Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q4 2016 Earnings Call Transcript

Published: 28 Jan 2017

[Operator:]

Good day everyone and welcome to Grupo Financiero Santander Mexico’s Fourth 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’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 fourth quarter 2016 earnings conference call. We 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 today’s call will be Hector Grisi, Executive President and CEO. Also joining us are Pedro Moreno, Deputy President of Administration and Finance; Didier Mena, Chief Financial Officer; and Rodrigo Brand, Deputy General Director of Public Affairs and Communications, all of whom will be available to answer questions during the Q&A session. Before we begin our formal remarks, allow me to remind you that certain statements made during the course of 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:]

Thank you, Hector. Good morning, everyone. We’re pleased to report the fourth quarter and full year results because we demonstrated our ability to drive profitable sustainable growth even as the macro backdrop remains uncertain. Our focus on becoming a client-centric bank is reaping rewards. We continue to leverage operating efficiencies while prioritizing investment policies and innovation to become a more productive organization. We maintained our focus on profitability despite increased competition, which has seen a moderation of loan volumes and are confident that our strategy will underpin Santander’s sustained profitability going forward. We also closed the year with a strong asset quality across all the metrics. We are particularly pleased with our capital optimization strategy executed at the end of the year which boosted our ROAE. We are proud of the progress we have made with our strategic initiatives today and confident in our ability to continue delivering our sustainable growth programs. The next slide despite the uncertainty that is impacting the economy, we are optimistic on the attractive long-term opportunities in our markets. Reflecting our confidence in Mexico financial system and our business model we are investing MXN15 billion between 2017 and 2019 additional to our current investments and initiatives. This is to support our goal of becoming our clients’ family bank and Mexico’s market leader in profitability and sustainable growth. In that sense will be targeted on three key Group’s initiatives. More than 50% will be allocated on total transformation of our distribution network as we will reorganize our business to drive innovation and invest in infrastructure including next-generation technology. We recognize the need to enhance our processes and digitalize operations. We are investing to provide higher quality service at a lower cost by regulated transactionality to lower cost channels. Close to one-third is expected to be invested in initiatives and strengthen the customer acquisition transactionality and loyalty. This includes Santander Plus and Aeromexico project launch as in 2016. The remaining 14% will be invested in new businesses that are complement to our value proposition such as auto financing, distribution with our third party insurance products and our mid-market clients and operating leasing in response to customer demand. Also in line with our commitment to support communities where we operate we expect to launch a financial inclusion offering, which includes our financial education program. Now to update you on the progress we have made around Santander key initiatives, first of all Santander Plus continues to perform well with customers up 72% in the quarter boasting over 1.51 million clients, 51% of which are new to the Bank. Our Aeromexico co-branded card is also proving very successful with over 430,000 clients at the year-end, 31% of which are new. We’re achieving that strong cross selling levels among these clients across our mortgages, loans and deposit portfolio. Our strategy to drive demand deposits have posted 17% year-on-year growth and is showing a consistent increase in individual demand deposits. In payrolls, we expanded our net acquisition flow reaching 324,000 new payroll customers in 2016, 41% more than the previous year. On customer acquisition, loyalty and digitalization, I would like to highlight the following points. Our focus on attracting new customers together with a significant reduction in our attrition rate has resulted in 645,000 net new customers in 2016, almost 90% more than the previous year. In turn, loyal customers increased by 20% reaching 1.7 million by year 2016. Digital customers had expanded consistently every quarter, increasing 60% in the year and, surpassing the 1.3 million mark. Moving onto the dynamics of Mexico banking system. Total system loans as of November, the most recently available public data published by the CNBV expanded by 14.6%. Consumer loan growth remained stable at 13% while system deposits were around 15% year-on-year. We believe that these figures do not yet reflect the recently changed environment in Mexico, which has impacted business and consumer confidence. Latest November and December data show that the uncertainty around the U.S. macro scenario have limited impact with households, SMEs and corporates showing growth performance. Remittances rose almost 25% year-on-year in November. Retail sales, grew at high single digits, Wal-Mart same-store sales, around 7.5% in December, and car sales expanded by almost 20% in December. We have revised our GDP expectation for 2017 due to market and expectations of a more challenging scenario. We believe, we expect consumer demand to soften compared to 2016, but our expanding should remain well supported by government rules, but could suffer from high inflation effect at real wages. In turn companies may be more cautious on their CapEx plans which with higher interest rates could impact loan demand. I will discuss this in more detail when we go to guidance. Please turn to Slide 8 regarding loan growth. We expanded our portfolio by 8% year-on-year. In total loan performance variable was below our guidance range for this year of 10% to 12% growth. This reflects the contraction in corporate and government loan growth as we pursue our strategy of keeping a strong focus on profitability. The retail loans in December were also soft reflecting the recognition of the stiffer composition and a more prudent risk pricing approach given the economic environment. Looking at our loan book in more detail, individual loans expanded 8% year-on-year as we maintain our strategic focus on driving payrolls and credit cards and while we see the hidden cost from on consumer demand, we're also experiencing strong competition in this market. Consumer loans were up 10% year-on-year and is stable quarter-on-quarter. Payroll loans posted a strong performance of 18% year-on-year and our Santander Plus program continues to win traction. Credit card loans decelerated to 8% year-on-year. Mortgage loans were up 7% year-on-year as we continue to see aggressive customer acquisition strategy survivals while market mortgage rates have more gentle breaks in this high interest rate environment. Overall, mortgage activity remains soft at high end and real estate transactions typically closed in U.S. dollars were impacted by high FX volatility and the hike in interest rates. Commercial loan growth decelerated 8% year-on-year from 16% in the previous quarter. We saw a sharp slowdown in corporate loans this quarter of 2% year-on-year as we had some large payments of short-term loans. We maintain our focus on returns and are not willing to sacrifice profitability, despite increased competition. Sequentially corporate loans fell 19% following a 39% increase in the previous period that was being driven by a few large sort short term transactions in connection with working capital needs as discussed last quarter. Similarly government loans were flat year-on-year as we prioritized profitability. I would like to highlight the strong performance in SMEs and middle market. Middle market posted a strong growth up 15% from 10% the previous quarter. SMEs were up 11% as our strategy to target mid-to-large size SMEs and maintain our reach with our focus continues to gain momentum. Overall return dynamics continue to improve in the segment. Looking ahead we maintain cautiously optimistic view for the year. Commercial customers remain important following the rate hikes last year, expectation of additional rises and economic uncertainty after the US elections. We also expect intensified competition. Moving on to volume deposit performance exceeded our expectations, rising 15% ahead of our 10%to 12% focus. Demand deposits were up 17% driven by the strong growth from individuals and SME as we remain focused on improving our funding cost. In this volatile market we also saw higher demand for low risk capital instruments, which contributed to the 11% increase in term deposits. Summing up we demonstrated the ability to keep achieving and sustaining profitable growth even at the macro backdrop remains uncertain and I'm confident therefore the periods ahead our value proposition, exceptional customer service and execution discipline will continue to reap returns for our stakeholders. Now let me turn the call over to Pedro, who will go over our capital position and P&L. I will then discuss guidance and afterwards we'll be happy to respond to questions. Thank you very much.

[Pedro Moreno:]

Thank you, Hector. Good morning everybody. We maintain a solid balance sheet in a challenging environment. The net loans to deposit ratio improved to 96.3% this quarter from 106.7% in the previous quarter giving us a very comfortable funding position to leverage future growth opportunities. Given the rising interest rate environment, our funding strategy focuses on increasing the relation of our debt with building our sales growth and diversifying our funding sources. Accordingly, during the year we issued notes, 2, 5 and 10 years totaling MXN10 million which allow us to double the average maturity of our local debt from 2.3 years to 4.3 years. Our liquidity coverage ratio stood at 153% well above the regulatory requirement. Moving to the income statement on the slide 13, net interest income remained strong up 13% year-on-year and 5% sequentially. Results for the quarter show the full benefit from the three interest rate increases that took place until June 2016. And to a lesser extent the one in September and also our profitable loan mix. This is still pending to reflect the 100 basis points increase occurred in the last four quarters. More significantly NII growth was driven by the loan portfolio which contributed with a 24 year-on-year increase in interest income up from 19% in the previous quarter. Our securities portfolio had an increase of almost 4% in interest income, which was impacted by market volatility. We're pleased to report the significant 11 basis point sequential improvement in NIMs reaching 5.12% this quarter. Net commissions and fee growth remained soft impacted mainly by weaker performance in credit cards and insurance products. However, we saw a sequential improvement with fees resuming growth of almost 5% sequentially following the 6% contraction in previous quarter. Our Santander Plus program continues to drive higher transactionality supporting the 17% year-on-year increase in cash management fees. This investment fund fees also increased 26% reflecting a better price mix. Financial advisory also performed well this quarter up 26%, as we closed some consortiums in our pipeline. While we are present across core capital markets on financial advisory opportunities, we remain cautious given over uncertainty. Credit card fees fell 24% year-on-year reflecting difficult comps, higher reward and issuance costs from Aeromexico co-branded card, and also the peso depreciation as some of our credit card fees paid are dollarized. Note however that current fees rose 16% reflecting higher credit card usage. Insurance fees fell 2% by soft SME demand. If you go to credit related insurance, offset the good performance in our online platform for car insurance. Summing up, we achieved a 15.6% increase in gross operating income driven by a strong a strong NII growth and significant trading gains, which were above our estimate quarterly average of around MXM600 million to MXM800 million. This figure represented 6% of total gross operating income. We closed the year with a strong asset quality across all the metrics. Loan loss reserves fell 2.5% sequentially and were in line with loan growth year-on-year. We also continue to improve our non-performing loan ratio across all segments. We total ratio of around 85 basis points year-on-year to 2.48% below market levels. Cost of risk for the quarter improved 14 basis points to 8.35% and reaching a 3.31% on a cumulated basis at the low end of our guidance range of 3.3% to 3.5% for the whole year. Looking at the census on Slide 17. We've seen an 80 basis points year-on-year in our efficiency ratio, reaching 14.4% in the quarter. This was the lowest level this year as we continue to focus on efficiency and profitability to mitigate the 30% increase in expenses in the quarter due to our strategic initiatives. Operating cost, excluding IPAB, gross 9.4% for the full year, above our expectations of 6% to 8% increase in cost in 2016 mainly driven by the amortization charges of our investment plans and the effect of the weaker exchange rate on some of our unrealized costs. As Hector mentioned at the beginning of our call, looking ahead, we will continue investing to strengthen our business and drive innovation to better serve grow their clients, which is expected to reap higher income as we keep a strong focus on profitability. In summary, we reported 11% year-on-year increase in interest income for the full year. This is after absorbing 130 basis points increase in the effective tax rate. Importantly, pretax earnings growth of 13% exceeded our 8% to 12% guidance range for the year. Note that effective tax strategy management enabled the 24% of effective tax rate in the year, is slightly below our expectation of 25% to 26%. Now, let me cover our capital optimization strategy before turning the call to Hector. Last December, we implemented a series of initiatives to further optimize our capital structure, which included the following. First of all, a MXN13.6 billion ordinary and extraordinary cash dividend from retained earnings. We also issued a $500 million of perpetual subordinated non-preferred contingent convertible additional Tier 1 capital in Basel III compliant notes. This is an innovative structure that was the first of its kind in Mexico. Our parent company, Banco Santander acquired 88% of the AT1 Notes maintaining its commitment to Mexico. In addition to optimizing our capital structure, these initiatives have allowed us to improve profitability metrics and maintain capitalization levels well above regulatory requirements to take advantage of future growth opportunities. As a result, return on average equity for the year improved by 120 basis points to 14.1%. While without this transaction, it would have been 13.5%. Our more efficient capital structure is expected to boost return on average equity going forward as well. In addition, our capitalization ratio dropped 30 basis points in the quarter to 15.7%, mainly reflecting our dividend payment for the first half of 2016. Our Tier 1 capital stood at 11.8% and core Tier 1 at 10.3%. Finally, these initiatives also allow us to increase total shareholders return [indiscernible] of 8.5% at the end of December, the highest in the Mexican stock exchange [indiscernible] compared to IPC index. So we are pleased to have delivered on our goal of driving profitable growth. Our strong bottom line performance underscores resilience of Santander Mexico's business against a more volatile global backdrop, as we execute on our strategic initiatives and focus on risk weighted assets returns on efficiencies. Now, before opening the floor for Q&A, let me turn the call to Hector Grisi, who will discuss the guidance for 2017.

[Hector Chavez:]

Thank you, Pedro. Moving to our guidance, we expect softer loan growth for this year rounding between 7% to 9%. In the current environment, we recently revised down our GDP growth estimates for 2017 to 1.8% from 2.3% and announced a forecast of 1.5% for 2018. We also expect the peso to remain weak with the foreign exchange rate estimated to be at MXN21.7 per $1.00 by the year end. Inflation is anticipated to reach 4.8% by December, triggering another 100 basis points increase in interest rates during the year. These factors, together with a more complex global environment and our focus on profitable growth amid stiff competition, are expected to result in soft loan growth for both commercial and individual loans. Deposits are expected to grow between 9% to 10% during the year as we continue to targeting [indiscernible]. In terms of asset quality, we are keeping a more prudent risk appetite, with cost of funding between 3.3% [ph] and 2.5% [ph] for the year. And we expect NPLs to improve, cost of risk is anticipated to remain stable, reflecting more conservative regulatory provisions, requirements and a different mix. Operating expenses are expected to increase between 10% to 12%, reflecting high amortization from the continued investment as we're undertaking in technologies, in processes and the impact of high inflation. As usual, this has not improved the deposit insurance fees, or IPAB, as a reversal from the employee cost returning the net EPS future payments. Our effective tax rate is forecast to range between 24% to 25% in the year ahead as we continue to approach a normalized effective rate of around 27% to 28% in the future. Finally, we anticipate net earnings to increase between 8% and 11%, as we remain focused on driving income growth despite the challenging economic backdrop. Insurance, while we are maintaining our cautious approach in terms of loan volume growth, we expect to continue to deliver improved profitability this year. We are committed to building our position as innovative, customer-centric organization and confident of sustained as the economy recovers. We're now ready to take questions. Operator, please go ahead.

[Operator:]

Thank you ladies and gentlemen. We will now conduct a question-and-answer session. [Operator Instructions] And our first question comes from the line of Tito Labarta with Deutsche Bank. Please go ahead.

[Tito Labarta:]

Hi, good morning. Thanks for the call. A couple of questions. First, in terms of your net interest margin, we saw net interest margin rose about 10 basis points in 2016, despite over 200 basis point increase in rates in the year. So I just want to get a sense, what do you expect for 2017 in terms of net interest margin, could you get some – maybe realize some of the benefits of the higher rates more in 2017, or with the slower growth, will that impact margins? Just want to get a better sense of your outlook for margins? Also, fee income was a bit weak. I know your financial advisory fees were somewhat weak for the year, dragging that down, but we also saw a big increase in commission expenses particularly on debit and credit cards. So I just want to get a better understanding of what you expect for fee income for this year? Thank you.

[Pedro Moreno:]

Well, net interest margin for 2017, as I said before, is we are planning to reflect the deposit side with 100 basis point increases. And we have a sensitivity, positive sensitivity assets. So, for every 100 basis points, we can expect MXN1 billion additional net interest margin every year. So, it is still uncertainty how much can be the interest rate raises this year 2017, but we currently expect that something between 25 basis points to 30 basis points improvement in this. In terms of fees, we expect to continue growing the earned fees, probably a double-digit growth, low double-digit growth in the earned fees, but we haven't still experienced these coming from the credit card issuances. So, at the end of guidance that these are all amongst single-digit growth, if inaugural, planned fees and paid fees.

[Tito Labarta:]

Thank you, Pedro. And then just to make sure I understood correctly, did you say about 25 basis point to 30 basis point increase in margin?

[Pedro Moreno:]

That’s right.

[Tito Labarta:]

Okay, so you're thinking to realize more of the benefits this year from the higher rate?

[Pedro Moreno:]

Yes.

[Tito Labarta:]

Okay, perfect. Thank you.

[Operator:]

Our next question comes from the line of Carlos Rivera with Citi.

[Carlos Rivera:]

Hi good morning and thanks, all, for the presentation. My first question is regarding the outlook for loan growth. I wonder if you could share a little bit more color there. What are the segments that you expect to grow more this year, particularly given the more challenging macroeconomic environment in Mexico? Is there any particular segment as you are cautious about and you don't want to outpace the market there. And my second question probably related is regarding the cost of risk. You have a range of 3.3% to 3.5%, so basically flattish to slightly up from 2016. So basically you are implying a little bit of deterioration there but not significant. So there also if you could share with us a little bit of your thoughts around these, why more tough environment in Mexico, cost of risk should not increase more than what you have in the range? What makes you believe that? Thank you.

[Pedro Moreno:]

Thank you, Carlos. Let me tell you what do we see. I mean, if you take a look a little bit of what we were doing last year and mostly towards the end of the year is that we have been managing the portfolio in a very dynamic way. What I'm basically telling you is that first of all, we are taking a look at our pricing and our different strategies every 15 days. We are really being up to date on what's happening in the Mexican economy at this point. So if you take a look, I mean we have taken a mix approach in terms and a different approach in the portfolio. While we, for example, maintain a little bit of rate in mortgages we increase the rates in individual loans and also we increase the rates of the loans for the corporate sector due to the fact that margins are coming off and there was a stiff competition and we are extremely focused on profitability. And that's what you see our portfolio basically dropping on the third quarter due to the fact, I mean, we paid almost MXN10 billion [ph] in the corporate sector due to the fact because decided basically to increase our margins there and to really have that good project in terms of reaping the returns. So what we expect for next year is we would be concentrating on the same strategy. I mean, we will continue to be growing in SMEs and middle market because that's where the profitable market is. On the corporate side, we will continue to be much more taking – being opportunistic in terms – I mean which value come in, we don't see the value then we won't do anything. And on the individual side, we will continue to grow – our growth in credit cards and basically payroll loans which are in our opinion premium given the market conditions probably the rest and with the risk margins and profitability and also of cost of credit. In terms of the cost of risk what I would like to tell you is that I mean we're maintaining our expectations that even with this market disruption that we've had – due to the fact that first of all we're looking very closely at our portfolios and we have concluded that at this point that we don't see any deterioration on them. So we continue to reviewing them every single week to see how are they doing and depending on that. And also what we've been doing very actively is in the corporate sector, in SMEs and middle market and also in the corporates we're taking a look different situations in the different sectors and tracking the different scenarios that basically increase our cost of risk. So we believe that at this point even with according to current situation that we don't see any troubles and we are confident that we will maintain the cost of risk in these levels.

[Carlos Rivera:]

All right. Thank you very much for the call.

[Operator:]

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

[Mario Pierry:]

Okay. Let me ask you two questions then. Good morning. The first one as you mentioned on your operating expense growth, you expect an acceleration because of your investments that you're going to continue to make. I also wanted to understand what part of this growth is due to the weaker peso or basically what percentage of your expenses are in dollars? Second question has to do with your outlook for trading gains. You had an extremely positive year in terms of trading. Should we expect – I think your previous guidance used to be between, I think, above MXN600 million to MXN800 million per quarter. Just wanted to get an update on that. Thank you.

[Pedro Moreno:]

Regarding the first question, the caution of our cost is around 7% of the overall overhead. And, yes it will imply at least 7.5% of the total increase from that mainly are related to the credit card business – any of the business are looking at few dollars. And also part of our IT investments. Second question is around the market.

[Hector Grisi:]

If you have seen, we have done some changes, basically in our team in that side. I mean we have basically changed a little bit the structure of our pricing risks and our international value will be more profitable, more oriented to client flow which basically has resulted in the numbers that you have seen. Also, we are very well positioned for the situation for the U.S. elections. We were actually very neutral in our approach to them so that what's the right coin in that point. And we are basically benefiting a lot for aiming huge increase in client flows, which we are basically taking advantage of. And I would basically continue to see the trend to end with a positive trading to continue to be around the number as you were saying, probably a little more things. Our position is quite in a route – good money at this point.

[Mario Pierry:]

Okay. So that would imply lower revenues from market income into…

[Hector Grisi:]

No, essentially much better than we were talking before, because along these numbers, we're talking about on maybe, at least MXN800 to MXN1 million per quarter.

[Mario Pierry:]

Okay. I thought you may say we will go back to the MXN600 to MXN800 number?

[Pedro Moreno:]

No, I think we're going to be able to be [indiscernible] in the quarter.

[Mario Pierry:]

Perfect. Thank you.

[Operator:]

Now our next question comes from the line of Carlos Macedo with Goldman Sachs. Please go ahead.

[Carlos Macedo:]

Good morning. Thank you gentlemen. I have a couple of questions, First question is related to asset quality on your consumer book, it weakened a little bit in the fourth quarter, not meaningfully. What would it take in terms of the –?

[Pedro Moreno:]

Sorry, Carlos. We cannot hear you. Can you just speak up, please?

[Carlos Macedo:]

Yes, sure. So question regarding asset quality, sorry, it weakened a little bit in the fourth quarter, not materially, but a little bit, just trying to get an idea of this is a sign of things to come, then what would it take for the yellow lights or maybe even the red light to go on in terms of signs from the economy, is it unemployment, GDP growth inflation, what are you looking for that would be due to become a lot more conservative in underwriting loans to consumers?

[Pedro Moreno:]

Well, if I understood well, you reflect due to – and mentioned there as we pushed the last quarter the number from the loans, this was mainly due to additional structures we made in the latest part of the homebuilders. This is what explains the improvement in the commercial loans. Individual performance has been weak. We are observing a very good performance. Payable loans not so much effective loans, credit cards quite stable. So we expect a – it's uncertain. We won't expect the duration. The quantity of latest business we are serving individuals are performing well. So we have seen quite a stable behavior. Plus we keep our standards up a bit that's why our guidance as you see for loan growth is a bit more conservative than it used to be. And in commercial loans, the behavioral effect of SMEs remains very, very, very stable. Middle market you see that improving and the big corporates we don't foresee any surprise as we had in the past observing in this any surprise. So, we're quite confident on the quality of our overall portfolio and we don't expect to change everyday feed. That's why we are quite confident on a stable non-performing loan.

[Hector Grisi:]

If you take a look, we've been very dynamic in the way we have managed the great portfolio, because we have been a little bit more recovered in the last quarter. We were much tighter basically in that and also our risk-based pricing approach has proven to help us in that regards as well. So if you see the mix of our portfolio of loans and how that has behaved in the last quarter, basically these are loans we didn't gross much. We did much better in the middle market when we saw it more profitable and the cost of risk wasn't that much. So we've been very active in terms of how do we manage the portfolio. And we were very much concentrating in basically getting the demand deposits mainly from our clients mainly the individuals and SMEs which have turned out to be very profitable for us given the rate increase.

[Carlos Macedo:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Jorge Kuri with Morgan Stanley. Please go ahead.

[Jorge Kuri:]

Hi, good morning everyone. I wanted to get a bit of clarity on your NIM expansion. You did say to a previous question that you're expecting 25 basis point to 30 basis point of NIM expansion, that's right?

[Pedro Moreno:]

Yes. I feel that – we have a feel that uncertainty on how can increase the interest rates during 2017.

[Jorge Kuri:]

All right, because I'm just having a hard time reconciling your net income guidance. If I use the midpoint of your guidance range for loan growth, cost of risk, expenses, tax rate and I assume 20 basis point expansion in NIMs not 30 basis points – 20 basis points, I end up with a midpoint net income growth of 14%. Your midpoint in net income growth is 9%. So I'm just wondering what part of that net income 8% to 11% has more negative assumptions vis-à-vis what's published here. For fees if you assume 5% growth I don't know you would have to assume a more negative outlook on some of the lines that you're not publishing in order to get to midpoint 9%. It's not that difficult, right. I mean it's just price times volume and cost and expenses and you end up with 13%, 14% mid-point.

[Pedro Moreno:]

Well, Jorge, you are right. I mean, the guidance is a bit conservative in the bottom line. We don't want to compromise or commit in certain uncertain parts. Asset for sales we are doing well in market-related income. We have not a position that can compromise who can risk our profit but it is very uncertain to predict this line. On the other hand you have seen expenses we are investing a lot and there have been quite some mark years how much the interest rates will increase. So if you take a positive, optimistic approach, yes you are right the net income growth can go 12%, 14% but with the [indiscernible] we don’t expect – I know you have a different opinion, but we cannot meet most of that optimism scenario.

[Jorge Kuri:]

All right. Thanks, Pedro. Sorry, go ahead. I’m sorry.

[Hector Grisi:]

Jorge, what I wanted to tell you basically is that you’re right in your approach in terms of the numbers but what I can tell you is that we have as you’ve seen a very aggressive investment program and we have to execute in a really surgical mode in order to really get our numbers correct and really deliver on the numbers that we’re trying to achieve. I mean this year has been really nice experience in terms of managing the portfolio, being more dynamic and we managed the Bank in many ways. I think it’s important that we as a management maintain a conservative approach in terms of what we’re trying to achieve due to the fact that as you understand, I mean we cannot – if we deviate just a little from whatever we do in revenues I mean we’re basically in a complicated situation due to the amount of investments that we are doing. So we really need to do really good execution on that and that’s where we’re focused on. And hopefully – I mean the economy basically holds in a nice way and not so complicated as we have seen in current years, then I believe that we can basically be more – less conservative. But at this point we don’t feel that – spending that we should basically be more aggressive or not.

[Jorge Kuri:]

Thanks, Hector. Let me ask a second question. You mentioned in your initial remarks that competition is increasing. So wanted to get more details around that. If I just take a very simplistic view at the moment sitting in New York and detached from some of these issues, but if I’m sitting here, I do see some of your competitors in this array still thinking whether or not they’re going to sell, thinking how they’re going to manage the business, now that is not a geographical unit, but more attached to the parent company, it’s some of them with existential problems and it doesn’t seem like because of that you would expect a very competitive environment. So can you just give us a little bit more color exactly on what you are seeing?

[Hector Grisi:]

Jorge, if you take a look at what happened in the last quarter to our loan portfolio then you can get a really good idea of what’s happening in the market. First of all if you basically look at our – I mean corporate loan portfolio, it decreased actually due to the fact that we maintain a really strong discipline in margins and the competition basically decided to take a rise and basically tried to gain market share which were basically not in the game of – that basically happens and we lost around MXN10 billion in the portfolio just in December alone just because the rest of the market sales regaining market share with pricing, which we believe is not the right path to take. We are not managing the Bank, we are managing the portfolio for the long term, not for the short term, and then we believe that the right approach is basically be responsible on the margins and the objectives we need to do and we need to focus on profitability. I mean, in the capital resource, we need to be very disciplined about how we manage it. Also take a look at what happened in individuals and not a lot in terms of individuals, I mean the competition has been really hard on some of – our competitors have decided to maintain the rates even what’s been happening in the market, which we don’t believe is the right way to do. And also we’ve been very also focused on risk in terms of – a little bit tightening – tightening a little bit the portfolio. And some situations have resulted in the clients paying us back and taking money from other institutions. So in that regard, we will continue with that approach and continue maintaining our profitability in that sense. I mean there are competitions that we have made in order not to lose market share, but we will be maintaining our position to be very disciplined about it. We don’t see our competitors basically doing the same. I mean there are a couple – I would say three or four competitors that they wanted to get market share and have continued to do so, even at the expense of lower margins.

[Jorge Kuri:]

Thank you. Thanks for the detail responses. Thanks.

[Operator:]

And our next question comes from the line of Marcelo Telles from Credit Suisse. Please go ahead.

[Marcelo Telles:]

Hi, hello, everyone. Thanks for the time. My question is regarding the guidance, just want to make sure I understand correctly, particularly your cost of risk guidance up like 2.3% to 2.5%, are you considering any impact from the change in regulation in terms of the additional provision requirements on the loan revolving credit lines? Thank you.

[Hector Grisi:]

You are basically talking about the B6, Marcelo?

[Marcelo Telles:]

Pardon.

[Hector Grisi:]

You’re talking about the B6 regulation?

[Marcelo Telles:]

Yes.

[Hector Grisi:]

Look let me tell you I mean, we took into account everything. And if you have seen our basic, our cost of risk is getting to be much more predictable in the – actually more towards the end of the year. We have been able to really knock out surprises that we have had in the past and we are really taken a good look of what’s happening in there now. In terms of I mean, on the regulation, we don’t foresee that due to the fact that we have a really strong control of what’s happening. I mean, let me give you an example, I mean we review all the cases on the SMEs that we’re having, we found out that we had a 120 SMEs that we thought that there were going to get in trouble and we decided to go and visit them one by one, and we actually ended up with a scheme that helped them out and we didn’t basically jeopardize our position with THE B6. Also, I mean in the situation of what’s more complicated, what basically would have been a [indiscernible] contractors and the situation with our own [indiscernible], we got an extension from the CNBV in order to help that particular clients in that sector. And we think they approached and helped some of them both the product and tell you I think the majority of the portfolio which have not had a situation and we have had to retake the government loan for a longer base. I think the portfolio is so much for price behaving very well.

[Marcelo Telles:]

Excellent. And one question, this one related to your OpEx expense growth in 2017. It seems that you will take advantage, right, after the better margins to invest more in the – in IT. If you could just elaborate a little bit more what your investment plan is and what are the areas that you’re seeking to improve with that increased expense. Thank you.

[Hector Grisi:]

Sure. First of all, I mean what we said a year ago when I came into the bank is that we were going to turn ourselves in a more client centric approach, okay. When our only driver in the past was credit, I mean loans, then it was, I mean, actually quite easy to do that. The problem is when you get and you turn the bank to be the Number 1 bank for your clients, they’ll start transacting with you a lot more; and that is actually what’s happening. When you use products like Santander Plus that which basically has the client and enables the client to transact a lot more with you and you have the digital clients increasing so much, our transaction management fees has rose quite a lot in all our – I mean, in people in that channels, mainly in our branches and our call center, I mean in the digital platform as well. So we have to increase capacity in all of those and basically to start taking our new approach or basically sending business not through – directly through the branch but different channels, okay; and we have been. So we need to invest basically in around 200 to 250 branches that, at this point, are completely collapsed with the amount of clients coming in, okay. So that’s a major thing that we need to do and we have started already to do it towards the end of the year, and that’s very important. Second of all, we came – we need the kind of program of Santander, a program that is basically our first digital 100% digital account that basically enables the client to open their account in the bank, a level 2 account, completely in a digital way; and that has done very well with basically coming out on – towards the end of the month on really, I mean to our mission [indiscernible] So that is helping us a lot. I mean – and we also have a huge investment of transformation because we are coming out with also onboarding for SMEs. We are basically going to – I want to give some credit towards the new store with digital platform. We are basically working on the customer journey. We have [indiscernible] so we are working in a whole bunch of different initiatives that will help a lot to our clients, will basically help us in getting more transactions out of our clients. While we continue doing that, our experience has been one which – once we have our really mature clients working with us it’s four times more profitable that a normal client that we only give our loans have to give [indiscernible]. And if you have seen the amount of deposits which have grown, because of that, our clients are basically using those as a main bank and they’re using us to transact, and that’s exactly what investments are going.

[Marcelo Telles:]

Excellent. Thanks for your answers, and congratulations on the quarter. Thank you.

[Hector Grisi:]

Thank you, Marcelo.

[Operator:]

And our next question comes from the Jason Mollin with Scotiabank. Please proceed with your question.

[Jason Mollin:]

Hi, thank you for the opportunity to ask a question. I’m interested in understanding a bit of these statements. Can you hear me, is that better?

[Hector Grisi:]

That’s on better. Yes, thank you.

[Jason Mollin:]

If I look – I’m not trying to understand the strategic comments that you want to price lending, you want to maintain prices and maintain margins to sustain your profitability, not go for market share. And I was doing some analysis of the risk-adjusted yields by segment for Santander Mexico and it’s interesting that the government segments, when we take the yield of, I don’t know, 5%, this is from November last 12 months, and risk-adjusted to 4.8% and we compare that to companies at 3.6% as a risk-adjusted loan yield, is there any desire, is it about diversifying risk in and size of the government, but it looks like that would be a segment that could provide good risk return dynamics, clearly consumer and mortgage or higher, not sure how you put expenses into that calculation, but if you could give us some comments on the exposure, which has been relatively stable for you to government, if that would be interesting? And my second question is on the consumer segment. I mean, your customer acquisitions have been very strong with your new product, Santander Plus. In fact, I think over 1 million clients now and half – 1.1 million, excuse me, and over half new. I mean, how expensive has it been to acquire these clients and how long will it take to make them profitable, or are they profitable from day one?

[Hector Grisi:]

Okay. Thank you, Jason. Let me tell you, I mean on the government strategy, look, I mean we will continue as we have been. It’s a very opportunistic market, okay. First of all, let me tell you, I mean it. And what we’re doing in government business is basically trying to maintain our market share in some of the different transactions or in the business that we have with some of the government entities, okay. So that’s, exactly, what we do. I mean, we really give loans out to the ones that we have – is in the payroll, so we have the payment accounts or whatever they do to transact with us. So the business is profitable when you combine it with transactionality. To give enough loans to government entities, we have that relation, it’s our business and we won’t do it if it’s not profitable, okay. So in government loans, we will continue and what we will do if it’s opportunistic basis and we see a good margin, then we will do it, okay. But it’s not the market that we are particularly very focused on. Only in the situations as I am telling you do we send our business that we do on a transactional basis, which is profitable. On the other side, going back to what you were saying is, Santander Plus have proven to be a really good – to be much better than we expected in a sense that it’s not as expensive as we thought it was going to be because we have had a lot of cannibalization on our client rate. This is our problem that which has been very much concentrated on getting new payrolls with our clients, and you’re going to see that, I mean, we’re doing very well. You saw that – I mean, we had a problem with accretion and we had diminished quite a lot. So that basically has enabled us to help us in profitability. First of all, we have a lot less cost in the amount of attritions that we have had; that’s number one, and that was something that was really important for us to tackle. Number two, what has happened is that once we get clients on Santander Plus the clients start to transact with us, and due to the fact that they basically have the direct debit to the checking accounts and everything, they maintained a lot better sort of results in the account. So they maintained their money, which is very profitable. And given this new rates, it’s more profitable. So, I think this strategy is proving – have been proven that works and we will continue to focus on that and continue to run the growth in that sense, because this is the right path to take. If you take a look at you will read that our mix at the year-end in terms when last year we closed the around 101% to 100% in terms of loans to deposit, now we are at 95% for the first time in a long time. I mean I haven’t been – maybe several months both parties the first time that we have a short list in deposit terms – in deposits versus loans, which is very profitable in a market like this one. So basically we drew an idea that even the acquisition causes a little bit more than where the competition has already, it’s proven to be much more profitable than we expected and the they increase our weights at sample scores.

[Jason Mollin:]

Do you think that you’ve reached a kind of – I mean I remember you had some pretty aggressive targets in terms of new clients and such but looking for 2017, do you expect the same kind of trends?

[Hector Chavez:]

Yes, we think so. I mean we have a very good – so far a very good trend and we believe this is going to continue like that. I mean we’re doing very well and we have our Bank very well focused on that and our different areas are really working towards that because let me tell you why. Because we are working really together. We are having, for example, I mean the investment banking area basically working really hard for us to get those corporate that we loan to change our deferrals to us. And you’re going to see that – I mean, you have seen this in this year and you are going to see it on the first quarter. We have a really good trend on that. And so we are working as one and also we have – as you know we have a second largest franchiser of middle markets companies in the market. Now we are taking advantage of them. So that basically has enabled us to get a lot more market share than our competitors in that sense. Even though there were number of point tables and we are working, we will settle that, I mean we are growing much faster on the competition.

[Jason Mollin:]

Thank you very much.

[Hector Chavez:]

Thank you.

[Operator:]

And our next question comes from the line of Carlos Gomez with HSBC New York, please proceed.

[Carlos Gomez:]

Hi, I got in late so you may have answered this question already. Can you let us know if you used the exemption that authority sellout had to reclassify any of your securities? Again you may have already talked about this. Second, you also mentioned in the call that you also have an allowance to treat some of PEMEX suppliers. Could you quantify how much of the portfolio that will be affected and how long that exception might take place? And finally on the capital side you have done this successful 81 transactions, you have successfully replaced capital that will increase your ROAE. On the other hand, you are starting the year with a CET1 capital of around 10% lower than the competitors in an environment which is not particularly friendly. Are you comfortable with that 10% or do you expect it to change over the year? Thank you.

[Pedro Moreno:]

Okay. Well, first of all securities, we have a very comfortable position in our article. We reduced the duration of securities. And we finally decided not to reclassify any of our securities – definitely increasing available for sale. Second question, the answer is no. We have a few restructure launch with the PEMEX suppliers that they are currently performing. So we don’t have any cushion or conservative additional provisions or reserves for that. We have to follow the methodology of CNBV to provide for results in our portfolios. And the third one, our Tier 1 capital is 11.8% don’t forget that the security – I know we have issue is Basel III compliant, additional Tier 1 so it’s absolutely same quality of capital than the Tier 1. So it’s not 10.3%, it’s 11.8%. We feel very comfortable, we see increased level of capital. The total capital including the Tier 2 is 15.7%. It’s even above the average of the market in Mexico, really well above the – we need. And we feel comfortable with the level of growth expected for the coming years.

[Carlos Gomez:]

That’s very useful. Thank you. And a comment on the 81, the interest that you pay on these notes, if it considered a part of interest income or does it go through the minority slang? Thank you.

[Pedro Moreno:]

If we figure as capital instrument, so the interest rates are not reflected in the P&L but in, it will.

[Carlos Gomez:]

Sorry. So, it doesn’t go through P&L at all. So the interest on the 81, it was – I understand correctly, the interest on the 81 note is charged directly to equity.

[Pedro Moreno:]

That’s right, that’s my position on equities.

[Carlos Gomez:]

Thank you very much. Thank you. We’ve reached the end of our question-and-answer session. I’d like to turn the call back over to Mr. Chavez for any further remarks.

[Hector Chavez:]

Thank you very much for joining Santander Mexico earnings call. I would like to invite you to download our new Investor Relations app so you can have easy access to our financial information on your mobile. If you have any further questions please don’t hesitate to call or e-mail us. Thanks again and have a great day.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude our conference for today. We thank you for your time and participation and you may disconnect your lines at this time. Have a wonderful rest of the day.