Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q2 2016 Earnings Call Transcript

Published: 28 Jul 2016

[Operator:]

Good day everyone and welcome to Grupo Financiero Santander Mexico’s Second Quarter 2016 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. Hector Chavez, Managing Director, Head of Investor Relations. Please go ahead, sir.

[Héctor Chávez Lopez:]

Thank you. Good morning and welcome to our second quarter 2016 earnings conference call. We very much appreciate everyone’s participation. By now, everyone should have access to our earnings release and the company’s presentations, which were released this morning before the market opened. Speaking during today’s call will be Héctor Grisi, Executive President and CEO. Also joining us are

[Héctor Grisi Checa:]

Hector, thank you very much. Good morning everyone. Good afternoon for those in Europe. I’m pleased to say that we had posted a solid quarter this first semester delivering strong loan growth and demand deposits continuing to drive growth in our deposit rates. This expansion was achieved to our improving asset quality, I will say and results also on the focus on efficiency and profitability and demonstrate the initial success of our strategic initiatives. I would like to take same time on this call to discuss our business strength and how to maintain to meet our role of becoming our customers’ primary bank and the leader in profitable growth in Mexico then I’ll go into the results for the quarter. First of all, to achieve these goals we’re working on three fronts as you can see in the slide. The first pillar is to establish a client centric model that puts the customer at the core of our business. We see to differentiate ourselves by providing exceptional service, a clear area of opportunity in our market and by offering attractive value that would increase our customer loyalty. This model will allow us to strengthen our position in the retail segment by attracting new high potential customers, retaining existing customers through transactional products and become their primary bank. For instance, at the end of May, we launched a comprehensive payroll program that will become one of the main drivers of customer attraction and loyalty. This key initiative, Santander Plus, is a unique and innovative program focused on client attraction, transactionality, loyalty and digitalization. This value proposition will want loyalty of current and new customers. During the program customers have to bring their payroll account to Santander and become a digital customer by using internet or mobile banking. Benefits include, cash backs in direct debits and in a select suite of independent maintenance [ph] as well as preferential rates in saving accounts, just to give you an idea. To date, over 200, 000 customers have signed up for this program of which 50% are new customers to the bank. The remaining 50% are existing customers who have added a few more pebbles to their portfolio that are required all under the program. To take advantage of the new rule on the payroll profitability regulations we are leveraging our unique position in corporate, needle market anatomies that we have disclosed before to attract new payroll customers and grow our individual demand deposit rates. Another initiative to attract and retain customers is the value proposition offered through the Santander-Aeroméxico co-branded card, launched this last February. This program has enjoyed direct associates and to date with over a 165,000 card holders of which around 25% are new customers. In just three months, we exceeded by far the initial expectation we shared on our previous call of featuring a 15,000 cards in the first year. So we are having new customers and successfully cross-selling all the products to recent client base. In the commercial business, we continue to consolidate our leading positions in key markets. Mainly, our total market positions in SMEs and middle-market, while in corporates and investment banking, our objective is to become the number two player in the market. We have aligned our corporate structure to fit business strategy. Digitalization includes the creation of a new division responsible exclusively for managing our relationship with clients across all different segments. This division ensures we have a deeper understanding of individual customer needs and continue our service on both offerings accordingly. The second pillar is the digital transformation of our business to reflect our strategy and goals. This includes upgrading our technological platforms and infrastructure that we’ll offer our customers innovative and quality service that satisfies their dynamic demands. With this, we will catch-up with the multinational competitors in the market by processing significantly higher volume at lower cost. We expect to add approximately 2.5 million new active customers over the next three years, which implies a 40% increase of our active credit rates. By the end of 2019, we will have subsequent increase in the transactionality and deposits for the bank. For this we need to upgrade our systems and invest in channels to further tailor our customer service. For example, we have released new versions of internet and mobile banking applications for both individuals and corporate cash management in the past few months. In addition, we are expanding our footprint in terms of ATMs, while we are starting to incorporate multifunction ATMs aiming to decentralize transactionality from the traditional branch network and to more cost effective channels. An important initiative is our Lighthouse project. It’s a project where we are reengineering our client on-boarding process to create a better customer journey. At this stage, we are focusing on our customer service efforts on individuals and SMEs, everything to digital platforms. We continue to implement our restart aggregation, which aims to unify our databases to improve customer data mining and sharing capabilities. In this particular context, we are going to be budgeting cleverly [ph] our IT and retail investments for the next three years to support and to see a better business increase for the new and existing customers. The third pillar is a sharper focus on profitability and efficiency. This is by having a more balanced bank with a higher share of consumer loans and lower cost deposits. This will be underpinned by efficient capital allocation, a strong risk management and an efficient overhead structure with productive investments. As you know, in terms of capital deployment we have conducted an in-depth assessment of the returns of our risk-weighted assets, maintaining a disciplined philosophy of only embarking on transactions that meet our return thresholds. Since the start of this year, we have taken a risk based pricing approach adjusting rates in SMEs and mid-markets according to the risk profile. We are now implementing this approach in credit cards and consumer loans. This also means that we will not sacrifice profitability to growing markets, where we see intensified competition. Profitable growth remains [indiscernible]. Our single focus on asset quality is also starting to show results, achieving lower cost of risk as well as core risk and MPL [ph] ratios. As part of our transformation, we have reorganized our corporate structure to reflect and best facilitate our new strategy. This means our corporate ransacking executed in the quarter to strengthen the organization including our management committee as part of our journey to become a more agile client centered bank. To summarize, we are really seeing promising traction from our high tended focus on our client centered business model, and our efforts to increase profitability. I look forward to sharing our progress in these areas during the coming quarters. Let me now review the trends of the Mexican banking system. Total sector loans as of May, the most recently are available public data published by the CNBV were resilient although growing at slower pace. Increases in interest rates together with continued FX volatility and acceleration in trade due to inflation are impacting commercial loan growth with consumer loans remaining the main growth engine. Actually consumer loans, mainly personal and payroll continued to grow during the May. We continue to see a robust performance of several indicators like retail sales, domestic car sales, formal employment, consumer confidence, which we believe are supporting demand for consumer loans. System deposit growth showed a slight pickup in May. Looking at Santander Mexico, we increased our loan book by 50% year-on-year with contributions from both retail and commercial loans. Let me now break that down in more detail for you. Individual loans rose 12% year-on-year supported by healthy consumer demand and our strategic commercial initiatives to continuous funding in this market despite increased competition. In particular, we are increasing our strategic focus on payroll loans leveraging new portability regulations on credit cards. Our key initiatives in the framework of our commercial strategy was the launch of the Santander Plus program last May, as I just discussed. This effort however has enabled us to gain 107 basis points in market share in the payroll loan segment. Note, that the acquisition of the Scotiabank’s personal portfolio in the second quarter of 2015, impacts from Peso, excluding this portfolio consumer loans increased 18% year-on-year. Credit card loans growths are strong, up 30% year-on-year and 3% sequentially. The driver behind these was the successful performance of the Santander Aeroméxico co-branded credit card launched last February. This card allowed us to get 83 basis points in market share year-on-year and we expect to continue spending our sharing this affluent segment of the market. Growth in mortgage loan continues at a slower pace this quarter, up just 10% year-on-year, and some players continue to implement aggressive customer acquisition strategies with low rates and fees and also the impact of the FX has affected this segment. Commercial loans expanded 17% year-on-year. Note that excluding 51 increased in government loans, we seem to be more volatile, commercial loans rose about 9%. Beyond our increased focus on returns from risk-weighted assets, we are seeing commercial customers being more cautious after the several interest rate hikes and the overall volatility in the [indiscernible] markets. Also this year competition has intensified across all segments. As a result of these dynamics, corporate loans remained relatively flat year-over-year, but grew 4% sequentially. We continue to see some triple A corporates paying their loans, which is difficult in this volatile segment and some issuing bonds in anticipation to potential further rate increases. SME loan growth slowed to 10% year-on-year, while we continue to strengthen our leading position in this core market, we’re also mindful of the returns on risk-weighted assets and we are seeing similar dynamics as a rest of the corporate loans. However, our strategy is starting to bear fruit, as we continue to spend in this segment while improving the spreads and lowering the cost of credit. Finally, middle-market loans continued to perform well, positioning at 14% year-on-year increase, enabling us to maintain our strong position in this segment. Deposits continue to expand this quarter, up 13% year-on-year, and 5% sequentially. Demand deposits represent 71% of total deposits, of course up from 65% in the second quarter of 2015, driven by strong growth from individuals and SMEs demand deposits and the reprising of our own term deposits. We continue to see positive results from our strategy to focus on select unfavorable consumers. This quarter we are also starting to see the initial benefits from the launch of Santander Plus that contributes to boosting individual demand deposits and reducing cost of funding. Now, let me turn the call over to Pedro, who will go over our P&L, I will then discuss guidance and afterwards I will be happy to respond to your questions. Thank you very much.

[Pedro José Moreno Cantalejo:]

Thank you, Héctor and good morning everyone. Starting with liquidity, our loan to deposit ratio remains above 100%. While our liquidity covenants ratio has stood well above regulatory requirements at almost 130%. In June, we issued a fat year of Ps.4 billion senior notes at a very attractive rate, further diversifying fund resources and extending debt maturities. We maintain a strong capitalization of 15.2% with core tier 1 at 11.8%, while continuing to implement efficiency measures to optimize capital allocation. The new CNBV regulations imply additional capital buffers for the so-called systemic financial entities. In our case, this means that 120 basis points buffer to rephrase our four years. Nevertheless we are very complied with this requirement in the fully lowered amount. Finally, in May, we paid a regular cash dividend amounting to 50% of the net income reported in the second half of 2015. This is the reason why we are having a slight decrease there from the previous quarter of 30 basis points in the tier 1 capital ratio. This together with a 50% dividend we paid in the first half of 2015, the total paid in December 2015, is equivalent to a 3.29% dividends yield. Looking at the profit and loss account, net interest income was up 13% year-on-year and 1% sequentially. The loan portfolio excluding credit cards contributed with a 15% year-on-year increase in net interest income, while credit cards contribution grew 9%. Also credit card loans rose 13%, net interest income contribution remains as impacted by the large share of customers that pay their balances in full. Note that loans rose 11.1% in April and 10.6% in May, only peaking up in June with the resulting lower contribution to NII. Also the most recent interest rate increase of June is not yet reflected in net interest income. Finally, keep in mind the loan needs was impacted by the 51% increase in government loans at the end of the month of June. The rebalancing of our securities portfolio at very attractive profitability level, by leveraging the recent interest rate increases contributed with a 32% increase in net interest income. Net interest margin for the quarter has stood at 4.86%. Moving down to the P&L, commissions and fees were up 10% on a sequential basis, while two factors impacted the year-on-year comparisons. First of all, the reclassification of the premium paid to NAFIN in connection with the warranties to SMEs which boosted cash management fees in the second quarter of last year. Excluding this benefit, cash management fees this quarter would have increased 2% year-on-year, supported by higher transactionality partly resulting from the successful introduction of Santander Plus. On the other hand, unusually high investment banking fees in the second quarter of last year, while this year the business is impacted by the significant market volatility. Insurance fees in turn saw a good performance, up 7% year-on-year, driven by continuing growth in consumer credit related insurances, life insurance struggles and our very successful online platform for car insurances. These more than offset a weaker SME demand for credit related insurances. Credit card fees were up 7%, but still below desired levels, reflecting higher rewards and issuance cost from the very successful performance of the Santander-Aeroméxico co-branded credit card. We expect this trend to continue in the second half of the year as this client base continues to grow. Also note that some of the credit card fees paid are polarized and there is an impact due to the peso depreciation. Let me also highlight the strong performance in investment fund fees that were up 23% year-on-year this quarter reflecting a better price mix. Summing up in the income part, gross operating income increased 9% year-on-year despite the difficult comps for the net commissions and fees. Trading gains were in low end of our estimated quarterly updates [ph] of around Ps.600 to Ps.800 million, up 11% year-on-year, but contributing only 4% of the total gross operating income. Loan loss reserves fell 4% sequentially and 0.7% year-on-year. Taking the conservative approach, you do remember in the last quarter, we provisioned certain loans to companies in the oil and gas sector and other corporates that were on our watch-list, which have not been required additional provisioning this quarter. The non-performing loan ratio contracted [ph] 81 basis points year-on-year, down to 2.86%. In particular, commercial non-performing loans fell 109 basis points year-on-year as we recognize some charge-offs as discussed last quarter. On the other hand, mortgages non-performing loans also saw an improvement, going down, 61 basis points year-on-year, as a result of the [Indiscernible] approach while consumer non-performing loans remain stable. SMEs improved slightly during the year. So, overall cost of risk for the quarter improved 23 basis points, down to 3.22%, and it stood at 3.29 for the six months period. It’s slightly better that our expected range in the guidance of 3.3 to 3.5 for this year. Moving down to P&L, our efficiency ratio for the quarter improved by 50 basis points year-on-year, down to 42.8%, as we continue to focus on the efficiency and profitability] and despite the higher expenses to support the strategic commercial initiatives. One of these initiatives was the above-mentioned right-sizing implemented this quarter. As a result, [Indiscernible] payments impacted personal expenses this quarter and will continue in the third quarter of 2016. This resulted in a 9% year-on-year increase in personal expenses. Operating costs were also affected by the 16% increase in IPAB insurance in line with growth in deposits and other funding sources. Similar to the first quarter, cost also reflect the amortization and depreciation of the stationary [ph] IT investment plan began last year and the impact of the peso depreciation on the portion of the costs that are dollarized. The combination of these factors result in a 9.8% year-on-year increase in operating expenses, as dividend IPAB operating expense rose 9.2%. For the first half of the year, operating costs, excluding IPAB, rose 8.2%, slightly above our post-guidance range for the year. In summary, our focus on return on risk-weighted assets on efficiency have resulted in a 14.5% year-on-year increase in net income and return on average equity up 70 basis points to 12.8% in the second quarter of 2016. This was achieved despite the 90 basis points increase in the effective tax rate. Profit before taxes for the quarter rose almost 16% and 5% sequentially, while increasing 13% on a full cumulative basis, slightly above our target of 8% to 12% for 2016. Now, before opening the floor up for Q&A let me turn the call to Héctor Grisi who will discuss the guidance for the year.

[Héctor Grisi Checa:]

Thank you, Pedro. Moving to our guidance, we assume that outlook for the year of what’s provided in our 2015 yearend call. It was a good quarter both in terms of business and net income results and we expect to see strengths with execution of the new strategic initiatives. We are now ready to take your questions. Please, Operator, go ahead.

[Operator:]

[Operator Instructions] our first question is from Carlos Rivera from Citi. Please go ahead.

[Carlos Rivera:]

Good afternoon everyone and thanks for the presentation. So my first question is regarding bigger items pretext income growth is pretty solid year-to-date, 13% year-over-year, so it is well above the guidance as you provided earlier. I know probably this could be related to easier comps as first part of last year was very strong, but would it be fair to say that results are coming ahead of your expectation and based on what we have seen so far, do you see you can delivering in the upper end of the guidance that is my first question. And the second question is related to government lending. We saw an acceleration of growth in this segment pretty strong growth. I’m just curious of the change in the strategy. I mean if I recall correctly in 2014 this segment group up very little. So basically just want to get your thoughts about what made you come back aggressively this year into government lending. Thank you.

[Héctor Grisi Checa:]

Why don’t you let me cover [indiscernible] for your question? Let me answer you the second question and then I’ll have Pedro give you the answer on the guidance situation. In government lending we did on an opportunistic basis as we have discussed before, it’s not part of our core business and we just do it in the particular situations where we are defending payrolls or custom ordered type of businesses with different governments and or we basically have an niche to have a particular transaction. So our strategy is want to be continue to be in the same environment [ph]. This quarter was surprised that we ended up with two particular transactions in that regard both our strategy keeps exactly the same point we are going to be protecting our business and we are going to be basically continuing on an opportunistical basis. Pedro, can you go ahead.

[Pedro José Moreno Cantalejo:]

Yeah, on considering the FX part of the question, yes we maintained the guidance property for Texas. You were right but that for the fourth quarter last year was very high and profit generator but at the trends are good in that side of the be P&L and we expect further interest rate increases. So interest margins will - so maintain the good trend also feel on the downside of the account we have seen quiet flat situation for the provision for some expenses, so the results will be that we will soon achieve comfortably the guidance we gave you.

[Carlos Rivera:]

Okay so would it be fair just say that the given the strong results and the further increases that we have seen in bank key core [ph], are you feel comfortable at least going coming on the upper end of the guidance and possibly with some upside risk?

[Pedro José Moreno Cantalejo:]

We don’t see it based on that.

[Héctor Grisi Checa:]

Yeah I mean Carlos I mean we are not in a very volatile environment, so in that sense I think we’re trying to be conservative but at the same time we are really trying to do our best in terms of managing the situations. So I think the best way to do is to maintain the values that we have.

[Carlos Rivera:]

Okay, understood thank you very much.

[Operator:]

Our next question is from Tito Labarta from Deutsche Bank. Please go ahead.

[Tito Labarta:]

Hi, good afternoon, and thanks for the call. My question just looking at you have been growing loans above the system now over last year or so and we are seeing higher interest rates you mentioned some corporate are getting little more cautious because of that off on the consumer side we didn’t see your consumer NPLs pick up a little bit in the quarter. So I want to you mentioned going more into payroll loans and we saw one of your competitors have some asset quality issues because of increased competition there. Just wondering any concerns about having grown past in the market with Feds rising, GDP growth remains so closer to 2% and 3% is there any concerns about any kind of stronger growth and rates rising and any impact that could have in terms of asset quality and gross down the road, thank you.

[Héctor Grisi Checa:]

Look I mean, thank you very much for your question. Look, at this point we are being very I would same cautious in their way we are managing the portfolio. As we explained during the presentation we have been not - I wouldn’t say cherry picking but we are basically I mean it says very think and things we are not putting it into our trial balance sheet what our thing comes in front of us. So we are very, very selective in the things we are doing and but we have not foreseen any worsening conditions on the corporate or anything like that. I think that people are taking advantage of the situation. We’re seeing some of the corporate trying to go long-term and trying to get fixed rates even the according to environment. We feel comfortable with the way we are managing our balance sheet under great portfolio at this point. And my point would be that I mean we see opportunities and the risk is the right one and it is worldwide and we are going for it and we don’t see any worsening at least up to this point.

[Tito Labarta:]

And what about on the consumer decide, did see consumer NPLs pick up a little bit in the quarter any concerns there either?

[Héctor Grisi Checa:]

Surprisingly it has not been the case. I mean cost of credit and the federal commons deliverable debt I mean, has maintained itself and we are not seeing any conditioning is worsening, not even in credit cards, not in consumer loans, we really see market has been very stable.

[Pedro José Moreno Cantalejo:]

Yes you are right we have seen even group manning in certain segments all the rates are related to delinquency and improved in this quarter. Non-performing loans, the cost of credit have in mind - this quarter 3.22% cost of credit which is the best in many quarters. We are observing with this more selecting approach to the corporate unless it means better cost of credit for them and consumer loans are relatively stable. So we do not perceive any risk in the worsening environment for delinquencies from now to year-end.

[Tito Labarta:]

All right now thanks it is very helpful and just you said you expect more interest rate increases. What do you expect to year-end?

[Pedro José Moreno Cantalejo:]

I mean we - I mean what - [indiscernible] First of all we believe that Bank of America will not follow whatever they’ve said though and also there could be some volatility given the elections in the U.S. So that could basically resolve into something that [indiscernible], so as we have said is very volatile situation, so we need to be aware and be basically prepare to whatever comes and we are working in that regard both I mean what we see as that there is some volatility in the market given what I just said.

[Tito Labarta:]

Right and do you have an expectation for how much rates will rise further till year-end?

[Pedro José Moreno Cantalejo:]

I just couldn’t hear you.

[Tito Labarta:]

Sorry, do you have an expectation on how much more you think rates will rise based on how you see things today.

[Pedro José Moreno Cantalejo:]

I mean it could be around 50 basis points I mean depending on what could happen and also I mean let’s say the volatility of the Peso, maybe 25 - 50 basis points.

[Tito Labarta:]

Fair enough, thank you very much.

[Operator:]

Our next question is from Jason Mollin from Scotiabank. Please go ahead.

[Jason Mollin:]

Hello thank you for the opportunity to ask questions. My first question is a little bit on this growth to the government side of things and you mentioned that the clearly you’re looking at this as part of strategy to enhance profitability. Can you talk about the spreads on these loans in and of themselves and is this negatively impacting the NIM. Secondly, on competition, if you can talk about the competitive environment you launched Santander Plus a couple - it’s now been I guess two months, has there I have been, I think we have seen some responses in the market and do you think this could actually increase the cost of funding in the system for all banks and lastly just a quick comment on the us over hundred million Peso increase in provisions for legal and tax contingencies, if you can talk about what generated that and descending level or is it just - more of a one-time item. Thank you.

[Héctor Grisi Checa:]

Okay, thank you for your question. What I will do is I’m going to answer part of it and I’m going to ask Pedro to help me out a little bit on the margin side. First of all on spreads what we are doing and exactly we are following that way of writing risks, okay. The approach that we are taking is front of fall risk-weighted assets and we are very - I would say, selective on what we do and what we put on the balance sheet. So we are rising risk in a different way what we are doing before and so different transactions we’re doing I mean we are basically shortening the tenure of some of the loans what we’re doing. We are rising a little bit higher on the longer tenures and we are going basically longer or shorter tenures. Basically as I said before trying to take care of [indiscernible], okay. So in that sense I believe that our approach to spreads is based on that our risk-weighted assets and risks and I think we are doing that pretty good job on that and you have seen the results first of all in what we are doing in SMEs and what we’re doing in the middle market and you’re going to see, I mean over the next semester what we’re doing on the corporate side. So in that sense we are very - being very cautious. On the side of doing government transactions as I said what we’re doing here mainly is first of all is the transaction that makes money cost [ph] we will do it, second is the transaction is to protect some of the other business that we have with some government entities then we will do it, both we are not subsidizing the rates in anyway, okay.

[Jason Mollin:]

So just understand that - sorry just to understand that better when we see let’s say Ps. 8 billion increase in government lending in the quarter is that I mean that probably got to be lowest spreads that you’re lending at right to the government entities is it is this should we think about this or no? Is this negatively impacting the margin it could be positive returns of course to the bank

[Héctor Grisi Checa:]

No, let me have Pedro answer your question, so you know exactly what we are doing in that. Pedro why don’t you go ahead and explain exactly what is happening to the margin. And then I will continue explaining you the rest of the spread.

[Pedro José Moreno Cantalejo:]

Just to clarify these secret increase in the over long term loans if you relate to the public owned companies these are credit lines facilities that we have with them and they decided to use these credit lines at the end of June. This is a very volatile disposal funds, the spread is reasonable, but it is very, very term. So the impact in the NAII [ph] is minimum, so this is not a matter of concern. It is quite normal that these companies take the funds we have available in the credit line or leave it. That is very, very common practice in the market. It is not that we are intensifying or reducing the overall spread of our corporate portfolio.

[Jason Mollin:]

That’s helpful, my other question quickly.

[Héctor Grisi Checa:]

Okay in terms of some Santander Plus, what we are looking that is we have got them responsible in some of the other competitors, yes they see a situation there and they are basically trying to fight back. But I believe that Santander Plus is by far the best product on the market. There is no product like it and for the all the other big banks to go to something like this can utilize their own deposits. So I think that is what is what going to be very difficult for them to follow. I think this is a unique type of product program as we call it because it is not a product it is a dynamic program that we are introducing to the market that we are going to need on a dynamic way basically to losing it with more things in order to make it better and better. Basically we want to continue to increase our participation in the market through these and this has enabled us to increase our deposit base as you have seen in this quarter.

[Jason Mollin:]

Thanks and may be just anything on this condition for legal and tax contingency.

[Héctor Grisi Checa:]

I’m sorry I didn’t get the question.

[Jason Mollin:]

Sorry, we saw an over hundred million peso increase in provision for legal and tax contingencies that I believe you record in the other income line so other income was bit lower based on this explanation we saw on the press release I’m just trying to understand what is going on there?

[Héctor Grisi Checa:]

Well, there was nothing really volatile. This required volatile line it includes many, many things of several items that could happen in the quarter. As something that different in this quarter we have the cost related to the termination of a note that we had in Santander in the former ING platform that we decide to do in repurchase these notes as very, very, very high cost and this implies an impact in this quarter on the other income line, but we will have a benefit of having a better funding cost in the coming months. But apart from that as I say nothing special it is a normal evolution of contingencies legal provisions and things like that nothing to be worried about.

[Jason Mollin:]

Thank you very much.

[Operator:]

Our next question comes from Mario Pierry from Bank of America Merrill Lynch. Please go ahead

[Mario Pierry:]

Hi, everybody let me ask you one question more related to some long-term strategy given the uncertainties in Europe especially following Brexit I was wondering if this changes at all your appetite for potential acquisitions or does it change the way you think about your capital ratio?

[Héctor Grisi Checa:]

Thank you, no, look I mean I think the Brexit is not changing at all in the long-term study as we have done in the past we continue to float every single opportunity as it comes up. As I said playing the best we have these three premium permissions [ph] in order to take decision on that towards the work that transaction how to cover the cost of capital. It has to be accretive at least in the first three years and it has to have a commercial fit to our business. And we will continue to with that strategy in that sense and if something comes up, we will sure take a look at it. In terms of the capital situation what we’re doing basically given that we know that the positions are calling we don’t know what is going to happen both we are taking care of our capital, capital is scarce and that’s what we are doing biggest risk-weighted assets and we are basically trying to set capital as more is just possible that doesn’t mean that we are entering into our like capital model or we’re not lending or anything like that not well basically being much more intelligent in the way we manage our capital. We are using our capital when we see the best returns and we’re working in exercise of capital allocation and we’re doing a lot of exercise in terms of return over risk-weighted assets in order to deploy capital in the best way possible.

[Mario Pierry:]

Okay, any views on could this potentially impact your evident payout ratio?

[Héctor Grisi Checa:]

Not at this point I don’t think so. We will continue with our policy of 50%.

[Mario Pierry:]

Okay thank you.

[Héctor Grisi Checa:]

Thank you

[Operator:]

Our next question is from Carlos Macedo of Goldman Sachs. Please go ahead.

[Carlos Macedo:]

Thank you. Good morning gentleman, couple of questions on the results more specifically fees and expenses. If you exclude the change in the accounting standard and financial advisory revenues that you generate and that have been very volatile. For the first up fees are up 11% year-on-year. How much further you think that can go on I know you have a recovery based on those particularly financial advisory line but 11%, 10% to 12%, a good number or how do you think or how should we think about that particularly given the effort that you put in the developing further your platform. Second question on expenses, I think Pedro mentioned that the layoffs created some expenses during the quarter, for the first quarter, second quarter, potentially into the third. Can you give us a little bit more color with regard to that how much it was and how much should we expect expenses on that - from to be pressured from that point. Thank you.

[Pedro José Moreno Cantalejo:]

Sure Carlos. Well first of all talking about fees, yeah you are right. Excluding these non-comparable items, I think fees are behaving with less than sales. I think we will soon improve in transactional fees, due to this Santander Plus program which is attracting a lot of transactional customers. So we can expect an improvement there. On the other hand, in student side, as I said, this is performing well, and we will continue to do so, and also in investment fund fees are behaving very well. We are not happy about credit card fees. This is a consequence of electing of fees paid in the season of new cards and rewards to the customers and the fees earned. It’s normal that when you are growing a lot your customer base, you will have a negative impact due to the acquisition cost. And naturally speaking, this will improve in the coming quarters, but it will continue to grow at this rhythm in the other Mexico program. We can see this year a low increase in the credit card fees. I am confident that the actual growth rhythm will grow from now to year-end. Investment fund fees and special fees are starting very low in this first half of the year. So let me not conclude but it will only - can only improve. So the first 55 card groups even in the worst scenario like the one I described, I think we keep quiet a good record, so second half will be better for fee income. And in terms of expenses, yes you are right. We are slightly above our guidance. In our guidance, we would even have the forecast for these severances. Have in mind that we have made a headcount, total headcount resizing, it means that cost at the beginning and savings in the coming months. So we don’t foresee difficulties and we will make to put it in best way, our best effort to get back into the guidance from now to year-end. But on the other hand we are investing a lot in IT, in improving our platforms, in getting an upgrade of our branches. So there is a combination of things. We will have savings in our personal expenses due to this resizing, and we will increase expenses and investments in IT and procedures. So overall, we are confident that we can - fit within the guidance we provided to you.

[Carlos Macedo:]

Okay, thank you Pedro.

[Pedro José Moreno Cantalejo:]

You’re welcome.

[Operator:]

Our next question comes from Thiago Kapulskis [ph] from BTG Pactual.

[Unidentified Analyst:]

Hello everyone. Thanks, for the opportunity to ask. I just have one question regarding your tax rate. It’s pretty much, what’s the level that we should see going forward. Is there a number that you reported this quarter, the recurring number or we should see some change going forward? Thank you.

[Pedro José Moreno Cantalejo:]

Well we are managing taxes very actively. We try to find out always investments that can help us in reducing our effective tax rate. We are increasingly repeat sort of the previous year which is quite normal, but this year we think we would be in the low range of our guidance. That’s right, it should be around 25%, that’s what this year, and increasing not only in the next couple of years, trending across the 28% which is our, let me say our running effective tax rate. Having in mind the Mexican, the official tax rate is 30%, so we have seen, we can always keep at least 200 basis points improvement. But it’s day-by-day management of the strategy and we have seen we can keep the actual tax rate from now to year-end.

[Unidentified Analyst:]

Okay, perfect, perfect. Thank you.

[Operator:]

Our next question comes from German Velasco from BBVA. Please go ahead.

[German Velasco:]

Hi, guys, good morning and thanks for the call. I have two questions. The first one is regarding the SMEs portfolio. We have seen a slowdown in the loan growth evolution, but as you have said you are increasing prices in this product. So in the net margin, can you tell us what will spread before they reprising the strategy and what is now? That was my first question and the second one is regarding your strong effort that you have been making in funding cost. What can we expect in the medium term especially in demand deposits? Thank you.

[Pedro José Moreno Cantalejo:]

Well, considering the first question in SMEs we have increased the spreads for a new business, we had made it right now. So now we are going at spreads right now around 8.5% to 9% for the inflow new businesses. Having in mind, the stock have lot of weight on the equation, so we are still in spreads from the stock below 8%, 7.5%, 7.6%, but on the other hand, our strategy that we are being more selective, more, more selective while we have improved the cost of variance for SMEs. So if you take as another rule, the net of risk is correct, is improving a lot and is about 5%, so the spread is very good. So I think this strategy has been successful.

[German Velasco:]

In terms of total full year what can we expect for the loan growth, is it fair to say a growth between 10% to 15% or would be higher than that?

[Pedro José Moreno Cantalejo:]

No, in total loan book?

[German Velasco:]

In the SMEs -

[Pedro José Moreno Cantalejo:]

In SMEs? No, I don’t think, maybe between 10% to 12%, but don’t try that number.

[German Velasco:]

Okay.

[Pedro José Moreno Cantalejo:]

But as I said more profitful and less risky stock and talking about demand deposits, to be honest we are even surprised of the good performance and the good results, new branches are already getting to maturity and contributing a lot of demand deposits. Also Santander Plus program has been very successful as a process. So we expect to continue growing individual demand deposits above 20%, it is a very good result. We are very markets here, of course it was our traditional weakness and we are catching up as a regard we had, it’s a hard task. But we are very happy on the behavior of this business and we expect to continue growing up this rhythm in the coming quarters.

[German Velasco:]

Okay. Thanks a lot.

[Operator:]

Our next question is from Domingos Falavina from JPMorgan. Please go ahead.

[Domingos Falavina:]

Yes, thank you for the opportunity. I also have a question on the deposit side. So as you mentioned, the demand deposits grew very nicely this quarter and reached about 71 of your total deposits. The one thing that caught my attention was on the cost side. It seems to me you grew the Santander Plus that you also implemented helped a lot to your deposit base. But your cost of funding also increased on the deposit side about 47% year-on-year. So what I am trying to estimate here is the average cost of funds for design, it seems to me that it increased from about 1%, 1.1% to about 1.3% in this quarter. My question is what’s then the cost of the net inflow? So not that, because we can see the total average, but we can’t see what exactly are you paying for this marginal inflow that’s coming in, because if you continue to grow that fast I am assuming that the cost of funding should also increase in design and continue to increase or no. How should we think about this design?

[Pedro José Moreno Cantalejo:]

No, not really. Let me clarify. So interest rate increases what I have really seen in improving the profitability of our deposits. Of course you have to circulate a part of this to the customers. But they will feasibility which is the relation between the increase in rates and the increase in the cost of your deposits is very, very positive for us. So we keep most of the increase in the interest rates. What you have observed is that we are enlarging the reason of our abilities because we are issuing notes, we issue a three year notes, if you remember in December of last year, we issue a two years note in the first quarter, and now as I mentioned, we issue a five years note and issuing that will increase the interest rates. So that’s why we are paying a little bit more now for the funding part of our business. But we are sailing for sure that coast that we will scale when the interest rates is up. So overall you are right, we have increased a little bit with the cost of our deposits, but relatively to the increase in the interest rates is only a small portion.

[Domingos Falavina:]

I understand. So your NII on deposits, your spread on deposits is on a nominal basis basically.

[Pedro José Moreno Cantalejo:]

Yeah of course, of course because the interest rate was up, so you have to sell a part of this to the customers. But you keep electricity [ph] which is the important thing.

[Domingos Falavina:]

But how should we think, it’s super clear but mode of going forward and we assume that you are deposit based because I assume that deposits, is continue to outpace the growth of other deposits. When we look at that line, should we think on, how should we think about like the cost obviously grows, like if it grows 20%, the cost should grow 30%, 35% and what should be the dynamics?

[Pedro José Moreno Cantalejo:]

Well we aren’t - we aren’t even calculating that one. Santander Plus for us is a combination, it’s not a product, it’s a combination of things, but we are searching with this program is to today the loyalty of customers. So you pay a little bit more to them in terms of rewards, but on the other hand you will receive more investments, more deposits in volumes, you receive the payroll, you receive the electronic banking activity. Overall, having in mind that the loyal customers is five times more profitable than the normal customer. So if that happens, relatively in short time, having that in the cost of deposits, but in the overall of the banking P&L should be very, very profitable.

[Domingos Falavina:]

Understood, thank you.

[Operator:]

Our next question comes from Carlos Gomez from HSBC. Please go ahead.

[Carlos Gomez:]

Yes two questions. The first one within also to the margin, how much of the increase in interest rates do you think is incorporated in the margins, and how much more do you have to ratings at 100 basis points that we have seen so far this year, what would be the average delay, and when should we expect the full impact on your NII? And the second more generic, I have to say you sound way more optimistic than you did six months ago. Is that a fair statement or it is reflection that you seem to be giving better guidance, you seem to be more relaxable credit, has the outlook changed for you either because the development have changed or because internally you have rethought what you seem to think six months ago.

[Pedro José Moreno Cantalejo:]

Well, I will answer the first part of your question and let Héctor answer the optimistic part of the credit. Well in these six months, the increasing interest rates were 62 basis points in an average. So nevertheless it happened 100 basis points, 125 basis points in December this year, the average is 62 basis points. And you are right, you will see that in sequential terms, our mean is quite flat. But let me outlook the fees. First of all, we haven’t changed the mix of our total assets. We increased our security portfolio, which now is 32% of our total portfolio. And we took advantage in one thing in the mid part of the quarter to take position in our outlook, we had momentum in the position that have very low capital from sanctioning, roll-up the spread, but lower than the loan book. This is one explanation. On the other hand, remember that we are implying a risk based management approach. I already explained the case in SMEs but we can explain the same for consumer loans and credit cards. The result of this is that we are having a slight compression of our spreads, but on the other hand, we are facing a very good improvement in our cost of risk, and you will notice this in the coming months. So with this approach we will measure more than the full gross mean, which will measure the post provision mean if you are along with the used base, I know that this is not the common method but we are focusing on this risk based approach. Our mean net of risk grew to 27 basis points, from 2.73% in the second quarter at 2015 to 3.00% in the second quarter of 2016. So this is what you will observe in the behavior of our results in the future. This is the relation why the mean only improved four basis points. Getting back to your question, the sensitivity of our interest margin to 100 basis points operation, it’s 850 million pesos in full year. So we already captured a bit more than the half of that and we expect another 50 basis points increase from now to year-end, which can be like 25 on average, we shall capture whatever is mathematical result of this. But answering your question, there is an offset in the NII but the major offset in the NII network solutions. And talking about the optimism of our approach, maybe Héctor will temperament.

[Héctor Grisi Checa:]

Thank you, Pedro. Look Carlos, I mean my first boss when I entered into banking 30 years ago told me that he was searching for a lack of belief optimist. So we are optimistic on that, we will continue on that pattern in my career. So I mean it’s not that I am being optimistic, or we are being optimistic. The early fees what we have been already over several months on the bank. We know exactly what needs to be done. We know exactly what we need to do in order to really take this onto the next stage and we are actually working on this and executing. We are right now have in place a really great team of professionals. We have assembled some changes, the structure of the bank as we said in the presentation. We now have a guy really in charge of the larger client segments. So with that I feel very confident that we are going to be able to execute our strategy, and to deliver on the results that we have promised and also that is not that we are optimistic, but we are really on top of things and executing.

[Carlos Gomez:]

Again so what do you say that therefore you have not to do with how the new management team feels inside the bank and knowledge about what you can deliver than external circumstances, that environment has not changed, particularly for their better or worse.

[Héctor Grisi Checa:]

Look the environment as we have commented has been volatile, there’s a lot of things going on, the Peso has been all over the place, the markets have been difficult in order to make money on that fees has been, also what is complicated, both, we have I believe we have the right strategy, we have the right thing and we are very confident that we can believe everything.

[Carlos Gomez:]

Thank you very much.

[Héctor Grisi Checa:]

Thank you.

[Operator:]

Our next question comes from Eduardo Nishio from Plural. Please go ahead.

[Eduardo Nishio:]

Hi, hello, thank you for taking my question. My question relates to your particular approach initiative, if you can talk a little bit more about on improvements in profitability to be the market leader, any time line on this, how long you have been thinking, I know you expect to take and any KPIs are you using to measure that, if it ROE, the gap between you and the market leader is roughly 8 percentage points, so I was wondering if how you relate that to your efficiency ratio, right I know pretty say like 42%, if you have any goals and how much you can take that efficiency ratio down and any targets under that, if you can comment on that I appreciate thank you.

[Héctor Grisi Checa:]

Well I think it is a combination of these things. I have stated before we are focusing on improving our margin net of risk based on this risk based growths. On the other hand, we are based on optimizing the deployment of capital to use it in a more efficient way. And at the same time we are focusing efficiency, we made a headcount recycling as I mentioned before and on the other hand we are investing in IT in order to make more efficient the whole operation. So the combination of these three things optimization of capital usage, optimization of risk based price approach and the cost efficiency will lead us to improve our bottom line sequentially in the coming through years. Our return on equity now is growing as you have seen 70 basis points year-on-year and 50 basis points in the cumulative six months. We are trying to achieve our goal of 16% in the year 2018 and we keep on trying, we keep on the trend, managing these three pillars and I think it is feasible to get there, the [indiscernible] are mainly the return on risk weighted asset and the efficiency ratio taken in their sideline these two metrics, I think we can be successful.

[Eduardo Nishio:]

Any benchmark on how much you can bring the new efficiency ratios down, I mean sort of number you are targeting?

[Héctor Grisi Checa:]

I think we have an excellent cost income ratio already, where one of the best in class in the Mexican system we are 10 points below the average, so it has to improve. We can see that our cost to income around 40% including EPAC cost is good one, we will continue fighting there, but have in mind the plans to achieve the sufficiency level, the success is to keep it.

[Operator:]

[Operator Instructions] And if there are no further questions, I would like to turn the floor back over to Mr. Chávez for any closing remarks.

[Héctor Chávez Lopez:]

Thanks all of you for your participation. With that we conclude our second quarter 2016 earnings conference call and please remember that if you have any more any more questions or comments -