021 to be a year of investments, and the comparison with 2020 will impact us, leading to expense growth that is likely to exceed inflation. We will continue investing and managing our cost control programs while also working on our branch network and enhancing efficiency. However, 2021 will be, like many other factors, a transition year. I’ll now pass the question to José Humberto for further comments.

José Humberto Acosta, CFO

Thank you, Juan. Ernesto, good morning. Regarding your first question, yes, in terms of the deterioration, we are foreseeing a combination of several factors. The first one is, deteriorations of 30 and 90-day past due, you're all going to see a pickup maybe in the first half of the year. Remember that when the reliefs ended at the end of the third quarter last year, we are seeing an increase in payday past due. Now we are going to see a deterioration and increase in 90-day past due. So as a result, we will probably see provisions coming in May and most relevant in the first half of the year. The second element is regarding commercial loans. In terms of consumer loans, because of their model in a certain way, the provisions at that level may stay, but we are foreseeing some deterioration in certain corporate cases that suggest that also deterioration will pick up. Just to give you an idea, to-date, we have 30 days past due at around 5%. We are expecting the number to reach a peak at around 6% for 30 days and 90 days, which currently is 3.8%. We are expecting maybe to reach the level of at least or around 5%. At the end of the day, we are naming this a transition year, which means that in terms of provisions, we are going to reach the normalization of the cost of risk in 2022. Meanwhile, this year would be a transition period in which probably the cost of risk will be at a level of 3% area. The second question was fully answered by Juan. Thank you.

Ernesto Gabilondo, Analyst

Thank you very much, Juan Carlos and José Humberto. I appreciate it.

Juan Carlos Mora, CEO

Thank you, Ernesto.

Operator, Operator

Your next question comes from the line of Jason Mollin with Scotiabank. Please proceed with your question.

Jason Mollin, Analyst

Hello, everyone. Thank you for the opportunity. My question is about the effect of the 11% depreciation of the Colombian peso against the US dollar in the fourth quarter on the results. Given your business in Central America, around 30% of the assets, liabilities, and equities are denominated in US dollars. With these significant movements, I think it would be helpful to confirm my observation that the decline in net interest income, which was down 19% quarter-on-quarter, is related to the losses on debt investments. The way you presented the other operating income seems to relate to trading, but there is also a notable net foreign exchange gain. From the numbers I see, the loss in net interest income was COP 152 trillion, while the net foreign exchange gains were COP 670 trillion. If you offset these, the impact of treasury appears quite robust. From a strategic perspective, I understand that the dollar-denominated business is not hedged, which means you will encounter that volatility. Could you share if there's any decision that might change this approach, or will this position remain in dollars as part of your strategy? Is there a possibility of implementing hedging in the future? Thank you.

Juan Carlos Mora, CEO

Thank you, Jason. You asked three questions. The first concerns the big picture. There was a depreciation of the currency in the fourth quarter, which is affecting several areas. Let me explain. First, on the asset side, there is a decline in the loan portfolio. As you mentioned, one-third of our loan profit is in US dollars. The second effect is on the equity side, which we view positively because 30% of our equities are also in US dollars, leading to a decrease of COP 1 billion. I want to emphasize that we are fully matched regarding our US dollar business structure, meaning our exposure in US dollars in Colombia is limited, with no more than 3% of our loan portfolio in US dollars. The rest of our international operations are fully matched, so regardless of FX fluctuations, we can maintain our solvency ratio without imbalances. However, there's a third aspect for this quarter concerning debt investments. It's true that investments show a decline due to short-term portfolio investments in US treasuries, which are negatively impacted by FX depreciation. Yet, this serves as a hedge for our other balance positions, which are reflected in operational income, resulting in a positive net effect. Ultimately, changes in the FX rate do not significantly impact our balance sheet due to this hedging. This scenario is specific to the fourth quarter. Regarding the NIM, its compression in the fourth quarter isn't due to FX but results from three factors. First, interest rates in Colombia are decreasing, and since we are asset sensitive, the repricing of loans is compressing the NIM. Secondly, stage three loans are increasing, affecting our portfolio, as 8.9% of our loans fall into this category. Thirdly, the relief program alters interest rates, affecting the new net present value and consequently the NIM. When considering NII, the FX impacts both sides of the equation. It affects interest rates from our US dollar loan portfolio and also impacts the interest rates from our time deposits, saving accounts, and checking accounts. Overall, NII is balanced due to these two elements. We expect NII in 2021 to be lower than loan growth, as we anticipate loan growth to consolidate in the second half of the year. Overall, we are not heavily exposed to US dollars, which informs our hedge management strategy.

Jason Mollin, Analyst

Thank you very much.

Juan Carlos Mora, CEO

My pleasure.

Operator, Operator

Your next question comes from the line of Sebastián Gallego with CrediCorp Capital. Please proceed with your question.

Sebastián Gallego, Analyst

Hello, good morning. Thank you for the presentation and opportunity. I have three questions today. The first one may be a follow-up on asset quality. I would like to understand a little bit better how should we expect on a sequential basis during the upcoming quarters the evolution of provision expenses. You mentioned that we could see that peak on, on NPLs and PDLs in the first half, but I just want to get a sense of how much we could see an improvement or how much can improve provisions on a sequential or on a quarterly basis? The second question is regarding actually dividends. You released your proposal as well yesterday. I just want to understand first, the material differences between the net income between full IFRS and the local individual net income? And also, what was your rationale behind the payout ratio in this proposal? And finally, my third question would be on Panama. How should we think about what could happen on provisions once the moratorium law is over? Thank you.

Juan Carlos Mora, CEO

Thank you, Sebastián. Regarding your first question about asset quality, definitely, as we mentioned, we think that the second semester is going to be better than the first one. Regarding quarters, we think that this first quarter we still will need to assess what is going to be the economic situation. Our expectations are on the positive side, meaning that we are optimistic that economic conditions, particularly in Colombia, are going to improve. We had a first month of the year, January, with some issues related to the second peak of the pandemic, but we see some vigorous economic activity that allows us to be optimistic on the economic performance. What we have in our models is that we introduced those macro parameters and we run the provisions - the provision models. So if we see that economic activity is improving, we will be incorporating those results in our models. We think that the first quarter we still will see some provision levels in line with our forecast or our guidance, but we will see further improvements in the second quarter and further on. Regarding dividends, basically, we have international norms of accounting, and it's the ones that we used to report and run the bank. We have local Colombian GAAP in which we report to the superintendents in Colombia. The differences are mainly related to provisions and how provisions are incorporated in the local way of accounting. So we reported on an individual basis, meaning our Colombian operation had a net income of COP 900 billion compared to what we reported on a consolidated basis. The way we are proposing dividends is based on the local accounting rules, and that is a 28% payout ratio. What is key for us is how the solvency ratio is going to behave, and we are very comfortable that the capital levels we have after this dividend proposal are satisfactory. So that's mainly the reason regarding dividends and regarding your third question on Panama. As I mentioned, it's currently under a moratorium until the middle of the year, but we are not waiting for that moratorium to end. We are doing the provisions. We have a healthy coverage ratio. After the moratorium ends and the second half of the year, we will start working with our clients on restructuring them and doing what we need to manage the situation. I don't know if José Humberto would like to add something to my comments. José?

José Humberto Acosta, CFO

Thank you, Juan Carlos. Just to complement the rationale why we are paying dividend, remember that 47% of our shares are preferred, and we have a dividend that we have to pay. That was the rationale. But the dividend payout as you can see in terms of yield is very low compared to what we paid last year. That's all Juan Carlos.

Juan Carlos Mora, CEO

Just to complement that last comment, we have preferred shares, and one of the preferences is to have a dividend equal to 1% of the issue price. So what we are doing is we are compliant with that dividend.

Sebastián Gallego, Analyst

Very clear. Thank you very much.

Operator, Operator

The next question comes from the line of Tito Labarta with Goldman Sachs. Please proceed with your question.

Tito Labarta, Analyst

Hi, good morning, everyone. Thank you for the call. A couple of questions also. I guess first to get to that 12% to 13% longer-term ROE target. Just to understand the drivers to be able to get there. You showed this slide on your margins at 4.9% in 2020, down from 5.7% to 5.8% in prior years. Do you need to get back to that 5.7% to 5.8% level margin? Is that dependent on higher interest rates? What could be the drivers of improving your margins going forward back to the historical levels? And sort of related to that, in terms of efficiency, I understand you're investing in digitalization of the platform and moving to the cloud. But also, like in Slide 16, you showed expenses to interest-earning assets fell to like 3.6% from a historical level like 4.2%. Is this 3.6% sustainable given the investments you're making? Is the 4.2% more reasonable to get to that 12% to 13% ROE? Where should that level of expenses to assets be? If you can help with those two, it would be very helpful. Thank you.

Juan Carlos Mora, CEO

Thank you, Tito. Let me elaborate on your two questions. The 12% to 13% ROEs and your question is dependent on margins. Clearly, we are at a low point of interest rates globally. I mean that's the case in the geographies that we operate, particularly in Colombia. We are in a very low interest rate environment. So what we expect, and I think general expectations is that interest rates are going to rise probably not in 2021 but in 2022. Since we are asset sensitive, that is going to give us some push on the NIM. The ROE of 12% to 13% will depend basically on the cost of credit. That's the main driver of our results. We keep working on interest rates, how the mix of our loan book is going to be that it's going to help. We will continue working on fees, and we have a big strategy on fees as we mentioned. We are moving aggressively to offer different alternatives to our customers, that's going to help also. We will recover some margin. I don't expect to return to the levels we saw before, but we will keep working on that, and that will come. And then for expenses, that is your second question, is another driver that we need to work on for achieving the ROE target. As I mentioned, 2021 will be a year of transition. You mentioned this 2.4% to 3.6%. I think we will target mid-term around the 3.6%. But it will take us some time. This year, definitely is going to be a year where we will have, as I mentioned before, our efficiency programs in place and we will keep working, but expenses are going to be higher. I don't know, José Humberto, if you want to elaborate on Tito's second question?

José Humberto Acosta, CFO

No, that's very clear, Juan Carlos. Thank you.

Tito Labarta, Analyst

Okay. Thank you, Juan Carlos. Just one quick follow-up I guess, I understand yes, it definitely depends on the cost of credit. And you probably don't get there till 2022, but even if you get to that cost of credit like 2%, it still seems you would need some margin expansion. And I guess just to try to take out whether interest rates increase or not, which is probably out of your control. What can you do to improve the margin? Is it, grow the consumer loan portfolio, improve your funding costs? I mean, we have seen some improvements on your funding costs. But what kind of like self-help can you do to get that margin up to help also boost profitability?

Juan Carlos Mora, CEO

Yes Tito. All of the above. As I mentioned, some recovery of the margin will come from interest rates that are rising. The mix is going to help. We are going to grow a little bit more in consumer loans that will give us a better margin. The funding cost also is going to help. Let me add some color. We are growing our savings accounts at a very healthy pace, and granularity is there. Our digital platforms that now have close to 10 million customers are giving us that granularity and are helping with the funding cost. So that will also help. We will have some better margins because of an increase in interest rates, the mix of what we are going to work on, adding more consumer loans, having been very careful about the risk, and the funding costs. I think that during this pandemic, we showed how strong our franchise is and how our capability to get deposits and our digital platforms are going to help a lot with the funding cost, so all of the above, Tito.

Tito Labarta, Analyst

Okay. Thank you, Juan Carlos.

Operator, Operator

The next question comes from the line of Carlos Rodríguez with Porvenir. Please proceed with your question.

Carlos Rodríguez, Analyst

Good morning, everyone. Thank you for the conference call and taking my question. I have two questions. My first one is, what will be the strategy for 2021 and onwards to tackle the new and coming banks, both digital and traditional banks and to defend your market share in Colombia? And my second question is regarding your guidance in efficiency and ROE for the coming quarters and for the year in 2021 going forward? Thank you.

José Humberto Acosta, CFO

Carlos, good morning. Let me begin with your second question.

Juan Carlos Mora, CEO

José, I'm here. Let me take your first question about competition. Competition is increasing from both traditional banks and new entrants like fintechs and nontraditional financial service companies. What are we doing? We are investing in digital. We are gaining market share with a healthy pace of client acquisition. We now have nearly 17 million customers in Colombia, which means that half of those who have bank relationships are with Bancolombia. This isn't just about market share in loans or deposits; we are acquiring clients at a rate of 300 to 400 new customers each month through our digital platforms. We are continually adding new features, including digital debit cards. Our ability to analyze credit risk and provide lines of credit through our digital platforms is well established. I believe we are well prepared for the competition ahead. We are experiencing growth, and the competition presents us with significant opportunities. Our initiatives over the past year have accelerated our programs, and we are growing at a very healthy pace. José, could you take the second question?

José Humberto Acosta, CFO

Yes, sir. Carlos, regarding your first part, return on equity as Juan Carlos mentioned, our goal for the midterm is to be between 12% to 14%, and that will be a function mostly of cost of risk. But going to 2021, to your specific question, we are forecasting at the end of this year, mid-single-digit return on equity. This is again because we are assuming that we will come from 3.9% cost of risk to 3% at the end of the year. That will be the most relevant point that affects the return on equity. Regarding efficiency, as Juan Carlos mentioned in the previous question, digital will be the key investments during this year and that will be focused on maintaining the competitiveness to maintain the level of transactions that we are having today. So our goal for mid-term is to reach the level of 45% to 46% efficiency level. And that will be achievable once those investments that we are planning to do this year begin to show on the net income side.

Carlos Rodríguez, Analyst

Thank you, Juan Carlos and José Humberto.

Operator, Operator

Your next question comes from the line of Alonso Garcia with Crédit Suisse. Please proceed with your question.

Alonso Garcia, Analyst

Good morning, everyone. Thank you for taking my question. My first question relates to taxes. I know there's a lot of uncertainty, given the tax discussions in Colombia this year. But what's your effective tax rate assumption for this year and for the years ahead? And my second question is a follow-up on provisions, where you mentioned that if you see improvements in economic expectations later this year, you would update your models and that would probably result in a release of provisions like basically the opposite of what happened this quarter. So I wanted to ask, if that's something embedded in your 3% cost of risk guidance, or if that would be an upside to that number? Thank you.

Juan Carlos Mora, CEO

Thank you, Alonso. Let me start with your second question about provisions. Yes, I mentioned that we will incorporate further information into our models once we know how the economic performance is going to manifest. However, that is not incorporated right now in the guidance we are giving around provisions. It comes with the expectations that we have at the end of the year and the beginning of the year, and it doesn't incorporate further improvements. If that improvement occurs, it's going to indicate that we are going to release provisions. I don't think that is going to be the case during this year. That could occur more towards the next years. Related to taxes, we expect a tax rate around 28% for this year. That is due to the mix of statutory rates and particularities around tax regulations in the different geographies in which we operate. I don't know, José, if you want to elaborate more on taxes or provisions.

José Humberto Acosta, CFO

In tax, specifically Juan, yes, there will be, as Alonso mentioned, very difficult to forecast taxation this year. But let me put it in perspective that there will be three factors that will affect the taxation this year. The first one is, you know that in our international operation the statutory tax is lower than the statutory tax that we have in Colombia, that will give you a bit maybe the opportunity to reduce the taxation. The second element is we have other operations with zero taxation, as for example, Bancolombia Panamá which will also help to maintain taxes at a level that Juan mentioned. The third element, that is also relevant regarding the operations in Colombia, is every time we have a mortgage, social housing or investment in productive fixed assets, we have our exemptions. So if you combine those, the number would be below 28%, as Juan Carlos mentioned.

Alonso Garcia, Analyst

Thank you.

Operator, Operator

Your next question comes from the line of Andres Soto with Santander. Please proceed with your question.

Andres Soto, Analyst

Good morning, Carlos and Humberto. Thank you for the presentation. I have a couple of questions. The first is a follow-up on your guidance regarding the cost of risk. Your total allowances to total loans ratio is 8%, which seems quite high to me. Yet, you expect the cost of risk to remain significantly above your normalized level in 2021. Could you explain whether this is mainly influenced by Colombia or if it is more related to your Central American operations? That would be my first question. My second question concerns expenses. You noted that digital investments are a key reason for the anticipated high expense growth, alongside challenging comparisons from 2020 to 2021. I would like to know where you currently stand in your digital investment cycle, how much you plan to invest in 2021, and what additional investment you foresee needing for 2022. Thank you.

Juan Carlos Mora, CEO

Thank you, Andres. The cost of risk currently stands at 8.1%, which reflects the provisions on our balance sheet in relation to our loan portfolio. This figure seems appropriate. We anticipate that in 2021, we will experience a high cost of risk, influenced primarily by the economic performance in Colombia, as well as in Panama. In Panama, we have several uncertainties regarding its economic outlook. Last year, Panama's economy was significantly impacted by the pandemic, but we expect a recovery similar to other regions. However, the main factor driving credit costs in 2021 will be Colombia, as it is our largest operation and accounts for three-quarters of our assets. While Panama will have an impact, we remain more optimistic about Colombia's economic performance, expecting it could exceed our current forecasts, although we will need to wait and see. We believe it is prudent to provide guidance of a 3% cost of credit based on the variables we're incorporating into our models, while keeping in mind that our normalized cost of credit typically ranges from 1.8% to 2%. A cost of 3% is relatively high, but as I mentioned in response to Tito's question, this is the primary driver of our results. Regarding expenses, it is challenging to determine our position within the digital investment cycle. We have invested significantly in digital since 2016 or 2017 and already have the platforms in place, but we will continue to invest. I cannot say when this investment will conclude, as we need to maintain the bank's competitiveness. However, we are beginning to see returns from these investments, which started last year and are expected to continue in the coming years. We may need to keep investing to ensure ongoing competitiveness, but returns will be forthcoming. José, would you like to elaborate on these two questions?

José Humberto Acosta, CFO

Andres, could you repeat, please, we couldn't get you?

Andres Soto, Analyst

Sure, José Humberto. I'm asking about the cloud migration. You mentioned in your initial remarks…

José Humberto Acosta, CFO

Yes.

Andres Soto, Analyst

I'm curious about the timeframe and total investment related to 2021.

José Humberto Acosta, CFO

Andres, we are investing for three years. The timeline is the implementation will take us three years moving to iCloud. The investment is at around $15 million to migrate to iCloud.

Operator, Operator

That's perfect. Thank you, José Humberto and Juan Carlos. Your next question comes from the line of Carlos Gomez with HSBC. Please proceed with your question.

Carlos Gomez, Analyst

Thank you very much. My first question is regarding how confident are you about the guidance for 4%, 5% ROE for this year? And in particular, how confident are you about the provisions in Panama which seems to be quite a fluid situation? The second question refers to the difference between local accounting and IFRS, and that is the basis for your dividend. Since your earnings were higher in 2021, does that mean that as provisions catch-up in local accounting, you might have lower returns in 2022 in accounting terms and therefore you might have less than 4%, 5% ROE in local terms in 2022? Thank you so much.

Juan Carlos Mora, CEO

Thank you, Carlos. How confident are we with the guidance of 4% to 5% ROE? We are confident; it's challenging in relation to loan growth. But it's achievable. We are convinced that we can achieve those returns during this year around 4% to 5%. That guidance is taking into account how we believe the Banistmo operation is going to behave. We are pretty confident that we can achieve those returns during the 2021 year. Regarding your second question, I will pass it on to José Humberto.

José Humberto Acosta, CFO

Thank you, Juan Carlos. Yes, Carlos, as we mentioned before, the key difference is the level of provisioning that we are having in comparing our models with the local accounting system. This is a particular year in 2020 which was the other way around. I mean, the IFRS provisioning level was higher than the Colombian regulation provisioning. We are expecting Carlos, next year that the gap will reduce, if you compare both. Again, we are not talking about reversing. We are talking about because of the mortgages, some provisions will reverse and will be coming down. But because of deterioration, you are going to see some provisions going up.

Carlos Gomez, Analyst

Sorry, when you say next year, you mean 2022, or do you mean 2021? Again, should we expect a reversal of the impact that we saw in 2020?

José Humberto Acosta, CFO

No. We are expecting for this year 2021, that the gap will reduce, if you compare both. Again, we are not talking about reversing. We are talking about that, because of the mortgages, some provisions will reverse and will be coming down. But because of deterioration, you are going to see some provisions going up.

Juan Carlos Mora, CEO

Carlos, let me provide more details. The main difference, as I mentioned, relates to provisions. During normal conditions, the two accounting methods generally align. However, in these unusual times, the IFRS model uses forward-looking measures and incorporates macroeconomic variables into its calculations. This is where the divergence occurs. We anticipate that, in the future, these figures will align. This year is not typical, so the numbers remain separate. However, we do expect convergence between the two accounting methods.

Carlos Gomez, Analyst

No, I mean, that is clear, that they will converge in the end. But you have essentially anticipated some provisions because of what you said, they are forward-looking in IFRS? And you incorporated the macroeconomic variables. So it stands to reason that if that comes to pass in 2021, you will have to provision more locally than you will have to provision in IFRS since you already have your provisions, which means that your results locally could be lower than under IFRS. I want to understand if there is any kind of confusion there?

Juan Carlos Mora, CEO

That could be the case, but it depends on how, again, the economic outlook or the economic behavior is going to be. Because if the deterioration appears and we don't have that deterioration reflected on local accounting rules, you are right, we will need to incorporate additional provisions on local rules. But it depends on how the variables behave. But your analysis is completely correct. But we cannot conclude exactly how it's going to be that behavior on local accounting.

Carlos Gomez, Analyst

Thank you for the clarification. Thank you.

Juan Carlos Mora, CEO

Yeah. Thank you, Carlos.

Operator, Operator

Ladies and gentlemen, we have ended the question-and-answer session. And this concludes today's conference. Thank you for your participation. You may now disconnect.