Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q4 2019 Earnings Call Transcript

Published: 31 Jan 2020

[Operator:]

Greetings, and welcome to the Banco Santander México's Fourth Quarter 2019 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.It is now my pleasure to introduce your host Héctor Chávez, Managing Director-Head of Investor Relations. Thank you. You may begin.

[Héctor Chávez:]

Thank you. Good morning, and welcome to our fourth quarter 2019 earnings conference call. We appreciate everyone's participation. By now, everyone should have access to our earnings press release and the presentation for today's call, both of which were distributed before the market open today and can be found in our Investor Relations website. Presenting on our call today will be Héctor Grisi, Executive President and CEO; Didier Mena, our CFO; and Rodrigo Brand, Executive General Director of Public Affairs.Following the review of our fourth quarter and full year results, we will be happy to answer your questions during the Q&A session. Before we begin our formal remarks, allow me to remind you that certain statements made during the course of this discussion may constitute forward-looking statements, which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to materially differ, including factors that could be beyond the company's control. For an explanation of these risks, please refer to our filings with the SEC and the Mexican Stock exchange.Héctor, please go ahead.

[Héctor Grisi:]

Thank you, Héctor. Good morning to everyone and good afternoon to those of you in Europe. Thank you for joining our earnings call this morning. We have had a very solid fourth quarter despite the challenging economic environment both domestically and abroad. Our loan portfolio expanded in line with Mexico's banking market supported by a retail segment as well as our government loans. Also, we continue attracting individual deposits while further enhancing our ability to cross-sell products. Although the economy has remained stagnant, our asset quality improved year-on-year, thanks to our prudent growth strategy and strict origination criteria.Net interest income along with higher fees drove our core earnings while market related income was higher than average in the quarter. And despite some uptick in our efficiency ratio and substantially higher effective tax rate, we delivered solid net growth – economic income growth with ROI and ROE relatively stable for the year. But before discussing in detail the evolution of the quarter as we normally do, I would like to spend some time sharing with you the results of our investment plan, which we effectively executed over the past three years and we are wrapping up this cycle.We are pleased with the results even though we still have much more ground to cover to transform our bank from an operating and cultural standpoint, we have reached a point where we have closed a significant technological gap versus our peers and we have laid out their foundations to continue building a stronger and more profitable bank and franchise in the country.Please turn to Slide number 4. As we have noted on earlier calls, we have reached the end of the third and final year of our investment program, which has started in 2017 and was aimed as strengthening our franchise and positioning the bank to boost profitability while also becoming more client centric. As you might recall, the investment targeted three key groups of initiatives. More than 50% was allocated to the transformation of our distribution network and upgrading our technology as we have reorganized our business to drive innovation and invest in infrastructure.We have been enhancing and digitalizing our processes and operations while also investing in providing higher-quality customer service, but at a lower cost by for example, we’re directing certain transactions to lower cost channels like mobile. One third of our investments were focused on initiatives to strengthen customer acquisition, transactionality and loyalty. This included the Santander Plus loyalty program, the Santander Mexico credit card and the payroll attraction project. The rest of the investment plan was targeted at new market segments, mainly financial inclusion and other financing as well as the distribution of third-party insurance product to our middle market clients and operating leases.Let me give you some more details in the next slides on where do we stand after completing these investments. In Slide 5, you can see the main items were 53% of the investment program was direct, mainly in enhancing our IT capabilities, utilizing the bank and improving our distribution network infrastructure. Our key initiative was launching our digital factory with the strategic partners and employing an agile methodology to digitize the bank operations and upgrade platforms and processes. According to the factory works alongside fintechs and companies like MasterCard, Accanto and IBM to allow Santander customers to do almost any banking transaction from their smartphones as well as digitizing our own internal processes.The development of our digital offering by our factory is centered on digital products and our mobile channels such as SuperDigital, a fully digital account, which addresses non-bank clients or digital natives, who prefer bypassing a bank branch. Near the end of the fourth quarter of 2019, we have over 376 – 600,000 of these accounts. Our mobile app, Super Movil has been enhanced over the past three years with over a hundred functionalities and features that improve our digital customer experience. These features include face ID access, card less cash withdrawals, customized personal and saving plans, the programming of direct debits, contactless payments through smartwatches and managing credit card certifications of our recognized charges.Bancos de Mexico CoDi's payment system is embedded in our app and we even offer our customers instant money transfers through WhatsApp and other messaging platforms, regardless of whether they already have an account with Santander or not. This service is called Santander TAP has more than a hundred thousand enrolled customers with more than half a million transactions in its first seven months of operation. Our Super Wallet app was designed for managing credit and debit cards by allowing the blocking and unblocking of cards at anytime. Checking balances in real-time, making contactless payments, generating credit card pins, keeping track, often paying with the reward points, later in the year we will launch [indiscernible] single app which is being developed here in Mexico and will be used across Santander Group’s subsidiaries.We have also made important improvements in terms of digital customer onboarding processes, which have allowed us to significantly reduce account opening time and bringing customers for immediate cross-selling opportunities. We also updated our call center system and CRM, which now provide us with better tools to cross-sell and improve our customer service. In addition, investments in data analytics and quality enhancements have been a key to boosting customer acquisition, attracting more payrolls and cross-selling more of our products all of which is crucial to strengthening customer loyalty and increasing revenues.Regarding our distribution network capabilities, the bank reached 1,093 full function ATMs, 10 times what we have had three years ago, getting to our network market share in ATMs. In addition, 73% of our traditional ATMs are new, that is 5,782 ATMs over the past three years. We are also completing the rollout of our new ATM platform. By identifying more than 800 micro markets in Mexico, we were able to tailor our branches accordingly to reach micro market needs along with better customer service. A total of 541 branches, which is almost half of our branch network have been transformed into this Smart Red format over the past three years. This model promotes the use of digital channels and self-service. In terms of incentives, we also transformed our distribution network model whereby branch managers are responsible for the branches on P&L and cost of risk.Among the innovative formats that we are introducing in our first Work Café in Mexico, a co-working space for both clients and non-clients, which is – in these two months of operation has shown an NPS of 92%. We are replicating this format elsewhere in the country as it has been implemented in all geographies of the Santander Group given its success in terms of the strengthening relationship with existing customers and giving more visibility on Santander’s broad portfolio of financial services. We also opened five Isla branches, a new format which specializes in transactions, offering a personnel and self-service experience with extended service hours and with a maximum waiting time of 15 minutes. In addition, we are in the process of opening 50 digital kiosks, called Islas Financieras, in 39 cities across Mexico. All these locations costumers are offered personalized assistance for using digital channels. Investment in our infrastructure includes opening 10 new corporate centers throughout the country.Please turn to Slide 6. I would like to highlight here that we are very satisfied with the success of these investments with regard to the current composition of our retail customer base. As you might recall, we launched several initiatives aimed at attracting new customers and strengthening the loyalty of existing ones. Among these initiatives, let me highlight our Santander Plus loyalty program, which as of December 2019 has enrolled 7.2 million customers with 53% of them new to the bank. We have attracted 1.3 million net new payrolls in the past three years, 36% more than in 2016 and almost 560,000 of those were opened in the last 12 months.This level of new payrolls is almost twice the number of payrolls that medium-sized regional bank has. In turn, our Santander Mexico co-branded credit card has more than 1 million card holders as fourth quarter of 2019 with 32% being new to our bank. And finally, our low-rated Hipoteca Plus mortgage is allowing us to attract more loyal customers. In 2019, 77% of new mortgage loans were linked to the Hipoteca Plus. These initiatives allow us to reach 3.2 million loyal customers by the end of 2019, twice as much compared to what we had prior to implementing our loyalty strategy and investment plan.Not only do we have more loyal customers, but the penetration level of loyal to active customers has increased by almost 12 percentage points from 21% in 2016 to 33% in 2019. And more importantly, the share of individuals in demand deposits has expanded by 610 basis points to 34% of our total demand deposits contributing to a better mix that we felt to reduce our funding cost. Digital and mobile customers are more loyal, enjoying a better customer experience, and also a more cost efficient to serve. Accordingly, our investments and efforts to further digitalize our customer base and build loyalty led to three times increase in digital clients, which reached 4.2 million by year end in 2019, while are mobile customer base expanded more than four times to 3.8 million in the same period.Mobile monetary transactions by individuals now account for 87% of total digital monetary transactions by individuals up from 57% back in 2017. Even though most of our investments initiatives are focused on the retail segments, Santander continues to consolidate leading positions in Mexico key commercial banking segments such as SMEs and middle market as we aim to become one of the top three players in corporate and investment banking in the country. During 2019, in terms of volumes operated, we consolidated our leadership by ranking number one in project finance, ECM, M&A and ETDs; and number two in local DCM. We have lunched several initiatives aimed at our commercial customers such as new electronic banking services designed for large companies and SMEs, digital services available through smartphones and tablets.Further, we have reduced approval time for SME loans from 48 hours to 60 minutes together with Santander Plus like loyalty program designed especially for SMEs and individuals who are commercially active. As you may also remember, last quarter we announced the commercial alliance with CONTPAQi, a leading company in accounting software for SMEs. Together we plan to develop financial products that meet the SMEs specific needs and to offer credit base on their transaction – transactional information.Finally, let's turn to Slide 7. Let me comment briefly on two other projects launched in the past three years that are evolving quite nicely. With regard to Santander Mexico’s financial inclusion program called Tuiio, we have opened 85 Tuiio branches in 18 States by the end of the fourth quarter of 2019 serving more than 105,000 customers. The total loan portfolio stood at Ps. 261 million, which implied more than Ps. 1 billion of loan origination. We are very proud of this program, which serves mostly women, but it is effectively contributing to financial inclusion of Mexico on bank population.Since TUIIO began operations, more than half of these customers have used ATM and or have obtained a debit card for the first time in their lives. We are planning to continue leveraging the technology to provide more products and services to this segment.Another point I would like to highlight is our auto loan business. Through Super Auto, we are working with 657 dealers and more than 100 automotive groups nationwide. We have established alliances with Peuguot, Suzuki and KTM, which have positioned Santander Mexico as their main financial partner along with personalized offers for the customers.As of December of 2019, this loan portfolio totaled over Ps. 2.2 billion. We've also successfully launched our commercial alliance with a leading insurance broker, allowing to offer P&C insurance to our commercial customers and complementing our existing offer of insurance products.And finally, even though progress in developing our leasing products has been slower than we expected, we have a team working full-time on the product and should have it market-ready shortly.To conclude this review, I wish to emphasize that even though we have completed our three year investment program, Santander Mexico remains committed to being the primary bank of growing number of loyal and digital customers to ongoing enhancement to our product offerings and to do term optimization of processes using the latest technologies.In order to accomplish this, we will continue investing as an integral part of our ongoing operating activities. I hope this gives you a clear and complete understanding of what we have accomplished during the past three years.Now, let me turn the evolution of our business during the fourth quarter. Then Didier will review our quarterly results in more detail. Looking at Mexico banking system on Slide 8. System wide loan loans further decelerates by the end of December, growing 4% year-on-year, a level we have not seen since March 2010, immediately after the financial crisis of 2008, 2009.Commercial and government loans drove the quarter's dynamic with a 2.9 and 4.1 year-on-year expansion, respectively. On the other hand, year-on-year growth in consumer loans accelerated, growing at around 5% among the lowest growth since 2015.System deposit growth decelerated further to 4.5% year-on-year from 5.2% in the prior quarter amongst slowest since 2014. The market’s soft performance was in response to a challenging year, impacted by conditions of uncertainty, originating both locally and abroad.For 2020, our expectations are more constructive. The approval of the USMCA by the U.S. Congress and in Mexico and the launch of the infrastructure program here should contribute to a picking up in private investment. In turn, this is expected to drive economic activity, spur our recovery in the construction industry and strengthen loan demand in the corporate sector. We also expect the consumer to remain resilient on the back of employment growth, growing real wages and high levels of consumer confidence.As the government begins its second year in office, a normalization of government spending should also result in better liquidity conditions for SMEs and for private consumption. Accordingly, we expect GDP to expand by almost 1% this year. Given the inflation expectations remain stable; we forecast a 2.6% for 2020. And as I said, we'd likely maintain a commodity monetary policy; we anticipate Banxico will lower rates by 75 basis points through the year, reaching 6.5 by year-end.Now turn to Slide 9 for an overview of Santander loan performance. Our loan book expanded by 3.3% quarter-on-quarter and a 4.5% year-on-year, finishing this year slightly above our 2% to 4% revised guidance for 2019. This higher growth level was supported by the solid performance of our retail segments, particularly mortgages, credit cards and payroll loans, together with a robust pickup in government loans by contract. By contrast, SMEs and corporate loans contracted slightly. Importantly, high-margin loan segments expanded almost 4%, accounting for around 53% of our loans at almost 70% of net interest income from loans.Please turn to Slide 10 for details on our retail loan performance. In consumer loans, our strategy continues to focus on payroll launch of our unsecured personal loans, by leveraging our strong position in the middle market and SME segments. Payroll loans expanded 11% year-on-year. Since we began focusing on driving payroll loans in the first quarter of 2017, this segment contribution to consumer loans has increased 53% to 62%.Further, we gained almost 170 basis points in market share. Personal loans in turn declined nearly 10% year-on-year. Credit card loan growth decelerated to 6% year-on-year from 70% in the third quarter credit. Card usage remained stronger at 11%, although an increasing percentage of customers continue to pay their balances in full in line with market trends.The solid performance in retail lending was mainly driven by our strategy of cross-selling products to our payroll and Hipoteca Plus customers while also supporting healthy assets quality and good levels of profitability. Finally, mortgage loan growth was up over 7% year-on-year, even after the sale of the Ps. 1 billion non-performing loan portfolio in January.Organic mortgage origination remained strong at 12% year-on-year compared with 11% growth for the industry. This represents the fifth consecutive quarter of exceeding market growth in mortgage origination. Our relatively strong performance in this category was mainly driven by Hipoteca Plus, which accounted 65% of total mortgage origination in this quarter and 77% for the full year.And in addition to cross-selling credit cards, as I mentioned earlier, we're also tracking quality lines to be Hipoteca Plus to cross-selling more financial products and services and thus expanding our share of wallet.Turning to Slide 11. Commercial loans expanded 3.3% year-on-year. The solid performance in the middle market launch and government trending was partially offset by the slight contraction in the SME and corporate segments.While government loans were driven mostly by public sector companies, corporate loans fell over 1% year-on-year due to economy’s weak performance during this year. In turn, SMEs contracted 1.5% year-on-year. On a sequential basis, the pickup in our commercial book was mainly driven by government loans, which increased 17% quarter-on-quarter.Moving to deposits on Slide 12, we continue to focus on increasing deposits from individuals relative to corporate deposits. Individual deposits were up 10% year-on-year as we continue making headway in attracting and retaining retail clients. This was the 12th consecutive quarter in which individual deposits expanded at a faster rate than corporate deposits. High interest rates continue to support individual term deposits, up just 11% year-on-year and growing 10 percentage points faster than corporate term deposits.Overall, individual deposits grew 250 basis points of share in total demand deposits and 210 basis points of share in total term deposits. This brought individual deposits to 34% of the total deposit base, up from 31% in the 4Q in 2018 and 27% in the 4Q of 2016, when we started to focus more on the profitability of Santander deposit base. In contrast, corporate deposits, which are, in some cases, now we now forego contracted 4.7% year-on-year.The contraction in corporate deposits was concentrated in a handful of clients with significant amounts. In sum, total deposits declined slightly year-on-year, also slightly below our guidance range of 0% to 2% growth. Sequentially, our deposits increased just over 1%.Before I turn the call over to Didier, who will review the capital position, P&L and full year 2020 outlook, I would like to put our fourth quarter and full year performance into context. Although Mexico's economic environment has remained challenging, we nevertheless continue attracting greater number of individual customers.As I discussed at the beginning of the call, we are very satisfied with the investments we have been making to drive customer loyalties and digital transactions, which are paying off in terms of customer acquisition and with our profitability in the medium to long term.Now that the cost of our three-year investment plan are designed, and we have a stronger franchise in place, we are confident that we can maintain this profitable growth momentum in the coming years and in a business environment that we will consider to be more supportive. Thank you for your kind attention. Didier please proceed.

[Didier Mena:]

Thank you, Héctor. Good morning, everybody. Turning to Slide 13. We maintain a sound funding position, with net loans to deposits at 100% and liquidity coverage at 159%, well above the regulatory threshold of 100%. We remain very comfortable with our debt profile with manageable debt maturities.Our capitalization ratio decreased 52 basis points sequentially to 16.4%, reflecting the dividend payment we made during the quarter, while core Tier 1 capital was down 40 basis points to 11.9% and Tier 1 stood at 13.1%.As you can see on Slide 13, net interest income increased 3% year-on-year. This performance was supported by steady growth in retail loans, mainly credit cards and payroll loans. Further, we maintain our focus on profitability across the balance sheet.For the full year, net interest income expanded by a solid 8.1% year-on-year, driven by higher interest rates on average throughout the year and by loan volumes. Interest income from the loan portfolio was up nearly 3% year-on-year with net interest margin contracting five basis points. For the full year our net interest margin expanded 14 basis points to 5.61%, benefiting from a 40 basis points expansion in the average benchmark interest rate.Moving down to the P&L on Slide 15, we continue generating solid growth in net fees, up just over 2% year-on-year. Insurance and credit cards were the main contributor to fee growth, driven by strong cross-selling to our mortgage and payroll customers and by sustained high usage levels, respectively. For the full year, net fees increased by 7.1% year-on-year, driven also by these two segments as investment banking, investment funds and cash management contracted is slightly on softer market dynamics.Turning to Slide 16. Growth in gross operating income was just above 11% year-on-year, driven by a positive performance in all areas of our business. Core earnings accounted for 94% of gross operating income, while trading gains increased above our historical average levels of Ps. 600 million to Ps. 800 million for a second quarter in a row.Declining interest rates and unappreciating peso together with improved client trading activity supported market making gains. On a full year basis, we posted a strong performance with gross operating income up nearly 10%.As you can see on Slide 17, we again delivered healthy asset quality with improvements across the board, these despite the challenging economic conditions we have been referring to. Loan loss reserves remained stable year-on-year, reflecting a healthy loan book. Sequentially, loan loss reserves were up 8.6% as provisions for consumer loans have a seasonal effect due to the Buen Fin that happened in November.For the full year, loan loss reserves increased 2% year-on-year, below the expansion rate of our loan portfolio. NPL ratios also remained healthy with total NPL ratio improving by eight basis points year-on-year at 2.28%. Overall is in line with system levels. Similar to the third quarter, improvements in mortgage loans and credit card NPLs more than offset a 52 basis points increase in SMEs, NPLs, which reflect weaker economic performance. However, at 2.42%, these NPLs remain at low levels.Also remember that in 4Q, 2019 Nafinsa guarantees for SMEs increased to 68% of the SME loan portfolio, up from 52% in the second quarter of last year. Commercial loan NPLs in turn register a six basis points year-on-year improvement. This brought cost of risk down 12 basis points year-on-year to 2.6% in the quarter well below our guidance range of 2.8% to 3% for the year. Sequentially, cost of risk also showed a slight improvement down two basis points.Now please turn to Slide 18. As we complete our three year investment plan, administrative and promotional expenses increased 12% year-on-year and 5.7% sequentially. Specifically, we recorded higher depreciation costs related to the investment programs and higher personnel costs related to efficiency programs that we implemented during the quarter. For the full year, costs were up 10% year-on-year at the low end of our guidance range of 10% to 12%.In the near term, the execution of our operational transformation program continues to impact our efficiency ratio, which rose 58 basis points year-on-year to 47.2%. For the full year, this ratio rose 23 basis points year-on-year to 45.4%.Turning to profitability on Slide 19. Profit before taxes performed well, up 17% year-on-year for the quarter and 14% for the full year of 2019. Net income increased slightly over 7% year-on-year to Ps. 4.9 billion, while our effective tax rate increased 688 basis points year-on-year. This resulted in an 8.9% increase in net income for full year, which was Ps. 21.3 billion. The result lies above our guided range of 5% to 7% increase, and despite the much higher effective tax rate of 25.6%, 354 basis points higher than the previous year, an overall weaker business environment. Return on equity was 14.8%, 30 basis points below the year ago level and down 175 basis points sequentially. For the full year, ROE remained relatively stable, contracted slightly by 7 basis points to 16.1%.Turning to guidance on our next slide. As we’ve been noting during this presentation, we are pleased to have made or exceeded our financial targets for the year, particularly given this still challenging macro environment. We’re also very pleased with the quality for our results and with a robust core earnings growth, especially considering that we ended the year with an effective tax rate slightly above our guidance range or to lower than expected inflation.Although we fell slightly below our target on deposit front, the result was due to our heightened focus on prioritizing return deposits over corporate deposits, a strategy that we will maintain in 2020. Note that total individual deposits increased 9.6% year-on-year. Altogether healthy growth in our retail loans coupled with a reduction in cost of risk, effective cost control and robust market-related income generated a solid result in the phase for much higher effective tax rate.Before moving onto Q&A portion of the call, a brief discussion of our guidance for full year 2020, it will follow. We’re expecting annual growth in our loan book between 5% to 7%. On the back of slightly higher GDP growth, we’re assuming a 0.9% year-on-year, as we expect this slight pickup in government spending and private investment that we also anticipate. Total deposits in turn are expected to expand between 2% and 4%, as we continue to focus on reducing our cost of funds by attracting more demand deposits from individuals and SMEs, while trimming the cost of our corporate deposits.We expect asset quality to remain stable with cost of risk in the 2.7% to 2.9% range, which includes the one-off impact of implementation of internal models for the mortgage portfolio. Please note that we are awaiting authorization from the regulator to implement this model. In terms of cost, we’re anticipating 2020 expenses to increase between 5% to 7%, as amortization and depreciation charges from our three year investment plan will continue affecting total cost. With respect to Santander’s effective tax rate, we expect it to lie between 26% and 27%, slightly higher than last year. Taking all this into account, we forecast net income to grow between 3% and 5%.In summary, we continue to execute our strategy with focus and discipline. By significantly enhancing the breadth of our products, digital offerings, distribution network and the overall customer experience, we continue attracting individual deposit at a solid pace and further strengthening customer loyalty. In addition to facilitating and driving the cross-selling of products, we have built a much stronger franchise in what continue to be a challenging economic and market conditions.Before concluding the remarks, I would like to reiterate that our company shares remains part of Mexico’s IPC index at an average trading volume of $6 million per day, which includes our trading volume in the ADR. And most importantly, we remain committed to direct and proactive communication with the financial community and to maintain a high level of disclosure, transparency and access to Santander’s Mexico’s management.We’re now ready to take your questions. Operator, please go ahead.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Jorge Kuri with Morgan Stanley. Please proceed with your question.

[Jorge Kuri:]

Hi. Good morning, everyone and congrats on the success of all of your transformation initiatives. Two questions if I may. On your guidance, there’s no mention about net interest margin. I’m so curious to hear what you are expecting 2020, given the declining rates, what will that mean for your name? Are you going to see a compression? What size? And two, on trading income, clearly a point out of the curve this quarter vis-à-vis recent trends. Can you walk us through how that should pan out over the next quarters? Is this a new sustainable level? Is this a one of what do you think is a more normalized level for the next year? Thank you.

[Didier Mena:]

Hi, Jorge, very nice talking to you. Regarding net interest margin dynamics, I think that there are several forces. That on one hand, we’ll definitely put significant pressure to turn in and basically the most relevant one is, as you rightly mentioned a reduction in the reference interest rate. We’re expecting, as Héctor mentioned, 75 basis points contraction in interest rates. If these reductions in interest rates happen in the first three meetings of the Board of Directors of the Central Bank, then the average reference rate would be close to 6.67%. And that will be very similar to what we saw in 2017, just as Héctor referenced.On the other hand, the positive things that will help us mitigate this reduction – the reference rate are the following; first, the continuous expansion of our individual demand deposits contribution to overall demand deposits. We’re also focusing, and I would say, very recently on monitoring the cost of deposits from SMEs and mid-market companies and large corporates. We historically, Santander Mexico have paid depositors in these segments much higher than our peers and then the system. So with discipline and focus, we are expecting that the cost of owns to come down.So this will also help us mitigating that impact. And also there is something quite important to the comment regarding the contractions that we saw in the fourth quarter of 2019 in our NIM. That was mainly associated with the acquisition of investment securities, we bought investment and securities with fixed rate in order for us to compensate for the potential decrease in interest rate in the coming years. So, that implies a negative carriage for the quarter. So that’s why we view that decrease sequentially was so significant.Throughout the year, when these decreases in interest rates start materializing, we’ll start benefiting from the actions that we took in the quarter. So all in all, we think that, NIM will be stable or there’s chance according to how all these things may evolved, we might see even a small expansion or small contraction. But it’s going to be relatively flat, which I think is positive news with a potential 75 basis point contraction in interest rate.And then on your second question, if we take a look on historical perspective, this quarter market-related income contributed 6.5% of our gross operating. The average since we became a listed company is 4.2%. So we don’t expect these levels to be a requirement, not only this year, but the coming years. We think that that we have this growth for several years, the range that we think is sustainable is something around Ps. 600 million to Ps. 800 million on a quarterly basis. So yes, it’s above the average. For the full year, it’s actually slightly below the average that we’ve seen since we came as listed company. For the full year, it’s still shy of 4% of our gross operating.

[Jorge Kuri:]

Great. Thanks for the detailed response.

[Operator:]

[Operator Instructions] Our next question comes from the line of Ernesto Gabilondo with Bank of America. Please proceed with your question.

[Ernesto Gabilondo:]

Hi. Good morning, Héctor and Didier. And thanks for the opportunity to my questions. My first question is on your expectations for cost of risk. As you mentioned, it is coming higher than in 2019 in light of the additional provisions for the recalibration of the mortgage portfolio. So when do you expect to recognize the Ps. 600 million, Ps. 700 million in the P&L? Do you expect it to be recognized gradually in each quarter or do you see a potential window at the end of the year if the regulator allows you to adopt IFRS 9 before 2021 and then the pass the impact through equity?

[Héctor Grisi:]

Hi, Ernesto, nice talking to you. I think that we have no option to make this gradual impact through our P&L. As soon as the CMBB approves the internal model then we need to make the provision on the following month. And it’s uncertain, where we will have that conversation. We think that, as we discussed in the earnings call of last quarter that we were expecting that to happen last quarter, it didn’t happen. We expect that to happen in both. But it is our control. It might be the case, I think there’s a very low probability that the CMBB do not approve this year and we might end up not innovating this charges through our P&L. But it’s completely binary. As soon as we get approved, then the following month we will need to make the provisions.

[Ernesto Gabilondo:]

Perfect. Understood. And then for my second question, I remember that in the last conference call you mentioned the possibility of a special dividend. We saw the fourth quarter results and the common equity Tier 1 ratio declined a little bit. So how much do you think would be the amount you will be considering to pay special dividend and if you are analyzing a more aggressive buyback program. Thank you.

[Didier Mena:]

Regarding the dividend, you might recall that we changed our dividend policy. So in the past we used to pay 50% of our earnings, okay, 50% by average. Then in anticipation of an accelerated loan growth, which is not happening. But that was the main idea. We changed the dividend policy so that we could dividend out the excess of certain level of core Tier 1 ratio. We defined that at around 11%, okay. Since we changed the dividend policy, our core Tier 1 ratio was below 11%. So we continue paying 50% of our earnings.Now for the first time – for the first year since we changed the dividend policy, we are surpassing 11% core Tier 1 ratio, okay. So that is allowing us to propose to our shareholders and the proposal will be made, it’s typically made on an annual basis in April in the shareholders meeting to increase the dividend payment because of these excess capitals that we have. Our proposal implies, our payout ratio that it’s slightly above 70%.Okay. And if it’s approved in the shareholders meeting at the end of April, it will be paid a bit at the – in May, as it’s historically has been the case. So you probably would call that we make two dividend payments throughout the year. We already paid 50% of the earnings we achieved in the first half of last year. So the second payment of the event 2019 results will take into account, the 50% of the second half 2019 earnings and on top of that, the excess dividend that will get us to a 70% close of payout ratio. So that’s on the dividend. The other question was on the top of the specialty? What’s it?

[Ernesto Gabilondo:]

The buyback?

[Didier Mena:]

The buyback, yes. Since the tender offer was announced, we have not been active for obvious reasons. We understand, we are very conscious about the investor liquidity since the tender offer was completed. So we would be in very quiet on our buyback program. So we will monitor liquidity and if it makes sense, we’ll differently buy more shares. But we were very mindful about liquidity.

[Ernesto Gabilondo:]

Very helpful. Thank you very much.

[Operator:]

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

[Jason Mollin:]

Hello everyone. Thanks for the opportunity to ask questions. So Santander Mexico has been emphasizing its focus on retail clients. We saw a lot of that in this presentation, specifically growing faster in loans to individuals than in loans to companies and government and prioritizing retail deposits over corporate deposits. Can you talk about the competition in the retail lending, in terms of rates? I mean, you’re very competitive on the mortgage side, but also on the deposit side, we are hearing from many banks that they’re looking to follow very similar strategies to offset margin pressure as well as interest rates come down. And then as part of that, if you can just talk about where were Santander Mexico sees the lending cycle for mortgages, credit cards in consumer. And how do you view the risk that consumers will rollover at some point and we could see material increase in delinquency. Thank you.

[Héctor Grisi:]

Thank you, Jason. Let me tell you, I mean in terms – I mean the market is quite competitive in Mexico now. If you take a look of what’s been happening, there are a couple of medium-sized banks that are basically trying to grow very aggressively, not just their deposits for also the long portfolio. So you have a couple in the basically tried to gain ground. Some of the other banks basically, I mean, have been more conservative in terms of how they have grown their portfolio and they’re basically re-accommodating the capital allocation in some ways and we are basically doing the same work. We’re concentrating ourselves in the sectors that we believe, there is less delinquency. There is also less probability of the cost of risk to come up and where we could have basically better returns.So in that sense, we’re trying to be a niche player. If you allow me to term given the size of the bank, both, we’re trying to move really fast to what we believe is going to happen in the market in the near time. The market is very dynamic in terms of what’s going on due to the fact that of the economic conditions in the country. And I started as well. So we have brought up very quickly. We have a meeting every couple of weeks to decide exactly how do we price our deposits and also how we price loans given that. And we’re going to be – we want to continue basically to grow on payrolls and to focus ourselves in deposits. The most important thing we need to do is to increase our demand deposit base. I don’t know if that answers correctly, your questions. But the competition is quite hard.In terms of how did we see the lending cycle, I think it has been pretty healthy and it’s going to continue to be like that. If you remember in my presentation, I said that for example in credit cards that the outlines are basically being very concerned about how to manage that. And they’re basically trying to pay down the balances as much as we can. If you basically see, I mean even though the user credit card more, they basically paying us better parts of the balance every single month. So that’s why the credit portfolio has not brought up the same base. If you see the growth of the invoicing is around 11%. For the growth, the portfolio is around 5% to 6%. So that basically tells you a little bit what the consumers’ is thinking about.In terms of the other portfolios. The only portfolio that we saw a little bit of – or we had a little bit of concern was direct consumer loans, which we basically stopped doing and concentrated on payroll loans, which basically had less type of risk. So in this type of markets, I believe you need to adapt. You cannot basically attack the market in the same way. You have to be smart about how you do it. But I don’t think that the lending cycle is in any way in a bubble or the people are very leveraged. I think that this continues to be room to grow.

[Didier Mena:]

Just complimenting on what Héctor mentioned, Jason. I would encourage you to look at the latest financial stability report by Central Bank, which they breakdown by income level, how the performance of asset quality and I agree fully with what Héctor is mentioned. However, if you look at low income individuals, you get to see a light deterioration in those income levels. And our exposure to low income individuals is very limited. So I think that those players that have a larger exposure to that segment, I think that they will have a more challenging year than others that are not that exposed to the segment.

[Jason Mollin:]

That’s helpful. Maybe just a comment on what you said about increasing the individual segment of the total demand deposits as a percentage of everything you have in your funding, but you mentioned 28% contribution in 2016 that improved at 34% in 2019. What’s the outlook for that or the targets for 2020 and beyond?

[Héctor Grisi:]

Look, I mean, Jason, in that way we’re going to be as aggressive as we can to continue to grow. I mean, our main goal is basically to be at the same level our competitors are, our main competitors. As you understand, I mean we always have had less individual clients compared to our peers. And this is basically what we need to focus to be completely balanced versus them in terms of our funding cost. One of our main concerns always has been the funding costs, which we are – is slightly higher than our competitors because of the mix of deposits that we have.So that if you ask me, that’s our main task this year. What we have done, we did a slight change in which, Didier Mena being cheerful. He’s also the Chief Investment Officer of the Bank in which he’s going to take care about capital allocation, about cost of funding and we’re going take a really close look and how do we basically decrease our cost of funding versus our competitors. So that’s the main task we held for the year.And just complimenting on that, just to give you a reference, Jason, if you look at two of our relevant peers, one of them has this same metric, which we are at 34%, they have at 44%, and the other one has 49%. So we will obviously not achieve that this year, but I think this is something that will be achieved the full time as we were focused on that. Okay.

[Jason Mollin:]

Very helpful. Thank you.

[Operator:]

Our next question comes from the line of Alonso Garcia with Credit Suisse. Please proceed with your question.

[Alonso Garcia:]

Good morning everyone. Thank you for taking my question. It’s actually a follow-up on cost of risk. I mean, this 600 million pesos to 700 million pesos in additional provisions for the mortgage portfolio this year would represent around less, actually less than 10 basis points increase in your cost of risk. But your cost of risk guidance suggest at 20 basis points increase at midpoint from 2019 levels or 30 basis points to the high end of the range. So my question is, what are the other drivers behind your expectation of higher costs of risk these years? Basically a function of mix with more individuals in your loan portfolio mix? Or do you have some concerns on any specific segment of your portfolio? Or any specific sector of the economy? Thank you.

[Héctor Grisi:]

Hi, Alonso. I think that the current segment that faces market wins in terms of the cost of risk, in my opinion, is SME, we kind of make activity in the stagnant. They are highly exposed, they’re more vulnerable than companies that are larger. So I think that’s the only problem in the segment that we are monitoring very closely. And we think that there’s a chance that the cost of risk could go up in that segment.

[Alonso Garcia:]

Understood. Thank you very much.

[Operator:]

Our next question comes from the line of Carlos Gomez with HSBC Global Asset Management. Please proceed with your question. Carlos Gomez, your line is live. Are you on mute?Our next question comes from the line of Natalia Zamora with GBM. Please proceed with your questions.

[Natalia Zamora:]

Hi. Thank you for the opportunity to ask questions and congratulations on the results. When I saw your guidance at first I thought it to be rather conservative in terms of the cost of risk. But if I understood correctly, you mentioned your cost of risk guidance for the year includes the one-off. Could you please elaborate on this?

[Didier Mena:]

Yes. Hi, Natalia, very nice talking to you. It’s basically, the one-off that we are expecting that is associated with the approval of our internal risk-based model from the CNBV, it takes into account into 600 million, 700 million pesos. So it’s basically adding that to our ongoing business as usual in loan portfolio. Okay. So yes, it takes that into account.

[Natalia Zamora:]

Okay. Okay. So that’s the approval you were talking about, which you said would be binary, the one you said could be – could arrive this year. Okay, great. It’s very clear. Thank you.

[Operator:]

Our next question comes from the line of Yuri Fernandes with JPMorgan. Please proceed with your question.

[Yuri Fernandes:]

Thank you, gentlemen. I had a question regarding debit cards and credit cards payments in Mexico. If you can tell us how big this line is for Santander Mexico like if there is any way we can see like how payments is important. And I have a follow up regarding – actually my question regarding Facebook. I know you have a partnership with WhatsApp in Mexico. But days ago the company announced that they want to…

[Didier Mena:]

Yuri, can you repeat your question much, sorry. You were – a little bit, and I couldn’t hear you. Could you repeat the question?

[Yuri Fernandes:]

Sure. Sure, the first one is regarding how big payments like credit card, debit card transactions are for Santander Mexico, if you can give us a number on that. And the second question is regarding Facebook perhaps moving to make payments in WhatsApp, if you see this as a threat, if you’re concern on that? I know, you use WhatsApp and you have like, you can make transfers on WhatsApp in Mexico, but if WhatsApp per se is starting doing transfer. If this could be a risk for you, like for any revenue line for Santander. Thank you.

[Didier Mena:]

No. Hi, Yuri. Probably one thing to take into account is that Mexico is one of the countries, where the use of cash is huge. 80% of the transactions are done cash. And if you break it down by amount, those that are below $25, the equivalent of $25 U.S. dollar of 500 pesos. 95% of them are done in cash. So even though taking this into account, the account, the credit card business is relevant for us. And actually, if you look at fee income that's the line item that is growing faster, not because of an increase in the overall balance, not because of – we have increased fees but because of the usage of the credit cards of our customers.Also it's worth you looking at the financial stability report because there's a trend in broad market in which the credit card customers are paying more – their balance in full. The percentage of clients that pay their balancing for is increasing. So you have – you cannot assume that the credit card payments are not growing fast enough just by looking at the dynamics of the loan portfolio. Transactionality has been picking up quite nicely for us. I think that the payments business is very relevant for us, not because of the payments per se but because of all the information that we can get out of what our customers are doing through what they're paying.So definitely something that is of a strategic focus for us. I think that the Santander TAP, that is what we are using through WhatsApp for our customers to make transfers between them. It's working quite nicely. And it's, the customer experience is fantastic. And it's very important to mention that one of the characteristics of this feature is that you don't need to have a Santander account to receive a payment. So you usually need – if you want to make the transfer, you need to have a Santander account.But it's up to the person that receives the transfer, whether they get it in Santander account. If they don't have it, they can open one digitally. They can deposit that in any account in the system and in any debit or credit card. So it's quite convenient. And as was mentioned in the call, we have now close to 100,000 clients involved in Santander TAP, and we think that the adoption will grow faster in the coming quarters.

[Yuri Fernandes:]

Super clear. Thanks for all the explanation.

[Héctor Grisi:]

Thank you.

[Operator:]

Our next question comes from the line of Carlos Gomez with HSBC Global Asset Management. Please proceed with your question.

[Carlos Gomez:]

Thank you and apologies for the disruption before. My question is regarding the costs. You have already completed your investment program, yet you are still projecting another 5% to 7% increase for next year. Can you guys, as to what we should expect for the next two to three years in your expense lines, whether at some point, we should see the investment to get off, and therefore, the total level of expenses to decline?And second, did you increase depreciation 28% this year; is that the line that you expect to continue to see and what is the average life of the assets that you are depreciating? Thank you.

[Héctor Grisi:]

Okay, Carlos, thank you. I mean in terms of the investment program, even though we have finished the extra Ps. 750 million, we're going to continue to be very aggressive investing in the bank in mainly two areas. I mean I think IT is going to be one important part in which we're going to be increasing the amount of money we put in there, also in terms of the digital platform; we're going to continue to invest in it.The way we are going to do it also is in a more – or in a smarter way. If you remember my presentation, I told you that we're going to come out with a new app early this year, probably by half of the year, we're going to start sometime in a month or so. And this app is going to be used for the rest of the group. So Mexico is developing that. And we are also – there is – for example, we are developing also a global platform for acquiring, and that's being developed in Brazil, and we're going to use it over here.So what's going to happen is we're going to come out with new products where we're working together with the other banks of the group. And that's basically just to tell you that the way we're going to be managing investments, and we're going to continue to grow. In terms of net numbers, I'm going to ask Didier to basically give you an idea. But the idea is basically to be very disciplined about how we grow the cost in the bank. We're going to be in a normalized situation.And the important part where we were behind in terms of the number of ATMs and some other things. I think we are already where we wanted to be. Also we're going to be very smart about how we put in more branches and infrastructure. We're going to continue to change into the SmartRed format, but we're going to do it less aggressively over the next few years. And in terms of other investments in new products, we're going to continue to develop that. And – but we're going to be much more in line with inflation, I think, for the next few years.

[Didier Mena:]

Regarding depreciation and amortization, Carlos, these lines have been increasing. It was close to 8% of our total expenses in 2017, and it's roughly 10% now. We think that this will continue expanding faster than the overall expense base as a consequence of the investment program. There's a range of the amortizations that happened, I would say, the vast majority between three and four years, others go all the way to 10 years. All the investments that we've done in the corporate centers, we have invested in 10 corporate centers throughout the country. So that – those investments, we have to amortize them for the longer term. But we should expect depreciation and amortization, so let's say probably, go all the way to probably 12% of our total expense rate during the next few years.

[Carlos Gomez:]

That's very clear. Thank you. And Didier, since you are on the line and you are in charge, how satisfied are you with development of retail deposits? And are you on plan behind plan or ahead of the plan that you had a couple of years ago?

[Didier Mena:]

That's a fantastic question, Carlos. I think that we're happy with the progress that we've made. But there's – we still have a significant way ahead. There are two things that we're working on. One is the mix. And the mix, the evolution is quite positive. But still, we are 10 percentage points below one of relevant peers, 15 percentage points below the other relevant peer. So the gap is still significant. That's on one front. And I think that we've made, in my opinion, significant progress. Unfortunately, this takes a lot of time. So we need to continue remaining focused on attracting and retaining retail clients. I think that the investments that we make go pretty much in line with having the capacity, the right infrastructure and the right service quality to make that possible.On the other hand, we have the cost of deposits, the pricing. And as mentioned, historically, we have paid more to our depositors. We're focusing on that so that we can converge faster to the cost of funds of the system and of our peers. So we think that the combination of those two things will make it possible that during the following two to three years, we can make that happen.

[Carlos Gomez:]

Thank you so much.

[Operator:]

Our next question comes from the line of Brian Flores with Citibank. Please proceed with your question.

[Brian Flores:]

Hi. Thank you for the opportunity. Just a quick question on your guidance on loan growth. Could you elaborate a little more at the segment level? And particularly, at the dynamics you're seeing in the government segment? Thank you.

[Didier Mena:]

I think that we have a very solid dynamic in terms of individual loans. And the single most relevant product within individual loans is mortgage loans. And mortgage loans are growing slightly below the market, and that's because of the impact of our execution, the loan portfolio acquisition that we made few years ago. Our origination rate is growing slightly above market at 11%. So we think that it will either be at high single digits or low double-digit growth rate in mortgages. We also expect that the – to continue gaining market share in payroll loans. And that's a consequence of our focus in attracting and retaining more payroll accounts. So it goes pretty much in line. Our growth in payroll accounts last year was close to 13%, and our growth in payroll loans was close to 13%. So it goes pretty much in line one with the other. We were starting to gain slightly market share in credit cards. We think that, that will continue growing 5% to 6% year-on-year.Now on the corporate side, I think that we should probably expect a softer growth on individual loans, and that's because of the exposure to economic activity. And within corporate, SMEs are – should continue having a soft performance. We think that mid-market companies are more resilient than SMEs. And the two segments that will continue to be volatile and depending not only on our underwriting criteria but overall market trends, it's both corporates and government loans. Corporate is just to highlight a couple of things. In the first half of last year, there was a high volatility in the market that they had corporates, large corporates tapping into banks to provide their financing need. With the capital markets being less volatile in the second half, then that's why we saw more activity in corporate issuing the debt and prepaying some of their bank facilities. Okay?So depending on how the market evolves this year when the DCM market started very strong, on a very strong foot this year, we might see corporate here being, I would say, stable or with a potentially slight contraction. And government loans, I think they're pretty volatile in it. Just bear in mind that we have exposure in this segment, not – not because of the loan, per se. It is because of the businesses that are associated with lending to these customers, and particularly, the payroll business associated with these customers. So even though we do look at it on a product basis, margins are slightly seen. When you take into account the business that comes with these customers, then it has a significant profitability. So the this segment is highly competitive. We will remain very aggressive in the relationships that we don't have, and it represents an investment in terms of our business.

[Brian Flores:]

Very clear. Thank you.

[Operator:]

There are no further questions in the queue. I'd like to hand the call back to Héctor Chávez for closing remarks.

[Héctor Chávez:]

Thank you, operator. Thank you everyone once again for joining Santander Mexico on this call. As always we wish to maintain an open dialogue with you and there's a standing invitation to visit us in Mexico. If you have any additional questions please don't hesitate to call us or email us directly. Have a great day.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.