Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q3 2016 Earnings Call Transcript

Published: 28 Oct 2016

[Operator:]

Good day everyone, and welcome to Grupo Financiero Santander Mexico's Third Quarter 2016 Earnings Conference Call. Today's call is being recorded, and after the speakers' remarks, there'll be a question-and-answer session. For opening remarks and introductions, I'd like to turn the call over to Mr. Hector Chavez, Managing Director, Head of Investor Relations. Please go ahead, sir.

[Hector Chavez:]

Thank you. Good morning and welcome to our third-quarter 2016 earnings conference call. We very much appreciate everyone's participation. By now, everyone should have access to our earnings release and Company's presentation, which were released this morning before the market opened. Speaking during the call will be Hector Grisi, Executive President and CEO. Also joining us are Pedro Moreno, Deputy President of Administration and Finance; Didier Mena, CFO; and Rodrigo Brand, Deputy General Director of Public Affairs and Communications, all of whom will be available for our Q&A session. Before we begin our formal remarks, allow me to remind you that certain statements made during the course of our discussion today 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 may be beyond the Company's control. For an explanation of these risks, please refer to our filings with the SEC and with the Mexican Stock Exchange. Let me now turn the call to Hector Grisi. Hector, please go ahead.

[Hector Grisi:]

Good morning everyone. Good afternoon here in Europe. Thank you Hector. Let me tell you that we reported a strong performance this quarter while continuing to improve asset quality and drive profitable growth in the Bank. Importantly, this was achieved against a backdrop of a more challenging global environment demonstrating the resilience of our business. Ongoing expansion in demand deposits and strong loan growth on the Bank's results and we are increasingly able to leverage operating efficiencies. The strategic commercial initiatives launched earlier in the year to become a client-centric Bank through a strong focus on innovation and operational transformation are starting to show very promising results. I must say that Santander Plus boasts over 700,000 clients driving client attraction and loyalty. Most importantly, 50% of these are new clients to our Bank. Our Aeronexico co-branded card is proving to be very successful with over 300,000 clients to date. Progress was also made in driving innovation and investment – investing in next generation technology, a key element of our strategy. We reached a milestone of more than a million digital clients this quarter and installed over 600 new ATMs at our branches, 70 of which are multifunctional ATMs. At the same time, we continue to consolidate our position in commercial loans maintaining a disciplined philosophy in terms of returns on risk-weighted assets and picking a risk-based pricing approach in SMEs and mid-market. We are committed to the ongoing implementation of our strategic initiatives and look the year ahead with confidence. Now, let us review the dynamics of Mexico banking system. Total system loan growth as of August, the most recently available public data published by the CNBV, showed slight deceleration in growth expanding 13.5% compared with 15.2% in the second quarter of 2016. Consumer loan growth in turn remained stable. While macroeconomic conditions in Mexico are resilient relative to many emerging markets, global uncertainty and volatility has translated into tighter local conditions. In this context, we recently revised downwards our GDP growth estimates to 2.2% from 2.4% for 2016 and to 2.3% from 2.7% in 2017. Robust performance of several indicators including retail sales and formal employment continued to support consumer loan demand despite softening consumer confidence indicators. However, higher inflation following sharp FX weakness has triggered interest rate increases. System deposit growth showed a slight deceleration in numbers down to 13%. Now, moving on to Santander's Mexico performance, we expanded our loan book by 14% year on year and 5% sequentially driven by both retail and commercial loans looking at that result now in more detail. Brazilian consumer demand, together with our increased focus on payroll and credit cards help us write 10% growth in individual loans reflecting our strategy. In this market we continue to experience strong competition. Consumer loan growth grows 11% year on year, a slight deceleration reflecting more difficult comparison period after the acquisition of the Scotiabank personal portfolio in the second quarter of 2015. On a comparable basis, consumer loan growth have increased around 13.4%. Let me highlight the strong performance in payroll loans. This is a result of our strategic focus on this value. And this value have proposition for our clients through the launch of Santander Plus program last May. The program continues to gain traction and maybe even poised to gain 55 basis points in the market share in the payroll loans up to 12%. Credit card loans posted solid growth as well, up 11% year on year and 3% sequentially, supported by the successful performance of Santander Aeromexico co-branded credit card launch last February. We're also seeing higher usage of our full suite of credits cards. This has allowed us to expand our market share in credit cards by 56 basis points year on year with 14.8% and we expect to maintain a strong position in this outland segment of the market. Mortgage loans continued to expand at a slower pace this quarter, up 8% year on year, as some players implement aggressive customer acquisition strategies with low rates and fees. Also note that overall mortgage activity levels slowed this quarter as many transactions of high-end real estate, typically in Mexico, quoted in U.S. dollars, were put on hold following the high FX volatility and the high interest rates. Commercial loans expanded 16% year on year. SME loan growth increased 11% year on year supported by the effective commercial initiatives targeted to the SME2 segment which includes mid to large-size SMEs. We are pleased to see a slight pick-up in the growth trend after we implemented the stronger focus on returns on risk-weighted assets and retail pricing. Our strategy is starting to bear fruit as growth is stabilizing in this segment while improving the spreads and lowering the cost of credit. We also maintained a strong position in the middle market loans with growth normalizing 10% year on year following a very strong second quarter. Corporate loans rose 39% year on year and a significant 36% sequentially reflecting a few sizable transactions. Note this is a more volatile segment and we do not expect growth to continue at such high rates. Government loans rose 9% year on year in line with our core strategy. Looking ahead, we maintain a cautiously optimistic view of this market as commercial customers remain cautious following several interest rate hikes and a more challenging economic environment. We're also seeing intensified competition in this segment. In terms of deposits, it expanded around 10% year on year this quarter or remained flat sequentially. Average deposit balances rose 14% year on year and 1% compared to the prior quarter. Demand deposits represent 70% of total deposit or from 66% in the third quarter of 2015 driven mainly by strong growth from individuals and SME demand deposits as we maintain our efforts to drive better cost of funding. Before turning the call to Pedro, let me highlight that overall we are pleased to continue achieving profitable growth as we improve asset quality against a still demanding challenging backdrop. This is the result of our execution discipline, commitment to customer service, and a demonstration of Santander Mexico compelling value proposition. Now let me turn the call over to Pedro, who will go over our capital position and P&L. I will then discuss the guidance and afterwards we will be happy to respond to your questions. Thank you very much.

[Pedro Moreno:]

Thank you Hector. Good morning everybody. We maintain a solid liquidity profile with our net loan to deposit ratio increasing to 107%, but still at a very healthy level. Our liquidity coverage ratio remained well above regulatory requirements at 111.76%. Against a rising interest rate environment, we have pursued the strategy of increasing regulation of our funding through the issuance of long-term debt financing. Accordingly, this quarter we issued a 10 years MXN3 billion note in anticipation of the 50 basis points increase in interest rates earlier in September. This is the fourth debt issuance undertaken over the past 12 months totaling MXN13 billion and doubling the average duration of our debt from 2.3 years to 4.6 years. Our capitalization index improved 80 basis points in the quarter up to 16%, mainly reflecting the regulator's approval of our internal model to calculate the duration of our deposit. Core tier 1 stood at 12.4% while continuing to implement efficiency measures to optimize our capital allocation. Moving to the profit and loss account, net interest income rose 15% year on year and an impressive 5% sequentially. This quarter shows the full benefit from the interest rate increases that took place in the previous quarters in December 15, February 16, and to a lesser extent, the one in June together with the continuous expansion of our loan book. The loan portfolio contributed with 19% year on year increasing interest income. Contribution from credit cards which until last quarter was soft, now rose in line with our loan portfolio as we are seeing a reduction in the served customers that pay their balances in full. Our securities portfolio contributed with an increase of almost 30% in interest income despite the interest rate increases. We are pleased to report a significant 15 basis points sequential improvement in NIMs reaching above 5%, 5.01% this quarter. Moving on to net commissions and fees, cash management fees rose 14% year on year reflecting higher transactionality supported by our Santander Plus program. Investment fund fees were also strong, going up 34% year on year, reflecting a better price mix. Softer credit card fee growth of 2% year on year resulted mainly from higher rewards and insurance was due to the successful performance of our Aeromexico co-branded card. Note however that earned fees rose 18% reflecting higher credit card usage. Furthermore, some of our credit card fees paid are dollarized and were impacted by the peso depreciation. Net credit card fees are expected to improve in the future supported by higher transactionality and lower insurance cost. Insurance fees were flat this quarter. Continued good performance in our online platform for car insurance, so-called Autocompara was offset by soft SME demand and individual credit-related insurances. We also review our sales practices to improve the customer experience. While our investment banking team is present across all capital markets and financial advisory opportunities, challenging market conditions have slow the pace of execution of this transaction. We are already serving a better performance in this month of October. A strong growth in AII together with a solid performance in trading gains resulted in a 11.9% increase in gross operating income. Operating gains were up 24% year on year and in the mid-range of our estimated quarterly average of around MXN600 million to MXN800 million representing around 4% of total gross operating income. Loan loss reserves rose 6.4% year on year, well below the 14% loan growth in the quarter. Sequentially, loan loss reserves rose 8.4% mainly driven by credit cards. Note however that despite a marginal increase in non-performing loans, asset quality in credit cards remains healthy with non-performing loans below market level. We continue to lower the total non-performing loan ratio which goes down 67 basis points year on year this quarter, reaching to 2.82%. Commercial non-performing loans declined 82 basis points year on year as we continued to see further asset quality improvement, especially in the home builders. Reflecting a more conservative write-down approach that we already commented in previous quarters, mortgages non-performing loans were down 79 basis points year on year this quarter. Talking about SMEs non-performing loans rose 17 basis points year on year reaching 2.50%, but in line with the average non-performing loans reported in this segment over the past four years. Cost of risk for the quarter improved 30 basis points, 3.41% and reaching a 3.28% on an accumulated basis. This is slightly better at our expected range of 3.3% to 3.5% for the year. Moving on to expenses, our efficiency ratio improved by 40 basis points year on year, down to 41.3%, reaching its lowest level this year. Higher profitability supported this performance and more than offset the 9.7% year on year rise. As discussed late last quarter, cost primarily referred additional expenses to support our strategic initiatives. First, administrative cost increased, reflecting higher expenses to market our program Santander Plus, the Aeromexico co-branded card, and the marketing of our brand at the Formula One Mexican Grand Prix that we – will be held this weekend. IT-related consulting fees in connection with our technological upgrade also contributed higher administration fees. Second, the final portion of severances payments resulting from the right-sizing of employees implemented in the second quarter contributed also to the 4.9% increase in personnel expenses. And third, the amortization and depreciation of extraordinary IT investment plan began last year, was the driver behind the 14% increase in depreciation and amortization. Also have in mind that operating cost were affected by the 18.5% increase in IPAB – the IPAB insurance in line with the growth of deposits and other funding sources including the debt issuances we already mentioned. Excluding these IPAB cost, operating cost grows 8.8% year on year in the quarter and 8.4% on an accumulated basis, which is slightly above our cost guidance range for the year. To recap, the traction on our commercial initiatives and a focus on return on risk-weighted assets and efficiency enabled a 13% year-on-year increase in net income. All this is after absorbing 190 basis points increase in the effective tax rate. Return on average equity was up 17 basis points to 13.4%. In addition, profit before taxes was up 16% year on year and rose 14% year to date, above our 8% to 12% outlook for 2006 – 2016, sorry. Now, before opening the floor to our Q&A, let me turn the call to Hector Grisi, who will discuss the guidance for the year.

[Hector Grisi:]

Thank you Pedro. Moving to our own guidance for the year, at this time we don't foresee any material deviations either positive or negative with respect to the guidance provided in our 2015 year-end call. This quarter, our results underline the sustainability and resilience of Santander Mexico business against a more volatile global backdrop. We continue to execute our strategic initiatives and are confident in our ability to keep delivering solid growth in the risk interest of all the stakeholders. We're now ready to take questions. Operator, please go ahead.

[Operator:]

Thank you. We’ll now be conducting a question-and-answer session [Operator Instructions] Our first question today is coming from Mario Pierry from Bank of America. Please proceed with your question.

[Mario Pierry:]

Let me ask you a question related to the high interest rate environments that we're seeing in Mexico. I wanted to get more of an idea from you how much of this is going to be reflected on your net interest margin? How much is already reflected on your net interest margin, meaning from the hikes that we have seen so far? Also if you could give us a sense of what this big increases that we're seeing in interest rates, what impact it could have to overall loan growth and also to NPLs, especially in the corporate side? So basically the question is give us a sense of how much this interest rate increases could impact your margin, your loan growth, and your NPLs? And also if you can give us a sense as well of what you're expecting in terms of interest rates for next year?

[Pedro Moreno:]

Net interest – in terms of net interest margin and net interest income, these results have not taken any effect from the last 50 basis points that were increased at early in October or at the end of September. So our sensitivity is – for every 100 basis points is like MXN850 million per year. So this 50 basis points will mean the half of that. This is still pending to be recognized. On the other hand, we have good performance in terms of our deposits. We are increasing as you know in a high double-digit rhythm. Our demand deposits will – it will also continue to collect the whole 175 basis points increase in the interest rates in the coming quarters. So the wins for these are on detail and we expect to collect still a good portion of this. On the other hand, we are not seeing really an impact, a huge impact of the interest rates in non-performing loans. Have in mind that the actual deals, for instance for individual consumer loans or credit cards, we're talking about 25%, 26%. So 50 basis points, 100 basis points will not really make a big difference in terms of acquisition power of the consumer. Different thing is that this hike of interest rates may pick up 300 basis points or 400 basis points. In that case, maybe it will affect the total installments that the individuals will pay and will have an impact in non-performing loans. The time being, we are not observing any deterioration due to this 175 basis points. And in terms of a spread, for corporates, most of the loans are floating rates spreads that are fixed. So we are not observing any changes here other than the typical efficient – not high competition in the spreads that we are observing in the last quarters and we have already commented about that, but we don't foresee this as related to the increase in the rates.

[Mario Pierry:]

Okay. And what about the impact on overall economic growth or overall loan growth?

[Hector Grisi:]

What we're seeing is even though we are expecting a slower growth environment for this year and next year 2017, we do maintain our view that the system as a whole will maintain its multiple of almost two times or twice the nominal growth of – twice the economic nominal growth. We haven't changed our view in that sense.

[Mario Pierry:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next question today is coming from Carlos Macedo from Goldman Sachs. Please proceed with your question.

[Carlos Macedo:]

A couple of questions. First question, your fee income line, I mean, you mentioned there have been effects of the Aeromexico card, and here and there, there is a volatility around the advisory services that go up and down, but growth has been underwhelming I would say, I think this quarter, last quarter little bit better, but still how should we think about this line? Is this a line that you expect to be growing double-digits sustainably or will continue to see this volatility from quarter to quarter on an ongoing basis? Second quarter – second question, sorry, you lowered the outlook for GDP growth, consumer confidence is lower, obviously competition has heightened as demand might have dried up a little bit on the lending side. Of course asset quality continues to be strong, but the pace of growth of NPLs on the consumer side is strong – strengthening as well. What is the outlook for NPLs there? Is there any risk that we see a cycle coming up given the aggressive levels of growth that some of your competitors like HSBC and to some degree even Bancomer have been reporting?

[Hector Grisi:]

I mean, first of all, in terms of – we believe that I mean in terms of credit cards we will continue growing at least double-digit. Even though the Aeromexico card is being – growing very well, we also are increasing in our placement of cards on a daily basis, has increased from about 2,700 cards to around 3,500 cards per day. So this has helped us to boost a little bit and we'll continue to see an opportunity in that market to continue growing. We are also expecting to continue growth due to the fact that we have not been able to exploit our client-base on the lower base of the parameter which we intend to launch pilot program in that sense. So I believe that that will continue going on, maybe not in terms of the size of the whole portfolio, but maybe in terms of the amount of cards, okay? Also…

[Carlos Macedo:]

Sure. I mean…

[Hector Grisi:]

Sorry?

[Carlos Macedo:]

I just meant on the fee side, I mean it's been a little bit volatile.

[Hector Grisi:]

Yes, on the fee side, as I was telling you, I mean it's been volatile due to many situations, no? First of all because of regulation in some ways, due to fact that we cannot link as you know some of the credit now to the insurance – to the bank assurance. So that has been a situation in which we're trying to correct in many ways to try to change our products and to change our mix in order to continue that way. Also you're going to see an interesting pick-up in terms of investment banking fees which is a market we're tapping right now and we're using our main relationships over there to basically to gain market share in that point. So fees, I don't think they're going to continue to grow double-digit, but you're going to see them growing at a pace between 6% to 8%, I believe that will be the right point to see where they're going, no?

[Carlos Macedo:]

Okay, great. Thank you.

[Hector Grisi:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Eduardo Rosman from BTG. Please proceed with your question.

[Eduardo Rosman:]

Hi, everyone. My questions, I want to discuss a little bit 2017, I know that maybe it's a bit too early, but just want to get a sense of what do you see for next year because when we look to your guidance for this year, I think it's pretty clear they are going to be able to meet that, probably in terms of pre-tax, probably are going to be able to do – to deliver the ceiling, right, of the guidance or eventually a little bit more. So I just wanted to get a sense for next year, if you think it's fair to imagine, let's say, similar metrics to the ones we're seeing for 2016 for next year as well. Or if you think that you can do better, right, because I sense that in terms of NIMs because of the higher rates and maybe because of a changing mix, you can do a little bit better in terms of NII and maybe pre-tax can accelerate. So just wanted to understand if you see 2017 much different from what you're seeing this year or not.

[Hector Grisi:]

Unfortunately, I mean, right now we're in the way of doing our budget for 2017 and I'm not in the liberty of basically telling you anything at this point until we finish off our numbers and we basically come up with a real idea of what's going to happen next year. So I cannot comment on that one, I'm really sorry.

[Eduardo Rosman:]

Okay. So can you please remind us if you have a medium term or long-term goal for ROEs and if this goal changed or not because interest rates are coming up in Mexico, or let's say, were you already expecting rates to go up in your mid-term goals and is this changing or not? So if you can comment on that.

[Hector Grisi:]

No, no, no. What I can tell you in that sense is that we will continue with our goal of coming with – to 16% ROE for 2018. That would be our number and that will continue to be.

[Eduardo Rosman:]

Okay. Thank you very much.

[Hector Grisi:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Tito Labarta from Deutsche Bank. Please proceed with your question.

[Tito Labarta:]

A couple of questions also. Following up on loan growth a little bit more, you had a big pick-up in corporate loan growth this quarter. So we're seeing loans are growing around 14% and you said you expect loans to grow on 2 times GDP, so they'll probably be closer to 10% than the 14% we're seeing. So I just want to understand is it just – was there just a spike in the corporate loans this quarter, so we should expect that to come down going forward whereas consumer loans should be sort of in the low double-digits, 10% to 11%, which is kind of what you're delivering there. I just want to get a little bit more understanding in terms of the mix in the loan growth given the spike we saw on corporates this quarter. And then a second question in terms of deposits. I know you're making a big push to grow there demand deposits of 16% year over year, although we did see a decline in demand deposits this quarter despite the big push on Santander Plus. So just any concerns there with what happened in the quarter? I mean, and total deposits are still growing around 10%, so below loan growth. I just want to get a little bit more understanding if there's anything in particular in the quarter that brought it down.

[Hector Grisi:]

Okay. In terms of the corporate loan book, I mean actually what we told you in the beginning of the year, it was that we are going to play in that market on an opportunistic basis in the sense that I mean we are very focused on return on risk-weighted assets and we're just tapping on opportunities and transactions that make sense to us. This is – that you see this as quarter one because I mean we came with a couple of interesting transactions, we decided to support the corporates in some particular acquisitions, and then following that, we supported them and we are getting really good returns on pick-ups of the transactions. And this is exactly what we are using our balance sheet for and I'm not going to tell you exactly what's going to happen in the corporate market because it is going to depend on the opportunities that we foresee for this. As I said, on an opportunistical basis. In the sense of the rest of the portfolio, you're going to see continuous growth in some of – in some particular areas. I mean, we'll still continue to focus our sales in the mid-market part of the corporate sector. We're still going to be very focused on SMEs, on very profitable growth, that's an important part. And also we're going to continue on – to maintain our positions in mortgages, in personal loans, and payroll loans which are very profitable for us as you can imagine. So I mean we're going to be continue to grow in the same sense that you have seen in the past, but very focused on profitability. On the second part of the question in terms of where deposits goes, what you're basically looking at is exactly our strategy that we designed since the beginning of the year. As you'll see, I mean we're growing very well in demand deposits mainly on individuals and SMEs, which we believe is the most profitable part of the area. Where we are lowering our deposit rate is in corporates due to the fact that it's very expensive to win that market. And we have decided not to do that and you have seen us going to the fixed income market to basically get some funding in there due to the fact that it's cheaper to do it in there than to do directly with the corporates. So what we're focusing on is not growth for growth, but growth in a profitable way, and this is exactly what we're doing, doing it in a very smart way and going to continue to do that.

[Tito Labarta:]

Okay. Thank you very much.

[Pedro Moreno:]

Thanks.

[Operator:]

Thank you. Our next question today is coming from Marcelo Telles from Credit Suisse. Please proceed with your question.

[Marcelo Telles:]

I have two questions. One, a more – a broader question, I'll take advantage all of you are here with us. Can you share what is your high-level thoughts on the Mexican economy? I mean, there is a lot of concern or rising concern that the economy is decelerating. So what is your view going to 2017 and do you see that in any way, shape, or form affecting the day-to-day other business? And my second question, a more specific one, you accumulated quite a bit of capital from the second to the third quarter. There was very nice increase in your core equity tier 1 and of course you had no decent profits, but on top of that there was a very big decline in the risk-weighted assets quarter on quarter. So I was wondering if you could elaborate on what drove that decline in risk-weighted assets, if there is something more to be done in terms of optimizing and how should we think about your dividend policy going forward?

[Pedro Moreno:]

Yes, on the economy, yes, what we've seen is in the third quarter, that was slightly slow down in general terms, mainly on the manufacturing sector. As you might know, now our view is that the economy in 2016 we grew around 2.1%, 2.2%, and we expect that for next year it will increase marginally to around 2.2%, 2.3%. What we think and what we've seen in the last couple of weeks is consumer demand continues relatively strong and we remain very positive in this aspect that will continue in 2017, but also we think that as long as uncertainly around the U.S. economy reverses, this will help industrial activity which in fact is the main cause of the deceleration in the last couple of months. If you see construction and oil production continues to affect negatively the overall figures. And nevertheless automobile production, same-store sales, and all indicators related to consumers remain relatively strong. We think that once all the volatility that is affecting the peso right now tends to diminish at the beginning of next year, this will also tend to positively affect consumer confidence. So the support for the domestic demand will remain there and if we see acceleration of the U.S. economy, this together will help to pick up in the second half of 2017. That's more or less our general view on the economy. We expect Banco de Mexico to continue increasing interest rates in order to control inflation. We don't see any drastic increase in inflation and we expect to remain very volatile this year, but also during 2017. Basically that's how we see the Mexican economy.

[Marcelo Telles:]

Appreciate it.

[Hector Grisi:]

I think on service sector, I mean in terms of the capital, as you know and we said that since the beginning of the year that we were going to work a lot in terms of looking and taking an approach in capital in a much more efficient way. In the way that we have generated capital and things, I mean, we are still looking at ways of continue optimizing it. As you know capital is a limited resource and we need to basically make the best out of it. We are basically maintaining our position to be in the same way our competition is in Mexico, and we believe also it's one opportunity to put this capital to work. As you know we have continued even though market conditions and everything, we can continue to grow substantially. So we'll maintain a capital position that is around this number that you have seen. In terms of dividend policies, as you know, I mean the Bank has a dividend policy of – what we have had over the past is 50% of net income. We'll continue to do that, and maybe an opportunistically basis, we will do something else, but that's really what we'll do.

[Marcelo Telles:]

Okay. That's very clear. Thanks a lot Hector. Appreciate it.

[Hector Grisi:]

Thank you Marcelo. A pleasure.

[Operator:]

Thank you. Our next question today is coming from Diego Ciconi from Scotiabank. Please proceed with your question.

[Diego Ciconi:]

I wanted to have a little sense on the credit quality. We're seeing improvements, both yearly and sequentially, not only in NPL ratio, but also in absolute amount of number of non-performing loans. So what do you think – do you think there could be further improvements in terms of NPL and what would that mean in terms of cost of risk? And my second question is regarding the performance of the cash-back projects. How is it going in terms of profitability and what do you view as the long-term strategy of this product?

[Pedro Moreno:]

Well, yes, you're right, we are observing in all the risk metrics certain improvement in both number of loans, cost of risk, coverage ratio. And yes, this is a normal trend we are observing in the last quarters. The impetus of new business we are booking is performing better. So we don't see any reason for changing this trend. Of course, the improvements will be every time more spread, but we foresee a good behavior of all these metrics. We were affected in the past two years for several, let's say, extraordinary events that I'm not necessary to repeat, it's whether the number from loans coming from the homebuilders and the Pemex suppliers. I think all these two events are already over. In fact part of the improvement in the number for loan ratio we are observing in the commercial business is due to that. We continue to charge off and to clean up these portfolios that we already reserved. So to answer your first question I think you can observe quite a flat or improving metrics for risk in the coming quarters. And talking about profitability of the program Santander Plus, I can tell you we are very happy of that performance. We are over-passing business cases we put on the table for this program. As Hector said at the introduction of the presentation, we already over-passed the acquisition of 700,000 customers, this program. And half of them are new customers to the Bank, which is very important. These customers are by definition loyal customers which means that they are much more profitable than an ordinary customer. And what is very important, 30% of those are born already as digital customers, which is very important, not only from the loyalty point of view, but also from the cost seasonality we made with these customers. So we are really happy with the program. You can say that this has been really a success. We see also the potential of this initiative because it's not only good for attraction of customers, is becoming also very good for reducing the attrition of our customers. So existing customers that are moving into the program are more loyal. We have reduced in 8% the attrition of our customers, so it's good in both sense. The results – final results are still far away from – these are definitive, but what I can tell you is, we are noticing much better volumes in demand deposits, we are observing much important cross-selling of other products with these customers, so you can say is working really very well.

[Diego Ciconi:]

Great. Thank you.

[Pedro Moreno:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Carlos Rivera from Citi. Please proceed with your question.

[Carlos Rivera:]

Couple of questions from me. The first one is related to the cost of credit. We saw a little bit of an increase this quarter, still well within the guidance. I was just wondering about what we should expect going forward, especially because it seems that the cost of credit has been trending down for several quarters until it reached 3.2% in the last one, and now it's slightly up also in the context of your guidance of 3.3% to 3.5%, it would seem that the level that we saw on the prior quarter was the lowest and it's coming out from there, is this a fair assessment? And my second question would be related to the loan growth in the consumer book. We're seeing pretty strong growth in credit cards and payroll loans above the market. However, the pace of growth seems to be decelerating a little bit. Earlier in the year we saw credit cards growing almost 14%, payroll around 30%, so I was wondering if you could give us a little more color on the competitive outlook for these two products? And also curious if you have been translating the higher cost of funding, the higher rates in Mexico through the products in your consumer book?

[Hector Grisi:]

Okay. Well, first of all, cost of credit, you are right, if you look at the third quarter isolated it were a little bit up, but well, this was due mainly to the increase in the credit card business volumes, which as you know, even though they are performing we have to reserve the expected loss the very beginning and this is quite a high percentage of the new business to generate. But if you take the nine months year-to-date, cost of credit is improving and it's improving to the level of 3.28% which is the lowest in many quarters. So 3.28% is even below our low range we gave for the year. In the future we expect this to even improve a little bit more. If it is flat is for the right reason, but we are growing the volumes more profitable at the end, but with the policies we are following of risk-based pricing as we are approaching to our main [indiscernible], at the end this will mean that if we are doing this, securing this well, this will improve, the spread as of risk it will be better. That's what we will hope to see in the coming quarters. Talking about the volumes of credit cards and consumer loans, yes, you're right, both together in our case, saw certain deceleration, but this is nothing worrying us. We've didn't changed our risk appetite, risk problems. It's simply that we are growing a lot in payroll loans, credit cards. We are growing based on – at our Mexico success. We are growing more than the market as well and we are being a little bit more cautious in the their secured loans out of the payroll loans, but overall jointly credit cards plus consumer loans, we are growing pretty close to the market and we expect to continue in that manner. So – but the answer here is we didn't change our risk appetite this business.

[Carlos Rivera:]

Okay.

[Hector Grisi:]

And first? I'm sorry, it was a third question out of this or the…

[Carlos Rivera:]

So just if you could comment, if you have been translating the higher cost of funding, the high rates in environment of Mexico to the products in the consumer side?

[Hector Grisi:]

Well, this is what I say, it's not so – the sensitivity is not so high for [indiscernible] up. We are managing this risk-based approach, so we are selecting the good customers and the bad ones depending on the rating. So we are moving our pricing based on that. And in terms of mortgage for instance, yes, we are moving prices due to the fact that most of them are fixed rate loans, so we have to translate these to the customers. I think credit card for instance are evolving day-by-day, makes no sense. In the case of consumer loans, as I said, depends on the rating of the customers we are applying the risk-based pricing.

[Carlos Rivera:]

Okay. Thanks a lot for the call.

[Hector Grisi:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Rafael Frade from Bradesco. Please proceed with your question.

[Rafael Frade:]

I have two questions. First, would we – just a follow-up on your comment about the performance of the insurance commissions, you mentioned that there were some 10-year regulation that avoid you to link insurance products to credit products. Could you just elaborate a little more on this? And secondly I would expect this quarter that you would do additional provisions for credit cards related to also some changes in the beginning of the year related to the amount of provisions needed specifically for credit card business. It was made – it will be made in the fourth quarter, just an update on this?

[Hector Grisi:]

In terms of the insurance commissions, what happened is basically regulation has changed and we cannot link our sales of insurance side to any loans, and we used to do it in the past and unfortunately we cannot do it and this has reduced a little bit the amount of insurance that we have been selling. On the other side the dynamic of our other insurance product side is doing very well and we're funding some other places where we can basically move and increase our insurance sales in many ways. Okay, but that's exactly what happened in the industry in that particular product and that was linked to an SME – with the SMEs, okay? It was operational insurance for the owner of SMEs and we cannot do that product anymore.

[Rafael Frade:]

Right. When this changed?

[Hector Grisi:]

Sorry?

[Rafael Frade:]

When this changed?

[Hector Grisi:]

SMEs at the beginning of the year.

[Rafael Frade:]

Beginning of the year. Okay. Yes.

[Hector Grisi:]

Okay? And that's particularly a problem. What you're saying on credit cards, we are going to do it both – the Mexican regulation basically allows us to do it and to charge that particular thing and that particular provision directly to capital. And I believe we're going to do that in October or November.

[Pedro Moreno:]

Yes.

[Hector Grisi:]

On particular charge.

[Pedro Moreno:]

On the banks, we have the deadline to accommodate our methodology to this new rule by the end of October. So we do that. It will mean a charge into capital of MXN1.5 billion, around that, and some calculations of month end, but we don't expect a major impact the flows in the future because have in mind that we have the highest – one of the highest coverage ratio for credit cards in the system. We are above 300% coverage ratio…

[Hector Grisi:]

Versus NPL.

[Pedro Moreno:]

So it means that this methodology will not only in the future affect our P&L.

[Rafael Frade:]

All right. That's perfect. Thank you.

[Operator:]

Ladies and Gentlemen, due to time constraints we have time for one more question coming from the line of Carlos Gomez from HSBC New York. Please proceed with your question.

[Carlos Gomez:]

My question refers to net interest margin. Rates are 175 basis points higher than they were last year and yet we have seen only 3 basis points improvement between the two nine months. Is this a delayed effect, you expect your improvement to come later, or it is something structural, I don't know, the relatives or any other element that makes you not be able to pass the higher rates through and to have higher margins as we have seen in other financial institutions? And if I may add on the guidance side, you are sticking to your guidance, yet we are seeing here loan growth of 14% and your tax rate lower than where you are. Do you expect something in the fourth quarter that will bring you closer to the guidance or you don't think that the difference is substantial enough to make it a change?

[Pedro Moreno:]

Well, three quick questions. First of all, NII, yes, as I said at the beginning of the conference, we are still to reflect part of the interest rate pieces in our net interest margin. The reason why it has been probably a slowing down the effect because don't forget that we have 50% of our asset which has been a denominator of equation, the mean is the loan book, but the other 50% is related to our treasury business, our ALCO positions, and our securities. We have grew a lot these positions. We were waiting for the capital – sorry, for the interest rate increases in order to take these positions again back to the balance sheet. So obviously this is a very profitable asset because they are governmental bonds mostly of free of capital consumption and very profitable capital-wise. Of course the spread is lower than the loan book, but this is the explanation why composition of our NIM is not growing so much. It's growing and is growing well, is the absolute value of our NII. As you can see, we are growing 15%. I saw recently a comparison with the rest of our peers. We are exactly the second best in NII growth, so first. Second question is regarding the guidance we gave for the year-end in respect of the loan growth and the effective tax rate, well I will say we are still a bit cautious on how the market can perform in this last quarter. We had a great pick-up in December 2015 due to a few – or big corporate loans enter into our books certainly at December. That's why we observed a 17% growth last year, but this is a [indiscernible] effect. That's why we are a bit prudent and we think that we can end the year closer to the high end of our range and to grab to our 14% growth. And in terms of effective tax, we are managing taxes highly efficiently. I think we will remain below the low range for guidance, but very close to the actual levels, yes.

[Carlos Gomez:]

Thank you very much, Pedro.

[Pedro Moreno:]

Welcome.

[Operator:]

Thank you. We reach the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Chavez for any further closing comments. Well, let's turn the floor over to management for any further closing comments. That does conclude our teleconference today. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.