Good day, and welcome to Banorte third quarter 2019 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ursula Wilhelm. Please go ahead, madam.
Thank you, Christian. Good morning, everybody. We're here for the Banorte's third quarter results. I'm Ursula Wilhelm, head of investor relations, and our CEO, Marcos Ramírez, will provide us with some remarks about the results and some longer terms thoughts. As usual, we will hold the Q&A session after his comments. Marcos, please. Thank you.
Thank you, Ursula. Good morning, everyone. Thanks for attending our earnings call. The market has been discussing and writing about the environment in Mexico, economic activity, and therefore how it can impact our business going forward. We continue to see good consumer activity, which is becoming the main driver of growth for us and for the economy, although at a slower pace. Corporates and companies remain prudent and vigilant of the decisions that the government is taking and their impact going forward. Capital expenditure is still low. Competition is strong, and we see some pricing pressure in segments like government and corporate financing. The Mexican central bank initiated the easing cycle, which we welcome as we believe it should stimulate loan demand going forward. In this environment, Banorte reported a good set of numbers with strong earnings growth and healthy asset quality.
Beginning with the quarterly results, please go to the page three of the conference call deck. I am sure you have taken this into account, but let me stress that this is the first quarter that shows the full absorption of the Interacciones merger, which happened on July 13 of 2018. The group reported MXN 8.8 billion after-tax net income. This translates into earnings per share of MXN 3.07, both increasing 1% in the quarter and 13% in the year. In fact, net income was MXN 27.5 billion year to date, getting us closer to our annual goal. Nine months earnings are up 26% annually, or 21% if adjusted by the one-offs disclosed early in the year. It is worth noting that almost all subsidiaries have their net profits growing firmly at 20%. Only insurance is tracking lower at 14% annual growth. It nevertheless is quite good.
Return on equity was strong at 19.6%, adding 15 basis points to this period. We are just a few basis points off from our 2020 plan target of 20%. The bank posted ROE of 23.6%. In terms of return of assets, we are already slightly above our 2020 target of 2.2%, as it expanded four basis points in the quarter to 2.24% and adding 27 basis points in the year. Moving to page four and five, let me give you the highlights of the results. Net interest income grew 3% in the quarter and 9% in the year, mainly driven by declining interest expense. This was possible in part due to a substantial decline in interest-bearing liabilities at the bank, which reduced the release funding cost by 10 basis points in the third quarter alone.
The cost of core deposits declined 14 basis points in the period as client loans were priced lower. This reflects the ongoing effort placed on managing down the funding costs of the assets acquired last year. In this respect, year to date, we have obtained a benefit of 90 basis points in the funding cost of the Interacciones assets. As we continue to work on optimizing the funding cost and its pricing, we anticipate an additional 10 basis points to sink in over the next coming months. We believe it's too early to see the impact of the 50 basis points rate cut on the bank's net interest income, as deposits are just starting to reprice downwards.
As per their duration, we expect the positive change on repricing to be more evident in the fourth quarter, both on the net interest income as well as on the net i nterest margins of the bank and group. In the quarter, the NIM of the group grew 25 basis points to 5.7%. Along with it, the NIM of the bank was up 23 basis points to 6.5%, while the NIM of the loan book grew 38 basis points to 8.3%. These positive trends in margins reflect the progress achieved in managing correctly the funding costs and mix. I am confident to tell you that we expect at least an additional 10 basis points growth in margin to take place between now and December.
Moving to fee income, net fees declined 12%, mainly affected by a MXN 283 million charge related to the acquisition cost from insurance on new premium underwriting. The decline is also explained by the MXN 207 million revenue of the second quarter, which is not repeated this quarter as it was related to the sale of some real estate assets. Client-related fees are tracking as scheduled, gross banking fees improved 3% in the quarter and 11% in the year on higher transactional volume from customers. The highlight of the quarter came from some market-related income. We managed very conservatively the balance sheet, always without taking unnecessary risks. Over the past 5 years, trading income has not represented more than 3% of consolidated revenues, and the group's profits result from growing customer interaction. This quarter, we obtained record trading revenue of MXN 2.3 billion, a good portion of it related to clients.
On market-related revenue, we booked a MXN 400 million gain on the correct positioning in fixed income, given the volatile market conditions observing the period, and MXN 155 million gain on the sale of available for sale securities. The remaining result, around MXN 760 million, is related to treasury operations on sovereign bonds and FX derivatives. Other income was up by 10% on higher revenues on the sale of reclaimed assets. Moving away from revenue, please turn to slide six, where you can see that expenses increased 11%. They include personnel-related costs of MXN 691 million related to salary increases and provisions. There were MXN 145 million in advisory fees, MXN 105 million in operating expenses related to the card businesses, and MXN 74 million in rents.
For the nine months, expense growth is at 9%, as anticipated, but the normalized expense run rate for Banorte alone was 4% in the quarter. The efficiency ratio was 40.2%, deteriorating slightly on lower operating leverage, but at a level that we feel comfortable with according to our 2020 plans. The efficiency ratio for the nine months stands at 38.5%, 50 basis points lower than the prior year. Efficiency improved again for the fifth consecutive year. During all this time, we have been able to achieve positive operating leverage successfully, despite the changing environment, the changing interest rates, and the changing economic roles. This has been possible thanks to a strong expense discipline at the core of the organization and operational efficiencies, and we remain concentrated on running an efficient operation. Moving on to the business, go to slide seven.
You saw in the earnings report that the loan book declined 5% in the quarter. Without any doubt, part of this decline is explained by the less loan demand, which has been sluggish through the year. Also, our lending decisions have been centered on prudent and selected growth, fostering strategic commercial relationships and prioritizing risk-adjusted profitability, as is evident in the risk-adjusted margin of 5%, which is at historical record high. We are convinced that it doesn't add value to grow without focus. Therefore, it is our priority to remain selective and rigorous in our credit and lending decisions. In the corporate and midsize company market, we are partnering with our clients, supplying them or financing mainly to cover working capital needs, keeping the loan book safely secured with adequate levels of high-quality collateral.
We also saw this quarter that many companies took the opportunity to refinance and improve financing costs. Several of our clients went to the international bond markets to refinance existing bank debt, the balance of our corporate loan book declined 6% in the quarter on loan prepayments. We expect the loan book will only grow between 4%-5%, excluding government loans, and not 7%-9%, as we had told you before. Consider it official that we are revising down the loan growth guidance for the year. At the other side of the spectrum, we remain very selective on SME risk. We don't see a lot of appetite from small companies to take on additional debt, and we remain selective, only lending to companies that maintain a strong liquidity position or have high-quality supplier receivables. The bank SME book has been flattish.
Moving to the government lending market, as we anticipated, the balance of government loans declined 16% in the quarter as we released some client exposures to the competition who was willing to take them at an unreasonable risk-adjusted return. In the consumer segment, we still see a growth story. We believe that there are good opportunities to grow with measurable risks, and for these reasons, our consumer book went up 2% in the quarter, with higher case balances across all products like mortgage, auto, and cards. In payroll loans, we have resumed growth, although not so evident in numbers yet, improved growth rates will be obvious in the fourth quarter.
We are lending again this product on the premise that the government employee segment has stabilized from the high turnover rates of the first half of the year, while in the private sector, we are taking the advantage of the salary increases. From the asset quality standpoint, we feel confident that the quality of the credit book is sound and healthy. Please turn to slide eight, where the main indicators are displayed. Let's review them one by one. NPL formation was low in the quarter, particularly in the consumer portfolios. As the loan vintages of the different products are performing better, reflecting the positive impact from the stricter underwriting standards in place. The write-off rate was 0.62%, increasing around 18 basis points and includes MXN 463 million write-off from a residual balance from the home builder legacy assets.
Adjusting for this amount, the normalized number was 0.56%, in line to prior periods. The NPL ratio was stable at 1.9%. By segment, there was a slight deterioration in the NPL ratio of the card, mortgage, and commercial books, reflecting slower growth in the denominator as the balance of delinquent loans was down 1%. The cost of risk for the quarter was 2.15%. It includes MXN 224 million in provisions for the home builder exposure that was charged off in the quarter. The cost of risk for the year stands at 2%, in line with the low-end range that we provided to you. The reserve coverage ratio declined slightly to 126%, yet remains strong and adequate for the risk in the credit portfolio. Turning to slide nine on the non-bank subsidiaries, let me start with the insurance company.
Seguros Banorte posted MXN 807 million in quarterly net earnings, up 14% annually. Retained premiums grew 8%. Lower claims, control expenses, and strong financial results resulted in pre-tax profit growth of 15.5%. Afore posted net income of MXN 845 million, 2% lower in the quarter, but up 21% in the year. The annuities company continues to post good results. For the nine months, net profits stand at MXN 758 million, up 20% versus the prior year. Let me talk about the capital position of the bank on slide 10. As shown in the earnings report, the capital ratio of the bank are strong at 20.3% and will remain strong with improving quality as we intend to reduce the proportion of Tier 2 capital. We have already called in approximately $205 million of Tier 2 subordinated debt.
Next year, we intend to pay at maturity two bonds for a total amount of $173 million. One last comment on the 2020 key point indicators on slide 11. I want to emphasize that we just crossed the two products per client ratio. It's a milestone for us and one of the important metrics that has shaped our strategy and allow us to reach the profitability that we committed with our shareholders. With this, I close the first part of my message, and let me switch gears to the macro picture. The Mexican economy has been slowing down much more than we expected early in the year, even though we depicted the less optimistic outlook among analysts. It is usual for Mexico to experience a slowdown every first year of government, but this time it has taken longer for clients to reactivate their investment projects.
As a result, GDP is growing at rates close to 0%. However, we have begun to see positive change in sentiment of local business community and global investors. Both manufacturing and non-manufacturing PMIs in Mexico shown an improvement in September, and the Mexican stock market index shows a clear inflection point since the central bank cut the reference rate for the first time in August the 15th. Business community and investors have realized the government has kept its promises of keeping healthy fiscal accounts and improving Pemex financial situation and to focus on increasing crude oil production. The 2020 budget is a fiscally responsible proposal, and the latest liability management operations conducted by the state-owned company have enhanced its debt maturity profile. Along with the government capital injection, it's clear that Pemex will be able to keep its debt repayments in good shape.
Turning to monetary policy, consumer price increases have remained at a moderate level, lowering 12-month inflation to the central bank target of 3%. It seems likely to see inflation between 3% and 3.5% next year. With low inflation levels and a relatively stable exchange rate, the central bank will likely continue with its easing cycle. We expect two additional rate cuts of 25 basis points each before year-end, leaving the reference rate at 7.25% this year. The easing cycle should continue in 2020 to lower the rate at levels between 6% and 6.5%. We expect GDP to grow at least 1.4% next year on improving business sentiment, lower rates, and a significant base effect, particularly because it will no longer be a first year of a new administration, there is a less steep learning curve to execute government spending.
We estimate a base effect of nearly 1% and a leap year effect of nearly 0.3 percentage points. Even though the U.S.-China trade war is having a negative effect globally, Mexico is benefiting from a positive substitution effect, receiving foreign direct investment in the manufacturing sector, particularly from Asian companies that are finding hard to export their production to the U.S. from their geographies. We acknowledge that challenges remain ahead. We are quite confident that we will provide the numbers we promised in our guidance, passing the 2020 plan with flying colors, and we will provide the new medium-term goals in the first quarter of next year. With this, I conclude my comments. Now let's move to Q&A. Thank you.
Thank you. Ladies and gentlemen over the phone, if you wish to ask a question at this time, please press star one on your telephone keypad. Please ensure that the mute function is switched off to allow your signal to reach our equipment. An automated voice prompt will indicate when your line is open to ask a question. Once again, please press star one to ask a question. We will pause for just a moment to allow everyone to signal. Our first question comes from Jorge Friedman from Citi. Please go ahead, sir. Your line is open.
Thank you very much for the opportunity. I have two questions, please. The first one, you had the impacts on specific cases this quarter. Just wondering if there is anything else in the spotlight that might be a concern for the coming quarters. The second question related to treasury results. We observed that in the MD&A, you mentioned that activity with clients increased substantially, but also you had stronger results with the market. Just wondering what level of recurrence we could expect in the coming quarters as well. Thank you very much.
I will start, Jorge, with the second one. We are expecting to normalize, let's use that word, in the treasury results for MXN 2.2 each quarter around that amount. Sorry, MXN 1.2, sorry, is the normalized standard, and we will go to that direction, and we expect that. Regarding the first one, anything else on the spotlight on the coming quarters, not as we anticipated. Everything that we know, I just said it, and there is nothing that we foresee right now that we should tell you. I don't know.
Yeah. Perfect. Just a quick follow-up there. There are any specific sectors that might be at stronger risk in the ongoing slowdown that we should be monitoring? You think that the slight tick-up that we saw in terms of NPL creation could also be related to the stronger growth in riskier lines, especially retail? Thank you.
Thank you, Jorge. I will pass this to our Chief Risk Officer, Carlos de la Isla.
Hello, Jorge. We don't see any sectors at this stage that could affect our portfolio. Slowdowns are not evident so far. As Marcos said, we don't have any particular concerns, at least for the moment.
Perfect. Thank you for the clarifications.
Thank you.
Thanks. Our next question will come from Thiago Batista from UBS. Please go ahead, sir, your line is open.
Yeah. Hi, guys. Thanks for the opportunity. I have two questions. The first one about the bank's capital position. Looking to the Banorte capital position, we see that the Tier 1 ratio now is 18.5%. In the last quarters, was high teens. Is this the comfortable level that the bank will probably work in the future? When you look to your capital targets, you focus more on the Tier 1 or on the Core Tier 1? My second question is about the services fees. If adjusted by the real estate gains that the bank booked in the 2Q, the fees declined materially in this quarter. It's not strong, around 7% quarter-over-quarter. We also saw an increase in the number of products per client, so cross-selling is increasing.
How do we conciliate these two points, and what the bank is expecting for fees in the future?
Rafa, go ahead, please. Thanks, Thiago, for the questions. The first one, I think what you mentioned about, let me go first to the capital target. I think the capital target, as we have mentioned to the market, we feel comfortable when we are around the 12.5 Core Tier 1. You have seen an increase on the total cap ratio, basically because we have been very successful in the market issuing additional tier one capital.
In order to really eliminate Tier 2 capital that is becoming non-efficient from a capital point of view. What you will see is a decline in the coming months of Tier 2, and you should be looking at a total cap around 18%, and Core Tier 1 should remain around the 12.5%-13%, depending on the time of the year before we give the dividend out to the market. That's related to the capital ratio. I don't know if it was clear, the explanation. You want me to go further into more details?
No, perfect.
Hi, Thiago. It's Ursula. Can you please repeat again your second question because it was not very clear.
No, on the fees.
Yes.
The fees of the bank post a material decline in the third Q. Part of that was caused by the sales of real estate assets that the bank booked in the second Q. Even adjusting for this, the fees dropped materially Q over Q.
Yeah.
Go ahead.
My point is, when we look to the cross-selling, you showed that the number of products per client increased further. I want to conciliate it. We are selling more products per client, but the total fees is not expanding. I want to see what will be the main trends of fees in the near future.
You have to look at fees on two issues. Net fees in the quarter were down, but it was not related to lower fees, but it was related to a specific charge that came from the insurance company, and Fernando can elaborate on that so you can understand why this happened. If you look at gross fees, gross fees are up around 7% in the year. Even if we break it down further, if you look at what we call basic banking fees, the one that are generated upon transactionality with customers, those are up almost 10% in the year, 11% to be precise.
What is lagging down, I would say, is that fees that are related to consumer credit are growing at a lower pace because the consumer portfolio, although it is still growing as you saw, it is growing at a lower pace than what it was growing in 2018 and in 2017. Other than that, fees from client activity and customer activity are as we expected.
Just the second one, you want to elaborate, Fernando? Yeah, please.
Well, hi, Walt. Let me explain what happened in the income statement of the insurance company, and particularly the item that is acquisition costs. What happened is that we increased a provision of a very large policy that we handle, which is the life insurance policy for all the federal government workers. What happened is that we experienced, during a few months, an increase in the loss ratio, and therefore, we decided on a provisional basis to change our methodology for our reserve, which is called the incurred but not reported reserve. Therefore, to not be showing some results that might not be observed in the future, we decided to increase the reserve at an underwrite rate on a very conservative basis.
This account has some reinsurance. According to the statutory accounting of the insurance commission, we had to put that reserve in the acquisition cost, which is where we handle all the commissions that we receive or that we have to give to our reinsurers. That's because of the statutory accounting and because we changed the methodology. Therefore, I can tell you that the loss ratio since then has been going down. Therefore, in the future, we will see whether this will be. I think we will be more than enough, which is what we just have put in place in the reserve. Even, we may observe that it was overestimated, given the recent experience in that account. Perhaps we will show that part of the reserve will go to results. That's what happened. The reason was not to show some results.
The results would have been higher, but we decided to be prudent. That's how we handle the insurance company overall. We are very prudent in the way in which we hold reserves and in the way in which we handle the business, and that was the reason why we changed this methodology, and that's why you observe this increase in this item of the income statement in the acquisition cost.
Thank you, Fernando.
Related to the cross-sell ratio, I think, and it's related to what Ursula mentioned. When you look at the cross-sell ratio, you have to look at the way we are really selling more and more at the bank that is basically going to analytics and doing the right offering to the client. The conversion rate from our campaign management processes that we have been managing at the bank has increased substantially in the conversion rate. We started at 3%, 5%. Now we can see some campaigns are reaching 18%-20% conversion rate. That's the way you will continue to see the evolution to the 2.2 that is our goal to reach to the 2020. Going back again, what Ursula mentioned, banking fees, related transactional fees that are related to the activity of the clients all over our channels continue to be strong.
You can see some weaknesses, and it's because of the sluggish that Marcos referred to the market is, basically in the infrastructure business, that has been extremely slow in the fee side. Overall, we continue to see good activity on the consumer. If you look at the results on the corporate business and the commercial business, they were up substantially on the fee side. I think that it's a mix, and it really reflects the kind of environment that we are managing the bank. You see some patches of good opportunities that we size them immediately, and in other ones, you have to go down and reduce your activity on that.
What you have to consider is the overall results are really showing the resiliency of the group by really producing extremely good results from the subsidiaries, the consumer book, and also how efficient we are managing the risk and the risk-adjusted margin for the group.
Yeah, very clear. Thank you.
Thank you.
Thank you. Our next question comes from Ernesto Gabilondo from Bank of America. Please go ahead. Your line is open.
Hi, good morning, Marcos and Rafa, and good morning to all your team. Thanks for the opportunity. How do you see loan growth next year? Your GDP growth is around 1.4% next year. Under this scenario, would it be reasonable to expect double-digit net income growth next year? What will be the assumptions behind that growth? I know you will provide more details next quarter, but any trends will be very helpful. In my second question, a couple of months ago, I believe Banorte's management met with AMLO. I believe you expressed your intention to participate in the financing of several infrastructure projects. Can you elaborate on what kind of projects are you willing to participate? If we can get your point of view in the last updates, news on Pemex will be very helpful. Thank you.
Thank you, Ernesto. Yes, as you were saying, we will release next quarter our forecast for 2020. I would like to stress that we are on our 2020 plan, and everything that is there is going to be there. So far, we think we will be doing it very well. We see, given that number, that we will grow at least two digits in the next year. I think that's all I can give you right now because we're working on that, but we feel comfortable, that's for sure, that we will deliver the 2020, and then we will launch whatever it's called for the next few years. We are working already on it, and it makes a lot of sense to us that we will provide you a very reasonable and very good, I don't know how to call it, plan for the future, no?
Rafa, you want to say something here?
Just additional what Marcos says. We are confident of what Marcos says. I think the key element that you have seen, and that has to do with the risk-adjusted margin, and I think something that the market is not taking into the full account on these processes, that the funding cost that we really incorporated when we acquired Interacciones, it peaked in January around the additional funding cost to MXN 700 million on a monthly basis. That was in January when it did peak. That has been going down to MXN 385, that same cost, because of all the action that we have been taking in reduce the funding cost and all the actions in the treasury and the balance sheet, and also a very well-managed policy on the growth in time deposits.
That MXN 385 that is currently where we are sitting on September should continue to go down to at least MXN 160 million per month. There's an additional benefit that you will continue to see flowing to the income statement. That's the reason why when people are concerned about the loan growth of Banorte, not on the consumer, and even in the consumer compared to last year, is because an additional benefit by managing the funding cost in a very active way that is going to continue to release a substantial amount to the net income in the coming three months and in the coming year.
Regarding your second questions, yes, we have been meeting with Mr. López Obrador and all the people there. For us, we want to keep everything on our radar. Then we are working with them in order to bankize all the projects and to say, "If you want to do this, we need this. If you want to do that, we need that," in order to make it bankize stably all the projects that they have. We feel pretty comfortable that in the future you will see a lot of projects that we will be working with the government. I think that's it for now. You will hear from us in the next year, a lot, I hope, in infrastructure and all this.
One thing, this is Gabriel Casillas, Chief Economist. I just want to tell you, Ernesto, just to add up a little bit on the GDP growth assumptions as well as on Pemex that you asked. With respect to the GDP growth assumptions, I think Marcos explained very well that our 1.4% GDP growth forecast for 2020 has to do a lot with the base effect. Actually, a simple calculation of base effect gives you around 90 basis points. You have to add that it's a leap year, that adds around 26 basis points. On top of that, now I can combine the Pemex question with this. In terms of Pemex, we are optimistic that they're going to be able to increase the oil outputs, mainly because of one thing.
I don't know if you remember, around three years ago, when José Antonio González Anaya took over as CEO of Pemex, oil prices were below $30 per barrel. In this context, trying to change Pemex from a production max company to a profit max company, he decided to shut down several oil fields, conventional oil fields, that were high cost at that time, around $18 per barrel. This took 250,000-300,000 barrels per day at that time. Nowadays, with oil prices above $50 per barrel, it seems very likely that Pemex is going to, once again, reactivate these fields. They're going to be able to move from the 1.7 million barrels per day right now production to 1.9 million barrels next year. This is another reason why we take into account that since year 2004, oil production has been making a dent on GDP.
It's not only going to stop subtracting growth, but it's going to actually add. This is, I think, the main idea of Pemex. Just to finish the idea on Pemex, I think it has been very important what Pemex has been doing in the past few weeks. For example, all the liability management operations that Marcos mentioned. That was very important to improve their debt profile, and also even reduce a little bit the debt with the capital injections of the government. I think it's really clear that they are not leaving Pemex there, and they will always pay the debt of Pemex. I think these are the main ideas. I just wanted to complement.
Perfect. Thank you very much, Marcos, Rafa, and Gabriel.
Thank you, Ernesto.
Thank you. We will now take our next question from Adriana de Lozada from Scotiabank. Please go ahead. Your line is open.
Hi. Good morning. I have two questions. The first one is about a legal case that we read about in the news about a MXN 1.2 billion fine. If you can give more details about that, it'd be great. Second, if you can give us details about the specific corporate write-off, give us a sense of the size and why it resulted in additional provisions and what we can expect going forward. Thank you.
The write-off was on an asset that is related to one of the home builders where we had exposure. It's not related to CFE. Just to clarify that.
Going forward, no interest.
We do not expect any more write-offs of that going forward.
On the fine, [Felix], can you?
Yes. It's not a fine. It's an old legal claim against one of the banks that we acquired in 1994, Banpaís. We cannot give more information because the legal trial is in process. On the other hand, it's fully covered by the indemnity that we have with IPAB when we acquired this bank.
Thank you. We don't have any worry about that.
Sorry, I couldn't hear the last part of it.
The fine, it's a judicial process that is in place. We cannot give you a lot of information. However, what we can tell you is that it is related to one of the acquisitions that Banorte made in 1994, and it is covered by the deposit insurance, IPAB. It is not an issue where we are concerned, or is not a contingency for Banorte.
Got it. Okay. Thank you very much.
Thank you. We will now move on to the next question. It comes from Nicolas Riva from Bank of America. Please go ahead. Your line is open.
Yeah, thanks very much for taking my questions. I have a couple of questions. The first one on capital. You explained that the target for the CT1 is around 12.5%. You're a bit over that. On the additional Tier 1 capital, you have a lot of it, more than 500 basis points of risk-weighted assets. In AT1, you have four perpetual bonds outstanding. If I look at the minimum levels of capital, the optimal level to have for you would be 150 basis points, 1.5% of risk-weighted assets in AT1 bonds, because of course they are expensive, you pay higher coupons. My question is, why does it make sense for you to have so much AT1 capital? The second question on government lending.
I remember that in the past you said that we should expect the government loan book to get diluted as a percentage of your loan book, I thought the idea was more or less for that loan book to remain flat, for the government loan book to remain flat. In this quarter, there's a big contraction in the government lending book, down 15% quarter-over-quarter. My question is, has your assessment of the risk in this portfolio changed, or why was there such a big contraction in the government loan book this quarter? Thanks.
The first one that you mentioned about the AT1, that you see a lot of AT1, you have to see the evolution that we have advised the market, that we are claiming the really expensive debt that was issued in the past when we did have some acquisitions, like the Ixe acquisitions. Some of Interacción is also, that is paper that we have to recall from that, basically Tier 2 on that part. What you will see in the past is not the level that we're concerned, because some of that will be used to really reduce the Tier 2. I think you should be getting used to see some slack on the capital base.
The reason for that is that when you look at Banorte, you have to look at a company that, in comparison with our peers like Santander, BBVA, HSBC, we don't have a parent company to support. What we have been the policy for Banorte for many years is to have a very strong balance sheet that really give all the peace of mind to our investors, not just in the equity side, but also on the AT1 and also on the fixed income side. That's something that you will see. You will see a very important reduction on the Tier 2s on the coming months. I think sometimes it might look that the AT1 could be in a surplus way.
Remember that also that allow us to do, and is considered on the amount of money that you can really invest on IT projects and things like that allow us to be always on top on that expenses without hurting anything on our capital base. Yes, it looks that is a lot, but you have to see the evolution that is coming in the next months. On the government book, I think that that has been even a note on some of the notes that came out yesterday that say that Banorte is losing 60% of the government book that we acquired. That's really not exactly right at all. If you look at the policy that we advised the market, that we want to have around 22%-23% of the total book, I think we are online on that.
The more important piece is that if you look at the profitability of the government book, I will refer just at this point in time just to the state and municipalities. The financial margin for the state and municipalities have grown 94% since we did the acquisitions and integrated with Banorte. Why? We have been very selective on which loans to keep and which loans to release to the market in order to really keep the risk-adjusted margin at the levels that we would like to have in that. Marcos referred to that there has been a very.
Unreasonable
unreasonable fight for the government book, but we have been able to keep really the relationship that we have, and the financial margin is at top 94%. What is also very important is that net profit for the state and municipality book is 54%, and the return on equity for that book is 53%. That assumption that we are losing, maybe we will be releasing some loans, but we have increasing the profitability of the book substantially. The same goes for the commercial book. The commercial book, if you look at the commercial book, that has been a sluggish growth, maybe, on the commercial. You can look at the profit for the book, 26% for the year. Financial margin, 16% for the year. The same goes for the corporate book. The corporate book, the net profit is up 36%, with good growth in financial margin.
When you see the risk-adjusted margin that is at record highs at 5%, it's because we have been extremely prudent, but we have also been providing all the services to the companies that we would like to do business with. All those services and the right approach to those companies All over the offering that we do to them allow us to have a very reasonable net adjusted margin and a very rich set of fees, and also a good growth on the deposit side. I think you have to go and look deeper when you look at what is going on with the government book. As Marcos says, immediately when we did the acquisition of Interacciones, a lot of the peers were after the book, and they created a really substantial decrease in the profitability of the new offerings that came into the market.
We were in a position because we advised to the market that we will be very selective on how we keep the profitability for the book, and we have been extremely successful in doing so.
Okay. Thanks very much, Rafa.
Thank you.
Thank you. Our next question comes from Geoffrey Elliott from Autonomous. Please go ahead. Your line is open.
Good morning. Thank you very much for taking the question. The Bank of Mexico's CoDi platform went live over the last few weeks. Can you discuss what you're doing to engage with that, and then give us some thoughts on what you think it is going to mean for you and for the financial sector? I kind of hear conflicting views. On the one hand, it's not going to generate fees directly for the banks. On the other hand, potentially a tool to drive financial inclusion. Kind of keen to get your take on whether we should be thinking about that as an opportunity or a threat.
Thank you, Elliott. Francisco Martha will help us with that.
Thank you. Yes. Thanks for your question. We have been working with Banco de México, very aligned with their requirements. If you're aware, we released our mobile banking CoDi release at the end of September, and we also implement CoDi in our paper solution, but it's for the non-bank segments. We're working on the solution. We have now as much as close to 20,000 people enrolled in the CoDi solution, and more than 3,000 people have already sent money using that solution. As mentioned, we have the paper solution for the non-banked segment, and we will work on pushing the solution. We don't know exactly how further it will go. Now, the Banco de México implemented Zona CoDi in the main square of the city, and we're working, we're collaborating, trying to convince all the small and medium merchants to join the solution.
Thanks. Do you see that as a potential threat to interchange fees you generate from credit cards, or do you see it as an opportunity? Just trying to understand how you think about it.
I prefer to see it more than a threat, more an opportunity. I truly believe that it will be more even that the payments trend towards being free. I think it's going to be used more like a springboard to enter in another type of revenue pools or another type of revenue models.
If I may add to what Paco mentioned, just imagine that if the CoDi continues to evolve and really reach a lot of the non-bank small merchants that we have all over the place, I think the flow that we can see getting into the accounts and things, will more than compensate for the merchant fees. As Paco mentioned, we see that as a big opportunity to really formalize a lot of the economy and really substitute the cash for the small merchants on this.
Great. Thank you very much.
Thank you. As a reminder, ladies and gentlemen, it's star one on your telephone keypad if you wish to ask a question. We will now take our next question. It comes from Gilberto Garcia from Barclays. Please go ahead. Your line is open.
Hi. Good morning. Thank you for the call. My question is on operating expenses. While they are indeed in line with your guidance, we were a little surprised by the sharp increase in personnel expenses. Could you give some color on what drove those expenses? Thank you.
Yeah, those expenses are mainly related to variable compensation that we provisioned based upon that we see clearly meeting our goal for the net income, of maybe a little above the net income. That's really what was it. We don't see any sharp increase on the coming months at all. That was basically to normalize the provision based upon the expectations of the net income related to the variable compensation and to the bonus pool. That's exactly what it is on that part. What you should continue to see is that really the expense ratio that we are aiming for compared to the revenue side will continue to be around the 38, 39 that we have guided the market. We don't see any reason why we shouldn't achieve that.
It was a sharp increase on this, and also the professionals' fees went up because there were some derivatives related expenses on that, but that's basically it. I think that you will see a more normal trend in the fourth quarter and continuing on the first quarter next year.
Understood. Thank you very much.
You're welcome.
Thank you. Our next question comes from Mark Lin from Lazard Asset Management. Please go ahead.
Good morning. Marcos, you mentioned earlier about the trade war substitution effect. How would Banorte specifically benefit from the inward Asian investment? As Mexico captures some of the benefits from, whether it's Asian or Chinese companies shifting the supply chains to Mexico, which manufacturing areas are we seeing this in place?
Thank you, Mark. Yeah, sorry. Thank you, Mark. Mr. Gabriel Casillas is going to help us with that.
Thank you, Marcos. Thanks for your question also, Mark. Well, let me tell you, we have had visits from several manufacturing companies from Asia in the past three months, particularly in the automotive sector. These have been the main companies. They're not necessarily automakers, but companies that work for automakers. They have told us that they have had some difficulties to export their stuff to the U.S. from their geography, sometimes not because of tariffs, but because of non-tariff barriers. They are seeking to invest in Mexico because of that, so in order to continue to export to the U.S. Yeah, it has been primarily in the automotive sector. I hope I answered your question with that, Mark.
Sure. Thank you.
Thank you.
Mark, if I might add to Mark, I think that Gabriel has been also really giving a lot of information to the market that if you look at the rate of growth of the center and to the north part of Mexico, that part continues to be extremely active and growing well above the GDP, 0.4 or whatever it is. That is where really Banorte is mainly located through the country. That activity will continue to benefit us and also the activity of the trade, but also the already existing high employment, good remuneration, good activity related to the supply chains in the center and to the north. That is where really Banorte has most of the geography really covered for that. We really continue to expect very good numbers coming from those regions.
Thanks, Rafael. Thank you. That's very useful.
Thank you.
Thank you. We have no further questions over the phone queue at this time, gentlemen.
Okay. Well, thank you, and see you next year, at the beginning of next year. Thank you very much.
Ladies and gentlemen, this will conclude today's conference. We thank you all for your participation. You may now disconnect.