Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q2 2017 Earnings Call Transcript

Published: 29 Jul 2017

[Operator:]

Good day, everyone and welcome to the Grupo Financiero Santander México Second Quarter 2017 Earnings Conference Call. Today’s call is being recorded. And after the speakers’ remarks, there will be a question-and-answer session. For opening remarks and introductions, I would like to turn the call over to Mr. Héctor Chávez, Managing Director, Head of Investor Relations. Please go ahead, sir.

[Héctor Chávez:]

Thank you. Good morning and welcome to our second quarter 2017 earnings conference call. We appreciate everyone’s participation. By now, everyone should have access to our earnings release and the company’s presentation, which were released this morning before the market opened. Speaking during today’s call will be Héctor Grisi, Executive President and CEO; Didier Mena, Chief Financial Officer. Also joining us is Rodrigo Brand, Deputy General Director of Public Affairs and Communications, all of whom will be available to answer questions during our 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 differ materially, including factors that maybe beyond the company’s control. For an explanation of these risks, please refer to our filings with the SEC and the Mexican Stock Exchange. Let me now turn the call to Héctor Grisi. Héctor, please go ahead.

[Héctor Grisi:]

Thank you, Héctor. Good morning to everyone. We have reported a strong second quarter with the switch on this course our focus on driving profitability across the bank, posting our ROAE above 15%. Our emphasis on profitability and intense competition resulted in a slow running total loan growth. Through importantly, we achieved a robust performance in our high margin segments and maintained some asset quality. Similarly, we maintained a solid growth rate in deposits. We aim of further driving customer attraction and loyalty. We expanded Santander Plus on the program anniversary last May. This included upgrading the value offer to reflect the higher interest rate environment and expanding beyond favorable accounts to customers with current accounts with the recurring deposits. In June, we also launched Select ME, a loyalty program aimed at empowering women targeted to high income customers. As always, we are looking diligently to foster innovations, digitalization and executing on our strategic investment program. In the following page, let me now review the trends in the Mexican banking system. Sector loan growth remains healthy as of May. The most recently available public data from the CNBV through expanded at slower pace due to expectation of lower economic growth and the impact of higher interest rates, which rose about 400 basis points in the loans in late 2015. Consumer loan and deposit growth was also softer, but still grew at around 11%. Activity was healthier than expected, underscored by resilient consumption, stronger external demand, sound labor dynamics and a higher consumer confidence, following the deep barrier in the year. We see a more stable macro and financial environment as uncertainties regarding the U.S. trade volatility decreased. However, the prospect of additional volatility cannot be dismissed. Competition has remained quite strong in the start of the year, particularly in mortgages, corporate and government loans for market spreads have contracted system-wide. Moving on to Santander Mexico, as you can see on Slide 5, we achieved a solid performance in high margin loans despite total loan growth decelerating to slightly over 3%. Individual SMEs and middle-market loan growth remains healthy, supported by resilient demand and commercial initiatives, despite stiffer competition. The share of corporate and government loans, however, fell to 23% this quarter, down from 27% in 2015, reflecting our focus on profitability and difficult comps. Notably, our strategic and more profitable segments, SMEs and middle-markets, increased their share of total loans to 38% from 34% in the end of 2015. Now, turning to a more detailed discussion of our loan book. Individual growth – loan growth decelerated to 4.5% year-on-year as we continue to experience strong competition in some of our products. Mortgages were particularly affected by this market dynamics, with a year-on-year growth slowing slightly over 2%. As you know, we have revised our strategy earlier in the year, bringing rates closer to market levels and enhanced our product offerings to counter aggressive pricing competition. While our initiatives will take time to translate into higher loan growth, we are starting to see a reversal in the trend, which has given us an uptick in mortgage obligation and closing. Credit card loans were up 6% year-on-year, over 2% sequentially. While credit card usage increased about 24% year-on-year, this is not fully reflected in loan growth as we continue to see an initial high number of customers pay the balances in full at the end of the month. The Santander Aeroméxico co-branded cards continues to post good results with more than 650,000 cards issued since we launched the product last year. 38% of them placed with new customers to the bank. Consumer loans rose almost 10% year-on-year, accelerating to around 4% sequentially. Personal loans showed a pickup in the quarter, while payroll loans increased 9% year-on-year, driven by the success of the Santander Plus loyalty program and our efforts to attract new payroll accounts, leveraging our strong franchise in corporate and middle-market. At the end of June, Santander Plus counted over 1.9 million affiliated customers, of which 52% are new clients to our bank. Under the leadership of our new VP of Retail Banking, who joined us this quarter, we are experiencing a strong origination of run-rates across most of our individual loans growth. Turning to commercial loans on Slide 7, robust performance in high-margin middle-market and SMEs, up year-on-year 13% and 9%, respectively, was partially offset by a sharp contraction in government loans, along with softer corporate loan growth. Government loans fell 23% impacted by prepayments on an overhand from the large loans this quarter and difficult comps as the year in the year ago quarter, these loans posted a significant 51% increase. Corporate loan growth in turn decelerated to 4.5% year-on-year, reflecting our discipline with margins. This strategy has enabled us to selectively expand in the segment, while improving very much the spreads. Middle-market loans were up 13%, while loans to SMEs rose 9% year-on-year supported our efforts to target mid to large-sized SMEs, maintaining our risk return profits. In terms of funding, we maintained a focus on growing our deposits from individuals. Our initiatives to offer innovative products, such as Santander Plus and our client-centric approach for individual and SMEs continues to show good results with deposit growth of 14% year-on-year. Moreover, individual deposits continued to post attractive growth of 29%, followed by SME deposits, which rose about 12%. While demand deposits were up 10%, the high interest rates environments drove demand for term deposits, resulting on a 22% increase. Turn please to Slide 9 for an update on our progress on the key strategic initiatives. We have grown net new customers by 110%, driven by the success of our strategic initiatives and our reduction in attrition. We now have more than 1.8 million loyal customers, 27% more than a year ago. Our digital clients also continued to increase, up 60% year-on-year, as we continue to transform our business model with a strong focus on digitalization and mobile banking. Global corporate banking maintains its contribution to overall results, underscoring our ability to prioritize profitability, sharp execution and an ongoing focus on key business. This has created the strong foundation for ongoing profitable growth. We remain dedicated to generating long-term sustainable returns and outstanding value proposition and the exceptional customer service. Now let me turn to – the call over to Didier, who will go our capital position on P&L and afterwards, we will be happy to respond to your questions. Thank you very much.

[Didier Mena:]

Thanks, Héctor. Good morning everybody. As you can see on Slide 10, we maintain a strong liquidity profile with net loans to the profit slightly over 92%, providing flexibility to fund future growth opportunities. Our liquidity coverage ratio stood at 178%, well above the regulatory requirement. Our capitalization ratio declined 55 basis points in the quarter to 16.2%, mainly reflecting the MXN4.2 billion cash dividend payments in May and the first coupon of the AT1 issuance for $13 million last April. Our Tier 1 capital stood at 12.7% and core Tier 1 at 11.4%. Now turning to the P&L on Slide 11, we continue to drive strong net interest income growth, up 15% year-on-year and almost 1% sequentially. This resulted in a net interest margin of 5.31%, up 4 basis points sequentially and 45 basis points year-on-year. Strong net interest income benefited from the average increase of 288 basis points relative to the second quarter of last year, a solid performance in high margin segments in line with our profitability focus and segue the implementation of our strategic initiatives. Interest income from the loan portfolio, which remains the main driver behind this strong performance was up 25%, while our securities portfolio contributed with year-on-year growth of around 22% in interest income. Net commissions and fees rose 3%, mainly on the back of higher investment banking and credit card fees. Investment banking fees remain strong, up 24% year-on-year as we were present in the few transactions that took place in the market during the quarter. Credit card fees maintained their growth trend, up 7% year-on-year, although this was still impacted by issuance and required cost from our Aeromexico co-branded cards. However, income remained strong with higher credit card usage, driving a 19% increase in earned fees, while we are gradually stabilizing the cost of rewards. Insurance fee, the highest share of fees, grew marginally driven by lower credit related insurance offsetting the good performance in our life and car insurance products. Net cash management fees fell 3%, as higher fee base of third-party branches more than offset the higher fees from collection and payments and account management, which have been driven by higher transactionality and client retention. To recap, gross operating income increased 14%, driven by strong net interest income growth and higher trading gains. Trading gains reached almost MXN1.1 billion, again, significantly above our estimated quarterly average of around MXN600 million to MXN800 million. Notwithstanding, net interest income and recurring fees represented 94% of total gross operating income. Turning to asset quality on Slide 14, NPLs declined 67 basis points year-on-year, reflecting improvements in commercial and mortgage loans. Commercial loans to MPLs declined 93 basis points year-on-year, reflecting the sale of a sizable share of homebuilder portfolio, while SME NPLs fell 53 basis points. Mortgage NPLs in turn, improved 70 basis points year-on-year, reflecting the sale of a portion of the legacy ING past due portfolio in the first quarter of this year, but increased 23 basis points sequentially. This more than offset the increase of 21 basis points in NPLs in consumer loans as a result of a slight deterioration in credit cards with the NPL ratio rising 33 basis points. Loan loss reserves increased 2% sequentially, principally due to higher provisions in consumer loans, mainly credit cards. This along with the shift in mix of our segment with higher cost of rates, were the reasons behind the 6 basis points quarter-on-quarter increase in cost of rates to 3.55%. As always, we will continue to diligently manage our loan book and are committed to strong risk management. Turning now to cost on Slide 15, expenses rose 13% year-on-year as anticipated cost related to our strategic plans resulted in higher administrative expenses, up 21% and includes marketing cost in connection with our plan attraction initiatives. Depreciation was up 20%, reflecting recent IT investments. Our efficiency ratio however, improved 109 basis points, down to 41.7%. We continue to expect a progressive rise in costs as we execute our 3-year investment plan. Overall, we achieved a strong bottom line with net income up 24% year-on-year to MXN4.6 billion. ROE rose 360 basis points to 16.4%. Even excluding the benefit from a lower effective tax rate, down 231 basis points in the period, profit before taxes was up significantly, 21% year-on-year. This reflects stronger net interest income growth driven by higher interest rates and modest volume growth with a better mix supported by the execution of our profitability strategy. Before opening the floor to questions, let me review guidance for the year. While visibility was limited earlier in the year when we provided annual guidance for 2017, many of the uncertainties dissipated throughout the first half. This weathered the strong results reported today and the progress achieved in the implementation of our strategic initiatives allow us to keep a more optimistic view for our annual 2017 results. Our targets for loan deposits and expenses growth remain unchanged. However, due to the shift in mix we are experiencing in the loan portfolio and the slight increase in credit card provision, we are adjusting our cost of goods guidance range by 10 basis points to 3.4% to 3.6%. At the same time, we are increasing our net income growth target to the range of 17% to 20%. This is mainly due to the solid margin increase achieved to-date and lower spend to our current expectation of an increasing effective tax rate from the impact of higher inflation. We now anticipate the tax rate to be in the range of 21% to 22%. We are now ready to take questions. Operator, please go ahead.

[Operator:]

Thank you. We will now be conducting question-and-answer session. [Operator Instructions] Our first question is from Tito Labarta of Deutsche Bank.

[Tito Labarta:]

Hi, good morning everyone. Thank you for the call. A couple of questions, mostly on I guess margins and loan growth, a bit combined, I guess first, in terms of margins, a good performance over the last year for sure, but how much more room is there for margins to expand, we have seen interest rates increase more than 300 basis points and may go up a little bit more, but we are not going unlikely to see that type of increase again and I know shift in the loan mix is also helping, so how much more room is there for further margin expansion. And somewhat combined with that question, loan growth has been weak, I think good strategy to focus on profitability, yet the system is growing much faster than you, so at what point does that normalize or does – is the system maybe growing too fast and maybe we will have some asset quality issues or we will eventually grow faster, just want to get sort of the disconnect between your growth and the systems growth and where that should kind of play out over the mid to longer term? Thank you.

[Didier Mena:]

Good morning, Tito. I think that in terms of margins I think that there is still some room for expansion and that’s a consequence of how interest rates have increased during the last, I would say 12 months to 18 months. Particularly in the first half of this year, we have seen interest rates increase 272 basis points. We – if interest rates do not increase during the rest of the year, we will see an expansion or an increase in the reference rate of 233 basis points, so even though it’s not as significant as we have seen during the first half of this year, we still – we will be experiencing an increase in interest rates. And I – and this is the most relevant contributor to our NIM expansion during the year. So yes, we think that there is still some room for expansion, but I think that we have seen – most of the expansion, we have already seen it.

[Héctor Grisi:]

Thank you, Tito. This is Héctor. In terms of loan growth, let me tell you what happened. What I can tell you is that we were very conservative after what happened towards the end of last year with the whole situation in the political arena, plus what we saw in pickups – in inflation in Mexico, so we were quite conservative and that basically resulted in notes lagging behind in some of our products. Also we decided to increase rates mainly in mortgages in which the market decided not to do. And we lagged behind the rest of the competition. We have seen that the portfolio even though cost of credit is up 2 basis points, we have seen the behavior of the portfolio is quite good. So, we have decided basically to be a little bit more aggressive. And since about June, July and a little bit the end – towards the end of May, we decided to change our strategy and to be more aggressive in that sense. We have changed loan growth after that. And historically, we have been growing more aggressively in those markets. And that’s why we are not changing our loan growth trends towards the end of the year because we believe we can pickup where we left. And we have not seen more deterioration in the market that we expected at the beginning. So that’s exactly what happened.

[Tito Labarta:]

Okay. Yes, no, that’s very helpful. So I guess your growth should pickup to be more in line with the guidance also that you have given for the year. And then if you think about maybe 2018, can you continue to pickup growth into next year in a maybe more normalized environment as some of the concerns you mentioned from the beginning of the year have gone away, so maybe loan growth next year gets to the double-digits? And then also just following up a little bit on the margin, I understand you see a little bit more expansion. But if we exclude the interest rate increases that we have seen once in a more normalized environment where rates say are steady, is there still room for margin expansion? You have talked about competition, so maybe once rates stop going up, does margin also start going up or given the mix shift, is there still some room, excluding interest rate increases, for margin to increase?

[Héctor Grisi:]

Yes. So, I think that there is room for some expansion as a consequence of the shift in mix as you rightly point out. Over the last 18 months or so, the loan portfolio – it has the mid-market and SMEs loans have increased 4 percentage points in our loan portfolio, while those loans have higher pay margin than corporate and government loans, that – these type of loans have decreased 4 percentage points. So yes, our strategy is to concentrate into segments that are more profitable will result in an expansion in net interest margin through time. This is not immediate. It takes time, Tito, as you well know.

[Tito Labarta:]

Okay, great. Thanks. And just the loan growth, can you grow in the double-digits next year? Is that more reasonable scenario for next year?

[Héctor Grisi:]

I mean, it all will depend on what we see and how the market is behaving. I think we are – we need to be very dynamic in a market like this, which is moving so fast. So I don’t think that – I mean, we need to see it, I mean, how the market is behaving and then we’ll take a decision on what to do then.

[Tito Labarta:]

Okay, fair enough. Thank you very much.

[Operator:]

Thank you. The next question is from Jason Mollin of Scotiabank. Please go ahead.

[Jason Mollin:]

Hi, thank you. My first question is on what you mentioned, stiff competition impacting your business. Higher benchmark rates was being discussed has benefited the NIM, but our lending spread is facing pressure, for instance. Can you give us a sense of what is the current lending spread on mortgage loans today versus a year ago? And is that one reason why you are not growing in that segment? And as a follow-on, higher rates are increasing funding cost as you show in your release. And even if we look at the CNBV data for May, SANMEX’s cost of demand deposits was about 2% higher than the system’s 1.5% and it’s been growing faster. And we had talked about this in the past, if you can describe that if this is related to the Santander Plus product that you are paying more on demand deposits or is this related to corporate demanding higher remuneration for their deposits? That’s my first question. The second, I can just say it now is more on asset quality, particularly in the consumer segment. We did see NPLs tick up there in the quarter, if you can just talk about that segment and if we should continue to expect higher nonperforming loans? Thanks.

[Didier Mena:]

Hi, Jason. Good morning. In terms of lending spreads, I would say that, that’s where probably competition is stronger. And if you look at the last 12 to 18 months, they are pretty much stable. So – and particularly in mortgages, that the vast majority of mortgages in the market have fixed rates. We don’t see an expansion there. So what we decided to do at the end of last quarter – at the end of the first quarter of this year was to launch certain incentives for the customers who are more loyal to the bank. So we’ve started giving some – either discounts or benefits to those types of customers for being very, I would say, selective in terms of where we dedicate this incentive. So let’s say we are being aggressive with the customers that not only have a mortgage with also who have the mortgage with us but with those customers that have a more strong relationship with us. So on that side, spreads are pretty much stable or even have compressed slightly. In terms of increase in our cost of funds and particularly in demand deposits and more than our key competitors, you’re completely right. And that’s a consequence of how much we still rely in corporate demand deposits. The whole idea behind Santander Plus is to attract more individuals, not only in deposit, but also on the loan side. And that will, through time, that – one of the consequences of executing properly that strategy is a reduction in our cost of funds. The Santander Plus program, I think, I would say, has not a material impact in our cost of funds. It’s still, I would say, minor in terms of the cost associated to the benefits of those customers bringing in their demand deposits. As you probably recall, of the MXN7,200 that we give benefits associated to this loyalty program, only half of it, MXN3,600 are associated to a higher compensation of demand deposits. And only more percentage of those customers associated with Santander Plus are getting the full benefit of the MXN3,600 associated with this benefit. In terms of asset quality, I’ll let Héctor go over that.

[Héctor Grisi:]

Yes. In terms of asset quality, I mean what we have seen is that we have got some particular situations in credit cards that the portfolio has behaved a little – I mean, the right word is, we have not seen the portfolio – I mean, what we have seen is that the portfolio basically behaved very well in January. We had a lot of customers basically playing down their balances. Then the portfolio complicated a little bit in February and March and then is behaving much better right now. But we have had some deterioration of the portfolio in those couple of months. And we believe it is because some of our customers basically decided to concentrate on buying goods – I mean, appliances and cars and things that they were thought that they were going to increase in price due to inflation. And that’s what we thought the portfolio behaved that – in that particular way. And then we have seen the portfolio normalized a little bit towards the past 2 months. So we have continued growth. The growth in cost of credit is around 2 basis points. It’s not that much. But we are basically concentrated and basically managing the portfolio as well as we can, so it doesn’t deteriorate any further. And that’s why the portfolio have not grown so much. Also we have to – we have seen this trending, which the portfolio is concentrated more on clients basically using more of the credit card for paying down their balances at the end of the month. And this is shifting the mix of our portfolio at this point, this particularly in credit cards. And the rest is basically behaving very well. On personal loans, we have seen – I mean 1 basis point deterioration, so it’s not that much, but is behaving much better than we expected and that’s why we basically decided towards turning more aggressive towards the market.

[Jason Mollin:]

Very helpful, indeed I would just mentioning on the Santander Plus, the chart you showed, the net new customers moving to 1.4 million, up from 600 million from last year is indeed impressive. So thanks for that and very helpful.

[Héctor Grisi:]

Yes. No that resulted very well. Santander Plus is helping us in one of the bigger products that we have, there was [ph] attrition and it’s helping us quite a lot. And we have also seen also the demand deposits growth due to that.

[Jason Mollin:]

Thanks.

[Operator:]

Thank you. The next question is from Philip Finch of UBS. Please go ahead.

[Philip Finch:]

Good morning Héctor and Didier. Thanks for your presentation and also congratulations on another solid set of results. My questions really relate to your guidance, first you have lowered your tax guidance as you mentioned earlier, can you elaborate what is driving this and if inflation starts come down, how sustainable is it. And secondly, we have seen obviously, you raised your net income growth guidance this year meaningfully, which is impressive, this appears to be in part driven by lower taxes, but also by improvements on the operational level, so can you elaborate on the key operational drivers for this improved profitability outlook and linked to this, given improving performance in recent quarters, what is your ROE target over the next few years? Thank you.

[Didier Mena:]

Hi Philip, how are you? In terms of guidance, first on tax rate, as you know there is still – from a tax standpoint, some inflationary accounting in Mexico, so an inflation of 6% benefits us. I think that when you look at it from a more normalized perspective, if inflation trends down to what the Central Bank is aiming towards 3% by the end of next year that will have an impact and that will increase our effective tax rate. And I would say probably, it moves – extremely correlated or almost one-on-one. So yes, we currently have that benefit of higher inflation. So that’s according to the current monetary policy of what the Central Bank is aiming at. We don’t think that that’s going to be sustainable. That’s a temporary benefit, okay. In terms of the increase in net income guidance, I think that the main driver is net interest income growth. It has been growing for the first half close to 15%. And that has to do I would say with two things mainly. First one is the impact of the increasing interest rates. According to our analysis, 75% to 80% of increase in net interest margin is associated with increase in interest rates. 288 basis points is a very significant increase in interest rates. And also as you know, I would say that the second effect in this increase in net interest income is what we are doing in terms of both our loan portfolio shifting towards a higher margin loans. And also in terms of our deposits, deposits are growing very strongly. Demand deposit has been growing faster than term deposits until the last quarter we were seeing – and we see that as a consequence of interest rate increases. Term deposits are accelerating, but our term deposit is associated with individuals. But I think that when you look at it from a growth perspective, I think that if we continue executing the strategy of bringing in new clients and retaining them, that would have an impact in margins from two perspectives. First, it will reduce our cost of funds. And secondly, it will increase the deals that we get from our loan portfolio. So this is not something that – the benefit of that would not be seen in the coming quarters, it will be seen in the coming years. It’s something that takes time to change. So for this year in particular, the very strong performance that we have had in the years associated with the net interest income. Also I would say, a strong performance in our training as well. And it’s allowing us – the fact that our income is growing at a faster pace than us, which are not growing slowly is – are the things that give us the confidence to increase our net income guidance in the range that we have provided, 17% to 20%.

[Philip Finch:]

Thank you, Didier. Just a quick follow-up, in the last three quarters, we are seeing your ROE is above 16%, so a strong improvement compared to recent years, so looking forward, do you have an ROE target at the moment?

[Didier Mena:]

No, I think that the target that we have was to get to 60% and we have already, we are already there. I think that there is a potential upside as we continue securing this strategy. I think that we are getting to our level where we think it is sustainable. And I think that through time we should have an expansion in ROE. But currently Philip, we are not aiming at a specific target, okay.

[Philip Finch:]

Okay. Thanks very much Didier.

[Operator:]

Thank you. The next question is from Carlos Rivera of Citi. Please go ahead.

[Carlos Rivera:]

Hi, good morning everyone and thanks for the opportunity to ask questions. My first question is regarding your loan growth guidance, I understand what you said before about some uncertainties in Mexico making you grow a little bit less and being more conservative on those anticipating so far, but to hit your guidance I calculate that you need a pretty significant pickup in the second half, so about 7%, which might require you to go a little bit stronger into larger ticket loans like corporate and government and you mentioned before that that’s where you are seeing some of the pressures on the spreads, so do think there is any risk to that 7% to 9% guidance, do you see yourself more towards the lower end and if the pressure on the spreads on those segments that could get you there were maintained, would you still prioritized the profitability of NII over the growth, that will be my first question? I will ask the second one after. Thank you.

[Héctor Grisi:]

Okay. In terms of – Carlos, thank you for your question. I mean the guidance, you are right, I mean it is aggressive for the second half of the year. First of all, let me tell you that our months of June and July have turned out very good in the sense I mean of pickup in volumes, mainly in the mortgages and in the personal credit side. Mainly also, we are doing very well in payrolls. So on that side, we are growing healthy in a good way. On the other side, I mean you are correctly point, competition is quite strong in government and institutions, but we have some projects over there that we believe are going to basically help us out in the second quarter. Also in GCV I mean, we have been keeping up some good transactions, some M&A situations are helping us in boosting our portfolio there. So we believe that we are going to be able to go towards this guidance. You are probably right, we are going to go probably more towards the 7% then to the 9%. And as always – I mean I always try to be conservative in why I tell you, so we have a very well managed what we are telling you. So in that sense, I believe we are going to be able to get there. It’s not going to be easy, but we are working towards that. And just to add on that information, we pointed out earlier that we have seen a pickup in the origination rates, in the run-rates of retail products. So, we think that, that will also contribute to an increasing of loan growth during the second half of the year, Carlos.

[Carlos Rivera:]

Okay, thank you very much. And my second question is related to provisions, particularly the ones that are mandated that the churning regulation – related to non-revolving credits. I believe that you haven’t done any of those that you can take against equities. So, can you confirm that you have not taken those? And if that is the case, when and how much would you expect to be booking related to that?

[Didier Mena:]

Hi, Carlos. Yes, we have not put those provisions still on the balance sheet. As you know, given that this changing regulation is going to be through equity, we are going to do it somehow before the end of the year. And our calculation is going to be much lower than the ones we put for credit cards. So, it’s not going to be a significant amount at least from what we understand at this point.

[Carlos Rivera:]

Okay. Can you remind me how much it was – credit cards a few quarters ago?

[Didier Mena:]

Yes. Last year, it was MXN1.1 billion.

[Carlos Rivera:]

Okay, alright.

[Didier Mena:]

This year, it is going to be much less than that.

[Carlos Rivera:]

Understood. Thank you very much for the answers.

[Operator:]

Thank you. The next question is from Thiago Kapulskis of BTG Pactual. Please go ahead.

[Thiago Kapulskis:]

Hi, everyone. Thanks for the opportunity to ask questions in this call. I have a couple of questions. The first one is related to your view on the interest rates, right. I remember you are saying that you see still some sort of, I mean, good effects from NIM, right? And I can see in your presentation that you don’t see rates falling in the short-term, right? So my first question would be how do you see such movements for interest rates going forward, maybe this year and also the next year? And my second question is related to OpEx, we can still see that you are still expanding a little bit more on OpEx. But I would like to see also your view on OpEx, how do you see it evolving, also for the remainder of the year and also next year? Thank you.

[Didier Mena:]

Regarding your question on interest rates, what we see right now is that for this year, Banco de Mexico has already reached its target. We don’t see any movement for the remainder of the year. However, we think that for next year, Banco de Mexico will continue following the Fed. So, we still think there might be room for a slight increase of around 25 basis points in 2018 and then afterwards, start decreasing the rates in the coming years. As you have seen, Banco de Mexico has been very preemptive in terms of their monetary policy. We think that inflation in the coming months will start to decrease this and together with the – some inflation that we have seen in the FX markets will give some room to maneuver for Banco de Mexico to remain at the actual levels at the group levels, but to follow the spreads in 2018. So, that’s basically how we see interest rates in general for the coming 12 months.

[Héctor Grisi:]

Regarding your question on OpEx, Thiago, our guidance is for the year to – for expenses to grow 10% to 12%. And we are exactly in the first half, in the middle of this range at 11%. If you break it down by key components, salaries and employee benefits are growing, basically by inflation at 6.2%. Then, the second and third most relevant pieces are increasing. Our expenses are IT, pretty much associated with the investment plan that we are executing. And also depreciation and amortization that is also completely linked to the proper investment that we are doing and that are amortized on a 3-year basis. So we think that expenses should be growing pretty much inline with what we have provided as guidance. This is not only for this year. I think that as you probably recall, we announced last year MXN50.3 billion, 3-year investment plan. The consequence for that is that we will see expenses growing faster than inflation during this investment period, with the expectation that we will see operating leverage as the consequence of this investment more towards 2020.

[Thiago Kapulskis:]

That’s very clear. Thank you for the answers.

[Operator:]

Thank you. The next question is from Domingos Falavina of JPMorgan. Please go ahead.

[Domingos Falavina:]

Thank you. Hi, Héctor and Didier. Congratulations on the results. Like I have actually two questions too. The first one is we are noticing sort of trading income consistently strong and I remember you guys mentioned the MXN600 million to MXN800 million as being a more normalized level. My question is like what do you think is the more normalized level now? Should we start contemplating around MXN1 billion in the quarter or something like that? And the second question has to do with the coverage. And again, we are noticing some pretty good coverage increase, reaching 160%, what’s the level you feel comfortable working in terms of coverage? Thank you.

[Héctor Grisi:]

In terms of trading income, Domingos, I think that we have seen quite stronger performance over the last few quarters. Now, this quarter is getting to MXN1.1 billion. I think that’s I would say higher than we expect. We think that the MXN600 million to MXN800 million is what we have indicated in the past. If our team has stated with trading continues over-performing, we will probably update that guidance. We currently see it within that range. And you probably recall that the corporate and investment banking team is new to the bank. Most of them arrived in April, May of last year. So I think that this over performance is a consequence of this new team, extremely competent that they are doing a great job. And they have delivered quite strongly. So rather than updating now for a higher number associated with trading gains, I would say that we continue feeling comfortable in that range. And if our team continues over-performing, we will definitely update that number.

[Didier Mena:]

On coverage, Domingos, remember that in Mexico, we use the expected loss methodology. So we are not targeting a specific level of coverage. That’s a result of applying the methodology. And recently, the NPL sales that we have done in the past couple of quarters, has helped increase the coverage, but it’s not a target that we pursue because of the methodology we apply.

[Domingos Falavina:]

So you don’t have any kind of like additional coverage that you do more on a macro level, everything is quantitative methodology?

[Didier Mena:]

That’s correct.

[Domingos Falavina:]

Okay, thank you.

[Operator:]

Thank you. The next question is from Marcelo Telles of Credit Suisse. Please go ahead.

[Marcelo Telles:]

Hi, good morning gentlemen. Congratulations on the results. I have two questions. One is still regarding the guidance, when we look at – part of the guidance seems to be explained by the lower tax rate and but also your trading income has been higher, but we still have perhaps another 2% or 3% of the guidance increase that will have to be explained by something else. And my question is, is there something related to – I mean, are we becoming more optimistic on fees, perhaps in our eye down the road that could explain that extra increase in the guidance beyond of course what would be explained by the lower tax rate and moderated income. And my second question is more in terms of strategy, I mean when you look at your current base today, what are the areas that in terms of products that you think you have more room to penetrate with your existing client base or you think now it’s more of a strategy that there is – you probably have to go to new customers to try to grow the business, just to understand where the growth is going to come from? Thank you.

[Didier Mena:]

Hi Marcelo. Regarding guidance, I would say that the single largest contributor to the increase is the performance that we have seen in net interest income, rather than tax rate or credit income. That’s a consequence that we have mentioned of the know-how, we are growing our loan portfolio, our deposit base and also the increase in interest rates. Particularly on fees, you have to probably break it down in fees earned and fees paid. While in terms of fees earned, they are growing roughly at 10%, 11%. We are still seeing fees base growing at a faster pace associated with, in part the rewards associated with the Aeromexico credit card portfolio. We are also seeing quite a robust performance in investment banking fees. We are participating in the most relevant transactions that are happening in the market. We continue to expect that to be the case further down the road. So we think that fees could expand somehow as a consequence of what I have mentioned. Regarding strategy, I will let Héctor comment on that.

[Héctor Grisi:]

Hello Marcelo, good morning.

[Marcelo Telles:]

Good morning.

[Héctor Grisi:]

In some of where the growth that we see is that, I mean we see opportunities in many parts of the regions. I mean first of all, as you can see on investment banking, just this year we have done quite a lot of things in the past 18 months. And the business is basically doing very well and growing very healthy. We have really good mandates over there that we expect to be able to deliver in the second part of the year and that’s something that will help us out. We also see some continuous growth in the middle market segment. And also what we are doing is exploring our client base in the mid-market to get more investment banking business that we didn’t used to do before. So that’s helping us quite a lot. We are also in SMEs, as you are seen the growth is quite good, both – the importance of the balance of the growth that we have had in SMEs. Because it is not just growth in loans at 9%, but it’s a really healthy growth in deposits and transactionality, what we didn’t have before. So what’s been happening is these clients are not just looking to us now for just – for credit, but basically they are using us for transactions. Our transactionality has grown to around 140% in the bank. And that’s also generating more business for us and is helping us in a healthy growth. And on the other side, on the commercial side, we see volume is picking up really well. Volumes have historically, have not been that good. And we are also coming out with programs that would help us basically, I mean loyalizing our client base. A loyal client is 4x more profitable that a normal client. And while client starts to mature, they are going to become more profitable in the future and that is going to help us out also to deliver the numbers that we are putting here. So hopefully, we continue this growth with new clients. And also exploring that client base is going to help us out in the future. So that’s basically what the model we are following was. It’s going to take time, but you are already looking at some of the early results.

[Marcelo Telles:]

That’s very clear Héctor. Thank you so much. I appreciate it.

[Héctor Grisi:]

Thank you.

[Operator:]

Thank you. The next question is from Carlos Macedo of Goldman Sachs. Please go ahead.

[Carlos Macedo:]

Thanks. Good morning, gentlemen. Thanks for taking questions. A question more strategic. I mean, looking at your decision recently to start accelerating loan growth again, on the consumer mortgages, etcetera. What drove that decision? Is it basically just what you have seen in terms of asset quality in your own portfolio? Because otherwise looking more macro, consumer confidence continues to be low, unemployment probably won’t improve anymore. GDP growth isn’t particularly strong. You see retail sales starting to falter a bit. Generally, it doesn’t paint a really good picture for the consumer. So, what – just trying to get an idea of what you are seeing and what that means generally for loan growth for you on the consumer side? Thank you.

[Héctor Grisi:]

Okay, Carlos. This is a very good question and it is a question that I make myself every single day due to the fact that I mean when you manage a portfolio this is exactly what you need to be looking at. What we have seen, first of all, is that we have some of our select clients that – who are going now from the bank to look for loans in – from mortgages to some other places. So we see that our client base in the select sector, basically, we have an opportunity to grow there. We are coming out with a new product in the mortgage side, we believe it is going to help us out in win these type of clients. We are not going down the food chain in this sector. We are continuing, basically to concentrate in our same sector that is basically the AMBs and we are going to continue there. And we see the trend that this sector is basically continuing to grow very healthy, mainly in the Mexico City, some parts of the center, cities around the Mexico City area like Puebla, Querétaro. You go towards the north – the growth is huge, okay? So, I mean, what we have seen is that we need to focus our business in a more regional basis, okay? So maybe I am not going to grow in Chiapas and Oaxaca, I mean the southeast of the country. In the southeast of the country I am going to concentrate in Mérida and Cancún, but we are looking at the business on a more regional basis. And this is basically helping us out to concentrate in the markets that are growing and that have a healthy growth prospect versus the markets that are not to doing that well such as Guerrero, Oaxaca, Chiapas and some other parts, like Campeche, okay. So you’re going to see us basically more focusing to that. And we’re changing our approach, and the way we manage our products. We are going to basically focus in the part, and that basically is – if you were in a mining company, we are mining where the gold is, not some other place. And this is basically helping us out and you are going to see that also in cost of credit, which is basically doing quite well. So we see that opportunity and we are working towards it. Also, in the middle-market, we see some opportunities. We are coming out with a pilot program and some of the clients that have been good – very good clients of ours that have been payrolls, which basically have – we have not tapped in the past, okay? So we are expanding towards there, because we see that there is a sector that has the stability and the rates are very good and the margins are also good. So that’s something that the bank has not done in the past that we’re moving towards there. Right now we have the pilot program, where the pilot program has done very well, and we are going to continue to work there, okay? So that’s the strategic part that we are doing and that’s exactly what we are going to concentrate on in the next few months.

[Carlos Macedo:]

Okay. Do you see – just a follow-up there, I mean, in Mexico more than other countries that the strategy seemed to be very different. How do you feel that your behavior is relative to the strategy in the market? You said there is a lot of competition for price. Do you think then that because of the competition in the larger centers that you might see movement towards these regions as well?

[Héctor Grisi:]

I mean, I hope not. I mean, my competitors are also very smart and they also look at the markets and they know what’s happening in the different parts of the country where they are operating. And they probably are going to start moving towards there as well. I mean right now, what you have seen in the first quarter and the second quarter is that we saw that the rates are going up. We moved really fast in basically beefing up deposits and you see the results over here. And we have the first mover advantage in that part. What we have been doing towards the second part of the year probably is going to help us and try to position ourselves better and also already showing signs in – since we started this in May and June and July. So I mean I believe that our competitors are going to basically move real fast as well. But I mean, right now we have the first mover advantage in that thing.

[Carlos Macedo:]

So, that’s my question. I mean, you don’t know what they are going to do, but you haven’t seen them so far pursue the same strategy?

[Héctor Grisi:]

No, so far not. I mean, we have heard of – I mean, we have some regional players that play in those markets and we see how they move. And we are moving I mean – and we are moving towards competing against I mean in their sectors. So, that’s exactly what we are doing. But we are going to be looking more at the business on a regionalized basis than on a nationwide basis. So we are moving towards there.

[Carlos Macedo:]

Okay, perfect. Thank you so much.

[Operator:]

Thank you. The next question is from Arturo Langa of Itaú BBA. Please go ahead.

[Arturo Langa:]

Hi, good morning. Thank you for taking my question. I just was wondering if you are seeing or have any concerns regarding the interest rate curve structure that is playing out in Mexico. I think it’s getting very flat or a little bit inverted. And I was wondering if that poses any challenges for you in the outlook for 1 year or 1.5 year? And I was wondering, if you could share some detail on what initiatives or how you are approaching this? Thank you.

[Didier Mena:]

Yes, we are seeing as a consequence of, I would say, our quite aggressive – or proactive approach of the Central Bank in terms of increasing interest rates. The short-term interest rates being at higher levels than midterm interest rates. So I would say that probably the challenges are more associated with our credit income, let’s say. It is difficult to visualize what is the right strategy depending on what would happen to the term structure of interest rates, in terms of, let’s say, our retail portfolio, we have certain products that have a floating rate, both on our assets and liabilities. And I think that, that they probably compensates the potential movement that we could see in the term structure of interest rates. So we are somehow hedged in that respect. So the only place where we think it is – on certain things associated with how it plays out is more related to trading income.

[Arturo Langa:]

Okay, perfect. Thank you.

[Operator:]

Thank you. There are no further questions in the queue at this time. I would like to turn the call back over to Mr. Chavez for closing remarks.

[Héctor Chávez:]

Well, thank you very much for joining Santander Mexico from this call. I look forward to maintaining and hope all is well with all of you. And you are welcome to visit us in Mexico. If you have further questions, please don’t hesitate to call us or give us an e-mail. Have a good day.

[Operator:]

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