Good morning. Welcome to Banorte Second Quarter twenty twenty Earnings Conference Call. All participants will be in listen only mode. By pressing star key followed by zero. After today's presentation, there'll be an opportunity to ask questions.
To ask a question, you may press star then one on your telephone keypad. Please note this event is being recorded. I would now like to turn the conference over to Please go ahead.
Thank you. Good morning. I'm Tomato Sanos, Head of Investor Relations, Financial Intelligence and M and A. I hope everyone is doing well and safely adjusting to the new reality in your hometowns. Welcome to Grupo Financiero Vannortel's second quarter earnings conference call.
Today's presentation may include forward looking statements that are subject to risks and uncertainties, which may cause actual results to differ materially. We ask you to take this into consideration. Our CEO, Marco Ramirez, will provide an update on the implications of the first full quarter into the lockdown in Mexico and the evolution of different measures aimed to strengthen the group. Furthermore, Marcos will comment on relevant events that took place during the quarter and will walk us through the main financial performance results. Meanwhile, Rafael Arana, our COO, will provide further detail on financial and operating results and will share some additional color on our expectations for the second half of twenty twenty.
As always, we will conclude with the Q and A session. Thank you. Marcos, please go ahead.
Thank you, Thomas. Good morning, everyone. Thank you for joining our call. I'm glad to talk to you again, wishing that you and your families are safe and in good health. From beginning to end, the second quarter of the year reflected the full effect of the pandemic on a global scale.
We have witnessed an unprecedented and challenging environment in which to live, in which to interact, in which to do business. Throughout these periods more than ever, we have been true to our commitment of being the strong Bank of Mexico. Our efforts at Vanorte have been focused on supporting our customers, taking care of our employees and ensuring a continuous and solid operation of our franchise amidst generalized uncertainty. For Mexico, the past three months have meant a significant decline in economic activity across many sectors as most non essential activities such as tourism, entertainment, construction, retail activity and many other services came to a halt, therefore impacting large and small companies and individuals alike. Since the start of the outbreak, both the federal government and Banco undertook actions to support households, businesses and the economy as a whole.
Main actions include increased spending in healthcare and the advances on social benefits to the most vulnerable groups such as the elderly. Programs with an economic focus have mainly consisted of unsecured loans to both lower income individuals and SMEs supported by guarantees from development banks. There have been also efforts from the Central Bank to improve liquidity in financial markets and ensures stability in the exchange rate market. The most recent meeting from the Central Bank resulted in a unanimous 50 basis points cut to the reference rate, which now stands at 5%, totaling a two twenty five decline versus January 2020. Market consensus points towards further reductions during the second half of the year to reach 4% by year end.
Actions from the CNBB include some loosening of regulations from banks contributing to increased lending. The private sector has taken a much more active role in Mexico with the Mexican Business Council partnering with IFBB Invest to provide up to $12,000,000,000 in loans to SMEs. All in all, there has been a broad response to the health and economic crisis, but there is still room for further stimulus. So far, the different measures excluding those from Banjiko to bolster liquidity totaled 9 and 94,200,000,000.0 or 4.5% of GDP. Despite these actions, the depth and breadth of the lockdown period has further reduced growth expectations in Mexico, which now points towards a 9.8% GDP contraction in 2020.
Later, Gabriel Casillas will provide further detail on these matters. Starting of June 1, the federal government announced a gradual reactivation of the economy prioritizing those industries with the highest economic impact of the country such as sport related manufacturing, construction and tourism followed by a slower reactivation of retail activity. The full effect of this reactivation is expected to influence our results in the months ahead. Thus, this is not yet reflected in these quarterly results. Focusing now on Vanorte, during the quarter, the bank remained fully operational with 85% of our branches and nearly 100 of our ATMs network available for our customers.
Our branches operate with the least possible staff and follow strict health guidelines to keep our employees and customers safe. Over 70% of our employees at the corporate offices remain working from home and we're evaluating different strategies and prudent timing to implement a safe return to our offices. As you know from a trade risk standpoint, we took measures early on to contain asset quality in our loan portfolio by tightening our risk policy, concentrating our loan growth efforts to serve our existing customer base and working very closely with the asset recovery arm. Beginning with Slide number three, in the March, we were the first bank to launch a relief program for our consumer and SME customers. The enrollment window was open from March 24 through April 30, very welcomed by our clients as 22% of our consumer portfolio and 35% of our SME book joined the program.
16% of our total loan portfolio is supported by this relief. We are ready to implement a second phase of support programs, leveraging on our data analytics capabilities to access individual risk levels in order to grant an additional one or two month grace period. This second phase will be open for previously enrolled as well as for new applicants. We also proactively approached our key commercial and corporate customers in vulnerable industries and supported them with additional short term liquidity lines on a case by case basis to help them overcome their most immediate cash flow requirements. Now that we have more clarity on the enrollment rate of our relief programs, we decided to provide more visibility to the market in our expectations for asset quality.
Thus, we requested authorization from regulatory authorities to generate COP 4,900,000,000.0 in additional loan loss provisions. Out of this amount, 1,900,000,000.0 were specifically assigned to write off existing SME and commercial portfolios and EUR 3,000,000,000 were anticipated as additional general provisions that we estimate will be enough to withstand the expected asset deterioration in 2020 and the anticipated peak in the year 2021. Switching gears to the Slide number four, one of the positive outcomes of this pandemic has been the unprecedented hike in adoption and utilization rates of the bank's digital channels. Transactions are migrating to web and mobile channels where we see significant transaction growth versus pre COVID levels. Leveraging on this significant increase, we kept enhancing our digital product suite by adding payroll loans to the existing digital offering of basic checking accounts, credit cards, mutual funds and insurance products.
The convenience of our new digital products together with the relief programs and the preventive measures that we have implemented have had a very positive impact in our customers' perceptions and experience with the bank. Our branch NPS score rose nine points during the quarter reaching 67 points and our mobile NPS reached 68 points further consolidating our digital presence in the industry. Another decisive step in our digital strategy was our recent JV between Vanorte and RAPI, the leading on demand delivery platform in Mexico. On Slide number five, you will see that this new venture is equally owned by VaNorte and Rafi and will complement our digital offering by enable us to offer convenient financial products and services to nearly 11,000,000 native digital young active clients who interact in Rapid's fast growing ecosystems. Now turning to the Slide number six, I will walk you through the main financial performance metrics for the second quarter.
Operating results were positive overall with good performance in the bank and the rest of the group subsidiaries. When we incorporate the additional loan loss provisions at the bank, Grupo Financiero vanorte net income for the quarter totaled 6,520,000,000.00. And without this impact, net income would have been MXN 9,870,000,000.00, up 8% versus the previous quarter. Consequently, our profitability metrics were also impact in particular our return on equity as it carries the effect of additional provisions and also the effect of accumulated capital at the group's level from the dividends that we have not been distributed. Return on equity for the quarter totaled 13%, while return on assets reached 1.49%.
Quarterly net income, interest income, the NII on Slide number seven was up 6% compared to last year. However, it shows an expected reduction versus the first quarter of the twenty twenty primarily explained by the high seasonality in the insurance business during the first quarter of the year and to a lower extent by the decline in reference rates during the quarter. Our initiatives to reduce our cost of funds have sustained it at 47% of the reference rate, adding resilience to our NIM, which ended the quarter at 5.3%. Core deposits continued with a positive evolution with a 4% increase during the quarter, 6% growth in demand deposits while time deposits declined 1%. Moving on to Slide eight, fees had an interesting evolution.
While those linked to loan origination were impacted by lower economic activity, transactional ones such as credit card fees were more resilient as declines in certain sectors were offset by relevant increases on online retailers. As of June, those fees were back to pre COVID levels. On Slide number nine, loan growth was primarily driven by mortgages, which had a 2% quarterly growth despite the intense market competition during the period. Our corporate and commercial portfolios also showed good performance supported by liquidity lines that were granted for key customers and by the absence of prepayments which prevented loan growth dilution. In line with our expectations, relief programs have had a positive effect on asset quality as this reduced the pace of NPL formation across the portfolio.
Excluding the effect of the $1,900,000,000 write off mentioned earlier, NPL ratio for the quarter will have remained at 1.7% instead of declining to 1.2%. Cost of risk were also impacted by the additional provisions reaching 4.2% during the quarter. Excluding this effect, it will have dropped to 1.8%. On Slide number 10, our liquidity position was further strengthened by the quarterly increase in deposits reaching 151%, way above regulatory requirements. As for our capital position, Slide 11, total capital rose to 19.7%, while CET1 totaled 13.2%, leaving the bank in a solid position to face the second half of the year.
Talking about our non banking subsidiaries on Slide 12, the insurance business showed good results considering their normalization from a seasonal increase in premium income in the previous quarter. Moreover, the annuities business now incorporates the recent acquisition of SURA's annuities portfolio. We expect very good performance in this business going forward as we materialize cross selling initiatives to these new customer base. The second half of the year will uncover the effects of the pandemic for the rest of our customer base. However, I am confident that we have implemented the necessary measures and have taken a prudent approach to strengthen our franchise.
With this, I conclude my comments. Now Rafa will provide more in-depth information on relevant operation and financial metrics as well as additional details on the rationale behind our provisions and their impact of Grupo Financiero Norte's profitability. Rafa, please go ahead.
Thank you, Marcos, and thank you everyone for attending the call. We have been talking to many of you during the past weeks concerning basically what's going to happen with the provisioning, what's going to happen with the NIM, what's the resilience of the bank. I think as Marcos mentioned at the beginning of the call, if we go to the Slide 13, I think we could start by tackling the net interest margin that has been of concern from many of you. As you can see on the Slide 13, the net interest margin of the bank for the first half of twenty nineteen was 6.2% and for the first half of twenty twenty is 6.2%, so 20 basis points less with a considerable reduction in the reference rate of 139 basis points. So the resilience of the net interest margin of the bank has proven to be based upon a much more profitable mix on the consumer book, Also, a much better cost of funding as we anticipate in the integration of Interxiones that when we rise the cost of funds to 54% of our reference rate.
Now we are sitting at 47% and we will continue to lower that number to 44%. That has given us the resilience on the NIM. As you can see on the at the group level, net interest margin stays the same for the first half of twenty nineteen that for the first half of twenty twenty once you take away the first quarter increasing the margin from the insurance company. All in all, margin still behaves in a resilient way based upon all of the actions that we have been taking with this and we expect to continue to reduce the cost of fund. As you know, during the pandemic, and this has not only been the case in Mexico, but also all over the world.
Since you get onto the relief programs, there's more liquidity in the market. And that liquidity has been has allowed us to move the demand deposits on a 20% increase from year to year basis. So that is one of the main reasons why the cost of funds continue to drop. So we have more liquidity coming from our clients, not just the consumer, but also the corporate ones. So as you see, we will continue to see a resilient behavior of our net interest margin.
If you look at the from the loan portfolio based upon all the things that you now on the spreads based upon the restrictions on liquidity and a much better mix on the portfolio, the NIM of the loan portfolio has moved 42 basis points up from the first half of twenty nineteen to the first half of twenty twenty. So overall, a very, I would say, accelerated drop in interest rates, but I think we have been able to cope in a very good way with based upon the funding cost, the mix, the fixed rate portfolio that now is close to COP 300,000,000,000, and that is giving us the necessary tools to try to contain the margin at a very reasonable levels. Okay. There has also been concerns about what's going to be the effect on the reduction on the rates on the sensitivity that as you know, three years ago, the bank was running with a sensitivity that every 100 basis points was EUR 1,200,000,000.0 of sensitivity due to the, I would say, very efficient work of all the teams related, the treasury risk, finance, all the people, the commercial areas. We have been reducing that sensitivity to in less of 100 basis points on sensitivity of 1,200,000,000.0 to $430,000,000 pesos.
So that has been a very good also, very good news in an environment that you see a drastic drop in interest rates, but you can counterbalance that with a very efficient managing in the ALCO book. Okay? Another thing that is important and I think has to do with many of the questions that we have been talking to you in the past week is what's the rationale for the provision and the number of the provisions that we set for June. We have been doing a lot of work with the risk people, the recovery units, the product people to know exactly what's going to be the behavior as we could anticipate with the information that we have from the portfolios that basically on the consumer and also on the corporate and commercial. As you know, we were the first ones to launch the relief programs onto the market and that really create a very important goodwill with our clients.
When we launched this relief program, basically it was aimed to stay at four months of no payments of interest and principal and then reset the loan after the fourth month with no increase in the number of payments when you see the total loan history. And also the bank decided to finance the interest for the clients and the capital financing for these four months in order to avoid a confusion to the clients when you sit with them and they will look that there was additional months that they have to pay and they have moving parts on the balance sheet. That is costing us for the first year, $240,000,000. And for the second year, it's going to rise to MXN480 million. But this has also benefited us by this having this relief program for a reduction of MXN1.3 billion of reduction in past due loans.
So I will go into much more detail into this, but I would say that once we set up the relief programs, then we start looking at the behavior of our clients on a one to one basis to see on the payroll that we pay close to €6,000,000 payroll accounts, what's really the flow that is coming to those accounts and link that to the payroll loans to see the evolution of those clients, how many of those were losing their jobs, how many of those were losing their salaries. So we could starting to build up a lot of information to see exactly what's going to be the behavior post this relief program. The same happened on the credit cards. The same we look at every single day what's the behavior of the credit card, what's the level of debt with us and with the other banks. And a very good surprise for us is that people that signed for the relief programs continue to pay the credit card based upon that the credit card became instrument for buying things on this remote way of doing things during the pandemic.
When you look at the SMEs, that is also a portfolio that people is concerned always when you see these cash crunches and lack of dynamism on the economy, Important to notice is that 3.8% of the total book is SMEs. SME was a book that didn't grow last year. We were flat or less than flat on the SME. And more than 50% of the portfolio is under nothing guarantees. Notwithstanding that, we are taking an approach on a one to one basis with the SMEs by visiting them on a personal basis, look at the business, see the potential of the business to continue after the pandemia.
So we have a pretty good idea of what's going to be the necessary buildup of provisions on the SME. And it's basically one of the main numbers that we use on these additional provisions that we just build up on to June was devoted to the SMEs and also for the commercial on a specific way on the write off parts. Before this buildup of provisions, the SME on the write off was up to nineteen months. Now we reduced that to ten months in order not to have any bubbles on the SME book. And I'm going to round you some numbers about what's going to what was exactly the buildup of the provisions.
And there has been some concerns that even without the provision and there was a rise in the past two loans and that's not the case. Let me just run you from the numbers. If you look at the recurrent numbers without the build of provisions for the quarter, the number should have been 3,500,000,000 of provisions that if you compare that to the MXN 4,300,000,000 of the first quarter, you see a reduction of MXN seven fifty six million on the past due loans on the book. When you add the provision in line that jump to instead of being 4.3% on the first quarter, that jump to €8,400,000,000 on the second quarter. Then it's when you include the full provision instead of the €4,868,000,000 of provisions.
Of these 3,000,000,000 were provisions against the income statement in June, and 1,800,000,000.0 was basically used for write off in order to clean the portfolio on the commercial and on the SME that will allow the balance sheet to have enough room to support any deteriorations coming from the pandemia and after the relief program. It's worth to notice that the regulators allow us to also move from the original four months program in some cases to add one or two months depending on the clients. What we did is not on the like in the first one on the general terms, We in the second wave of this relief program is on a one to one basis based upon the capacity of the client to become current. Some clients that they continue to be employed, but they have been had a reduction in their salary, so they need some more time on relief. So we are on a very one to one basis on this second wave that shouldn't move the expected numbers that we reserve from this provision is more than we anticipated.
These numbers that we build up, this €4,800,000,000 should be enough for all of 2020 and most of 2021. I think we will consider that 2021 will be covered enough, but we are not sure at this point, but we are in a way confident that that will be the case. And the reason for that is that during the relief programs, what really happens on the recovery units that allow the portfolios to, in a way, become much more clean is that there's no migrations from bucket zero to bucket one to bucket two because all those contention lines rise to record levels. So creating this EUR 1,300,000,000.0 of relief in the NPLs that we expect that will come from the coming months. So all in all, we are confident with the numbers that we are reserving.
There has been a very delicate and extreme detailed analysis of these programs and evolutions and cost of risk. Some of you asked us when this is going to peak. Our expectation is that this will peak and I'm also looking at other parts of the world that I think we are reaching the same number that this will reach in the second quarter of twenty twenty one when our cost of risk will be close to 3.9 and then drop again to the usual numbers of the 2.1. It's quite important to notice that Banorte enters this cycle of pandemia with record numbers on NPLs on cost of risk on the low end of those numbers. So and also with a very strong capital base on that.
There have been some questions, what was the charge of this 4,800,000,000.0 against the capital base. It was 18 basis points against the capital base what we consume of the with this additional provision. So instead of the 13.46, we are now sitting in core Tier one of 13.21. That is a substantial rise against the first the numbers on the first quarter If I move now to the other lines that we are doing to control the lack of evolution on the margin side that we have seen, we have control in that, but we know that we are losing some basis points on the margin side. We are dealing with the cost lines, not with the personal expenses because we are not laying off any of our colleagues in 2020.
But basically, we are taking away most of the discretionary cost in order to reduce the guidance that we gave to you at the beginning of the year of 5% to 5.5% expansion on the cost line. Now we are looking at a number very close to four below four. This continues to support a good cost to income ratio that should continue to move in the right direction. If I as Marco said, and I would like to stress is that the bank, based upon the structure of the group in addition to the bank, is becoming more and more resilient on how do we generate the profit lines. As Marcos mentioned, the instrument business, the annuities business, even the Afore that usually is delivering a 12% return on equity, now is delivering up to 15% return on equity based upon all the positions that we hold.
And when you have a reduction in rates, you get benefit on that. So all lines of business at the group are working well and supporting our clients. So this is our main goal to really being able to support our clients. And I also would like to jump into a consideration for you. Once we took the provisioning buildup on June, I think it's worth notice what should have been the numbers if we continue to do on a recurring basis.
I think this is really an exercise on paper, but I think shows the resilience of the bank. If we continue with the current numbers that the group and the bank is generating, the return on equity for the group without the provisioning line would reach numbers very close to the 18%. And the return on equity for the bank also should sustain numbers very close to 20%. We already discussed the net interest margin, the efficiency cost. But another question that has come to us is what's going to happen with the return on equity for the group.
I think it's worth mentioning that the buildup of the dividend is now sitting at the group, as Marcos mentioned. So that is hurting the return on equity on the group, but that will continue to stay there until we get the goal from the CMBB or from our assembly to move the dividend from that. But the resilience of return on equity from the bank continue to be noticeable, as I mentioned to you, at a very, very high numbers close to the 20%. Obviously, we will not reach the 20% return on equity for the group in 2020. I think we will try to be as close as we can.
Yes, we will reach for the bank that number, but not for the group. And we are confident that all the other numbers that I've been mentioning to you, provisionings, margin, cost, funding, the rate of growth also of the loan book has been also a good surprise. If you strip away the government book, the loan book is growing close to 80%, good growth close to 80% for the year. The mortgage book continues to be resilient. Credit cards, we are being careful with the credit card, but I think we could still see a small growth on that.
Payroll loans that was flat and negative last year started to build up to numbers close to 3% to four And in the Corporate and Commercial with all the withdraw of lines, you can see numbers growing on the Corporate and the Commercial well above last year's because there's no prepayments anymore. Those lines are now being returned most of them to the bank. That's why you see also this buildup on the funding side. So overall, I think we entered this cycle with a very strong capital base. We just issued an AT1 paper into the market just to as we have been telling you, we don't want to have any more Tier two on our balance sheet.
We are reaching the same numbers that we had in the past when we were not issuing T1s and only T2 on the composition of the capital numbers. So Vanortis is the strength of Vanortis is clear. We are proactively managing the pandemia. We have going on a one to one basis to our clients to sort it out the evolution of this pandemia. We are managing the funding.
We are managing the margin. And also the way the bank has been working, as Marcos mentioned, during this pandemia show us that we are well ahead on the digital revolution of the in the market. The NPS, just for you to know, grew substantially during this pandemic because of the opportunity of the relief programs and how we have been managing our clients. I think the goodwill from our clients will also be a substantial part of how do we manage the relationships with them. So with this, end my remarks.
And now we move to Q and A as we always do.
We will now begin the question and answer session. Our first question is from Ernesto Gabilondo from Bank of America. Go ahead.
Hi, good morning, Marcos, Rafa, and good morning, everybody. My question is on provision charges and risk coverage ratio. We believe the NPL ratio was low due to the reprogramming and the restructuring of the loan portfolio, and that helped the reserve coverage to be at 200%. However, once we start to see NPL showing up, do you have a target for the reserve coverage ratio? And then my second question is on the relief program.
As you mentioned in your presentation, individuals and SMEs represented 16% of your total loan portfolio. However, if including corporates, where do you see all the reprogramming or restructuring as a percentage of total loans? And linked to these relief programs, you mentioned that you have anticipated COP 1,900,000,000.0 in regards and that you have created preventive provisions of
COP 3,000,000,000.
However, how comfortable are you for not needing more preventive provisions this year or even more in 2021 considering that the real impact will start to be seen after ending the relief programs. And we still see uncertainty on how fast will be the reopening and the shape of the economic recovery for Mexico. On the other hand, if you have certainty on the potential provisioning for the year, would you be able to provide some kind of net income guidance for the year? Thank you.
Wow, Ernesto. Thank you. A lot of questions. Let me start by the 3.1. We feel comfortable with the information that we have so far.
We will need more additional provisions during the year, even for the next year. That's our target so far with the information that we have and we expect it not to move. And I will ask Rafa to go to the target of the coverage ratio, please.
Higher on the based upon what we have been doing, but I think our aim and goal has always been from 130 to two forty. When you say that I think it's quite important, Ernesto, to notice that what we mentioned about what's the effect of the relief programs. The first thing is that since there's no evolution on the deterioration of all of the loans that are on the relief programs, what you start building up and Marco describes this very well that you see a disconnect from the accounting and the reporting from the really ongoing situation is that you start build up in addition to this $4,800,000,000 you start also building up additional provisioning because this deterioration is not happening at the book. So you are not building up those provisions. You are reducing that.
That's the number that I just gave you to you, that ARS735 million. So we feel very confident that this year we have more than enough provision for that. And with this additional month or two months that the government the CMBB just granted to the bank, what you will see is that even you now should be looking at November to see some numbers coming from the deterioration of the book. What I can give you is numbers that shows you what the real effect on the deterioration of the loans that we already been seeing based upon this observation that we are doing on the clients that are on the relief programs. And we have seen that there's no more flows coming to their accounts.
And that could hurt this, I would say, margin that we are writing on a monthly basis based upon the methodologies. And it's extremely low. I mean for the car loans, less than 0.6% of the clients are not really should could have been paying the payment for the month. In the payroll 1,100,000.0 related to the margin and credit cost 1,100,000.0 So we still see extremely positive numbers on deterioration. When you look at the payrolls and you see I think we are on the safe side saying that close to 13%, 14% of the payrolls that we pay are not receiving any more payments.
That's not related to the payroll loans, it's payrolls, okay? People that are losing employment and things like that. So that's not a thing. You are just losing deposit debt, but you are not losing on the credit side. When you jump into the payroll loans, you have to divide it clients that continue to be paid, clients that have been a reduction on their salary and clients that are not any longer receive any money.
We have that very, very well documented and we don't see that we will need any more provisions also for the payroll. Credit card has been a good surprise for us because even on the relief front, they continue to pay our clients. The mortgage book, as you know, the loan to value is close to 52%. And SMEs, we have nothing guarantees and dealing on a one to one basis. So we are very confident that we are building enough provisions and all the actions that we've taken will create another buffers for the provision in line.
That's the first one. The other ones that you say on the corporate and the commercial, there was no relief program from the corporate and on the commercial. On that there's no like stop payment of principal or interest. In that what basically the commercial and corporate people did and I will ask the commercial and corporate people to guide you to this is basically provide enough liquidity with a new loan for specific purposes, okay? But we have Rene on the line and he is the Head of Corporate and he can guide us on this process.
Go ahead,
Sure, Herrad Marcos. Thank you. Ernesto, basically, we have been working with our clients on on tailor made solutions, and this this is dependent on the on the sectors and the specific client situations. We really didn't use these special relief programs for corporate clients as as they were mainly designed for for individuals, and therefore, were limited in the scope and and the reach of the programs. So so this gives us an advantage.
We will not see a significant pressure on on in October or November when when the programs expire. This this has allowed us to, after the provisioning that that was made in June, to to reach levels of NPLs of of 0.3%. And this after we fully provisioned a couple of nonperforming loans that we had in our books since since 02/2019.
02/2019.
So right now, what I
can see is that we're we feel very comfortable with the work that has been done with the clients. We've reached more than 90% of the clients with these specific tailor made solutions. So we do not see a deterioration of the portfolio this year. Of course, it it will have to it it will depend on on on the opening of the economy. I mean, there there are sectors that are being hit harder.
And if we do not see an opening of the economy towards the second half of the year, there are some sectors that will be hit the most in 2021. But for 2020, we feel very comfortable with the work that we've done, and we don't see any deterioration of the portfolio.
Thank you very much, Marcos. I find that never is helpful. So just a follow-up. Do you think provision charges should normalize in the second half? But do you think they will continue to be higher on a year over year basis, right?
Yes. On a year to year basis, it should have been if you take into consideration of the additional provisions that we build up, the usage of this provision is still to be seen. But yes, what we have seen is that if you look at the balance sheet numbers and you look at the numbers of the provision in last year was $18,000,000,000 Now we are sitting at the same number, dollars billion now. So if you see that the potential recurrent deterioration of that number could jump to 20,500,000,000.0 or 21 for the year including these extraordinary provisions on that part. But yes, it will be a high number compared to the last year because of the additional provisions because the portfolio before the pandemia was behaving extraordinary well as you can see in NPLs on mortgages, car loans, credit cards, payrolls, commercial and corporate.
So I think we were quite diligent on provide our clients the liquidity and the peace of mind in order for them to work with them. And as Rene just told, on a tailored basis with the corporate and commercials without any relief programs, we are tackling the liquidity issue that they have. So we are very confident that we are really doing a state of the art process in order to address every need of our clients during this process.
Perfect. Thank you, Rafa. And still difficult to provide a net income 2020 guidance, right?
I don't feel confident, Ernesto, to do this, but I will be feel very confident by the end of the third quarter to provide you the guidance. But if you look at the first five months of the evolution of the net income, think can give you a pretty good idea what will be the number for the end of the year once we set up these provisions. So we will do it
in the next conference.
Perfect. Thank
next question is from Jason Mollin from Scotiabank. Go ahead.
Hello, everyone. Thank you for the presentation. You, you addressed a lot of my questions and what you have discussed. But I just wanted to understand, two things that I wanted to get some color on, additional color. You you talked about the decision to extend the loan forbearance program for a couple more month a couple more months.
I I understand on one hand, you're offering more oxygen to your clients that needed to get back on their feet. We don't have a lot of certainty about when the reopening and how that will work. But on the other hand, this is, you know, prolonging the problem of identifying who's gonna start paying or not. So I just wanted to understand that decision to extend the loan forbearance program a little better if you can give us your thoughts there. And secondly, you know, you you you had talked for years now about the targets, the the the long longer term profitability targets, 20% ROE in 2020.
And, clearly, if you exclude some of the impact or the the provisioning impact on the on from COVID and and everything we're living right now on on the other line items, looks like you would have been there. How does that impact you know, I I believe that there were compensation objectives based on reaching these targets. Are those being postponed till 2021? You you mentioned that that variable expenses should be coming down because that won't be part a big part or if if I understood it. It sounded like you were canceling variable compensation.
But how should we think about that? And you guys have done a great job at getting the profitability up. No one saw COVID coming. How are you going to handle this in terms of incentivizing the people who really brought your ROE up to this level from levels previously well, well below? Thanks.
Thank you, Jason. The first one, you are right. The way I see it, Rafael is going to give us more color, but the way I see it in the past, was like a chemo for everyone we send the medicine. And now in the future, thanks to the tools and the analytics and all these, we can see all our clients and that's different. We will send to each client different medicine.
So it's going to be another type of approach. Obviously, it's totally different internally or where I don't know the accounting, is more difficult to do it, but we have the tools to reach to. I wouldn't so you will hear how it works in the next months, but we are very happy with the way that we are doing these things. The second, the target to profitability for the 2020, we're not giving up. Let's wait for the next in these three months and maybe we can change a little, but the objective is the same.
So we are comfortable that the vote is big. We are a financial group and still we think that we can make it. Let's see. How to incentive people? Everybody's incentive.
We are surprised how the people is working. The home office, are asking for new chairs because they are sitting the whole day. And so we are very happy with how the people is reacting to all these. I don't know, Rafael, if you want to say something.
I think what Marco mentioned is clear. And Jason, obviously, if you look at where we are taking the expense line down, one is mainly bonuses TOPS are going to be no more than 45% for the year TOPS. And as you mentioned, there was a specific goals related to achieve the 20% return on equity that we did on 2019, but we promised on 2020. So that's still to be seen as Marco says. But on the first, think all bonuses have been reduced substantially for this year and we will see how we reach that but it's going to be a tough road but we try to aim for it.
On the other thing that is your concern that we are just extending the pain. I would just start and I will ask Gerardo, that is the Head of Risk, to guide us to what's the rationale for the second part. Go ahead Gerardo, please.
Thank you, Marcos. Hello, Jason. Talking about the consumer and SME loan book and the extension in the enrollment program beyond two additional months, we have proceeded as follows. First, we have created one model for every credit type that we have within the consumer loan book in which we have separated the past due loan portfolio, the ones that are currently enrolled and the ones that are not enrolled. We have created three clusters with good quality, low quality and medium quality loans.
We have assigned a reserve of 1.3 up to 4% of the principal. We have assigned a risk profile based on some parameters like the rating, internal rating, external rating, the batch rate, the leverage, all the deposits, also dispersion, and some other SME parameters, we have assigned a probability of default, which is differentiated by each prototype: auto, mortgages, payroll, credit cards, SME loans. And after that, we have a forecast in which we are basing our additional reserves for 2020 and 2021 for each of the products that I just mentioned. We have implemented different strategies to preserve our loan portfolio quality. Strategies have gone from deferral and support programs as you may know and we are very confident that this extension of the forbearance programs will increase the number of cases from 610,000 to around 800,000 and the loan balance associated with those extensions in the Phase two of the program will increase the MXN 131,700,000.0 to MXN 155,000,000,000.
That is a 3% increase in the loan book, which has been or who will be enrolled in the program. This is going to provide a jump from 16% of the loan book to perhaps 19% of the loan book. We consider this final because we are reviewing as Rafael was saying before, the status of each case to provide a custom solution to one of them, to each and every one of them. So that's the way we're proceeding with these forbearance programs and the extension, which we consider will be final.
Yes. Thank you. So Jason, as you mentioned, it seems that we are just extending the pain, but as Gerardo mentioned, we are not this is not a general program. This is on a one to one basis based upon what Gerardo just mentioned, which clients are really going to be in good shape in two or three months because the pandemic is extending more than expected, which are really going to be without any possibility. So they are now in the recovery unit.
So this is not extending the pain. Honestly think as Gerardo mentioned, this is adding an additional caution to the buildup of these buffering provisions that we are doing and also allowing extraordinary capacity for the recovery unit to go on a one to one basis to our clients. So on the other thing, as you mentioned, tough luck maybe for the bonus if we don't reach the 20%. There has been a reduction already to the 45% for this year, but we need to continue to see how close we can come to the numbers.
Thank you very
much for the color.
Thank you, Jason.
Our next question is from Tito Labarta from Goldman Sachs. Go ahead.
Hi, thank you. Good morning, everyone. Hope you're all well and safe. Thanks for the call. A couple of questions.
One, following up on the provisions, just asking it in a slightly different way. If we exclude the extraordinary provisions in the quarter, your cost of risk was around 1.8%. Last year, was around 2%. First quarter, 2.2%. So barring any additional provisions as things get worse, is this sort of the cost of risk that we should expect between maybe 1.8 to 2.2 more or less?
Is is that a reasonable assumption going forward? And then my second question is just looking a little bit deeper on the insurance results. There's some mixed trends there just to understand. I understand the seasonality in the quarter. Pretty just looking on a year over year basis, we saw a huge increase in the technical results while the interest income did come down.
I imagine the decline in interest income was due to to lower rates. But just if you can just go through a little bit deeper just to understand the big increase in the technical results and is the decline in the interest income for insurance specifically related to lower rates? Thank you.
Thank you, Tito. Yes, the way we see things so far, we don't have the major goal, but yes, it will go from 8.8, sorry, point eight to around 2.2, 2.4 around that is the way we see things right now. Don't know, Rafael, go ahead with the next one.
Tito, thank you. No, yes, the running rate of cost risk always has been from 1.8 to 2.2. Even at the beginning of the year, we guided before the pandemia that we will be moving from 2.2 to 2.4. So I think the run rate should be 2.2. What is very important to notice is what you mentioned.
We are entering this cycle with a record 1.8 cost of risk without the extraordinary provisions. So that is also giving us room to manage this. On the insurance business, as you mentioned, the interest income grew 25% on a 28% annually as you mentioned because mark to market valuation of the positions that we have. I think also what is quite important for the insurance business that continues to do well even if it has been a reduction on the traditional products that we usually try to accompany with that insurance like mortgages or car loans on that. Also, the technical reserves have been going down because there has been less robberies, less crashes because people are not driving on that.
And how exposed we are to the health side, we are very, very low have very, very low exposure to the health side. So the insurance business will continue to be a good story through the remaining of the year, but basically it's the mark to market valuation of the positions.
Okay. Thank you. That's very clear. You,
Tito.
Our next question is from Thiago Batista from UBS. Go ahead. Hi,
guys. Thanks for the opportunity. I have the first one follow-up on the asset quality. In this stress scenario, you showed that the nickel ratio should achieve 2.5 more or less in the second. So if you can comment a little bit on what were the main max scenarios max scenario assumptions that you used in the simulation?
And also, how much more provisions would be required in this scenario? And finally, in the stocks, why this peak of 2.5 would be, let's say, a little bit below the peak that the detail achieved in the financial crisis? So this is the first question. And the second one, if you can comment about the bank's view on the possible pension reform in Mexico. So what would be the main impact for Banorte?
So if you can give us a color on this reform.
Rafael, please go ahead. So Thiago, if I hear you well because there was some noise on the line, your main concern is if this provision is that we just build up based upon what they have built up. As Gerardo mentioned, they are built up on a case by case basis, on a product by product basis, basis on the expected loss and also all the information that we have. And also we stress the scenarios in a very important way. I think when we are talking about on the second quarter, we expect the cost of risk to reach almost the 4%.
You are really stressing the book at a substantial level. Remember, when we did a very, very aggressive stress test to say that if we could support the capital numbers of the bank, we even jumped the provisions up to ARS 42,000,000,000 and and the core Tier one was 11,200,000,000.0 $11,300,000,000 So we are very confident on these numbers. I mean, we are doubling the more than doubling the cost of risk when we see the peak on the second quarter of twenty twenty one. So we are confident on that. We pride of how the recovery unit, the risk people, the product people has been really tackling this on a very detailed and dedicated way.
So we see any hiccups on this. I mean, we don't know exactly where the pandemic is going to go, but the country is now reopening and start to moving forward. So slow, but moving forward, still horrible numbers coming from economic growth, but from the near future look a little bit better. So if you ask us that NPLs are good enough of what we are provisioning and NPLs could be 2.4, 2.3 for the end of twenty twenty one, I think that numbers are already being considered on the evolution of the provision and on the risk analysis that we do.
This is Gerardo, Thiago. I will add to what Rafael is saying that we have contemplated two scenarios. One is a stress scenario in which recovery takes long and the other one is an extreme scenario in which we have a recovery in an L shaped. So we have considered even the extreme scenario and we feel comfortable based our macro assumptions like inflation, employment, potential growth and also what it is required from us given the loan profile that we have and the multifamily of risk that we have to mitigate.
I think what Gerardo mentioned is quite important because if you look at the mortgage book that is a fully provided book with a loan to value and you also look at the government book that is under the trust characteristics of the book, a very safe and secure book, More than 40% of the portfolio plus in addition of the SME of the nothing guarantees. I think the portfolio has a lot of coverage already based upon the type of business that we are in.
Perfect, perfect. And the second question, not sure if the line is better now, but on the pension reform in Mexico, what is the possible impact for Banorte?
Rafael, Rafael. The pension reform looks pretty well from the standpoint that workers will have a better pension on that. Still we need to see what's going to be the effect on the fee side, what exactly going to be the detailed ruling for this. I think on the overall numbers and picture, looks in the right direction. We need to look at the details.
And remember that we are the largest pension for a company. So we have already very large economies of scale. And therefore, if you look the numbers that we are now returning on equity 15.3%, before it was 12%. Therefore, it has been under going a very detailed restructuring being becoming more and more and more efficient. So I think we have the scale to support this reduction.
We need to look at the details. In the overall, we will have a lot more assets under management to manage. So I think we still need to see the detailed ruling of this. But on the overall, I think it was needed. It's a step in the right direction, but we need to continue to really accompany this with a much more efficient moves that we have taken in the past.
But I think we are very confident of the evolution that the Afore company is having up to today.
Thanks a lot.
Next
question We have received a question from Rodrigo Ortega that basically was the same question that we just answered. So Rodrigo, if you have any further questions, let us know. But I think it was basically the same as Thiago.
Okay. Our next question is from Marcelo Tejes from Credit Suisse. Go ahead.
Hi. Hello. Hello, Marcus. Hello, Rafa. Thanks for, you know, for the opportunity to ask questions.
I have a couple of questions here. The the the first one, you know, there seems to be kind of like a, you know, a disconnect, right, between, you know, your speech and and what is happening, you know, on the ground in Mexico, right, when you look in terms of, you know, the amount of, you know, job losses, you know, that we've seen, you know, since the beginning of the pandemic, you know, it's been more than, you know, the the first two years of job losses post the COVID crisis. And in your scenario, you know, for for provisions, you know, you seem to to consider, like, kind of the the o eight crisis as, you know, as a proxy for that. But it does look like that, you know, Mexico is heading to a a significantly much worse environment. So what is the risk that, you know, may be, you know, overoptimistic on your cost of risk assumptions going forward?
And just putting some numbers, right, if you look, you know, based on the 16%, you know, of the loans that has been restructured, you know, that that's about a 125, you know, billion pesos. You know, if you consider your 2.2, 2.3% cost of risk for the next quarters, you know, they'll probably we'll probably talk about maybe, like, 30,000,000,000, right, in terms of of provisions vis a vis, you know, almost a 135,000,000,000 pesos of loans that are, you know, let's say, being having forbearance terms or or being restructured, so which is just a quarter of it. So how can you be so sure, you know, that this will be enough? And my and my other question is regarding your liquidity position. You did improve, you know, from one twenty to 151%.
But on the other hand, you seem to have to tap, you know, still a very significant amount of emergency lines from from Banco de Mexico. You know, I was looking at your numbers. It looks like, you know, the amount of credit lines from Banco de Mexico were almost 4x higher than what they were a year ago. And they there was a significant increase since the fourth quarter. And what is the risk that this opposes to your margins down the road once those liquidity emergency lines have to be paid off and you have to replace those lines with a lot more expensive lines?
And what's your strategy to replace those lines down the road? Thank you.
Thank you, Marcelo. Good and tough question. First, we think that we are something like documented optimism that we have we are collecting all the data. We can see what the clients are doing and we know Mexico as a bank maybe better than the a lot we know them. So I will ask Gabriel Castillas first to give us like a frame of confidence in which we are moving, worst case scenario and the best case scenario.
And from then, we are taking the data and that's why we are kind of optimistic. No? Gabriel, are you there, please?
Yes. Of course. Thanks, Marcos. Thanks, Marcelo, for your very insightful question. You're it's very true what you're saying.
You know? Employment situation is not what we're seeing in the unemployment rate. As you know, it came up from 3.2% to 4.7. And it has actually declined a little bit. But I am pretty sure that you've seen the numbers.
If you take a look to the employment report, there there's a lot of people now available to work that is saying that they don't have a job. But because they say they're not looking for a job, they are not part of the unemployed. So so if we add them up, unemployment rate could be right now around 20%. So this is alarming. But two things that I would like to to say about these two things.
On the one hand, unfortunately, if you take a look to what has happened to these people that have unfortunately lost their employment situation, the ones that have lost it are pretty much, like, 75% People are earning one up to three minimum wage times minimum wage. In this context, as you know, in in our in our loan book, we do not have a a lot of those of those people that unfortunately lost their jobs. So that's on the one hand. And the other, and this is very important, is that our our analytics area and and risk management and the product area have been working, as Rafael mentioned, in a case by case scenario, pretty much checking,
you
know, whether they're getting the they continue to get a to get a salary or those kind of things. So so, yeah, I think definitely as as Marco was saying, I think this is a a very documented optimism in this context.
Marcelo, I think what you say is, I think if you were sitting and trying to manage in an institution like Vanorte, you can look at it in either in three ways. The first one, this is going to be a disaster. Nothing is going to happen because there hasn't been enough support from like in other parts of the world in order to support the SMEs of the companies of that. So the burden is on the banks on that. So in that way, you also have to understand how is the composition of Panorte.
When you look at the payrolls and this is linked to the payroll loans, we didn't have any growth last year on the payrolls basically because there was many layoffs from the government that stopped completely. But close to 55% of our payrolls are coming from the civil servants. So that number will stay there and we'll continue to do so and also link it to payroll book, okay? So that's a big difference on that part. We know that the SMEs are going to suffer on the payrolls.
We're already tackling that. But not many of those have a payroll loan with us, so we will lose some deposit lines on that, I'm sure of that. Job losses will continue to expand. It depends on how long the pandemia continues to go. I mean, a big effort has been ongoing on the private sector to try to stay with employments as long as they can.
And we already see some very good recoveries in the Central Part Mexico and in the North Part Of Mexico that are linked to the NAFTA to the new NAFTA deal that is creating a better image of what's really going to be the unemployment rates going forward, not today, going forward the coming months. Also tourism is becoming more open in Cancun and also in Cabo, obviously at levels that were is quite low compared to the usual levels of that, but that also is coming. There will be some setbacks on that. I'm sure it will come to that. So when we are looking at the cost of risk, we are not staying at a 2.3%, we are picking up to the close to the 4% on the second quarter of twenty twenty one.
But also looking at the numbers of the recovery unit on how these contention plants are working and how these are buffering our capacity and also our buildup of NPL formation, I'm confident of also what Gerardo mentioned of what we have been doing. Just to give you of how detailed this managing of the book is going, on a branch by branch basis, on a client by client basis, we are targeting who needs to call, how it's going to follow that, when goes to the recovery unit, when you start doing additional restructuring issues on that. So we are fully on motion on that. We know the growth is going to be coming a lot less than the past years. But the most important piece that we are now measuring our people is to keep our book healthy and online.
Obviously, the picture is not pretty at all, but the picture is getting better than it was a month and a month and a half and a month and a half ago. So this is what is if you ask me if this is going to be good enough, a colleague of you, I will not say his name, but he just the other day told me the building of provision is art, but it's also is becoming more an art than a science because you have to really see how the market and how the different parts of Mexico behaves on this reopening on that part. So if you ask me, is that going to be good enough? We hope it's going to be good enough. We are confident it's going to be good enough.
But if we need to build more provisions, we will build more provisions on that because we have the strength on the capital base. We continue to deliver profitable numbers on a month to month basis. So we have enough caution on that. On the liquidity side, let me be very clear. We are not drawing any more lines than anyone.
If there's a facility to be taken at a better cost than I can go into the market, I will take it, but not because I need it, but because it's a cost it's an opportunity cost if I don't do that. But I'm not taking any more than that. We are not taking any advantage of the buffers that the CMBB offer on the capital ratios or on the liquidity side. Liquidity, as you mentioned, it stops. And when we issued this $500,000,000 AT1 was because we are looking at a very good pipeline of companies close to $800,000,000 that need to be funded that are linked to the NAFTA deal and we are confident on that.
So we are not building up liquidity based upon facilities given by the authorities. If they are there, we will take them, but we are building liquidity based upon our funding, our capacity to fund our clients, our capacity of our retail branches to build up demand deposit that is growing 20%. So believe me, we are not taking advantage if the only way we will take an advantage of that is if the price is better that we can get into the market, but not because we cannot get that into the market.
Rafael, I no. That that
saying regarding liquidity I'll let Marcelo and and then I
I'll let Gerardo say please, Marcelo, go on. Yeah.
I know. Just wanna I just wanna say, I mean I mean, that's exactly, you know, my point because the you know, you guys had had to tap the market. And still, you know, if you look at the, you know, the amount that you had to raise in terms of, you know, credit with Banco, vis a vis the growth that you had in your, you know, in your liquidity coverage ratio, it seems that you really needed that extra liquidity to close the gap. And and given that perhaps, you know, have a bigger, like, duration mismatch or, you know, between assets and liabilities. And and and my and and my concern here is, you know, if this, you know, this is certainly, you know, a a cheap a cheaper but temporary sort of, you know, instrument.
It doesn't seem you know, the the the point that I make is that the all these liquidity that you took didn't lead to, you know, a significantly higher liquidity above that. Actually, you know, your increasing liquidity was probably less than the amount, you know, that you you got from Valjico because you you probably had a gap that you had to fill. And No. My concern here is that if this represents a a potential, you know, downside at March that you can also mention how how should we how do you get out of those liquidity mechanism? Are they, like, one year term, two years, or maybe you can hold on to them for for many years?
So, and what is the cost associated with those?
No. Marcelo, I can tell you this. We can draw we can get away from those lines today, and there will be no issue on the the on on our liquidity numbers. There will be a small reduction on that. And the pipeline in dollars will be more than funded with the last 81 that we just issuing to the market.
We are doing everything on our own. If there's an advantage to be taken, we take it, but not because there's a necessary tool for us to keep operating. And I
will ask Gerardo to if you want to add something. Sure. Hi, Marcelo. I will add that core and sticky deposits, it's the main ingredient in this liquidity that VaNorte has. We are we we have to report to the to the board of directors the liquidity coverage ratio with and without a bank Banquico's volatility waivers.
If you do that math, you will find out that no more than 2% of this 150.8% on average liquidity coverage ratio that we had on June is explained by those waivers. So I'll be happy to to to to give you the numbers whenever you you see fit because
Yeah. No. I'm not talking about the waivers. I'm talking about the the the actual liquidity that was Yeah. Yeah.
That's right.
I sum up all all the three the three things. One, the volatility waivers. Two, the the free up of the DRM, depository of Roscia Monetaria. And third, the the the the Subasta of dollars, we could get rid of them and we will be well above one hundred and forty percent one hundred and forty five percent. We don't have any worries around that, but we have been professionally managing those deposits.
The liquidity has been built by core and sticky deposits and the structural balance sheet. So I'll be happy to show you those numbers.
Yes. It'll good to take that offline because the numbers just don't reconcile, but happy to follow-up. Thank you.
Thank you, Marcelo. As always, we're more than happy to have and provide you all the necessary information that you're required to do so. But believe me, there was a big mandate for us. The capital has to be very strong. Liquidity has to be prime in order to support our clients.
And if there was facility to be taken that could be cheaper than what we can get into the market, We will take it not because we need it, because it will be full from us not to take that opportunity.
Thanks, Rafael.
Thank you, Marcelo.
Thank you, Marcelo. Thank you.
Our next question is from Brian Flores from Citibank. Go ahead.
Hi, good morning. Thank you for the opportunity to ask questions. Just a quick follow-up on the on what you're seeing on the SME portfolio. Based on previous comments made on on, think, after the first quarter, we saw a a little increase on on the guarantees provided by by nothing. Is this something originated because you're pursuing to increase them or because you are making some guidance in that particular segment?
Wrap up, please, Bahrain. Look, let me go to the numbers. 3.8% of the total book is SMEs. Of those more than 53%, 54% are under nothing guarantees. We are withdrawing more guarantees as you mentioned in the last three months by using that facility in order to keep our book clean, but not because it's something that we already paid for that.
And nothing has been very supportive of the guarantee. So we are very pleased of the way nothing has been behaving during this process supporting the client. So as I mentioned, SME is a portfolio that we are actively managing on a one to one basis, visiting clients, offering them possibilities, looking of who's going to be gone forever, who's going to be needing more time. So SMEs and remember, we have not grown the SME book for the last year and this book, okay? So and just for you to see nothing, just announced a tourism program in order to support those small companies that are linked to the student side.
So I think nothing is moving in the right direction and helping SMEs in the right way.
Thank you. And just a quick follow-up. Is this a trend? I mean, do you expect to keep tapping on the source? The nothing, is this something you expect to keep increasing?
Or are you comfortable at the current levels?
No. I think we will continue to withdraw more guarantees if we need it. But I think we are reaching our level. We moved from €50,000,000 withdraw to €90,000,000 €110,000,000 at the peak. So I think that's where we are staying on that part.
Okay. Thank you very much.
Thank you.
The next question is from Nicolas Riva from Bank of America. Go ahead.
Yeah. Thanks very much for taking my questions. I have a couple of questions. The first one is a follow-up on a prior question on the pension reform bill. So if I think about the impacts for the bank and for the holding company, for the group separately, you already mentioned the positive impacts for the holding company basically through the Apore through higher contributions into the assets under management, which, of course, is going to be good in terms of fee income for the Apore.
For the bank specifically, I would imagine there's going to be a negative impact on personnel expenses from the higher contribution from contributing an additional 1%, I believe, per year through the next eight years. Is that I mean, you assessed have you quantified in a way the negative impact on the bank from those higher personnel expenses? I would imagine it's going to be then a bit less than 1% of your bottom line per year. But any color on that would be helpful. And then the second one, Rafael, you mentioned in your initial remarks about the recent issuance of another perpetual bond.
Can you talk about the use of proceeds of this $500,000,000 that you raised if you plan to redeem any existing debt? And there was one particular comment that you made in those initial comments, which was that the idea would be not to have any more Tier two I would imagine this applies to the legacy Tier two debt from the acquisition of Ixe, for example, but not to the the 2,031 that I would imagine that you're gonna continue to have outstanding. And also, if you can explain us one more time, what's the rationale maybe for having so much 81 capital? I mean, the optimum level would be for you to have about one and a half percent of risk weighted assets in these 80 ones. Of course, they are not cheap for them for you to issue them.
If you can explain to us, yeah, why you have why you think it makes sense to have all this much 81 outstanding? Thanks. Did you guys hear my questions?
Yes. Was cut off, but I think I got the whole picture. First talking about pension reform bill, we are very happy with that. It's a proposal, so let's wait a little bit and then we can discuss it. But so far for the country, it's very good and whatever happens to the country and is very good it's good for us.
If we want to reduce a little bit the commissions, it's good. We will negotiate obviously, but we're very happy with what is going on and we need to wait a little bit what happened with this proposal. That's all we can say right now. And the second one, the 80 bond, please Rafael?
Yes. On the initial one, Marco says, what's going to be the effect in the coming eight years that they are just announcing that without any specific ruling of how you have to build up more contributions to the bond. We haven't calculated that, but honestly, I don't think it's going to be a material effect that it can be counter there should be counter effect by many ways. Like for instance, once with the pandemia, what you have seen is that you need a lot less physical space that you need to have in the past. So there's ways that we can balance that on that.
But in general, I think it's going to be good. And remember one thing, Banorte has the largest foray. We have the largest economies of scale. So honestly, what I think about this reduction in fees is more consolidation is coming and we're going to be benefit from that. On the other part, the AT1, let me just give you a little bit of history about this.
Banorte has always been having a mix of Tier two on Basel two and core Tier one that it reached on the past 31% of Tier two compared to the total cap. If you look at the numbers that we are reaching now with a completely different core Tier one, it's simply the same numbers. We are below that. We are 29%, okay? So that why we don't like the T2 is exactly as you mentioned, the legacy of the IXI is extremely expensive.
We did some tender offering last year. We continue to try to get rid of those Basel II. We don't want to fragment AT1s and AT2 on the capital numbers. AT1s are much more efficient for us based upon the strength of our capital base. The use of proceeds for that is basically funding on the dollar book.
These are already been matched by the money in dollar for companies that are have flowing dollars are linked to exports. So basically what you do is you take a funding in dollars well below your cost of capital and you use that to fund that on a dollar to dollar basis. So basically, you are issuing capital below your cost of capital in dollar terms that are already being fully matched with the money in dollars for the clients. That's the rationale. In addition to the liquidity because AT1s, as you know, they don't have any issues in liquidity.
Tier two, they start to lose efficiency long before the call date. On the AT1s, on the perpetual characteristics of this one, you don't need to add specific liquidity assets when the call date is closed. It helps you on the liquidity, it helps you on building up your capital, your total cap is much more efficient on the funding side. As you know, this goes against return earnings. And when you look at the returns that the bank is providing on the capital base above the 20%, I think it's an extremely good use of proceeds when you deploy that into the market.
Okay. Thanks very much. Good afternoon, Markus.
Welcome.
Next Thank you. Question is from Carlos Gomez from HSBC. Go ahead.
Thank you very much. Thank you for extending the call beyond normal levels. And first of all, congratulations to Thomas. This is his first quarterly conference call as Head of IR, and we wish him very good luck. Two very minor questions from us.
The first one also on the pension reforms, and we wanted to know what possible impact it has on your annuities business, not so much on the authority, but on the annuities. And second, on the margin, you focus on the impact on the first half as a whole, but the reality is that your NII in the second quarter was 6% below the first quarter. How confident are you that you will not see that decline further in the second half? Thank you.
Marcos, yes, go ahead, Pablo.
Yes. It's I mean, the annuities business Carlos and thank you for asking because I think we are very proud of the evolution of the annuity business. As you know, we just bought a portfolio from another company because we are the largest one. That gave us another income a benefit of MXN 110 close to 110,000,000. And the annuities business is becoming more and more a key driver of the profit of the bank with return on equity above the 27% and a very good opportunity that we are not having in the annuity business is that we are also lending to our clients baking the loan with the annuity.
And the portfolios that we are buying, they were very underpenetrated on that part. So the margins to be made on that on these portfolios are quite significant. So the annuity business will be really a stellar unit for us. It already is and will continue to grow nicely on that. Nothing to concern on that.
I think on the other side is everything is going in the right directions. We have the first position in the market. We are building up profitability. We are building relationship with our clients, good margins on that. The other part is that the margins.
The margins when you look at the reduction on the spread on the book on a year to year basis, our book has come when you do all the overall book from eleven point seven five on June 2019 to ten point six nine on June 20. So you see that there's a lot of resilience based upon the fixed book portfolio. But the most important piece that is related to the margin is that the cost of funding has dropped substantially from close to 3% last year to 2.2 this year on this same timeframe. And another big number that dropped and is helping us on the retaining on the resilience of the margin is that the funding that the treasury needed to fund the Interaciones book that peaked at 123,000,000,000, now it's only close to EUR 16,000,000,000 and the cost that was past year was EUR 7,500,000,000.0 for this part of the book and now has dropped to EUR 4.49. So all this managing on the funding side and also the resilience that we have on the fixed rate portfolio and also on liquidity premium that now you are putting on the spreads on the book, I think we can sustain for the bank a reasonable margin around 5.8%.
Thank you very much.
Thank you.
Our next question is from Natalia Kornfield from JPMorgan. Go ahead. Thank you everybody for taking my question. It's actually a very simple question. I am looking at your order income in your financials, and it increased quite substantially quarter over quarter.
And I just wanted to know what was the main driver of that?
Natalia, thank you very much. We were waiting for that question. The first question from Rafa?
Yes. Natalia, if you look at the components of that, the other income and it's quite important to look at the other income and compared to year to year basis, taking away the extraordinary like the INB and this part. The main number that you see and jumps on that is has related to a benefit that is concerned on the tax side, okay? And this is basically related to inflationary numbers. When we did the provisioning for the last year, we aim to have an inflationary rate of 3.2% and it came at around 2.8%.
So this basically, we over provision that so we are pulling those provisions away now that we have the goal from the fiscal department.
This concludes our question and answer. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.