Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q1 2020 Earnings Call Transcript

Published: 3 May 2020

[Operator:]

Good day, everyone, and welcome to Banco Santander Mexico’s First Quarter 2020 Earnings Conference Call. Today’s call is being recorded. Following the speakers’ remarks, there will be a question-and-answer session.I now like to turn the conference over to Mr. Héctor Chávez, Managing Director and Head of Investor Relations, who will make some opening remarks and introduce today’s other speakers. Please go ahead.

[Héctor Chávez Lopez:]

Thank you and good morning and welcome to our first quarter 2020 earnings conference call. We appreciate everyone’s participation today. By now, everyone should have access to our earnings press release and the presentation for today’s call, both of which were distributed after the market close yesterday and can be found on our Investor Relations website.Presenting on our call today will be Hector Grisi, Executive President and CEO; Didier Mena, our CFO; and Rodrigo Brand, Executive General Director of Public Affairs. We will begin with a discussion of the actions that we have taken to help mitigate the risks related to the COVID pandemic. Next, we will briefly review our first quarter results and then we will be happy to answer your questions during the Q&A session.Before we begin our formal remarks, allow me to remind you 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, including COVID-19, 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.Hector, please go ahead.

[Hector Blas Grisi Checa:]

Thank you, Héctor. Good morning, everyone, and good afternoon to those of you in Europe. Thank you for joining our earnings call this morning. I hope you and your families are healthy and safe.We’re entering unprecedented times, a moment that is testing our flexibility and ability to act swiftly in every aspect of our business. During this call, we would like to spend most of the time discussing the actions we have taken to address and mitigate impact of COVID-19 pandemic on our business.However, we will also give you a brief summary of the most important trends and metrics of the quarter. The materials that we usually present every quarter that will not be covered during the call can be found in the annex of this presentation. Should you have any questions associated with those materials, we can address it during the Q&A session.Over the past 6 weeks, we have been implementing a series of measures to help protect the health and safety of our employees, the wellbeing of our customers as well as maintain business continuity. Before discussing in more detail these protective measures, let me underscore our conviction that Santander Mexico is well positioned against the current and growing impact of the COVID-19 pandemic.Our agile and experienced management and operational teams, our conservative origination standards and our prudent financial management have allowed us to build a very strong balance sheet in recent years. Once again, we ended another quarter with stable asset quality and low levels of cost of risk and NPLs, thanks to our prudent growth strategy and strict origination criteria.In addition, the successful execution of our medium-term strategy that the investments we have made in IT and digitalization over the past 3 years have enhanced our ability to serve our customers at a time when social distancing is required nationwide.Turning to our financial results, we delivered a very solid first quarter with no material impact from the COVID-19 pandemic in our P&L. However, not surprisingly, loan and deposit volumes began reacting to the new environment. Until mid-March, retail and commercial loans as well as deposits behaved very much in line with past trends.However, during the last 2 weeks of the month, when the stricter lockdown measures were implemented to mitigate the pandemic, commercial loans registered a significant spike, resulting in 12% year-over-year growth in our total loan portfolio at the end of the quarter. In turn, due to this activity among our corporate customers, commercial deposits increased significantly, expanding total deposits by 15%.Despite the sudden increase in loan demand, our capital and liquidity positions at the end of the quarter remained at high levels, underscoring the strength and resilience of our balance sheet.Please turn to Slide 4 to review the recent actions we have taken to address the current health crisis. Since late February, we have been focused on 3 key priorities

[Didier Mena Campos:]

Thank you, Hector. Good morning, everybody. Please turn to Slide 8 for an overview of our recent loans and deposit performance. Our loan book increased 12% year-on-year and 9% quarter-on-quarter, finishing at levels much higher than we had been expecting for all of 2020. The rapid expansion of our loan portfolio was due to a 16% increase in commercial loans as large corporates, midsized companies and government entities reaffirm their credit lines, generating significant increases in each of these segments.Compared to first quarter of last year, loans in these segments expanded 28%, 17% and 19%, respectively. Note that approximately 30% of the expansion in commercial loans was related to the 22% depreciation of the Mexican peso, which affects U.S. dollar-denominated loans that make up 12% of our loan portfolio.In contrast, SME loans increased 5% year-on-year and 2% sequentially, registering the third consecutive quarter of a sequential contraction in the back of a weakening economic environment even prior to the COVID-19 outbreak. At the same time, individual loans registered 6% year-on-year growth with mortgage and payer loans each expanding a solid 8% year-on-year. Our credit card portfolio is the only retail segment that began to display a negative impact from COVID-19 pandemic as it contracted 3% quarter-on-quarter due to lower usage and lower balances during the last 2 weeks of March.As you can see in the graph on this slide, our deposits reflect the results of several campaigns to compensate for the significant increase in corporate loans in March. Total deposits expanded 16% year-on-year as individual deposits rose 9% and corporate deposits by 19%, both compared with first quarter of last year. This represents a 17% sequential increase, a rate we have not seen since the fourth quarter of 2018.On Slide 9, let me go quickly through the main items in our P&L. Net interest income expanded nearly 3% on the back of lower interest rates, which declined 119 basis points compared with year-ago levels. Modest growth in high-margin segments also contributed to soft NII growth. Provisions increased almost 20% year-on-year due to the implementation of our internal risk model for mortgages. Fee income grew 6% year-on-year, supported by a solid 10% expansion in cash management fees, 6% growth in insurance fees and a solid double-digit expansion in investment banking fees.The lower usage of credit cards mentioned previously and the negative effect of the peso’s depreciation on fees paid were the main drivers of a 4% year-over-year contraction in credit card fees during the quarter. In turn, heightened market volatility and high client volumes allowed to register a solid Ps.883 million in market-related income.Our expenses grew nearly 6% year-over-year as our 3-year investment program is now behind us. Depreciation and amortization charges related to these investments contributed to the quarter’s increase in expenses. With this, our efficiency ratio improved 86 basis points year-over-year to 43.95%.All in all, we delivered net income growth of 2% compared to last year’s quarter, supported by fees and market-related income that compensated for the softer net interest income growth that reflects lower interest rates, lower growth in high-margin loans and a material nonrecurring increase in provisions. Our ROE was 15.48% in the quarter, 92 basis points lower than a year ago.Please turn to Slide 10, where I would like to elaborate on our asset quality and relevant lending exposure. As of today, it is difficult to assess the extent of the pandemic’s impact on asset quality as it will depend in part on how long social distancing restrictions will remain in place and the magnitude of the expected contraction in economic activities, but also the effect that the debt-relief program will have on our retail and SME customers.I would like to highlight the solid position that we currently have to face this scenario. On the retail front, we have been focusing on the [finance] [ph] segment of the market such as mortgages and payrolls. Our mortgage portfolio has a loan-to-value ratio of 69%, and according to previous experiences, customers tend to prioritize their home mortgages in economic downturn.With our SME book, 68% of the portfolio has guarantees issued by Nafinsa, one of Mexico’s development banks, which allow us to choose the way to present. On the commercial side of our business, we have a diversified portfolio with limited exposure to some of the most vulnerable segments such as export, import, transportation, hotels and restaurants, oil and gas and automotive industry. As for the first quarter of this year, only approximately 9% of our loan portfolio is related to these sectors, which includes our PEMEX exposure.Additionally, our stable cost of risk and NPL ratio over the last several quarters reflect a healthy portfolio that stems from our prudent origination standards, which also positions us well during this emerging crisis. In response to the economic effects of the pandemic, we are proactively monitoring our credit portfolio and have implemented credit risk plans that we are integrating with a broader commercial strategy.As you can see on Slide 12, we have strong capital and liquidity positions, as Hector noted earlier. At the end of March, our bank’s common equity Tier 1 ratio stood at 11.1%, which is significantly in excess of the 8.2% minimum requirement established for banks to [protect] [ph]. The decision taken during the shareholders’ meeting to postpone the dividend payment for 2019 does allow us to further strengthen our capital position.In terms of our liquidity, our first quarter liquidity coverage ratio reached 136% at the end of the quarter, averaging 125% over this quarter, despite significant spike in commercial loans that we disclosed previously and without taking into account the senior notes that we issued a couple of weeks ago.Moving to Slide 12. I just want to remind you that on April 13, we withdrew our full year 2020 guidance. Our fundamentals remain strong. And first quarter results have been tracking to the earlier guidance and were not materially affected by the pandemic.However, given the unprecedented nature of this health crisis and the uncertainty surrounding its duration and impact on our operating and economic environment, we expect that our 2020 results would likely be affected. When this degree of uncertainty eases sufficiently and we feel that we are in a more comfortable position to offer reliable performance guidance, we will do so consistent with our ongoing commitment to be transparent with shareholders and the rest of the financial community.We’re now ready to take your questions. Operator, please go ahead.

[Operator:]

Thanks. [Operator Instructions] Our first question comes from the line of Jason Mollin with Scotiabank. Please proceed with your question.

[Jason Mollin:]

Hi, thank you for the opportunity to ask questions. My first question is related to what you show on Page 6 of your presentation, the support measures for COVID-19 by the government with their corresponding fiscal impact. And the number for Mexico that you’re citing here, it looks very low relative to the other countries that you put here. Do you think that the Mexican government needs to increase their fiscal support? Will it be enough really to get Mexico through this crisis is my first question? Thank you.

[Hector Blas Grisi Checa:]

Hello, Jason. Yes, I mean that number is you’re completely right, it’s pretty low compared to the different emerging markets and other developed economies in the world that we have said. I don’t believe that the government basically will change their strategy at this point. The President basically has been very keen of maintaining fiscal discipline. And he doesn’t want to incur in a big fiscal deficit, even though the Mexican economy can sustain a little bit more of what we have.At this point, I don’t have any indications from connections and talking with government that we will have more support. So that’s something that we’ll have to come up later on, and we’ll keep you posted of what happens. But at this point, it is what it is.

[Jason Mollin:]

Thank you. And my second question is on the capital markets, particularly in the fixed income market. You just did a transaction. And how are you seeing those markets functioning now? Do you think that market prices for – I mean we’ve seen certain market players show dramatic increase in yields. Some would – I would actually say look distressed. Are you seeing that in the marketplace? Is that a concern where you’re seeing, is it companies that were raising money at, I don’t know, 8% now looking at their bonds trading at 30% plus?

[Hector Blas Grisi Checa:]

I mean, look, I mean it has been a very complicated situation. At the beginning of the crisis, we saw a huge lack of liquidity, which had basically Banco de Mexico has been tried to change, given the amount of liquidity they’re injecting into the system. But the important thing is that, I believe that it’s going to be hard for companies to access the capital markets unless there are more – we have more clear scenario in the future.So I think it’s quite important for the government to help us in that sense. We have been talking to the Secretaria de Hacienda in that regard. And they understand the situation. We have also talked to Banco de Mexico, and they’re working on that. I mean they’re concerned on that particular issue. And they understand that there is a lot of corporate paper that is coming into the market, that is coming due in the next few months, and that we need the market in order to support it due to the fact that the bank market will be very – not very big, but will be limited to cover all what is basically coming due.But I believe that the authorities understand that and that will give the correct incentives for the market basically to open again. I mean, I’m talking about the peso market, not the international market, right.

[Didier Mena Campos:]

Just to complement on what Hector mentioned, Jason. There’s a significant difference in what we are seeing in the local markets relative to international markets. Large corporates in other geographies, I would say, have 2 avenues to access liquidity. First is issuing corporate bonds and then the second is relying on their relationships with banks.And what we saw in March was a very strong issuance of investment-grade companies I think was the record issuance in that month. And in Mexico, local capital markets are very, very quiet. There were very limited issuances in March. So basically, large corporates in Mexico are relying in banks for their liquidity needs. So that, in my opinion, puts some pressure to the banking system and it’s critical for the system that capital market starts working back again.And I think that the central bank has taken some measures. And hope that it starts impacting the functioning of this market because it’s critical for the economy.

[Jason Mollin:]

Thank you, Didier. Thank you, Hector. I appreciate the [indiscernible].

[Operator:]

Thank you. Our next question comes from the line of Ernesto Gabilondo with Bank of America. Please proceed with your question.

[Ernesto Gabilondo:]

Hi, good morning, Hector and Didier. And thanks for the opportunity to ask questions. My first question is on loan growth. We know this is an important tick-up, but I think it was mainly driven by the peso depreciation in your dollar-denominated portfolio, but also from companies withdrawing the credit lines.So just wondering, how do you see the trend continue during the next quarters? Do you think we can continue to see this kind of growth, second quarter, but then by year-end to really show a deceleration in terms of growth? Are you focusing in your guidance, providing them with liquidity or are you financing new projects?And then my second question is on your cost of funding. Just wondering how much do you think it can be increased by the recent big debt issuances that you mentioned? And then, just very quick last question in provision charges. We have seen different management strategies among the Mexican banks in how to provision this year. So I don’t know if you are evaluating to create provisions based on expected losses or are you going to see higher provisions by yearend and first quarter of next year after the grace period? Thank you.

[Hector Blas Grisi Checa:]

Thank you, Ernesto. I mean, first of all, in terms of the loan growth, yes, you’re right. I mean some of it grew because of the devaluation of the peso. But, I mean, the majority of the growth in the portfolio is because of the big clients and medium-sized companies basically pulling mainly their lines and their committed lines. As you know, I mean, there is a lot of experience in the Mexican business community in this type of crisis, and people, what the first thing they did – they do basically is protect their liquidity and to access the credit lines due to the fact that they believe it’s the best way to manage themselves during a crisis.So we have taken a look of the outstanding lines that we have, and we don’t see a growth in the second quarter as much as we had before. I mean, we believe that, I mean the worst is over in terms of the amount of big credit lines coming out of the system. And it’s now more stable and this is what we foresee.Not a lot of new projects. The majority has been that. And some of the big projects, as you know, are on hold because of the pandemic. So we’ll see how the market reacts in the next few months when we start to getting out of the pandemic and the economy starts to move again. So, we’ll see exactly what does going to happen.On the second and third question, please, I will ask Didier to answer that.

[Didier Mena Campos:]

Yes, hi, Ernesto. Regarding the impact in our cost of funds associated with the recent issuance, let me put things in perspective. We issued US$1.75 million. It’s roughly Ps.42 million. That represents 3.8% of our interest-bearing liabilities, okay? Our interest-bearing liabilities as of – in the first quarter, have a total cost of 4.95%. So the issuance that we did was at 5.375%. We have needs in U.S.-dollar-denominated loans. So the impact that it has is, I would say, it’s marginal of a few basis points in terms of the overall impact.Now, regarding the provisions, as we discussed earlier, the banking commission is allowing Mexican banks to, let’s say, postpone the – or classify all the loans that’s enrolled in the relief programs to treat them as performing. And therefore, do not have the necessity to create a provision, okay?So we’re starting to analyze the behavior of those clients that are enrolling in these programs to have a better understanding as to what will be the need to create provisions when the program ends, okay? So we were still evaluating whether to make additional provisions, so let’s say excess provisions in anticipation of when these programs end.I think that the most important item in our view is to analyze how deeply affected or not will be our clients as a consequence of the pandemic. And once we know that, we will make the necessary provisions accordingly.

[Ernesto Gabilondo:]

Okay, so thank you. And is your corporate portfolio entering into this relief program or it is excluded and then you can create provision based on expected losses for this portfolio?

[Hector Blas Grisi Checa:]

No, I mean the majority of this portfolio is behaving very well. I mean there’s, as always, some companies are not in the best shape. But I mean we don’t foresee any big restructurings right now on the big corporates, on portfolios. In the mid-sized companies, there are some companies under stress, and we are working with them to have the amount.For the majority are some of the companies that are basically completely closed and need some, basically, time in order to be able to pay the loans and I mean due to the fact they are completely on hold because of the crisis.

[Ernesto Gabilondo:]

Okay, well, thank you very much, Hector and Didier.

[Operator:]

Thank you. Our next question comes from the line of Marcelo Telles with Credit Suisse. Please proceed with your question.

[Marcelo Telles:]

Hi, hello, everyone, and thanks for the time, Hector, Didier. Is it possible to share with us if you have done any sort of, like, stress test analysis regarding the current situation? How should we think about the impact for you and for Mexico, in general, if you compare this crisis to the crisis in 2008 and 2009?

[Didier Mena Campos:]

Hi, Marcelo, how are you?

[Marcelo Telles:]

Hi, Didier.

[Didier Mena Campos:]

Yes. We – there’s requirements, regulatory requirements associated with doing a stress test. So, yes, we have definitely – we have done some stress test analysis associated with potential scenarios. And the current, let’s say, we will provide several scenarios to regulators. So, the one that is more adverse has a GDP contraction of 8% and downgrades of the sovereign and PEMEX and CFE. So I would say that is, it’s a very, let’s say, severe scenario.Probably, I’d say, even more severe than what we are expecting right now in the pandemic, okay? And with those numbers, I would say that the bank continues to comply with certain room in terms of our capital position, our liquidity position, we still have – obviously, in this scenario, there’s a significant impact in terms of profitability, but we would still show profits, and I would say that a significant level of profits. So there will be a significant contraction but still generating profits. So we have those scenarios at hand, Marcelo. I don’t think that they – we can use them fully to, let’s say, understand exactly what’s going to happen with the pandemic. But definitely, it’s a good point of reference, just to understand certain magnitudes.One of the things where this scenarios differ to what we’re seeing right now is that in all of these cases, there’s a contraction in loan growth, a significant contraction in loan growth. And at least what we’ve seen at the start of the pandemic is that – and as shown in our first quarter results, there was a significant increase in loan growth.For the rest of the year, we would expect still a marginal increase in demand from corporates and midsized companies, a contraction in the retail portfolio. But overall, probably the loan portfolio could stay at levels that we’re seeing right now. So there’s – I would say that’s probably the most significant difference to the scenarios that we currently – they have with regulators. So I would say that there’s a higher impact in terms of the contraction of net interest income associated with lower volumes in the loan portfolio.

[Marcelo Telles:]

Thanks, Didier. Just one follow-up question, if I may. Regarding your decision not to frontload provisions right ahead of the expected deterioration. What is the framework that you are considering in terms of when to provision and how much to provision? Is – do you have a goal, like a minimum goal, in terms of your portfolio, the core equity Tier 1 that you don’t want to go below or how the parent company’s desire to keep a higher common equity Tier 1 plays out there? So if you can just help us understand a little bit the rationale for not doing frontload provision at this point.

[Hector Blas Grisi Checa:]

Hello, Marcelo. How are you? This is Hector to talking to you.

[Marcelo Telles:]

Fine. How are you?

[Hector Blas Grisi Checa:]

Yes. I mean – as you can understand, I mean we’re in a very difficult scenario to basically be able to really tell you what’s going to happen. I mean it’s all going to depend, I mean, how deep is a pandemic; how long are some of these business closed. And we had on – Didier has told you, I mean, a very deep analysis of how deep can this go. I mean – but what I can tell you is, it’s very complicated to predict. So it’s not that easy. We’re trying to basically be very harsh in the way we’re managing this. But Didier can basically – and his team are working hard on this.

[Didier Mena Campos:]

Yeah, just to complement on what Hector mentioned, Marcelo, we don’t have in mind like at all in terms of core Tier 1 ratio. I think that at the end of the day, an end result. Whatever we do gets reflected in the core Tier 1 ratio. I think that our policy has associated with asset quality and with provisioning, has to do with understanding the expected loss that we have throughout the portfolio and the probability of default, okay. So it is probably, in our opinion, better to wait and see what’s the real magnitude of asset quality duration than to make an assumption right now as to how bad it can get because, in our opinion, this 6-month holiday payment period will definitely help some clients, and they will definitely have – they will be in a position to pay back.

[Marcelo Telles:]

Thank you.

[Operator:]

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

[Carlos Gomez-Lopez:]

Hello, and good morning. First, congratulations on the bond issuance. I think it was the first in the sector after the pandemic, and the first one done on a work from home conditions. So I think that was quite impressive. I want to ask about the SME sector where you have a large presence. Obviously, we don’t know how long this is going to last, and we don’t know what the impact is going to be. But when talking to some of your peers, they tell us that they expect a nonlinear effect. So if it lasts 2 months, there will be some losses. If it lasts 3 months, there will be more. But if it lasts longer than that, it will be significantly worse than in other circumstances.Do you share that view? Do you have a view as to how much, how long your SMEs can last and when we could see losses escalate if the situation prolongs for too much or too long?

[Operator:]

I apologize, Carlos. Shall you repeat your question, please?

[Carlos Gomez-Lopez:]

Yes, of course. My question is how long do you think that the SME sector can sustain with lockdowns without significant losses, meaning at what time would you expect losses in the SME sector to escalate, after 2 months, 3 months, 4 months? Thank you.[Technical difficulty]

[Operator:]

Apologies, ladies and gentlemen. The speakers are reconnected.

[Héctor Chávez Lopez:]

Hello? We are sorry for the interruption. We got disconnected. We can – I don’t know if you heard the last answer for Marcelo.

[Operator:]

Apologies. Yes, we heard Marcelo’s answer. Mr. Carlos Gomez from HSBC, can you please repeat your question?

[Carlos Gomez-Lopez:]

Yes, sure. My question to you was about the SME sector and whether you – when do you expect the SME sector to hurt and losses to escalate if the lockdown lasts for more than 2 months, 3 months, 4 months? Do you have a time frame in which you would start to worry more about it? Thank you.

[Didier Mena Campos:]

Hi, Carlos. I think that the most vulnerable segment in, not only in our loan portfolio, but I would say, in the economy is particularly SMEs. And going back to the point that Hector was making in terms of the – how low is the fiscal stimulus that the Mexican government is pulling together, I think this is – in this segment is where it’s going to be more badly felt. We think that every week is critical for some SMEs. SMEs are the largest employer in the country. So it is worse. It is worrisome, I would say, from a banking system standpoint. I think that we have a relatively sound position because last year, we started to increase the guarantees that we use associated with this loan portfolio.So we increased the coverage in this portfolio going from 32% to now 69%. So that’s good in our case. But definitely, we are extremely concerned. We – the lack of enough stimulus associated with SMEs, we have continuously voiced this to the government. We are still in discussions with the different regulatory agencies in order to try to put together something that is stronger than what has been offered so far. I think that in our case, given the fact that close to 50% of plank in our SME portfolio haven’t bought the program, the debt-relief program, we think that we’re going to get to know exactly the magnitude of this effect, I would say that 5, 6 months from now.

[Carlos Gomez-Lopez:]

6 months from now? Thank you very much. And again, congratulations on the bond issuance. I think you didn’t hear it before. Thank you.

[Didier Mena Campos:]

Thanks, Carlos.

[Operator:]

Thank you. Our next question comes from the line of Domingos Falavina with JPMorgan. Please proceed with your question.

[Domingos Falavina:]

Thank you. Hi, Hector and Didier, as well. Thank you for taking the question. I’m not very familiar with the taxing in Mexico or like what exactly is the advantage. You guys are sounding to me very cautious like unprecedented crisis. You mentioned you were concerned. And when we look at provisions, coverage ratio was about stable-ish. They grew 19% provisions year-on-year. You’re basically going to do anything...

[Hector Blas Grisi Checa:]

Domingos, we cannot hear you very well. Is there a way that you can speak a little louder, please?

[Domingos Falavina:]

Sure. Sure.

[Hector Blas Grisi Checa:]

Thank you, Domingos.

[Domingos Falavina:]

I’ll put my headset again. Is it better now?

[Didier Mena Campos:]

Yes, it’s better. Thanks.

[Domingos Falavina:]

Okay. Sorry about that. So my question is I’m not very familiar with, like, maybe taxing implications or not. But basically, you guys are coming out very cautious. You mentioned an unprecedented crisis. You mentioned that you were very concerned about the crisis. And yet, when we look at your provisions, for example, we only saw them growing 19% year-on-year; coverage ratio, about flattish. Some banks in Mexico doing similar some like Inbursa [indiscernible], growing 90%-plus provisions. And you mentioned in your remarks that you think it’s better to wait to see the implication before doing provisioning. My question is why is it better to wait? Do you have tax benefits? Because the risks are clear. The more you kick this forward, the more you have to backload potentially massive provisions in the year-end. So I understand when you say it’s better to wait, then you elaborate a little bit why it’s better. That’s question one.And the question 2 I have is did the parent company, Santander Spain, provide any guidance or any expectation as far as when to do preventive guidance? I’m asking this because we saw very large provisions than in Europe, in Spain, €1.6 billion post-tax, and we’re not seeing that in Brazil nor in Mexico. So my question is did Santander Spain recommend anything as far as provisions go.

[Didier Mena Campos:]

Hi, Domingos. Regarding your question as to why it’s whether – why it’s better to wait, I think it has to do with making the provisions, understanding exactly what’s the magnitude of the impact rather than making an assumption as to how that can be affected, the loan portfolio. I think it has to do with that. And if you look at our...

[Domingos Falavina:]

But it can reverse, right? I’m sorry to interrupt, but it can reverse. You can do. And then if you don’t use it, you reverse it back or you gradually consume it, right? You could do that.

[Didier Mena Campos:]

Yes, you’re right. We can do that. However, we don’t feel comfortable right now with the information that we have in terms of the size of the provision that we need to put forward. And most likely, if we do it right now, we’re going to end up not really making an accurate estimate. We might end up under-provisioning or over-provisioning, so rather than doing that, we think it’s better to wait and see exactly what the magnitude of the deterioration. What is for sure is that it’s going to get – asset quality will deteriorate. And we have a strong capital position.We’re starting this – we’re entering this crisis with also with a sound profitability. So I think that we have room to sustain any deterioration of our asset quality. So we don’t – we think that the best thing to do is to understand better the magnitude of the impact. That’s basically what is driving us not to make any anticipated provisions right now.Now in terms of your second question, I think that the corporate didn’t provide any guidance in terms of making provisions or not. I think that they – they’re making some general provisions, but we were not asked to do – or whether to increase or not our provisions. I think that there’s also independence in that regard or autonomy in that regard. And we follow, let’s say, our local regulation and also the information that we have.

[Domingos Falavina:]

Okay. No. Very good to know the independence point because we were getting questions on that. Thank you.

[Operator:]

Thank you. Our next question comes from the line of [Lemar Cela with Behrens] [ph]. Please proceed with your question.

[Unidentified Analyst:]

Thank you very much for taking my questions. [Lemar Cela from Behrens] [ph] here. I’ve got 2 questions. So the first question is on the portfolio which is put forth for the period. I just want to understand, out of that 16% of your loan book, which is supposed for grace period, what was the net interest income contribution of that portfolio? And perhaps you can also, for SMEs, explain me the guarantee, what that guarantee entails? Like is it guarantee on NPLs or interest for that SME? So – and I mean when you look at technicality of this balance sheet being put for a grace period of 6 months, what do you expect beyond that 6 months? How does that work in terms of balance sheet functionality?And my second question is with respect to your capital ratios. I think the capital ratios are solid. I do like the fact that you have deferred the dividend payment for foreseeable future. But I just want to understand, I mean it dropped by 1 percentage point, and I think in the disclosure, it says like higher risk-weighted assets. Perhaps you can explain what kind of risk-weighted assets move north and whether the FX impact had any material impact in terms of, I mean, capital CET1 dropping down so. Thank you.

[Didier Mena Campos:]

No. Regarding your first question and how the SMEs guarantees work, there’s, let’s say, a pari passu first-loss guarantee with Nafinsa. So we share basically the loss that we have if there’s a client that comes past due. So we just have to – there’s a process that we need to file with Nafinsa in terms of making sure that the SME was fully compliant with all the guidelines that we have for this program. And once we show to Nafinsa that this particular SME is not making loan payments, then we get reimbursed 50% of the losses that this particular client has. We pay a premium for that, okay. So that premium has been moving, let’s say, depending on the specific time where we negotiate this with Nafinsa. But it has been as low as 3.5% and as high as 5%, 5.5%, okay. So that’s how the SME currently works.

[Héctor Chávez Lopez:]

And – Hi, [Lemar] [ph], this is Hector Chavez. Just to follow up on your first part of your first question. The way it works is that with the deferrals on the payments of both capital of interest on this portfolio for 6 months, the interest is still taking into account – it is taken as accrued towards the NII of the bank. It is – we don’t have a flow of interest, but we do reflect it in our P&L.

[Unidentified Analyst:]

And to that point, just if I can, I mean, follow up. So I mean 16% of that loan book is off a grace period. How much of, I mean, net NII does it generate per quarter, that 16% of loan book?

[Héctor Chávez Lopez:]

Well, it’s a mix of – given there is a mix of SMEs, loans and mortgages, we still don’t have the calculation. We still are receiving some of the additional registrations as of today, and we still have some other that we have to do. So it is – we still have to calculate, but we don’t know how much of net interest income that accounts for because, again, it’s a completely different mix of loans.

[Hector Blas Grisi Checa:]

And regarding Europe...

[Unidentified Analyst:]

Okay. Perfect. But I mean – yeah. Just on – so you can’t also – I mean, can you give me also the LTV adjustment on that book and potentially the average duration expansion. I mean, average duration expansion is roughly 6 months. Let’s take it 6 months. I just want to know, like, whether you have those calculations in front of you. What is the average duration of that, I mean, 16% loan book and I mean LTV adjustment, so pre-COVID LTV level and post-COVID LTV? If you could share that, that would be fantastic.

[Héctor Chávez Lopez:]

Yes. We’ll take into that account for the next call. We do need all the details. I think that when we have the full amount, we’ll, of course, keep track in the next call how that portfolio is behaving.

[Unidentified Analyst:]

Perfect.

[Operator:]

Thank you. Our next question comes from the line of...

[Hector Blas Grisi Checa:]

Just sorry, there is a another…

[Héctor Chávez Lopez:]

There is a follow-up on the capital?

[Hector Blas Grisi Checa:]

Yes. Regarding your question on capital ratios, definitely, if you look at the composition of our risk-weighted assets, two-thirds of them are associated with credit, 26% are market-related risks and 7.5% are the operational debt risks. What we saw in this first quarter, associated with the volatility in markets and with the depreciation of the peso that risk-weighted assets associated with the market risks increased more than what we saw on our credit risks.We think that if you look at how this could perform over the following quarters, we are not expecting a significant increase in terms of credit risk from now, marginally I would say. And there’s a chance that we can still experience volatility in the financial markets throughout the year. So this breakdown, I would say, could be similar going forward.I think that the impact that has loan growth in our capital ratio, it would not be that significant in our expectation. I think that the capital ratio will have some pressure associated with market risk and also with some – the impact that we could see in terms of some financial instruments losing a certain value.

[Operator:]

Thank you. Our next question comes from the line of [Carlo Diego] [ph] with Santander Bank. Please proceed with your question.

[Unidentified Analyst:]

Sure. Hello, Didier, thanks for the call. And as you mentioned, the initial expectation of the market we would have seen so far of a loan growth contraction. But we have seen the other side, we have seen a loan growth, as you mentioned, pulled by the same clients. So, obviously, the cost of risk is difficult to measure, and at the same time, also a strong deposit growth.So just wondering, we have seen previous periods of distress in Mexico, 2009 with the virus AH1, the NAFTA negotiation, Trump the new President. And it seemed that the reason someone would buy your stock, the stock of a big bank, is diversification, the strong capitalization, the deposit base, your market share, so not just being for the quarter or just the next 6 months because nobody knows the real number of the provisions.What is the long-term strategy of the bank? We have seen the bank invest for plans of 5 years and more. And obviously, the current stock price, when you are trading below book value and with the deep discount that you are trading, obviously a market is implying a strong hit over your loan growth, which doesn’t seem feasible right now. So not just watching for the quarter but watching for the long term, what is your view there, Didier?

[Hector Blas Grisi Checa:]

Thank you. Let me – this is Hector. Let me give you an overview of what we’re looking at and what we’re thinking. I mean right now, we are most convinced that this is not going to be a blip in terms of the economy going down and then right back up again, okay? But we have been already in a situation in which the economy was in recession before entering the pandemic, okay?And we knew that, and we were basically taking precautions in terms of that. So we were very, as you saw, our portfolio didn’t grow as much as in some other institutions because there were some parts of the portfolio that we decided to be more prudent in the way we were growing the total portfolio, okay? So we understood that we are entering into a low part of the cycle, and we were basically preparing for that.Secondly, our strategy basically has been very keen on getting new clients to the bank. New clients to the bank is a key part of the strategy, because if you compare our bank in size versus our peers, the amount of individual clients that the bank had or has is less than the one our peers has. So we – our strategy basically is going to continue in exactly the same way to attracting new clients, individual clients and attracting deposits, okay, because our cost of funding, as Didier was just discussing, is actually above our peers because of that.Okay. So our strategy works even in a complicated situation in the economy as in a normal situation of the economy. So we’re going to continue with our strategy over the long term. In the meantime, basically, we are basically taking decisions of what are we going to do with the portfolio and where are we going to grow the portfolio.In the parts where we grew the portfolio is in the big corporates that are strong, that has the enough liquidity and that we don’t foresee that we’re going to enter into a problem, because the Mexican companies, at this point, they have very good position in terms of the long-term debt that they have. They don’t have, I mean, short-term maturities, and they’re not over-levered. I’m talking about the majority of the big Mexican corporates. The medium-sized companies as well, they’re in a good position.Probably the worst or the more complicated one are the SMEs that we just discussed at length and that we have the portfolio very well guaranteed by NAFIN at this point. So we are not so much concerned about that portfolio. And we also were very prudent in the way we were managing that portfolio, okay?So in that sense, I believe that the bank is in a good position to sustain a period of crisis as we are to pass through the next few months and maybe a year, up to a year. And both our main strategy is going to continue to be the same. We are, of course, I mean, decreasing cost. We are taking the provisions.And we are basically operating on a structural environment, but we are very well prepared for that, okay? You are right, we are trading below tangible book value, and we – I mean, we acknowledge that. But, I mean, I believe that the bank has very good capabilities of being profitable even in these current times.

[Unidentified Analyst:]

Sure, thank you.

[Operator:]

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

[Brian Flores:]

Hi, just a quick follow-up on the proportion of the portfolio that is involved in the relief program. Do you have any expectations on where this number might end? And the second question is just if you could elaborate a bit on what you mentioned regarding the mortgage portfolio and the trends that you’re seeing there? Is this something that you believe is recurring or more of a one-off for the quarter? Thank you.

[Héctor Chávez Lopez:]

The clients that have enrolled in the relief program, please, just to put things in perspective, the clients that are eligible to join these programs are individuals, so individual loans and SMEs. That comprise close to 50% of our loan portfolio, okay? If you look at the breakdown of those clients that have showed interest in joining you have up – the loan portfolio of those clients is close Ps.120 billion, as Hector noted earlier.We are just few days, well, actually, it ends up today, the deadline to register. So I understand that other banks have extended the period of enrollment. We are not considering that. So we think that the numbers that we’re sharing with you are relatively close to what we’re going to get to see. So we’re not expecting a significant increase from the numbers that we showed to you.Regarding the mortgage portfolio, if your question is associated with the provision that we made this quarter, we disclosed it a couple of quarters ago that there was coming this change in model that we’re using. And it was just pending regulatory approval, which we already have. So we made that and that’s non-recurrent, okay?

[Brian Flores:]

Very clear. Thank you.

[Operator:]

Thank you. At this time, there are no further questions. I’d like to turn the floor back to management for closing comments.

[Héctor Chávez Lopez:]

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

[Operator:]

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.