Banco de Chile

SGO:CHILE

Earnings Call Transcript 2020-Q2

[Operator]

Hello, everyone, and welcome to Banco de Chile's 2Q '20 Financial Results Conference Call.

If you need a copy of the press release, it is available on the company's website.

Today with us, we have Mr. Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations; Mr. Pablo Mejia, Head of Investor Relations; and Mr. Daniel Galarce, Head of Financial Control.

Before we begin, I would like to remind you that this call is being recorded and that the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements.

I will now turn the call over to Mr. Rodrigo Aravena. You may please proceed.

[Rodrigo Aravena, executive]

Good afternoon, everyone. Thank you very much for joining us on this conference call. Today, we'd like to present our analysis of 3 main areas: first, evolution of the macro environment with a special emphasis on the role of economic policies and strong fundamentals as key factors in the potential recovery in the future; then we will present the main advances in critical strategic areas of our bank; finally, before moving to the Q&A section, we will go over our financial results for the second quarter of 2020.

I'd like to start with an overview of recent developments on the macro side. Please move to Slide #3. Chile has been experiencing an ongoing contraction since March in line with the trend observed in most countries. This downturn has mostly been explained by the strict social distancing measures which aim to reduce the spread of COVID-19. This has led to a sharp drop of 14% in the GDP during the second quarter, as seen in the chart on the left. The breakdown shows a significant deterioration in sectors more intensive in social activities, such as hotel, restaurants and transportation.

On the other hand, the positive growth posted by mining production has offset the sharp decline in the rest of the economy.

The overall CPI has also been falling. As seen on the other right chart, CPI went down to 2.6% in June from 3.9% in February before the pandemic. This trend has been driven by the slight growth reflected in the lower nontradable inflation and the stability in the Chilean peso, which has reduced tradable prices.

The labor market has also been affected by subdued growth. The bottom-left chart shows the increase in the unemployment rate to 12.2% in June led by the annual decline of 20% in total employment and the 15% drop in the labor force. I'm aware that this scenario described so far is not entirely encouraging. However, we are committed about the future, especially relative to other countries in the region. In fact, the lower [ duplication ] of the Chilean currency, as shown in the chart on the bottom right, confirms the better outlook for Chile. Therefore, the natural question is, what is behind this positive view? Let me try to answer this question on the next slide.

Several factors support a positive view of Chile in the future. One of them is existence of sound fundamentals, which make Chile the strongest economy in Latin America. Apart from having the highest per-capita GDP and the most stable economy, we also have a unique combination: the lowest vulnerability and the most significant room to implement countercyclical policies.

As the table shows, Chile has the best country risk reflected in the lowest sovereign credit default swap among peers. Thanks to this, the government has issued bonds in foreign market with very favorable conditions. Additionally, Chile has important buffers that make possible the implementation of further fiscal and monetary measures. Resources available from the Central Bank, including international reserves and the credit line with the IMF, are nearly 20% of the GDP, while the net fiscal debt was only 14% at the end of 2019 due to $22 billion held in sovereign wealth fund.

Chile is also less vulnerable to external shocks. According to statistics released by the IMF, foreign investors represent only 10% of the local equity market due to the strong base of domestic institutional investors. Consequently, Chile would experience lower impact if there were capital outflows from emerging countries. That's why typically the Chilean markets have been more resilient in negative cycles.

These fundamentals are even more relevant when they are supplemented by a strong countercylical policy, as we've seen in Chile. The magnitude of the fiscal policy can be seen in the significant rise in the fiscal deficit, as the left chart shows. Chile can implement these policies because of the solid position it had before the pandemic, as shown in the chart on the right, due to the low public debt relative to most countries in the world.

The improvement in GDP growth will likely take place in the short term. Let me explain why in the Slide #5. Chile is easing the social distancing measures adopted in this pandemic as a result of the improvement in the number of active cases of COVID-19. The other chart shows the continued downturn of them, while the number of recovered people has risen significantly. Based on these positive trends, the government reduced zones in quarantine, making possible the beginning of gradual normalization. The change followed a period marked by very strict social distancing measures where, at the chart on the bottom shows, more than half of the population was under quarantine. In fact, the Stringency Index, which is released by Oxford University, confirms that Chile applies strict measures due to the temporary suspension in schools and commerce as well as constraints to the mobility. These changes should be augmented by the economic measures adopted in this crisis.

As we mentioned in the previous conference call, Chile has been recognized by having a coordinated, timely and robust response from different economic authorities, as the table on the right shows. The government has announced measures equivalent to nearly 11% of the GDP, including the fund of $12 billion, to finance transfer to vulnerable people and public investment for the next year. These resources supplemented the measures announced before, such as the capitalization of both FOGAPE and the unemployment fund.

The Central Bank has eased even more the monetary policy. In addition to the interest rate cut to 0.5%, the Board implemented a forward guidance model anticipating that the interest rates will likely remain at 0.5% for the next couple of years and also announced an extension of the FCIC program by further $16 billion and asset purchasing in the open market by $8 billion.

Finally, Congress approved a bill that allows withdrawal of up to 10% of personal savings held in pension funds. Despite the long-term impact, this measure will contribute to an increase in private consumption this year. Additionally, they will discuss a change in the constitution that will allow the Central Bank to buy and sell treasury bonds in the open market, providing an additional tool to stabilize liquidity in stressful scenarios.

All in all, we expect a recovery for the next year, which I'd like to discuss in the next slide. Please go to Slide #6. This table summarizes our macroeconomic forecast. We expect the GDP to decline by 6% this year. Since the GDP plummeted by 14% in the second quarter, this estimate is consistent with better growth ahead, which is more likely after the recent easing in social distancing measures announced by the government. In this environment, we estimate a 4% growth in 2021 as a result of expansionary policies, the better outlook for the global economy and favorable cover prices. Nevertheless, we are aware of the unusual uncertainty mainly that's related to the future evolution of the pandemic as well as internal factors. We expect the CPI to be at 2% this year and 2.2% next year due to the subdued growth and the stable currency.

These changes in the macro conditions have had a direct impact on the banking sector. Please move to Slide #7 to analyze them. Undoubtedly, [ a slight growth ], weaker employment and lower inflation have affected the result of the banking industry. Total net income adjusted by Itaú figures posted CLP 457 billion in the second quarter, which is 7% lower than the previous quarter and almost 50% down relative to the same period last year. In a broad sense, this decrease is mainly explained by the pickup in provisions, lower dynamism in loans and, to a lesser extent, the lower NIM due to the reduced CPI.

As shown in the chart on the right, there was a lower nominal growth in total loans mainly in those related to more profitable products as reflected by consumer loans declining 6.8%. In the case of mortgage loans, quarter-on-quarter growth slowed to 1.4% during the quarter. The changes are explained mainly by lower disposable income and lower consumer confidence. On the other hand, commercial loans maintained the pace of growth, increasing 3.7% quarter-on-quarter as a result of implementation of COVID loans program.

Total provisions increased, doubling the level observed the same period last year. This increase is mostly attributable to the considerable deterioration in commercial loans -- sorry, in commercial sectors affected by pandemic and the weak employment outlook, resulting in banks recording an important level of additional provisions during the quarter. Due to this, the cost of risk for the industry increased to 2% from 1.15% last year. It's essential to keep in mind that these figures have not reflected the total impact of the weaker economy in asset quality yet, particularly for loans evaluated on a group basis, due to the deferral of housing and consumer loan installments that have been implemented during the crisis. Therefore, a part of the deterioration over the next months is likely for these types of loans. In fact, cost of risk for individually evaluated loans should have already been part of the outlook for the economic sector in which those companies participate.

I'd like to finalize this part by highlighting the important role that the banking industry is playing in the current crisis. We know about the positive correlation between GDP and total loans, which tend to be higher in the case of commercial loans. This means that, in positive cycles, loans to companies grow even faster than the overall economy; while in negative cycles, we get to see a contraction as was the case in 2009. The chart on the bottom shows the strong relationship between them. However, today, that's very different.

Despite the sale of -- the fall of 14% in the GDP during the second quarter, commercial loans increased by 3.7%. This decoupling has been attributable to the pickup in loans with a state guarantee mainly to SMEs, which are known as COVID loans. This confirms the strong countercylical role that our authorities and the banking sectors are playing in this crisis, which undoubtedly will contribute to a faster and healthier recovery after the pandemic. It's important to highlight this has been possible thanks to the solid position of Chile as well as the robust position of Chilean banks, especially in terms of capital.

Now we would like to move to our advances in key strategic pillars and the financial results posted in the last quarter. Please flip to Slide #9. Banco de Chile has been recognized by its ability to post consistent and robust results over time. Since we aspire to continue being the most sustainable and profitable bank, we have reinforced 3 main aspects of our long-term strategy: digital transformation, efficiency and productivity and increasing commitment to ESG standards. We strongly believe that strengthening these areas will be critical in transforming Banco de Chile according to the challenges that arise in the new business and social environment.

Now Pablo Mejia, our Head of Investor Relations, will share with you the advances accomplished in these areas. Pablo, please go ahead.

[Pablo Ricci, executive]

Thanks, Rodrigo. Please move to Slide 10, where we'll highlight some of our initiatives in digital banking. The pandemic we are facing is changing the way we live, especially in terms of using technology to fulfill our needs. In this sense, digital initiatives that we have implemented in the last years have allowed us to understand the customers' behavior further and has built a solid basis to provide 100% online solutions for most of their requirements during the sanitary crisis. Even though we already have robust platforms, we recognize that the pandemic challenged us to accelerate our digital transformation as we provided an essential service, and our role is critical to support our clients' financial activities.

As you can see in the time line, we have innovated in our digital experience for our customers in several fields, focusing on delivering the best customer experience through the incorporation of business intelligence, data mining, analytics, digitalization of our process and branches.

In order to continue to provide the best customer service for our customers, we're working on launching a new digital onboarding platform that will give a significant improvement with the possibility of opening a new account 100% online at a very low cost for us. This will also allow us to gain a greater number of customers, particularly within the younger segments as we will promote financial inclusion -- as well as we will promote financial inclusion.

Another recent advancement in our front-office digital platforms is our new web page that offers improved customer experience and incorporates analytic tools. It's more modern, secure and intuitive and has inclusive features for the visually impaired. We also included a heat map that will provide us with valuable information to understand even better our customers' preferences.

Those efforts contributed to establish the best digital bank in Chile as well as having the best online platforms according to Global Finance. All the investments we have made in the previous years allowed us to undertake high digital demands of financial services in the current crisis. During the pandemic, we processed over 6x the number of pre -- the number of loans pre COVID using robotics. And through agile development, we were the first bank in the market to provide a facility to postpone installments for personal banking customers 100% online and to offer COVID loans to SMEs through our digital channels.

On the other hand, we also noticed that usage rates in digital channels have been intensifying significantly. As we can see on the bottom of the slide, online consumer loan originations increased from 37% during the first half of 2016 (sic) [ 2019 ] to 46% of total operations in the first half of this year.

On the right side, the activities done through our online platforms continued growing and now represents 88% of total monetary transactions, an important rise in mobile transactions, representing an increase of 16% year-on-year.

Although we acknowledge that the lockdown mostly explains the higher digital channels preference, we believe that this trend will continue after the pandemic has finished.

Please turn to Slide #11. The successful implementation of our digital transformation has played a critical role in providing the best experience to our customers. Despite this challenging period, we've continued to show excellent indicators. As you can see, we posted once again the highest brand recognition in the Chilean industry and top of mind for the high income segment with a very wide gap with our closest competitors. Along with our superior brand recognition, we're also the leader in customer satisfaction as measured by Net Promoter Score.

It's important to note that we have historically been recognized as the bank with the best customer experience levels according to many different sources. We attribute this success to the quality of our services and products which have helped to generate stronger, long-lasting relationship with customers. These figures are reinforced with the recognition of receiving a distinguished national award for customer satisfaction in 2019.

Another relevant point I want to mention is the strength of our brand. In one survey, customers are asked if they were to switch to another bank, which bank would they choose. As you can see on the chart in the middle, we are the most preferred bank in Chile.

Another key aspect we highlight is related security and solvency, where we lead the perception with a large gap when compared to the next main competitor. This position in surveys is especially relevant in the context of new regulations, where it will be much easier for customers to switch from one bank to another. This customer satisfaction is most clearly demonstrated by our low attrition rate. So you can see it has remained historically low on the chart on the bottom left, which we believe, if not the best, is one of the best in the Chilean banking industry.

Please turn to Slide #12. Another aspect of our long-term strategy is efficiency and productivity. Our combined focus of digitalizing the bank by implementing technologies that increase productivity and streamlining processes together with identifying savings areas and implementing better cost controls has begun to bear fruit.

In addition to these improvements, in 2019, we started a process of optimizing our branch network, which includes a new service model that was -- that has resulted in a decrease in branches. We have reduced our network to 336 branches, almost 50 less than compared to the year earlier. The new office model should not only permit further improvements in efficiency but also increase client experience, which is even more important in this context. We have implemented, for instance, new intelligent self-service machines to provide more services that traditionally had to be executed by the service desk area.

Another measure that contributes to reducing our costs is our purchasing desk, which has shown excellent results due to the reduction in expenses in areas such as acquisitions and services hired.

Through all of these initiatives, we have been able to show consistent and significant improvement in our productivity as measured by loans per employee and total asset expenses as seen on these charts. We expect that, through these projects, we continue improving our productivity and delivering a better customer experience. We strongly believe that, through the greater use of technology across our business, we should continue to see improvements in efficiency in the long term.

Please turn to Slide 13. The final aspect I would like to share before moving on to our second quarter results is the advances we have made in our commitment to sustainability. Today, we are witnessing an unprecedented health crisis that is still impossible to quantify the effects that it will have in the long term. We are aware of our role in supporting the recovery of economic and social development, especially in challenging times, and now this is not an exception.

During the pandemic, we strengthened our commitment with society and implemented a national support plan. We took several measures to support our customers. Apart from being the first bank to offer the option of reprogramming loans 100% online, we're the first bank to offer SME customers COVID loans. For this segment, we went beyond providing liquidity and hosted fourth -- for the fourth time our national entrepreneur challenge, where we achieved a record of 56,000 applications, and we promoted it a virtual fair for 60 entrepreneurs where they were able to exhibit their product.

Furthermore, we have also implemented many actions that aim to reduce the consequences of the pandemic for vulnerable groups in Chile. We delivered packages with essential groceries for people with disabilities and their families, offering food, medicine and telemedicine services to senior adults as well.

All of these efforts rewarded our banks to be recognized as a financial institution that did the best job in taking actions during this health crisis, as seen on the chart on the right.

Please turn to Slide 15 to begin the discussion of this second quarter. During this quarter, we recorded a bottom line of CLP 112 billion with an ROE (sic) [ ROAE ] of 12.5%, a level we consider reasonable given the magnitude of the crisis we are facing globally and the low level of inflation for the period.

We also outperformed our peers. Apart from having the highest profitability indicators and coverage ratio, we maintained the best capitalization level, as shown on the chart on the right.

We are confident that our prudent risk management approach, strong capitalization and our consistent strategy will allow us to continue delivering sustainable and superior profitability for our shareholders.

Please turn to Slide 16. Operating revenues dropped 6% year-on-year due to the fall of inflation from 1.2% to only 0.3%, impacting noncustomer income and, to a lesser extent, a slight decline in customer income, which even though remains strong when taking into consideration the weaker environment.

In this context, NIM fell 4.5% last year to 3.5% this year, as you can see on the table on the bottom left. About 50% of this decrease was caused by lower CPI we had this quarter and the effect of the lower contribution of demand deposits of -- to our cost of funds given the slide in interest rate. To a lesser extent, these factors coupled with the negative impacts of mortgage loan renegotiations at lower rates in the second half of 2019 and the new regulation regarding automatic payments of overdraft lines, which became effective in January 2020, both partly offset by higher income from loans. The rest of the decrease in NIM is explained by higher exposure to low-margin and low-risk assets, such as the Central Bank's short-term bonds, used to comply with the reserve requirements linked to boost demand deposit balances and other effects.

As the chart on the upper right shows, customer income remained relatively stable as a result of opposite forces. The lower overnight rate -- interest rates sharply reduced the contribution from deposits even though the impressive growth in balance was seen during the last month. On the other hand, as mentioned, there were positive contributions from the increase in commercial loans, higher sales in the distribution desk from the treasury division and higher fee income.

Most of the rise in fees was associated to a $9.3 billion increase in insurance brokerage linked to the partnership with an international insurance company. Unfortunately, this was partly offset by a substantial decrease in economic activity amid the strict lockdowns that lowered transactional fee income from other sources such as cards.

The market volatility also affected revenues from our mutual fund and stock brokerage business due to customers moving to -- their AUMs to fixed income funds that generate lower fees as well as lower transactions and stock trading.

I think it's also important to note that our fee business is chiefly related to the retail segments. Although we had some drawbacks this quarter as a result of the weak activity that affected the aggregate demand from customers and, therefore, transactionality, we believe that this is temporary. Despite this impact, we continue leading the industry in net operating income and fee margin. As you can see on the charts on the right, our margin as a percentage of average interest-earning assets reached 3.8% and 1.2%, well above the average level of our peers.

Please turn to Slide 17. Total loans reached almost CLP 31 trillion this quarter, increasing 7% year-on-year and remained basically flat quarter-on-quarter. Demand, except for COVID loans, was weak across all segments this quarter. In the wholesale segment, we posted a year-on-year growth of 5%, but the quarter-on-quarter dropped by 3%.

There was a similar trend in personal banking loans, increasing 5% year-on-year and falling by almost 2% quarter-on-quarter. The annual rise was mainly due to residential mortgage loans that grew 8%, while in contrast, consumer loans during the same 12-month period decreased 6%. On a quarterly basis, mortgage loans remained flat and consumer loans actually dropped 6%. These results were attributable to the strict lockdowns and the weaker economy as we discussed in the beginning of this call. This resulted in reduced host -- home spending as well as lower demand for home sales. In fact, expectation of the National Chamber of Construction is that new home sales will actually drop by 40% in 2020, and the sector will only return to normal business levels mid-2021. We expect that the dynamism of the personal banking loans should continue weak throughout the remainder of the year.

These results were almost offset completely during the quarter by the strong growth we experienced in COVID loans for the SME book, which grew 19% year-on-year and an impressive 14% quarter-on-quarter.

Please turn to Slide 18. As mentioned, the strong results in the segment was attributable to the government's stimulus package for companies that provide guarantees of up to 85% for working capital loans. We are proud that we have been able to assist our customers in the country by taking part in this program.

We placed during the quarter over CLP 1 trillion, equivalent to 3.7% of total loans as of June 30. Most of these loans were direct to provide liquidity to small- and medium-sized enterprises. And as of July 2, we granted almost 25,000 loans with a market share of 18%, which is similar to our market share in the sector and aligns with our risk appetite.

In terms of total loans reprogrammed and taking into consideration the total value of the loan, we were the bank with the lowest proportion of total loans amongst our peers, as shown on the chart on the bottom right.

Finally, if we only look at the installments that have been reprogrammed and -- of the loans granted, this reaches only CLP 495 billion (sic) [ CLP 494 billion ] or 1.6% of total loans, as the chart on the top right side of this chart -- of this slide demonstrates.

I think it's very important also to highlight that the banking industry has made an important effort to assist those customers. We believe that the efforts combined with all of the programs that the government has provided Chileans should make a difference during the economic recovery post COVID.

Please turn to Slide 19. We continue to have the best funding structure in Chile. This has been possible thanks to our customers using us as their primary bank account. This is clearly demonstrated by the strong increase we had in demand deposits, which rose 37% year-on-year and 11% quarter -- on a quarterly basis.

Also important to note the significant change that the rise in DDAs has for our funding structure. Today, our demand deposits represent 28.5% of total funding, up from last year, 25.7%, and significantly higher than our peers, as shown on the bottom-right chart. More importantly, approximately 75% of our DDAs come from nonfinancial counterparties, which represents a stable source of financing. Aligned with this, we have been able to replace time deposits from financial counterparties with DDAs.

We also have a well-diversified funding base, which is very relevant today, as can be seen on the chart on the left. Undoubtedly, this makes another positive difference of Banco de Chile.

All in all, our strong brand coupled with our leading risk indicators and our strong Tier 1 capital base of 10.9% allow us to place debt at favorable conditions and has permitted us to maintain a leading level of cost of funds of only 2% in local currency.

We're confident that this crisis will open new opportunities to strengthen our already solid relationship with our customers and continue increasing our share of wallet. Our long history of prudent risk policies and very reasonable growth have been fundamental to sustainability over time [ and intertwines with ] our long-term strategy.

Please turn to Slide 20. Managing risk globally across all levels of the corporation is key -- is a key component to our consistent and attractive results. Our Board of Directors play a vital role, actively participating and establishing policies and guidelines for accepted risk levels for developing and validating provision models as well as to define additional provisions. Management is responsible for controlling and complying with the mandate of the Board, especially in terms of control of different types of risk.

As you can see on the chart on the right, cost of risk this quarter jumped to CLP 139 billion, up from only CLP 68 million last year and CLP 126 billion from the first quarter. However, our net -- NPL ratio dropped from 1.4% in the first quarter of 2020 to 1.3%. This combined -- combination of higher costs but lower NPLs was principally due to 2 factors.

Please take a look at the chart on the bottom right. First, CLP 70 billion of the CLP 139 billion posted in the second quarter were due to additional provisions. These provisions were recorded to protect the bank against unforeseeable economic fluctuations. In line with this, the pandemic has brought forth many uncertainties, such as city-wide lockdowns, deterioration in employment and financial stress in companies. These uncertainties have made it extremely difficult for traditional risk models to properly gauge credit risk. And as a result, our Board approved the establishment of these general provisions. It's important to note that these allowances are not for any certain segment, sector or customer, but they are for the entire portfolio implemented in different circumstances, such as the one we are facing today.

Second, the remainder of the quarterly provisions was chiefly due to the impact of COVID-19 on the financial position of certain large customers, which have suffered a deterioration in their business environment and income-generating capacity. As a reminder, large companies are evaluated on an individual basis for provisioning purposes using a forward-looking approach.

In terms of retail book. The retail book composed by consumer, mortgage and commercial loans evaluated on a group basis, delinquency levels have remained relatively stable. Nevertheless, this was mainly due to the support measures we provided this segment, which included grace periods, loans at preferential rates and government-backed COVID commercial loans for SMEs.

In addition, as a way to promote lending and assistance to banking customers, the local regulator gave special treatment to reschedule loans in terms of provisioning, which has a positive effect on cost of risk when compared to a normal period even though we expect deterioration in the portfolio in the next few months.

In this regard, we are confident that our prudent risk policies have made Banco de Chile the most prepared banks that face negative cycles, as shown on the next slide, #21. As you can see, our coverage ratio reached 235% as of June 30, significantly higher than our peers. And we recorded the lowest delinquency ratio of 1.3%. Our prudent risk culture has also contributed to creating the highest level of additional provisions in the industry, reaching CLP 283 billion, as you can see on the chart on the bottom right. All of these figures demonstrate the soundness and quality of our portfolio and our prudent management when it comes to risk. Our consistent and successful strategy has been centered to grow our portfolio responsibly, and this has allowed us to portray a solid track record of dependable results.

As shown on the following slide, 22, a well-diversified portfolio with lower overall exposure to the riskier segments also contributes to these results. Our portfolio is highly diversified and concentrated in lower-risk sectors. Despite this, we are the most profitable bank in Chile because our customers choose to use us as their primary account, and this provides many additional benefits that I'm sure you're all aware.

As you can see on the chart on the top left, retail segment represents 63% of our portfolio, and this is divided in 3 main areas: First, consumer loans for middle- and upper-income individuals as well as mortgages are focused to the low-risk individuals. We have the highest market share in high-income individuals, which are low risk in nature. Second, our exposure to consumer finance through our Credichile brand is only 2% today, significantly lower than the level we had in 2009 during the subprime crisis, which represented nearly 7%. And lastly, our SME book is a very high-quality portfolio that has had historically low levels of cost of risk and is closely related to our upper-income individuals. We may not have the largest market share in this segment, but we certainly have the best portfolio in the industry.

The remaining portion of the portfolio is the wholesale book that represents 37% of total loans. We work with the largest companies and multinational corporations in Chile, and by nature, this segment is lower risk. For this reason, we're proud that we have historically had a solid performance when it comes to wholesale risk.

The pie chart on the bottom of the slide shows our exposure to different sectors in Chile. As you can see, our penetration in the highest-risk sectors is lower than our peer group. In retail, hotels and restaurants, we have an exposure of 9% versus our peers of 11%. In construction, our exposure is 7% (sic) [ 8% ] versus the competitions' 10%. And lastly, we compare similarly to our peers in transportation, but it's important to note that we don't have any important loans to the airline industry.

We are confident that our prudent approach to risk management should set us apart in the coming months when banks have more information regarding the quality of portfolio and how this will translate into cost of risk.

Please turn to Slide 23. More important than ever is our focus on managing costs. As you can see on the chart on the left, we managed to maintain total operating expenses basically flat quarter-on-quarter and decreased 4.4% year-on-year. The yearly drop in expenses was driven by lower salaries and other expenses, as shown on the chart on the right. Specifically, we were able to increase our business activity without increasing significantly our salary and also had a reduction in severance payments and loan loss provisions on cross-border loans due to higher appreciation of the Chilean peso this quarter as compared to the second quarter of 2019.

In addition to this, we lowered our outsourced sales force services by absorbing these functions internally during the second half of last year. And we lowered marketing expenses by reducing media expenses, market research and adjusted loyalty program.

These reductions were also partially offset by higher IT expenses related to software licensing to adjust the bank quickly in this environment. Also, we incurred higher expenses linked to fixed asset maintenance related to sanitation, new safety measures related to the pandemic as well as costs associated to updating our branches to the new service model, among others. On a year-to-date basis, we recorded an improvement in efficiency, as shown on the chart on the bottom right, reaching 43.6%.

Please turn to Slide 24. Before moving on to questions, I would like to highlight the favorable comparison of our stock versus our main peers in Latin America. As you can clearly see, we're the stock that has

[Audio Gap]

[Operator]

Pardon me, ladies and gentlemen. It appears we have lost connection to our speaker line.

[Technical Difficulty]

[Pablo Ricci, executive]

I'm sorry about the technical difficulties.

If you please turn to Slide 24. Before moving on to questions, I would like to highlight the favorable comparison of our stock versus our main peers in Latin America. As you can clearly see, we have the stock price that has been the most resilient in this crisis. We have recovered part of the drop that -- from pre-COVID level. This is clearly a result of the market understanding that we're not only the most profitable bank in Latin America, as shown on the chart on the bottom left, but this is accomplished in a dependable manner throughout all of the cycles.

It's also important to mention that we may have recovered to post -- or near-post COVID levels, but we still have multiples that are well below the levels that we've had in the past.

Despite the current economic environment, we are confident that the better perspectives for the economy coupled with our strong fundamentals and strengthening the key aspects of our long-term strategy will allow us to continue being the best long-term alternative for investors.

Thanks for listening. And if you have any questions, we'd be happy to answer them.

[Operator]

[Operator Instructions] Our first question will come from Ernesto Gabilondo with Bank of America.

[Ernesto María Gabilondo Márquez, analyst]

My first question is on the reprogramming portfolio and the FOGAPE program. Can you give us some idea of how much both the reprogramming and the FOGAPE represented of your total loan portfolio? And why do you think the percentage of reprogram portfolio seems significantly lower when compared to Santander Chile?

And then my second question is on credit provisions. Considering that you have created additional provisions of CLP 70 billion during the quarter, do you think this was the peak in provisions? Or do you continue to see higher provisions by year-end when you start to see NPLs showing up after ending the relief programs or from the exposure to high-risk economic sectors?

[Pablo Ricci, executive]

Thanks. Well, if we look at the participation in the most recent information, we have similar levels of COVID loans as our competition. We're a bank that's approved a significant amount of the loans. Today, in dollars, we have, as of July 24, about $1.9 billion issued to companies, a large proportion of those to SME customers. And it represents somewhere close to 30,000 customers today.

Do you want to add?

In terms of that, I think our levels are very similar to what our main peers have issued.

If we go to the...

[Rodrigo Aravena, executive]

Provisions. Additional provisions.

[Pablo Ricci, executive]

The levels of provisions. It's difficult to have a clear understanding of how the economy will recover and the current position of our customers. What we can see today is that the portfolio is still in relatively good shape, but we have a limited amount of information. What we do know and we've seen is good payment behavior in recent information. But we can't rule out that, in the future months, there could be levels of provisions similar to what we've seen in the past months, quarters. So it's something that we have to continue seeing

[Audio Gap]

[Ernesto María Gabilondo Márquez, analyst]

Okay. And then just a follow-up on the reprogram portfolio. When looking to Santander Chile, they mentioned that close to 30% of the loan book was reprogrammed, including the FOGAPE loans. Do you see the same proportion to your loan book?

[Operator]

And pardon me, ladies and gentlemen, it appears we have lost connection to our main speaker line again.

[Technical Difficulty]

[Pablo Ricci, executive]

Sorry about that again. So just finishing up in terms of the provisions, one of the important things -- Ernesto, are you there?

[Ernesto María Gabilondo Márquez, analyst]

Yes. I'm here.

[Pablo Ricci, executive]

Okay. So I think one of the important things to mention as well is that the -- what we've seen in the month of July is good payment behavior of the customers that did take on these reprogramming of loans. So a large portion of the customers took on reprogramming in April. And what we've seen in the payment behavior of that book is positive results, but we can't confirm that this will continue in the future. So we do need more information to understand, and that will allow us to know if we'll have the same level or changes in what we've seen in the prior quarter.

[Rodrigo Aravena, executive]

I would like to add one idea. This is Rodrigo Aravena. It's important to keep in mind some factors that will likely affect the [ additional provisions ], for example, the impact at the end of the grace period, for example, the potential increase in the unemployment rate. So basically, we've seen an increase of the unemployment rate from 7% to 12% last month. We can't rule out that it will increase even more.

But more importantly is that we have a very important uncertainty in terms of the final impact of this crisis in the economy. We don't know how big was the devastation. And more important is that we don't know about the length of devastation. We don't know when the economy will replace the economic growth, et cetera, so that's why we are not providing more guidance in terms of the cost of rates for the future. It's important to keep in mind the driver, but unfortunately, we don't have enough information as to provide more specific guidance for the future.

[Pablo Ricci, executive]

And maybe a follow-up on the first question. So the market share and loans, we have 18.4% with information as of -- this information was as of July. But it's important to mention that this level of loan market share is actually higher than our market share in commercial loans. So it makes sense at this level of market share for our customer base.

[Ernesto María Gabilondo Márquez, analyst]

Perfect. And I was looking to your presentation on Slide #18, and I was looking to the volume of loans reprogrammed. And as of July, as you mentioned, you have around 35%, right? And I'm looking that Santander has around 41%. So what do you think will be the difference of your competition having a higher market share than yours?

[Pablo Ricci, executive]

No. The market share in terms of the loan reprogram -- it's important to mention one very particular thing of the Chilean banking industry: the reprogramming of these loans isn't a lead indicator of the cost of risk. Some of these loans obviously have -- could be more problematic. What we've seen is positive results in this first month. But it's not a lead indicator because there are certain characteristics which customers have to comply in order to be able to have this loan reprogram at Banco de Chile, and many banks were similar. But one of the requirements wasn't a requirement that you had a loss of income. It was that you are a good customer, you're paying on time. And due do to that reason, it's not a good lead indicator for cost of risk.

So what it is, I would say, an indicator is how well each bank -- if there's a very large business -- if there's a bank [ with any percent of their book reprogrammed ] is how they provide this to their customer base and how easy was it to do it online. With a larger bank, it was a simple process that was done online. In the case of our bank, you can see which loans were reprogrammed. Each bank has a little bit different composition of those reprogramming. And then we included the credit card option to reprogram those into installments.

So it just depends. It's not a very -- it's not a lead indicator. That's why I want to say. It doesn't show that, automatically, if you have a 35% or 20% level of reprogram, it's a lead indicator for the future. It's how the banks implemented this.

[Ernesto María Gabilondo Márquez, analyst]

Okay. Understood. Perfect. And then considering the additional provisions that you've created in this quarter, it seems that it was the quarter with the highest provisions. Do you think this was the peak of provisions, including these additional provisions? Or do you think we should continue to potentially have another one like this one by year-end or in the next year once we finish the reprogramming of the portfolios?

[Pablo Ricci, executive]

It really depends on the evolution of the economy and how the economy begins to open and the impact in the overall economy, so in companies and in individuals and employment. So that will be a key area that we have to see.

Today, what we're seeing is the lockdown starting to ease, better information regarding the virus in Chile. That could be possible. We need to see how this evolves in order to have a clear understanding on if this is the worst month, if it's the next month. It really depends on the evolution of the virus and the impact on the economy.

[Rodrigo Aravena, executive]

So basically, we can't rule out more provisions, for example, if in the case that the economy get worse. So it's very important to keep in mind that this crisis is different to any other crisis that was in the past. So that's why it's very important to highlight our very robust position in terms of the -- our coverage ratio. So as we mentioned in the call, we are probably the best bank when faced with negative cycles. So we can't rule out more provisions if the economy remains weak.

[Operator]

Our next question comes from Claudia Benavente with Santander.

[Claudia Benavente, analyst]

I have 2 questions. The first is, how much should we expect to be provisioned for the COVID loan deductibles? Have you started to provision this? Or if not, when should we expect this impact?

And the second question is maybe a little bit of a follow-up on what you were saying. Within the clients that have reprogrammed loans, can you provide some color on how much actually reprogrammed the loans as a necessity versus those that took it as an opportunity? Probably, you have many of those customers that have their current accounts with Banco de Chile, so probably, you can have a better idea of maybe who were the most troubled one versus those who took it as an opportunity.

[Pablo Ricci, executive]

Well, maybe just in case someone's not aware. So the provisions for the COVID loans, basically, what happened is that the regulator -- for all the loans that were FOGAPE guaranteed, the regulator indicated detail in terms of the constitution of provisions related to the deductible of the COVID-guaranteed loans. So specifically, according to this current regulation, banks must provision the deductible of the loans that were originated opposed to when the guarantee is exercised. So specifically, what the regulator stated was when the expected loss, excluding the FOGAPE guarantee, is lower or equal to the deductible, the provision should be determined without the guarantee. When the expected loss, excluding the FOGAPE guarantee, is greater than deductible, the provisions should be determined based on the aggregate of the deductible plus expected loss using the FOGAPE guarantee.

So therefore, what we're expecting is that there should be more provisions in the banking sector beginning in September. We're calculating the impact of this change and will be recording it in our books from September 2020. So that's what I can say regarding that.

And in terms of the installments of the reprogram. Like I mentioned, most banks, what they did was provide -- made -- setting guidelines, which customers could have -- take to be a part of this reprogramming to undertake these grace periods. So you could have very good customers or customers that would need these grace periods. So it's not a good lead indicator on how the loan -- the quality of the loan book is.

Also, since it wasn't a requirement that we would request customers to show us information regarding if they had an impact on their salaries, it's not clear what percentage of the customers need, needed these grace periods and which didn't. What is clear, and I think it's very important to mention, is that the level of deposits in Banco de Chile have grown by over -- between 30 -- around 35% for individuals. So our individuals have more deposits in their accounts. There's different reasons for that, but that's something very important to mention, that our customers are high-income individuals, so they're not -- they're a little bit less susceptible to these volatilities in the economic cycle.

And what we've seen today of customers is that we've had very good payment behavior in the first month of paying of installments that were due. So that's very positive from what we've seen so far.

Claudia, are you there?

[Claudia Benavente, analyst]

Yes. Is it possible to have an idea of maybe -- within the reprogrammed loans, how many of the customers have a checking account with Banco de Chile?

[Pablo Ricci, executive]

Basically, when a customer enters Banco de Chile, they have a package of products. Most of our customers use on Banco de Chile as their primary accounts. So most of these customers have a current account. So it's not -- it's very uncommon that a customer will have a product that isn't a current account customer. So most of the customers should be current account holders.

[Claudia Benavente, analyst]

But basically, for the consumer group, then you can identify those that have seen their salaries at least reduced. So therefore, there, you can see maybe the proportion of those that may -- could have a higher probability of having a default.

[Pablo Ricci, executive]

Again, not necessarily. Since you can have more than one bank account, so not necessarily you have your savings in one account versus another. So it's information that we have. It's not public, but what we do have and what I can say is that the first month and the most important month of reprogramming that we did was in April, and that was due in July. We had very good levels of payment behavior.

[Operator]

Our next question comes from Sebastián Gallego with CrediCorp Capital.

[Sebastian Gallego, analyst]

I have 3 questions. The first one, a follow-up on more of the same in terms of asset quality. I just want to get a sense on when should the benefits provided to customer start to fade and, actually, if you are providing more extensions to those benefits. That will be the first question.

The second question is regarding the pension fund withdrawal in Chile. I would like to know if you can comment on the behavior of clients on whether you can comment if those clients are repaying debt or not. How are you seeing those clients so far with the information we have as of now?

And third, considering that also Rodrigo's in the call, I just want to have his perspective on the upcoming vote for the new constitution in Chile and how this should play out going forward. Should we expect more -- I mean, some more of the same that we saw in October last year? Or do we -- should we expect a more calm and stable outlook in terms of the social crisis?

[Pablo Ricci, executive]

Thanks, Sebastián. In terms of the asset quality for the consumer book, most of the value is coming in, in July. April was the most important month for the consumer book [ based on these grace periods ]. And what we've seen is, in the overall of these customers that took on these grace periods, a very good level of payment behavior. It was a very positive information that we've seen so far.

In terms of if there's more benefits, there was. We announced for the mortgage loan book 3 additional months that customers could postpone. Again, the reprogramming of loans, customers can take these benefits if they need them or if they see it as an attractive rate. So it's -- there's certain characteristics that a customer must comply, which is being on time for their loan, et cetera, and then they can take on these loans. So it's not a lead indicator in terms of the book.

And it's important to mention that there's 2 ways to analyze this: One way is with publicly available, and you can analyze all the banks, which is the total volume of the loans that have some relation of an installment reprogram, which is available on the website of CMF or what we've shown on slide -- I think it was 16 -- 18, which is only the installment of the reprogrammed. So the 3 months installments represents today, CLP 490 billion, which is 1.6% of total loans. So it's not a very significant amount of installment that has a new loan associated there. In terms of the 10% of the pension fund -- I guess that would be the main new benefit. And so right now, we have 3 more months, 6 months as of April. SMEs have 6 months since they take on the SME COVID loans. So we should see a gradual fading throughout now and the end of this year and the beginning of next year amongst -- first, starting with consumer loans, mortgage loans and then commercial loans for SME customers .

And for the 10% of AFP, it's something that's been discussed -- well, it was approved, but the funds haven't been issued. So it's very hard to know or identify where those funds will end and which customers will take on those funds. I think it's important to mention that one of the things that Banco de Chile has been very strong in the past is getting customers to use us as their primary bank accounts. So generally, the customers that work with use Banco de Chile as the primary bank accounts. So that should be something positive as well as there is funds that flow into Banco de Chile.

Rodrigo?

[Rodrigo Aravena, executive]

Yes. Let me add one idea to what Pablo mentioned, that this 10% of the withdrawal from the pension funds will likely contribute to increase in the short-term private consumption. So that's why we are expecting a better growth in GDP, in loans as well by the end of this year because of the temporary, perhaps, increase in private consumption as a result of this -- the withdrawal of this 10% from the pension fund. So what basically we are highlighting here is that this is one additional factor supporting our better outlook for the future, especially with the impact in private consumption in the short term.

With respect to your third question, it's too early as to provide a more accurate estimate in terms of the potential changes in constitution and what would be the impact in the -- in economy, et cetera. And I'm saying this because we are aware that the main challenge in the short term for the economy is to recover the economic growth. So that's why now there is an important discussion in Chile in terms of the main policy. The government has been, for example, very active in terms of implementing -- as far fiscal spending. If you make a comparison with Chile relative to other countries, we would be more aggressive in terms of increasing the fiscal spending in order to recover the economic growth. So that's why, in part, when you compare the GDP estimate for 2021 in Latin America, Chile should have one of the best economic growth in the next year.

After the recovery, where we expect it to be by the end of the year, there will be several discussions on the political side. We know that we will likely have a discussion for the constitution, we would likely have for the official election for the next year, so we are aware about the potential impact on economic growth.

But all in all, we are positive for the future in Chile. We are confident that the second quarter was the bottom of this negative cycle. We are expecting a positive growth on a sequential basis for the fourth quarter of this year. And all in all, we expect economic growth of nearly 4% for the next year.

[Operator]

Our next question comes from Neha Agarwala with HSBC.

[Neha Agarwala, analyst]

Following up on Claudia's previous question on the deductible for the FOGAPE loan. I understand that you start making these provisions in September. But could you give us a sense of the magnitude of these provisions that might be needed? CLP 30 billion to CLP 40 billion, does that sound reasonable? Or should it be more or less?

And related to that is there was a change in the treatment of FOGAPE loan guarantees for the capital calculation. What would be the impact on your Tier 1 ratio from that? Is it already included in the numbers that is presented? Or would that change impact your 3Q capital levels?

I'll ask my other questions later.

[Pablo Ricci, executive]

So in terms of Claudia's question, what we can say is that the -- how this is calculated is basically when the expected loss, excluding the FOGAPE guarantee, is lower or equal to the deductible, the provision should be determined without the guarantee. And when the expected loss, excluding the FOGAPE guarantee, is greater than the deductible, the provision should be determined based on the aggregate of the deductible and the expected loss using the FOGAPE guarantee. So what we can say is this is being calculated. And there's something that will be attributed to this beginning in September, but we don't have a number that we can give you at this time.

And can you repeat the second question, please?

[Neha Agarwala, analyst]

My second question is on the accounting treatment of the FOGAPE loan guarantees. There was a change in the treatment of these guarantees which would positively impact capital ratios. So is that change already being accounted for in your number for 2Q? Or would that impact the 3Q number?

[Rodrigo Aravena, executive]

[ Pablo, did you want to take the last here? ] Actually, the impact for us is not relevant. Actually, we don't have any impact into this new treatment for FOGAPE loans. It's just a change from the risk-weighted assets to -- from capital [ to risk-weighted assets ]. So it's not a big change there for us. It is not relevant at all.

[Neha Agarwala, analyst]

Okay. Then the next question is on the trend that we can expect in terms of NPL ratio and cost of risk. I believe you -- and today, we don't have a very aggressive charge-off policy. So should we expect the NPL ratio, once it starts increasing, to remain at the relatively high levels for a few quarters and gradually write off? Or will you be more aggressive in writing off loans as you learn about the quality of the portfolio?

And in terms of cost of risk, should we expect bulk of it to be in 2020 or more evenly distributed between 2020 and '21? And any particular quarter in which you think the cost of risk should peak?

My second question is on additional provisions. You showed that you have very high level of additional provisions versus your peers. But you mentioned in the previous call that you will probably not be using it in the current crisis. So has that view changed? And do you think that you would probably trigger the use of these provisions if required in the coming quarters? Or would you like to just maintain them at these levels?

[Pablo Ricci, executive]

Okay. In terms of write-offs, there's a regulation -- there's regulations that determine when a loan should be written off. And there's certain characteristics such as a consumer loan is after 6 months, mortgage loans are a much longer period time frame, a few years. And there are certain conditions that you can write off loans before that. But probably, what we should see today is something within the normal write-off period. There could be a decision. We can't rule it out that there is an extraordinary write-off. But it's not something in -- that we could give guidance at this time.

In terms of cost of risk, the cost of risk that we should be seeing is something that, in this year, obviously, the peak of the pandemic, should be affecting the banking industry. And for next year, it's difficult to determine a number because it's not clear the out -- the economic outlook of the pandemic. We don't know if -- or when vaccine or medicine will be made in order to combat the pandemic. And I think that's the biggest uncertainty and the reason why we can't give guidance for 2021.

[Rodrigo Aravena, executive]

So I'd like to add an idea. In the case that the economy fell 6% this year, for example, and the economy to grow by 4%, for example, next year, it should be consistent with an unemployment rate in double digit until 2022, for example. So that's why it's very hard to make any comparison with this crisis because this time is really, really different. So that's why we don't know the length of this crisis. We don't know what is the actual impact in terms of the outlook that -- the economic cycle. So that's why we don't have a more accurate guidance in terms of cost of risk. And that's why, as well, we can't rule out more additional provisions, for example, because there is a big, big uncertainty in terms of the future evolution of the economy. And we're aware as well that we can't compare this crisis from any other crisis in the past.

[Pablo Ricci, executive]

Also, I think it's important to mention that we can't roll out additional constitutional -- additional provisions or relieving provisions because it's not clear, the outlook. So we have to see how this evolves. So it's not clear on how, when these versions can be used.

[Operator]

Our next question comes from Alonso Garica (sic) [ Alonso Garcia ] with Crédit Suisse.

[Ricardo Garcia, analyst]

My first question is actually just a follow-up as to the requirement for claims to adhere to reprogramming. I didn't get quite right if you ask for documentation for sort of claims demonstrate that they had an impact on their income from the pandemic or if you did not ask for such documentation.

And my second question is on Basel III implementation recently in Chile. The regulator put for consultation details for the risk weighting rating factor for market risk. So I just wanted to hear your thoughts if -- based on that new information, what's your new expectation for Basel III impact on your capital ratios?

[Pablo Ricci, executive]

So in terms -- I think it's important to give a more clear understanding of the reprogramming loans. So basically, in Chile, what happened was different from other countries. And there's many different ways that different countries and banks operate and even [ in Chile ]. But most of the large banks in Chile, what did they do -- and what did we do specifically with [ second sale after this year ] is that we offered this reprogramming of loans without taking into consideration or requesting that customers send us information regarding if they had a significant impact.

It was an opportunity to build stronger relationships with customers. We used our digital initiatives to offer these products quickly online, 100% digitally. They didn't have to come to the branches. And customers regardless if they had more income than last year, less income than last year, they are rich, they need this benefit had an opportunity. Everyone had the same opportunity to receive a reprogram of their loans. So this is the reason why it's not a very good lead indicator of risk.

What is positive is what we're seeing today in terms of the payment behavior. So the payment behavior has been very positive in the July figures, which is the bulk of the consumer loan book which is being repaid, which is beginning the repayment today. So it's customers taking advantage and some that need it, some that didn't need it.

[Ricardo Garcia, analyst]

Okay. And just could you please repeat the figures -- payment figures in July just to get a sense on how much of your reprogrammed portfolio is back and in time with the payments?

[Pablo Ricci, executive]

The consumer loan book is the one that has 3 months repayment, which is being paid today. So most of the consumer loans that have been reprogrammed was done in April. So most of that is being repaid today in the month of -- sorry, in the month of July. We're in the second month now.

And the other question was Basel III. I didn't quite -- could you repeat the question, please?

[Ricardo Garcia, analyst]

Yes. I mean there was -- one of the uncertainties regarding Basel III implementation in Chile had to do with the risk weighting factor for market risk. And I believe the CMF -- for consultation details on that recently, like 1 or 2 weeks ago. So I wanted to hear your thoughts on what was put for consultation. And based on that, what's your expectation for the impact of Basel III implementation on your capital ratios? I believe last time, you're talking about an impact, probably negative 50 basis points from implementation of Basel III. So I don't know if that still the case or if that's changed.

[Daniel Ignacio Galarce Toro, executive]

This is Daniel Galarce again. Regarding Basel III, actually, we've seen the new methodology on market risk, risk-weighted assets from the regulator. We are actually analyzing now this new methodology. And as far as we have estimated, I think that the impact is similar to the rest of the rules, some of them better, some of them worse. But I would say that, on average, they are quite aligned with what we expected before.

So basically, we believe that we will have an impact on our capital ratios due to Basel III, the transition to Basel III, of course, but this is not different than we have disclosed in previous calls. So basically, the impact, I would say, would be in the range of 80 to 100 basis points in the capital ratio, and this is including this new methodology for market risk-weighted assets.

[Operator]

This concludes our question-and-answer session. At this time, I would like to turn the floor back to Banco de Chile for any closing remarks.

[Pablo Ricci, executive]

Okay. Thank you for our calendar quarter conference.

[Operator]

Thank you. This concludes today's presentation. You may now disconnect your lines at this time, and have a nice day.