Banco de Credito e Inversiones

SGO:BCI

Earnings Call Transcript 2020-Q2

[Operator]

[Audio Gap]

Mr. Juan Enrique Pino, Head of Credit Risk Management; Mr. Jose Marina, CNB's CFO; and Mr. Hugo Loynaz, CNB's Chief Credit Officer; and Mr. Sergio Lehmann, our Corporate Chief Economist.

[Operator Instructions] In this presentation, we will cover the main aspects of the bank after the COVID-19 outbreak started, where we will be reviewing the following topics, as you can see in this slide.

Now I will leave you with our Corporate Chief Economist, Mr. Sergio Lehmann, who will take you through the main macroeconomic figures.

[Sergio Lehmann, executive]

Thank you, Andrés. The world economy is under an unprecedented shock due to the pandemic outbreak. Uncertainty related to economic asymmetry conditions remain high. Economical policies around the world have unveiled massive expansionary programs to face the crisis, mainly through cash transfers to households, fiscal backed credits and liquidity programs, among others.

In Chile, fiscal and monetary economic programs are among the largest as a percentage of GDP worldwide. The first slide shows the large negative impact over U.S. GDP during the first half of 2020. Second quarter GDP contracted by 32.9% annualized quarter-on-quarter, the largest decline since 1940. Investment and private consumption were the main negative figures, reflecting the immense shock of the crisis on households and companies. In coming quarters, is expected some economic recovery due to business reopening. In Chile's, sanitary and confinement measures will lead to a sharp decline in second quarter GDP, around 14% year-on-year, is expected a gradual improvement in economic activity during the second half of 2020 according to a gradual reopening of the economy.

June economic activity contracted by 12.4% year-on-year, better than expected, mainly driven by increasing mining activity and some gradual recovery in retail sales. We expect a 5.6% GDP contraction in 2020 and a recovery slightly above 3% in 2021. Recently, a 10% withdrawal from pension funds was approved by the Congress in planning a transitory positive consumption in coming months. Markets impact of this measure will be moderated by the Central Bank of Chile, deepening the current use of unconventional monetary tools. Recently, the Central Bank of Chile unveiled liquidity measure in financial markets related to this event. We have seen a significant negative impact over the labor market. In U.S., payrolls contracted around $20 million in April. May and June figures, however, show the largest job gains. In Florida, we saw a similar path.

In Chile, the labor force participation rate plunged to 51.9% in June, and unemployment rate rose to 12.2%. Unemployment insurance and job creation program have compensated further labor market worsening. Chile has unveiled massive economic stimulus to face the crisis. In the fiscal side, we highlight labor market job protection, emergency income to household, fiscal backed credit to SMEs, among others. It does involve public resources equivalent to 12% of GDP. In the monetary side, there are a huge unconventional monetary measures such as banking bond purchases reoperation and banking credit facility programs. Additionally, a sovereign bond purchases program is under legislative approval.

The next slide shows the relationship between commercial loans and economic activity. The banking system has a difference with other crisis in the past is playing a key role to contain the impacts of the pandemic. Commercial loans through special credit programs and liquidity provision to SMEs and creditory programming have strongly increased. We highlight the some capital structure in the Chilean banking system to support the economy. Nominal interest rate in Chile are slightly rising in the latest, but maintaining around historical lows.

Now I will leave you with our corporate CFO, José Luis Ibaibarriaga, who will continue with this presentation.

[Andrés Atala S., executive]

José Luis, you have your mic on mute. Please start again.

[José Ibaibarriaga Martínez, executive]

Now? Now, Andrés?

[Andrés Atala S., executive]

Yes. Yes sir.

[José Ibaibarriaga Martínez, executive]

Okay. Thank you very much, and thank you, Andrés. Thank you, Sergio. Good morning, everyone, and thank you for participating in this second quarter conference call. Hoping that you and your families are staying healthy during this pandemic. I would like to start stating that this scenario has allowed us to reaffirm the strength of how we do business. Where once again, we want to reinforce our long-term strategy based on customer experience, sustainable growth and a strong culture. As we mentioned in the last call, we have taken several measures from very beginning to face this new scenario. Given this, I will briefly address our top priorities for this year.

One -- and the first one -- the first of all is to ensure that all our employees stay safe as the first and main concern. Today, 70% of them are working from home. The second one is to be close to our clients, providing them financial support in order for them to face this financial effect of the pandemic. Since the very beginning, the bank has been 100% operative, providing the necessary support to our customers. The third one is risk management, implementing a proactive approach by booking additional provisions in Chile and in Florida as a way of addressing the complex economic scenario. The fourth one is to place a special focus in our efficiency plan. The fifth one was to maintain the bank a strong financial position to face this crisis. BCI's soundness has been once again reflected in our liquidity and capital ratio, both well above regulatory limits. In terms of consolidated financial results, this first half of the year, we have seen a positive result in gross margin, growing 10.65% year-over-year. The positive result in operating income, combined with expenses that has been managed has made an improvement in efficiency -- reaching an efficiency -- reaching at 44.99% this quarter.

On the other hand, we have seen higher risk expenses, which when [ Enrique ] will cover further in this presentation.

Finally, in terms of taxes, this has of the year, we have seen higher taxes expenses of 32% as a result of higher value of City National Bank investment due to the U.S. dollar appreciation.

Please move to the next slide. BCI's local portfolio amounted to USD 34.5 billion in second quarter 2020, increasing 18.3% year-over-year. This growth was mainly driven by the commercial portfolio, increasing 25.5% year-over-year and 14.4% since December 2019, where we must consider that the FOGAPE loans represent an increase of roughly USD 2 billion in the commercial loan portfolio.

Additionally, during the first quarter of this year, the wholesale segment was particularly active in terms of loan generation. This higher volume was mainly explained by large companies searching to increase their liquidity by working capital in this year of high uncertainty and volatility. On the other hand, consumer loans have slowed as the crisis deepness, decreasing 1.5% year-over-year.

From the standpoint of financial services, June became the third consecutive month when the loan stock decreased as a consequence of this economic scenario. Particularly, they will also be affected by the initiatives that the government will implement to support households and especially the middle class to cope with this crisis. Lastly, mortgages loans keep up the growth momentum, increasing 14% year-over-year, and they remained stable compared to previous quarter.

Please move to the next slide. We have also reinforced our commitment to our SMEs customers through solutions that provide relief and flexibility. I am really proud of the team effort which has developed this product in a massive, simple and digital way, where 90% of the FOGAPE application has been approved by the bank. As shown in this chart, since the very beginning, BCI has fully adhered to the COVID-19 credit program, so the company has the liquidity and working capital to go through this crisis, where 74% of the operation have originated through our web.

Now I'm going to pass it along to Juan Enrique, who is going to discuss our asset quality and loan portfolio composition.

[Juan Enrique Pino;Head of Credit Risk Management, executive]

Thank you, José Luis. Hi, everyone. I'm the Head of Credit Risk management BCI, and I'm happy to be with you and give you more details on the loan portfolio.

So let's go to Slide #12, please. Regarding our loan portfolio, it is -- you can see that it's pretty well diversified by customers line of businesses and economic sectors. As for loan distribution, 48.9% corresponds to wholesale banking; 38.5% to personal banking, of which 2/3 is comprised of residential mortgages; and 10.6% to SMEs, where our finance division represents 2.1% of local portfolio. That's basically the correspondent banking activity.

As you can see in the chart in the upper right side, our commercial loan book is pretty well diversified. It should be noted that the direct exposure to sectors that you may be interested in, such as entertainment, hotel, health and restaurants combined, is below 5%. In addition, it should be highlighted that around 80% of these loans are collateralized for government guarantee.

I would also like to address that the exposure to the commerce loan book is also well diversified and distributed among several sectors such as shopping malls, car dealers, wholesale and retail trade businesses. In terms of loan portfolio concentration, the exposure to the 20 largest customers account for less than 10% of the total loans.

Can we go to the next one, please? As José Luis mentioned, we have been doing everything at hand to provide the necessary financial support to our clients. You can see in the upper left graph the mortgage loans, we believe that the option that we gave to customers is about deferring up to 6 installments was of great value to them, since 55% of them took the offer. That 55% is a result of one, the amazing financial conditions [Technical Difficulty] so not only those ones affected, and anyone who believe it was a good business [Technical Difficulty]. So 10% of the guaranteed FOGAPE COVID loans, both principal and interest payments had [Technical Difficulty] but also by deferring.

The next section, please. Okay. The financial support for clients who demonstrated good payment behavior. As you can see in the chart, in the [Technical Difficulty] the NPLs remained stable as of June 2020. In the commercial segment, the NPL ratio is 1.73%in the local market. Although in terms of ratio, we can see a decrease, we should consider that the amount of nonperforming loans this quarter increased 2.33% relative to previous quarter. This was mitigated by the increase in commercial loans, which grew 6.59% quarter-over-quarter.

In the consumer segment, the NPL ratio reached 3.06% (sic)[ 3.08% ] in the second quarter of 2020, the stock of consumer loans fell, contributing to the increase of this ratio, and that is a demand factor. When excluding CNB and financial services, this ratio drops to 2.63%, although revealing an increase of 49 percent points in a year-on-year basis.

Financial services NPLs have impacted the consolidated debt ratio in the consumer segment, picking up in May 2020 with NPLs of over 5%. As of the end of June 2020, there has been a slight improvement in the indicator, reaching 4.82%. It should be noted that financial services account for less than 2% of BCI's consolidated customer loans as of June 2020.

Let's go to the next one, please. Mortgage loans. So mortgage represented 2/3 of the consumer loans. Regarding our mortgage portfolio, the weighted average mortgage loan-to-value ratio has dropped from 72.5% to 67.5% in the period that we're showing here in the chart. And that's a reflection of a reduction in the highest loan-to-value tranches. This is a result of more prudent origination policies, also a portfolio that is more mature. And that has allowed us to have a more robust mortgage book and provides resilience to the portfolio against a scenario of stress in the industry.

Can you go to the next one, please? In terms of risk, we should take into account the following effects. The grace periods have mitigated a further increase of regulatory provisions. As an example, loans in default for over 30 years have not shown so far a major increase. As you can see in the chart in the upper right side of this slide. Likewise, this year, we have made more than $43 million of additional provisions and $31 million in this quarter only in order to anticipate future risks and thus building conservative financial statement, which allow us to face potential scenarios that our risk model may not be currently recognized. We have implemented multidisciplinary things among risk, commercial and strategy divisions, which have been coordinated and working collaboratively in order to face these contingencies through proactive measures. Example of this is that we have carried out an internal due diligence on the entire wholesale banking portfolio in order to assess, which is an impact at our company level, which is the -- what do they expect in terms of the new normal and when is it that they believe they're going to reach the new normal in order for us to appropriately reflect that in provisions and in order to build the best financial solutions for them going forward. Having said that, we believe all this is transitory, where the impact on risk will depend on how deep and how fast economy recovers.

So let's go back now to José Luis Ibaibarriaga to continue the presentation, and I'm happy to answer questions afterwards.

[José Ibaibarriaga Martínez, executive]

Thank you, Juan Enrique. Now we will continue with the financial results in the local operation. Afterwards, Jose will talk about City National Bank numbers.

This quarter, the bank has good results in terms of operating revenues by growing 5.15% year-over-year, underpinned by higher treasury income and commercial loan volume. Despite the increase in operating revenue this quarter, net income was offset mainly by greater voluntary provisions, as Juan Enrique recently commented. In the domestic market, the net interest margin decreased 50 basis points, mainly due to the effect of a lower inflation and higher growth in the commercial loan book segments with lower spreads such as the FOGAPE COVID program. And on the other hand, the construction in the retail business also adds a downward pressure in this ratio. In addition, renegotiation of last year mortgages loans also had an impact in the net interest margin. Nevertheless, the low Central Bank monetary policy rate at 0.5% has positively impacted the cost of funding. On the other hand, net fees decreased 13% year-over-year. This significant decrease is mainly explained by a decline in fee income, which in turn was mainly triggered by a drop in court services as a result of the economic slowdown after the COVID-19 outbreak started.

Lower-than-expected fee income from credit and debit card use was the tangible fallout of this lower economic activity that hit both BCI and financial services. During this quarter, remuneration for insurance brokerage also fell as expected result from the decrease in sales since the focus in the consumer portfolio has been on this management. There was also effect on the new fraud regulation that came in force in May, which impacted multiprotection insurance from the start point of BCI insurance broker.

For what is expected to be a challenging year for the banking industry in terms of profit, it is even more critical to keep expenses control. The bank is constantly seeking cost savings in order to improve efficiency. Indeed, our corporate efficiency plan will continue to be very active and in this quarter, the efficiency ratio reached 43%.

Lastly, it must be added that financial services has been able to maintain an efficiency level under 35% despite a more complex business scenario. BCI has maintained high liquidity indicators, different strategies have allowed us to successfully overcome the contingency that we have generated since last October, managing to keep the flow-on liquidity constant to the different businesses, areas and local subsidiaries and the bank in general.

The bank's total deposits in Chile increased 26.6% year-over-year, where noninterest-bearing deposits grew 50% year-over-year due to the high-growth of retail and wholesale banking customers. The aforementioned combined to higher liquidity in the market and the issuance of subordinated bonds have helped to increase the bank's LCR reaching 163%, well above regulatory limited.

Please move to the next slide. I will also want to address the bank's capital position, where we are facing this crisis with sound capital ratios and solid capital base, well above regulatory limits, reflected in one of the highest credit rating in the banking sector of emerging markets.

Risk weighted asset. Strong growth is mainly explained by City National Bank, 35.9% due to the 4% volume growth and increase in stock associated with FX. However, it was absorbed by the investment reflected in equity when considering the Tier 1 ratio, the request -- the rest of the growth was generated from local loan originated 20%, particularly the FOGAPE COVID program.

Among other important effect that explains the valuation of this indicator, a decrease in the value of huge accounting on equity due to the fall of interest rate should be highlighted.

Regarding Tier 1 ratio, we maintained our commitment to be around 10% in the medium term, as we have mentioned in our last call. Likewise, we believe that for the next month, we'll have a transitory pressure in capital ratio.

Now I will leave you with Jose Marina, City National Bank CFO; and Hugo Loynaz, the bank's Chief Credit Officer.

[Jose A. Marina;City National Bank;Chief Financial Officer, executive]

Thank you, again, José Luis, for the opportunity to join you on this quarterly earnings call to review City National Bank's performance over the past quarter. Good morning, everyone. My name is Jose Marina, and I am City National Bank's Chief Financial Officer. I'm pleased to be joined today by Jorge Gonzalez, our CEO; and by Hugo Loynaz, our Chief Risk Officer.

City National Bank has made a significant positive impact on our clients and communities over the past 5 months, as I believe you will see during our discussion today. Given our collective renewed focus, we will be addressing 4 themes during today's call. First, we will touch on our first quarter's results and the impact of COVID-19 on those results in terms of provisions as well as loan and deposit fluctuations. Second, we will spend some time reinforcing our strong liquidity, capital and asset quality positions as we embark into this period of increased uncertainty. Next, we will demonstrate to you how we assisted our clients during these challenging times while successfully operating the bank remotely. We will also discuss on segments directly impacted by the COVID-19 and provide you relevant details on the segments that are most impacted. Finally, we will conclude by discussing our revised strategic direct for the remainder of the year. With that said, let's give you an overview of a robust and comprehensive response to COVID-19.

Regarding operational resilience, the bank has been operating remotely since mid-March without any disruption whatsoever. This is not an accident. The seamless conversion to remotely operating the bank is doing our ability to effectively develop and test business continuity plans in prior years. We've been able to originate and close over 9,000 PPP loans in a completely remote and virtual manner. This serves as a testimony to our operational resilience. From a customer standpoint, our banking centers all remain open with services primarily being provided through our drive throughs. Clients can visit our banking center lobbies with appointments following social distancing protocols to protect both our employees and our clients. We also implemented 90-day deferral programs for both commercial and consumer loans that be considered for a 90-day extension, and we have been a very active participant in the Paycheck Protection Program, which we'll address further later in the presentation.

We are also currently focused on providing relief to our clients and prospects through the main Street lending program and have already closed loans under this program. We expect significant activity in the mature lending program during the third quarter.

Finally, the health and well-being of our employees and their families is always our top concern. To the end, we have enhanced our employee health benefits to include COVID-19 testing for all employees and their families. We are also persistently communicating with all of our employees as they work remotely and have developed a comprehensive bank -- back to workplace plan in order to ensure employee safety, once our offices reopen

Not only do we have the infrastructure to operate remotely, we have also developed all the capabilities necessary for our customers to transact remotely. We saw a surge in our digital channels during the second quarter with number of bill payment enrollments increasing by 24% in the quarter, a 31% increase in customers making mobile deposits and a 22% increase in registered online users. We also processed over 9,000 PPP applications remotely and have already received several main street lending program applications remotely. These accomplishments were made possible by our continued investments in digital capabilities.

Moving to our financial results. We first want to briefly update you on our balance sheet fluctuations in the quarter. Our gross loans increased by nearly $1.5 billion, with PPP loans accounting for $1.8 billion of that increase. Our client deposits increased by over $1.5 billion, with noninterest DDA accounts -- accounting for $846 million of that increase. We continue to enhance our already strong liquidity position, and you will see in subsequent slides that we have strong on and off-balance sheet sources of liquidity.

I'll also point out our strong capital ratios. You can see our total and Tier 1 risk-based capital ratios continue to increase, while our Tier 1 leverage ratio declined from the 10.81% to 10.04% quarter-over-quarter due to the impact of our $1.8 billion of PPP loans on average assets. Nevertheless, our leverage ratio remains quite strong at over 10%, and the PPP impact is temporary given the short-term nature of these loans.

Finally, you can see our asset quality metrics, which we'll discuss in more detail later in the presentation. On this slide, you can see that PPP loan production was the main driver of our loan growth in the quarter, while our client deposits increased by about $1.5 billion as our broker deposits declined in the quarter.

On the next slide, you can see our PPP loan production by size and the distribution between clients and prospects, 63% of the units generated covering 57% of the balances of our new clients that did not previously have relationship with the bank. These customers turn to us when their previous banks cannot provide the needed PPP loans in a timely manner. We are committed to helping our community and provided PPP loans for a significant amount of new clients. We are currently focused on cross-selling banking services to these new clients and converting these transactions to long-term customer relationships. The $1.8 billion of PPP loan production generated $56 million of fees that will be realized over the next 2 years.

It is important to note the outsized impact we had in our communities. Although City National Bank has a 1.9% deposit market share in the state of Florida, we provided 5.8% of all PPP funds to Florida-based businesses. Therefore, we generated 3x our fair share of PPP loans based on our deposit market share.

On this slide, you can see the increasing trend of our deposit base over the past 5 quarters, while we have also been reducing broker deposits. Regarding the composition of our deposit base, you can see the increasing composition of noninterest DDAs, that now total 34% of total deposits or 35% of client deposits once you exclude broker deposits. We have also been able to reduce our cost of deposits over the past 5 quarters, including a 51 basis point reduction over the last quarter.

This slide provides some further details on our investment portfolio and demonstrates that our ability to substantially -- demonstrates that our portfolio is substantially comprised of highly liquid and safe mortgage-backed securities. 11% of the portfolio is in corporate bonds, consisting of some of the largest names in the U.S. The portfolio had substantial unrealized gains as of June 30, totaling $73.5 million.

Regarding liquidity, you can see that we have over $7 billion of committed liquidity sources, representing 42% of total assets. Our unpledged cash and unencumbered securities totaled nearly 15% of assets, while we have $1.4 billion of available liquidity at the Federal Home Loan Bank. We also have $3 billion of available liquidity at the Federal Reserve Bank discount window, bringing our total liquidity sources to $7.3 billion. This slide clearly demonstrates City National Bank's strong on and off-balance sheet liquidity sources.

On this slide, we clearly demonstrate our strong excess capital position. Our Tier 1 leverage ratio of 10.04% provides us with significant capital buffer, as you can see. We have $351 million of excess capital to reach a still solid 8% Tier 1 leverage ratio, which is still well above the 5% threshold to be considered well capitalized. As you can see, our Tier 1 leverage ratio declined from 10.81% to 10.04% quarter-over-quarter. This temporary decline is the result of our active PPP participation that added $1.8 billion of new loans over the quarter. Without the PPP loans, our Tier 1 leverage ratio would be about 10.9%. These capital buffers do not take into account our strong pre-provision earnings capacity that serves as our primary capital buffer, which we will discuss later.

Now I'm going to pass it along to Hugo Loynaz, our Chief Risk Officer, who is going to discuss our asset quality and loan portfolio composition.

[Hugo Loynaz, executive]

Good morning. Thanks, Jose. I'm very pleased to join all of you on this earnings call and discuss our credit profile with you. This slide illustrates that we enter this period of uncertainty with an exceptional asset quality. Our NPLs increased slightly in the quarter, but remained at a low level of 54 basis points. Additionally, our charge-offs are insignificant for a portfolio that is over $11 billion, and that's excluding the PPP loans. It is also worth noting that charge-offs recorded year-to-date are substantially unrelated to the impact of COVID-19. We have achieved these results through our strong credit culture that has been in place since the Great Recession.

Finally, I'll point to the breakdown of nonaccrual loans, which totaled $58 million. 71% of our nonaccrual loans are real estate secured loans.

Please turn to the next slide. So on this slide, you can see that 72% of our loan portfolio is real estate secured and that the segment of our portfolio that is real estate secured is also very well diversified, with nearly half of real estate loans comprised of residential and owner-occupied CRE loans.

Also of note is our conservative lending approach, which results in a low weighted average LTV for all real estate security loans of only 55.8%.

Please turn to the next slide. As you can see, we've had great success in reducing our deferrals through mid-July and have had a significant amount of deferrals expiring over the next couple of months. We are considering a second 90-day deferral on a case-by-case basis and have been able to move 75% of all expiring deferrals through July 16 to paying status. Our ability to reduce deferrals by over $1.4 billion or 46% from May to July is a significant step forward for sure.

On the next slide, please. As you just saw on the prior slide, our deferments are down to just over $1.5 billion as of mid-July, representing 14.5% of our loan portfolio, again, excluding PPP loans. About 66% of our deferrals are in commercial mortgages, which has a weighted average LTV of 55% and 87% of all deferrals are real estate secured. Also, the bank has recourse on 82% of the loans on deferred.

On that note, I'd like to discuss the loan segments most directly impacted by COVID-19. On the next slide, please. As you can see, about 22% of our loan portfolio is in segments directly impacted by COVID-19, with 25% of these loans on deferral as of July 16. The 3 largest segments are CRE retail, hotel and travel and restaurants. These 3 segments comprised 3 quarters of our impact of loans. So we will discuss each segment over the next 3 slides.

We have $811 million of exposure in CRE retail in shopping centers and things like that, with over half of the exposure in anchored shopping centers, anchored by stores like Walmart, Publix, which is a major grocery chain here in Florida. As you can see on the wheel on the top left of the slide. So the overall weighted average LTV of the segment is extraordinarily low at just about 50%. Most importantly, you can see that the vintage of the portfolio on the bottom right is more concentrated in production from 2014 and prior with very little production originating in the 2018, '19 and '20 periods. Therefore, this is a well-seasoned portfolio with a very low weighted average LTV. The vintage distribution and the LTV metrics are optimal for minimizing any potential losses in the future.

Please turn to the next slide. Hotels is the next segment that we will discuss. You can see from the graph on the top left that 95% of our hospitality exposure is real estate-secured with an even lower weighted average LTV of only 42%. On the right-hand side, you can see that the vintages of the real estate security exposure is very well distributed over the past several years with very little production over the last 3 years.

Just like the retail segment, this vintage distribution and low LTV is optimal for minimizing any potential losses. The segment on the wheel on the top left, that is in red, representing 8% of our hospitality exposure consists of non-real estate secured exposure, primarily related to large timeshare companies with a long-standing record of success. We are monitoring all of our clients in the hospitality industry in order to provide them with the relief that is needed and to keep abreast of developments in their business activities. Many did avail themselves of the PPP program.

Please turn to the next slide. The final COVID-19 segment that we will discuss is the restaurant segment. As you can see in the wheel on the top left of the slide, about 23% of our exposure is real estate-secured. That exposure is broken down in the chart on the bottom right of the slide, and you can see that the vast majority of the vintages originate from prior to 2016, resulting in a very well-seasoned portfolio with an LTV below 50%. The rest segment of the wheel represents our national franchise exposure, that is 69% of our total restaurant-related loans. You can see that the detail of that exposure in the chart on the bottom left with all of the exposure to value, quick service brands have performed well during economic downturn. So these are your fast food chains typically in economic downturns performed very well.

We are certain that disruption in this segment is going to be temporary, and these names will perform well as the economy continues to reopen within the States. The yellow segment of the wheel represents restaurant exposure in our markets with much of that exposure also consisting of names you may recognize in Florida. Like our national franchise exposure, we're staying close contact with all of our restaurant clients and actively monitoring their activities.

Now I'm going to pass it back to our CFO, Jose Marina, to discuss our loss provisioning and income statement impact for the second quarter. Jose?

[Jose A. Marina;City National Bank;Chief Financial Officer, executive]

Thanks, Hugo. This chart shows the activity in our ALLL in the second quarter. We accounted for the impact of COVID-19 through our macroeconomic factors based on changes in GDP and the unemployment rate for the second quarter. With these changes substantially accounting for all of the $26 million of provisions recorded in the quarter. There was also minimal charge-offs and recoveries -- in the quarter with the bank recording a net recovery of $76,000.

It is important to mention that as a wholly owned subsidiary, BCI, CECL is not applicable to City National Bank until 2023. As a result, we remain under the incurred loss model that preceded CECL. Regardless, City National Bank will continue to actively provision in future quarters as the economic impact of COVID-19 continues to develop, and we continue to estimate the impact on our loan portfolio.

Next, I'd like to briefly address our second quarter results. Naturally, our net income declined by nearly $8 million over the linked quarter to $25.1 million as a result of the provision expense increasing by $13 million. However, you can see that our net interest income increased by $5.3 million or 5% quarter-over-quarter as a result of our PPP activity, which we'll address further in an upcoming slide. Notwithstanding our proactive loan loss provisioning, you can see that City National Bank's core earnings engine remains strong.

Our core earnings, which represents earnings before loan loss provision, taxes, intangible amortization and other nonrecurring items, actually increased year-over-year by $4.6 million or 4%. Expanding further on net interest income, you can see that we've been able to increase our net interest income over the past 5 quarters, but most notably, over the past 2 quarters. You can also see that our PPP activity was a significant driver in our net interest income increasing this past quarter.

Regarding key ratios, we've already addressed many of these during the presentation. In summary, I would remind you that we have exceptionally high capital ratios protected by low levels of nonperforming loans and ample liquidity.

Finally, I'd like to close by briefly discussing our strategic priorities for the remainder of the year. Obviously, the realities of COVID-19 made us revisit our 2020 priorities, and we have a new definition of success for the current year. First and foremost, maintaining our regulatory excellence is at the foundation of everything that we do.

Next, we will be focused on active portfolio management. Identifying challenges early on and monitoring those clients that are most impacted will be key. Our extraordinary PPP accomplishments will only help this effort. Third, we are currently focused on providing clients and prospects additional relief through the Main Street lending program. We believe that we will be making a significant impact with this program just as we did with PPP. Fourth, we will continue to enhance our sales effectiveness processes as an organization. We have attracted key prospects to the bank via our PPP efforts and have also created a lot of goodwill with existing customers by timely processing their PPP and Main Street lending program applications in securing them funding. We will be focused on cross-selling new clients brought to the bank via PPP or Main Street and increasing the share of wallet for existing clients as well. The definition of success by our participation in these programs will be determined by our ability to cross-sell these clients and make them lifetime City National Bank's clients, greatly enhancing the bank's long-term value.

Next, we will plan for the successful integration of Executive National Bank. We are actively working towards obtaining all necessary regulatory approvals and are working in conjunction with executive National Bank to monitor their business activity during these challenging times. Finally, we are working to optimize our expense infrastructure and have already identified and executed upon cost-saving initiatives. You will be seeing the results of these initiatives in the upcoming quarters.

In conclusion, I'd like to restate that we enter this period of uncertainty from a position of strength. We have all the characteristics of a fortress balance sheet, ample liquidity, significant excess capital and a strong credit culture that results in strong asset quality. We are currently focused on all of our relevant objectives that will not only preserve City National Bank's value, but it will enhance our value once we emerge from this period. Our commitment to assisting our clients and the goodwill that we have created through our active and outsized participation in the PPP program as well as our current focus on the Main Street lending program will undoubtedly enable us to emerge from this period as a stronger and even more profitable institution.

And now let's turn the call back to the BCI team for final thoughts and a wrap-up. Thank you.

[José Ibaibarriaga Martínez, executive]

Thank you, Jose. Thank you. Now we will briefly discuss our main advances in digital transformation. Today, more than ever, it has become clear that our effort dedicated to our digital transformation has allowed us to respond quickly and in a simple way to the needs of our clients. As you can see in the slide, some examples are that 84% of our personal banking clients have entered a digital channel, web, apps, mobile web in the last 30 days. Regarding our app new users, increasing more than 40% in the last year with an excellent user rating. Also, this year, we have been historical -- we have seen historical car insurance and demand deposit figures. Example of this is our demand deposit online transactions reached 97% of the bank's operation.

Regarding MACH. This year, it has reached more than 2.4 million accounts and launched new functions with more than 1.6 million activated visa prepaid card. Also, we would like to address that more than 100,000 e-commerce physical payments and in-app services already accept MACH. This outstanding growth is a result of a great user satisfaction of 75% in net promoter score, as you can see in the slide.

Regarding our payment ecosystem strategy, we continue to make progress with a regulatory approval process and expect to be in market in the fourth quarter of this year, with objective to evolve from a single-acquired model to one with multiple acquirers with increased capabilities and competition. With this initiative, along with MACH, Google, Visa and Garmin Pay, we want to become a significant player in the acquired -- acquiring a payment solution market in Chile.

In summary, as you have seen in this presentation, the bank has a strong financial position to face this crisis, both in Chile and in U.S.A. We have focused on key areas, developing special plans for customers, employees and suppliers. What was -- for what is expected to be a challenging and complex second half of the year, in terms of profit for the banking industry, our key focus is control our risk and our expenses. We have booked additional provisions in Chile and in U.S. in order to anticipate future risks and thus have a conservative financial statement, which allowed us to face potential scenarios that the risk model may not currently recognize.

So thank you for participating. And now we can address questions that you may have.

[Andrés Atala S., executive]

Thank you, José Luis. The floor is now open for questions.

[Operator Instructions] The first question comes from Jorge Pérez from Itaú.

[Jorge Pérez Araya, analyst]

I know that you can't give any guidelines. But I want to know about your expectation in the consumer loans. We have seen that the book is dropping at a faster pace in this crisis. So do you expect a recovery for the second half of the year? Or we continue -- we should continue to see a decrease in the book?

[José Ibaibarriaga Martínez, executive]

Sergio, you want to address that? Or I can do it.

[Sergio Lehmann, executive]

I can do it.

[José Ibaibarriaga Martínez, executive]

Okay. Thank you.

[Sergio Lehmann, executive]

Thank you for the question. Well, we are expecting some imposing consumption in the coming months. This is mainly because of the 10% withdraw from pension funds. So we're expecting some increase, as I said, in consumption. They're going to contribute about 2% to 0.5% in the GDP growth for this year, given this particular situation. So in our view, at least, we should expect some recovery in consumption pass in the coming months coming with this. In addition, we are expecting some advances in the reopening of the economy. So for the coming months, in that sense, we are also expecting some positive numbers month -- compared with previous month, not in our base. But anyway, we are expecting some recovery in the economy in the coming months.

[Andrés Atala S., executive]

Our next question is from Sebastián Gallego from CrediCorp.

[Sebastian Gallego, analyst]

Can you hear me?

[José Ibaibarriaga Martínez, executive]

Yes.

[Andrés Atala S., executive]

Yes, sir.

[Sebastian Gallego, analyst]

Perfect. I have several questions. The first one on the FOGAPE loans and the PPP. But particularly on FOGAPE, BCI continues to be well above its regular market share. I just want to have a sense or if you guys can provide more color on why is BCI being more aggressive compared to their fair share in the market, even if it goes against the capital position? That will be my first question.

The second question would be on asset quality. I just want to get a sense on the need for additional provisions. Have you record enough provision -- additional provision as of now? Or should we expect the third and the fourth quarter to be even higher compared to the second one?

And finally, just a long-term question. Even though there is a ton of uncertainty, I would like to know what are you guys thinking about how long can it take to recover pre-COVID profitability levels?

[José Ibaibarriaga Martínez, executive]

Okay. Regarding the FOGAPE and why we have basically doubled our market share is basically driven by our long-term strategy of relationship with our customers. We have been very active, understanding that this is a time where we have to help the viable customers, helping them with cash flow to go through this crisis. But one of the main aspect that we were so active is that we have been investing in digital transformation and basically, we have a very simple, agile way of taking those loans and customers were really happy obtaining the loan so fast.

So basically, it was a combination of a long-term strategy attitude; and two, that we have the business process in place, a digital process that allowed us our customers going in and obtain the loan very, very fast.

Regarding the last -- the number third of your question, very easy to answer. When are we going to come back with the profitability after the COVID? Honestly, Sebastián, we don't know. You are seeing what's going on in other parts of the world where they open and then they are thinking of closing. So until there is no vaccine or a specific treatment in a massive way that can arrive to this -- to the country is really complex to answer that question. And regarding the asset quality, I don't know, Juan Enrique, if you want to address that question.

[Juan Enrique Pino;Head of Credit Risk Management, executive]

Sure. I think Sebastián second question was about the need for additional provisions, Sebastián. Is this Okay?

[José Ibaibarriaga Martínez, executive]

Yes, yes.

[Juan Enrique Pino;Head of Credit Risk Management, executive]

So yes, you've seen that in the past 4 months, we have been regularly building up voluntary provisions at an average of $10 million to $11 million. We believe we're going to continue doing that for the time being. There's no stop for now. And you also know that for the loans that we built, that you mentioned in your question number one about FOGAPE COVID, the regulator has issued indications as to when and how should those provisions be calculated, particularly with regards to the deductible that those 3 tranches have, which is between 2.5% and 5%, and that has to happen between September and December of this year. So you have those 2 effects: one, our monthly discipline of building up incremental reserves that we review month by month. But so far, it has been between $10 million and $15 million, an amount that we're going to have to build and all banks will have to build between September and October relative to the FOGAPE -- to the deductible of the FOGAPE COVID loans. I don't know if that answers your question?

[José Ibaibarriaga Martínez, executive]

Thank you, Juan Enrique. Sebastián?

[Sebastian Gallego, analyst]

Yes. Just -- yes -- you wanted to complement?

[José Ibaibarriaga Martínez, executive]

No, no, no. I just want to know if you feel that we answered the question or not.

[Sebastian Gallego, analyst]

Yes. Just probably, if I may, one additional question on CNB. Just to clarify, I want to thank you for the key highlights of the CNB presentation. If you could expand on the situation to induce an incurred loan loss provisioning instead of a forward-looking model, considering the current situation. Because if I understand, well, all across at least the LATAM region, I mean, there is a need to use a forward-looking model, including the IFRS 9 in most of the countries.

[Jose A. Marina;City National Bank;Chief Financial Officer, executive]

So Sebastián, on that question, obviously, CECL -- since City National Bank is not a publicly traded bank, CECL is not applicable to City National Bank at this time. We are working towards to implement it. Obviously, COVID hit us in something that was unexpected and came immediately, and then that's something you can't just turn on and off just like that. You have to process, you have to run parallel, et cetera. Nevertheless, we are being proactive in our provisioning needs and working through our qualitative factors, in order to increase our provisions, even though, as you see, our asset quality continues to be strong. But we're working with the -- through the qualitative factors in order to provision accordingly.

[José Ibaibarriaga Martínez, executive]

And in terms of Chile, Sebastián, the answer is more or less the same as the model -- the risk model do not necessarily recognize the risk that we are going to have, that is why we are constituting so much voluntary provisions in order to be prepared.

[Andrés Atala S., executive]

We can continue answering questions. So the next one is coming from Gabriel da Nóbrega from Citi.

[Gabriel da Nóbrega, analyst]

So I actually have 2 questions. The first one, is regarding your NPLs. We saw that specifically on the consumer side, we already saw them increasing. But my question here is, when are you expecting to see peaks of NPls, mainly because you were given the 6-month deferment programs to your mortgage loans, around 55%. And then you [Technical Difficulty] of your core and recent grace period programs as well. So just trying to understand here, if you allow me a follow-up, if I understood correctly, you continued to build up these provisions until the end of the year? [Technical Difficulty] and ask another question afterwards.

[José Ibaibarriaga Martínez, executive]

Sergio. Do you want to take it?

[Sergio Lehmann, executive]

Yes. We're not going to know how long till those deferrals expire. And that's going to be known in the first quarter of November. Of course, we have it actually based on several collateral indicators as to how those customers are behaving in several ways. So we should see some increase but relatively modest. That's our estimation with regards to the residential mortgages.

With regards to the traditional consumer portfolio, meaning credit cards, personal installment loans and all that. And those have already started to expire. And we have -- in terms of the severance restructures. And we have seen that the ratio of deferrals that mature that require either an additional deferral or restructure is pretty low. It's in the ratio of 5% to 8%. And as the bank understanding the situations in which our customers are, we're willing to give more time to customers. So we don't believe that NPLs are going to manifest in the short run.

We are here to give time to customers, those that have the solvency and they have the viability to respond in the long run. So that's why probably you should be more focused on our activity regarding building up provisions rather than in evidencing the duration of the portfolio through NPLs. Because we do want to give the chance to customers to get back to normal. As to provisions then, we have not taken a position except for how long are we going to be doing that, but it will be for as long as necessary. We may eventually even change the pattern of building up $10 million to $11 million per month. That's yet to be defined. So I couldn't tell you more. We don't have a position as to whether this should stop this year or eventually continue for next year.

[José Ibaibarriaga Martínez, executive]

And I think, Gabriel, you have a second question.

Gabriel, are you there?

[Gabriel da Nóbrega, analyst]

Sorry, sorry. Yes. So my second question is actually on your cost side. During the quarter, we saw that you had some very good cost containment strategies on the other administrative expenses. However, I also believe that this is where you include your IT investments. And being that during the pandemic, a lot of your consumers are starting to use more digital channels. I would expect higher investments here. So I'm just trying to understand how are you being able to balance the IT investments versus decent cost containments, which we're doing.

[José Ibaibarriaga Martínez, executive]

Okay. I think that, that is a great question. It's part of our main strategy. We have been investing a huge transformation as we have talked in last conference calls, going through the IT architecture, going through customer journeys going in data, data analytics and et cetera, et cetera. And today, we are starting to see that those investments has been used by our customers. And not only -- and the pandemic has allowed us to be 100% operative in all this period of time. And what we are seeing is not different what you are seeing in the rest of the world is a migration from physical channels to digital channels. And the efficiencies that are coming from that is something that you should see in the future.

Regarding the branches, it's early to tell. But obviously, the tendency is that we will have different kind of branches a smaller one, more dedicated to advisory more than a transaction. So yes, we expect that we are going to continue seeing an improvement in efficiency. Obviously, we are going to have some challenges in the revenue side of the efficiency ratio as the loan book is not going to grow according to Sergio's expectations of the macroeconomic figures. So yes, we are starting to see improvement according to the investment that we have done. Basically, we speed the process of that. And now we have to capture the physical areas that branches that we need to see how and when we are going to change this -- change them.

I don't know if I answer your question, Gabriel? It was a little bit long. Andrés, do we have another question?

[Sebastian Gallego, analyst]

Sorry, thank you, yes. This answers perfectly.

[Andrés Atala S., executive]

Yes, indeed. The next question is coming from Neha Agarwala from HSBC.

Okay. Next question is coming from Claudia Benavente from Santander Investment.

[Claudia Benavente, analyst]

So I was looking through the 2Q results. And the consumer book, you can see that the last 3 months, the NPL formation ratio has been posting continued deterioration. But as you have been very proactive from creating additional provisions, the coverage ratio for the consumer book remains above 400%, basically, unchanged since February. So I was wondering if that could be sort of like an input we may take a look to? That's the level that you feel comfortable with ahead? Or if we could expect the this coverage reducing its level ahead to, I don't know, what -- maybe the question would be, what would be the level that you feel comfortable with ahead considering that probably we will start seeing more deterioration on the consumer book by year-end, most likely?

[José Ibaibarriaga Martínez, executive]

Thank you, Claudia. Juan Enrique, do you want to take it?

[Juan Enrique Pino;Head of Credit Risk Management, executive]

Sure. Claudia, I think that the level of provisions relatively to the size of the consumer portfolio, you should not be seeing a decrease. I wouldn't focus that much on the ratio of provisions to write-offs or to charge-offs. But specifically because, as you know, write-offs are not going to manifest regularly as we see in a normal period. So my suggestion to you would be to focus on total provisions to portfolio. And we don't see that reducing in the short run. In fact, we believe that as we continue building up voluntary reserves, our share of those reserves are going to go to the consumer portfolio anyway.

[Claudia Benavente, analyst]

So basically with the level that you mentioned of creating additional provisions, you feel that could be enough considering that the last 3 months, the consumer book has been posting a continued deterioration.

[Juan Enrique Pino;Head of Credit Risk Management, executive]

As said, we believe that -- remember that I've said that we plan to continue building up voluntary reserves, and that a share of those incremental reserves that we're going to be building up every month. It's going to go to the consumer portfolio as well.

[Andrés Atala S., executive]

Neha is back. So Neha from HSBC, the mic is yours.

[Neha Agarwala, analyst]

And I apologize. I was muted and I couldn't speak that time. My first question is on the FOGAPE loans. So what is the spread that you make? I think it's 3% that you make on the FOGAPE loans? And how does that compare to the spread that you generally make on the corporate and SME loans? What I want to understand is if these FOGAPE loans would add further pressure to your margins or not?

Then my second question is, I understand that you're going to make more provisions in the coming quarters. But could you give us some sort of sense in terms of the trajectory that we should expect? When should the provisions peak? Would it be in the fourth quarter or in the first quarter of next year or later? So any color on that would be very helpful.

And then lastly, on the financial services business. If you could give us some more information regarding that business with regards to what are the trends that you are seeing with the customers in the financial services business? And how has the unemployment -- the increase in unemployment impacted that business and your outlook, that would be very helpful?

[José Ibaibarriaga Martínez, executive]

Okay, Neha. First, FOGAPE. The FOGAPE program that the government put in place basically has a fixed rate. That is the monetary policy, plus a 3% margin. Is this -- the margin, the typical margin of this client, the answer is no. Basically, the spread that they have is higher. Nevertheless, despite that is getting lower our NIM, we have to take in consideration that these loans are government security, where the growth in this segment are key and with less risk. So basically, the net between the lower spread net of the government guarantee is basically going to be netted. It's not a huge business. It's more in order to maintain SME companies alive. And I think that in the long-term is going to be a good decision. It's different from the program that Jose explained in the PPP program in the U.S..

Regarding the provisions, I think that Juan Enrique did a very detailed explanation. We are going to continue making provisions, trying to anticipate whether risk models are not reflecting today. So we will continue with that strategy in order to have safe financial statement.

And the third one, regarding financial services, and I think that I have said this in the past. Financial services is part of the payment ecosystem strategy. We believe that is a strategic asset that we have -- yes, it was affected by the crisis of October and then has been affected by the pandemic. Nevertheless, we strongly believe that it's going to be a strategic asset for us in the future. And what is happening is that the business case is going to be delayed around 2 years. We were coming -- before October, the business case was great, and the result was great. But this kind of thing happens in the -- and we are well prepared to support them in terms of what is the future of this year and next year. We believe that this is going to be a complicated year. But they are taking measures in order to collect, to control cost, and it's going to be something that we are going to profit next year. And the recovery, the recovery of next year is going to be according to the recovery of the economy. And the 10% of the APP of -- I think that is something that will impact positively to that segment because it's the lower segment of our bank. So we still believe that we have a strategic asset there that we really appreciate it.

I think I answered 3 questions, Neha. Andrés?

[Andrés Atala S., executive]

We want to say thank you for your extra time and your flexibility. We have the last question is coming from Daniel Mora from CreditCorp Capital.

[Daniel Mora, analyst]

I have a question related to MACH. How do you monetize the operations with these MACH users? Is there any fee that you charge when the customer do a transaction? Or there is any other fee related to these operations? I want to have more detail regarding how do you monetize this operation?

[José Ibaibarriaga Martínez, executive]

As we have talked, MACH is going to become a digital bank. We -- today, we have more than 2.2 million customers. The way that we are going to monetize these assets is by creating use cases where customers can use their MACH application in a daily basis, and we are improving, as I did mention in the presentation how it has increased day-to-day basis and how much prepaid credit card and case of users has increased.

The way that we are going to monetize is charging to the businesses for the use of that. Today, we are charging not too much. But we are arriving to the changing point where you are going to start seeing an increase in our commissions. We still believe that is an investment that we will have to continue putting money, but we strongly believe that if we are creating value in some areas of the bank, MACH is creating a lot of value. The thing is that what investors see is basically the profit and loss statement, but it's not seeing how much value MACH are creating for the corporation today.

As always, thank you very much for participating in this call. We extend a little bit longer because we really want to give you some head ups in City National Bank, especially in how well they are doing and how controlled they have the risk. In Chile, with Juan Enrique to go deeper in the risk area, that is basically what we believe is your main concern. But at the end of the day, we have a strong growth in margin. We have controlled our expenses. We have not seen the deterioration in risk through our models. That is why we have been creating additional provisions in Chile and in U.S. in order to have conservative financial statements. We do have a strong capital ratios. We have a strong liquidity. So we feel comfortable that we are going to be safe, helping our customers. Taking care of our employees and hoping that this crisis can go soon. And we will arrive to a new normality soon.

As always, the Investor Relation team is always ready to answer any additional questions that you may have. And thank you very much for the time that we excess, but we believe that it was important to you to go deeper in this quarter. Thank you very much. Thank you very much, Andrés and the team for organizing this call in a digital way.

[Andrés Atala S., executive]

Thank you. And thank you, everybody.

[José Ibaibarriaga Martínez, executive]

Bye-bye

[Sergio Lehmann, executive]

Thank you. Bye.

[Jose A. Marina;City National Bank;Chief Financial Officer, executive]

Thank you.