Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Please stand by. Good day, everyone, and welcome to the Grupo Financiero Santander Mexico’s Third Quarter 2014 Earnings Conference Call. Today’s call is being recorded. After the speakers’ remarks, there will be a question-and-answer session. For opening remarks and introduction, I would 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 2014 earnings conference call. We very much appreciate everyone’s participation. By now, everyone should have access to our earnings press release and the company’s presentation which were released today morning before the market opened. Speaking during today’s call will be Marcos Martinez Gavica, Executive President and Chief Executive Officer. Also joining us are Pedro Moreno, Executive President of Administration and Finance; and Rodrigo Brand, Deputy General Director of [indiscernible] 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 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 Securities and Exchange Commission and the Mexican Stock Exchange. To begin today’s call, Marcos will provide an overview of our performance this quarter, followed by a review of Mexico’s market and financial system trends. And afterwards, he will briefly go over our performance and our views going forward. Marcos, please go ahead.

[Marcos Martinez Gavica:]

Thank you, Hector. Good morning to all of you. Thank you for joining us in this earnings call. And let me begin by saying that we are pleased to report that total year-on-year loan expansion of 17%, the second consecutive quarter doubling market growth. We have seen a positive performance in SMEs, mortgages and middle-market. While consumer launches do reflect some consumer demand, we need [ph] market growth. And talking about deposit, demand deposits particularly in the [indiscernible] continue to drive expansion in our deposit base, up 12% during the period, also, our financial system trends. The cost of risk was stable while NPLs increased slightly this quarter. We remain committed to maintaining our prudent risk management. A lower than anticipated level of activity in both higher margin consumer loans and capital market transactions affected both profitability and efficiency while we maintain a tight control of costs. This quarter, we also launched a comprehensive program that further enhances our strong commitment to the high potential SMEs market. This is Mexico’s largest financing and service program for this market. Looking ahead are some unfocused business strategies resume [ph] as well to take advantage to the continued pick up in economy activity. And talking about the macro, looking at the macro, we continue to see some signs on economic recovery this quarter, indicating a reversal in the trends. For example, data for July shows the construction and industrial production indicators as in positive territory. While September employment and consumer comps [ph] data show signs of recovery, consumer spending indicators such as retail sales are not showing too much traction, a serious [ph] factor, among others, by the fiscal reform and higher inflation. Based on this, we maintain our GDP growth estimates of 2.5% for this year with a stronger performance in the second half. In 2015, we expect a GDP growth of 4% accelerated principally by recovery of manufacturing export to the U.S. market, the execution of the public budget, in particular the infrastructure program and other recoveries in consumer spending. So while we are optimistic about the future, we are also cautious about the speed at which consumer spending will recover. In terms of interest rates, we expect a stable environment for the remainder of the year, a 3% increase to 3.5% by mid-2015. Inflation is expected to decline at 3.4% for the next year. And in the next one and while fundamentals remain solid, softness in consumer and commercial loans together with delays in infrastructure investment continues to affect loan system growth. We believe that lending activity should pick up progressively in the coming quarter as the economy continues to recover and projects reach investment phase. Deposits for the system as of August, the most recent available data, were up 8.2% year-on-year, decreasing as mildly [ph] from September. Now looking at our performance. Total loans expanded 17% year-on-year, doubling market rates. Organically, growth was 14%, still significantly above market. We pay loans where demand guided [ph] behind the expansion, up 26% in the period, reporting a year-on-year growth across all products. Corporate loans, in turn, fell 21% year-on-year reflecting pre-payments from certain clients and the delay of materialization [ph] of infrastructure and private investment projects. And while several projects have been announced, it takes a while until these projects enter in the financing phase. On a sequential basis, corporate loans fell 3%, offsetting the 1% growth in retail loans. Moving onto the individual loans, we achieved a 22% year-on-year expansion well above market levels. Mortgage loans were the strongest performer of 34%, significantly exceeding market growth. Even when excluding the acquisition of ING mortgage portfolio, these loans grew a healthy 16% year-on-year scalable market. In the credit cards, the credit cards expanded 6% year-on-year. While softer than expected, this was above market rates. Although credit card placement remains at a steady pace, we are seeing lower average usage. Maintaining our focus on innovation, we introduced this quarter the first co-brand in American Express credit card in Mexico. We also continue to penetrate the open market, focusing in medium and high income individuals and keeping conservative credit foreign standards. Consumer loans rose 12% year-on-year in line with market rate activities [ph], soft consumer activity. Remember that this was achieved despite the sales of the portfolio or the very long [ph] portfolios in the first quarter of the year which represent around 300 basis points of our growth rate. The commercial loans continue to post a good performance of 13% year-on-year, mainly driven by SMEs and middle-market. Loans in the high potential and profitable SME segments increased 25% year-on-year. Just to give you an idea, SMEs represent 72% of employment and 52% of GDP. We have a leading positioned in this quality [ph] segment. A focus on driving transactionality through a differentiated problem-solving has allowed us to deliver a strong and healthy growth over the last four years. Remember that more than 50% of this loan portfolio is guaranteed by Nafinsa. We are also opening a new specialization branches to double the foreign SMEs footprint. We have opened three offices this year and plan to open 12 more by the first quarter next year to further support our position in this segment. As I mentioned at the beginning of the call, last August we launched a program to provide full comprehensive attention to SMEs in coordination with the development banks in order to further strengthen [ph] our position as the perfect partner for the SMEs. This program aims to provide not only financing but support for recruiting for employees on training, offering them solutions to overcome those barriers. In addition to this comprehensive program, we also have established a MXN1 billion fund to provide equity related instrument to the segment. The middle-market loans were also strong, increasing 19% year-on-year, double than the market did. And corporate loans, however, were down 21% year-on-year and 3% on a sequential basis as the SME is still affected by the low economic recovery. We continue to see corporates using debt in the highly liquid capital markets and taking advantage of a very low interest rate. Finally, government and financial entities grew 64% year-on-year mainly driven by the two state-owned energy companies. In terms of funding, demand deposits continue to expand at double-digit rates of 19% and above average in achieved [ph] growth. This continued positively because of funding while we continue to optimize term deposit cost. An ongoing focus on SMEs and select client base together with our branch expansion program continue to drive a positive growth. In terms of liquidity, we maintain a healthy profile with a loan deposit ratio on 97%, reflecting a strong demand and positive growth during the quarter. Our debt maturity profile remains healthy and position us well in an environment of potential interest awaiting this [ph] next year. This is further supported by the strong capitalization of 16.8% and an efficient capital structure. Now moving to the P&L. We reported the second consecutive quarter on sequential growth in net interest income of 3%. Note, this has been achieved in a historical low interest rate environment. This is also a recovery from the low level reported in the first quarter although these are resulted from the organization of our capital structure. We expect the sequential recovery in net interest income to continue with its upward trend and to be further supported by higher consumer activity as the economy strengthens. Year-on-year, net interest income rose 5% and net interest margin has stood at 4.9% or it would be 5.22% discounting the effect of the subordinated debt addition at the end of last year. Moving to the net commissions and fees, we reported good growth in insurance, cash management, investment funds and comex. Performance was affected by declines in credit card fees and softer investment banking activities. Two factors impacted credit card fees. First, cost including the introduction on new credit card launches. Second, investment incurred [ph] and new placement through other marketers to reach out the open market. This is, however, improved sequentially. During the quarter, capital markets operated volumes and primary placement and project finance transaction growing lower than expected, affecting investment banking fees. Higher risks, have a [indiscernible] ahead, we should materialize when market conditions recover and infrastructure projects entering financing phase. Gross operating income rose 4% year-on-year principally driven by return to [ph] earnings. The sequential comprehension reflect higher trending [ph] gains in two quarter of ‘14. Remember, the last quarter, our treasury management took advantage of the decline in interest rates, leveraging our more active approach in market making activities. This quarter, we return by a standard run rate of MXN600 million to MXN800 million per quarter. With respect to asset quality, our total NPL ratio rose 3.7% with year-on-year increases in mortgages and commercial loans. Higher mortgage NPLs mainly reflect integration of the ING portfolio and in matures [ph]. And commercial loans NPLs in turn increased 71 basis points quarter-on-quarter. This quarter, we have some loans related to projects with recorded delays in execution. In line with the applicable methodologies, these loans were classified as non-performing requiring higher levels of provisions while we have in the structure. At the same time, NPLs for the SME segment increased slightly to 2.79%, still a very healthy level. And excluding the homebuilders and the ING acquisition, total NPLs stood at 2.26%. Finally, provision increased 4% on a sequential basis while the cost of risk remain stable and below the target for this year. Note that this increase doesn’t apply a trend [ph] as mainly response to those projects related loans that were classified and non-performing. It will mean [ph] that a new structure, any portfolio even though is in a covering [ph] position, you have to put it a non-performing for the next three payments. After that, you can take it out again. On the expenses front, costs have remained stable for four consecutive quarters. We continue to invest at the strategy business and new branches. At the same time, we’re reducing recording expenses to offset our ongoing investments. While the efficiency ratio remains relatively flat on a sequential basis, it increased 3.1 percentage points year-on-year to a solid 3%. This reflects a lower than expected level or activity in both higher margin consumer loans and fee related business. While we continue to actively manage and maintain tight cost controls, we maintained our guidance to grow expenses below 10% for the full year and expect our efficiency ratio will move closer to around 40% as we see a higher level of activity. Finally, reported net income for the quarter was down 45% year-on-year. Keep in mind, however, that result in the comparable quarter includes an extraordinary benefit expenses of MXN2,800 million before taxes last year. Excluding this item, comparable net income for the quarter was down 17% year-on-year and 12% sequentially. This was principally due to a lower than expected high margin consumer loans and fees, reflecting on a sluggish economic environment as well as higher position and I explained before. As always, we are working on solidifying [ph] businesses’ growth and producing innovative projects and expanding our client base, while maintaining a tight control of net expenses and asset quality. This focused approach should be reflected in our bottom line as the economy continues to recover. We also continue to actively manage our taxes strategy lower than the impact of the normalization of our respected tax rate. As a result, the effective term rate this quarter was 19.4%. And finally, looking ahead, we continue to see some signs of economic recovery this quarter on seeing [ph] a positive trend, further supporting Mexico’s solid macro fundamentals. As we have seen throughout the year, consumer demand has been weaker than expected, both for the industry and for Santander Mexico. Therefore, at this moment, we don’t have much visibility in terms of the speed in which a continuous economic pickup will translate into higher consumer loan growth. Nevertheless, despite having reduced EBITDA estimates for the year from 3% to 2.5% last quarter and given you our expectation for a sustained market recovery, we maintained our 15% total loan growth estimate for the year. At the same time, lower than anticipated growth in high margin consumer loans will most likely affect our operating comp targets. All other guidance metrics remain in place. A positive growth this quarter was on the top end of our guidance range of between 10% and 12% for the year. This was mainly driven by selected resource and SME with demand deposits of 19%. At the same time, cost of risk of 3.5% this quarter remain below our guidance of closing the year below 3.7%. And we expect cost of risk to improve slightly in the next quarter. In terms of costs, this 9.6% year-on-year increase in operating expenses reported year-to-date is in line with the guidance provided early this year and we expect to close the year with costs below our original guidance [ph]. The growth of the costs, we expect it to be around 8.5% at the end of the year. And finally, our objective is to reach an expected tax rate below 28%, although this quarter we posted a tax rate substantially below this target. And we’ll continue to actively manage and implement tax strategy. These strategies will allow us to deliver an effective tax rate of around 20% for the full year. In summary, while consumer demand is still lagging behind, we are very optimistic about the future. We expect the consumer to slowly recover as buyback and public investment continues to materialize, employment is growing and disposable income rapidly increases. In this context, our sound consumer-oriented business strategy position us well to leverage a full recovery in the economic activity. With this, we are ready to take your questions.

[Operator:]

Thank you. (Operator instructions) And we’ll take our first question from Philip Finch with UBS.

[Philip Finch:]

Yes, hi, good morning, Marcos, Hector. Thank you for the presentation and the opportunity to ask a couple of questions. First question is really focusing on your asset quality where we did see the NPL ratio and provisioning levels rise quite considerably in the quarter. Can you elaborate a little bit more on the NPL trends, especially regarding your corporate and middle-market segments where you mentioned there are some deteriorations? And regarding the homebuilders exposure, can you just clarify if this is a legacy exposure or are we seeing new NPL problems for homebuilders? And my second question is regarding the net interest margin outlook. As you said, you’ve had some very low interest rates for a prolonged period of time and this clearly has put pressure on margins. But as we move into 2015 and the potential for policy rates to go up next year, could you remind us what the sensitivity could be for you if policy rates started to go up and how this could impact margins going forward? Thank you very much.

[Marcos Martinez Gavica:]

Thank you, Philip. Well, as we told you in the presentation, the NPL is affected especially for the new methodology talking about SMEs and middle-market, different than the mortgage shares that is the impact of the ING portfolio that is being maturing. But talking about the other, there were some companies that are affected by the environment or are being rescheduling their programs for the contract that the government is giving them. And when you have a structure in the new methodology, any loan, you have to put it in a non-performing for the next three payments. And that affect those in an amount more than around MXN500 million. And that’s why you see that it’s increasing instead of decreasing. And we think that one of it for sure, December is going to be out because it’s going to be three payments – monthly payments. And maybe we have in the next future, short future some other companies will restructure because they need to do that and it’s healthy to do it. And the impact will be there but it won’t be something very different in that it has been in the next quarters. That’s why we are not worried about it and you will see normalizing this part of the – this tendency in the next quarter or the next one. Saying that, I don’t know if with this I answered your first question.

[Philip Finch:]

Yes, that’s very helpful. So just to clarify, the rise in NPL ratio should be temporary and we should see it stabilizing, normalizing in the next one or two quarters, is that correct?

[Marcos Martinez Gavica:]

The homebuilders fortunately are looking the light at the end of the tunnel. We then [indiscernible] we have started to given them a new launch, bridge [ph] launch. We’re starting the operation. We have approved now two new projects. We know that we’re not hands on [ph] the same and that HSBC and DBA [ph] is going to give the new lines in the next three weeks. Then what we’re expecting is a recovery in this one. In the economics [ph], we are ready and the banking system is ready to give a new bridge launch. But we are waiting only if the judge has to recognize the debt that they have with us, to give new money and to have a preference of the old money. The judge will weigh in [indiscernible] and related to the [indiscernible] the company is ready and we’re ready. Then now the TGO [ph] is better than it was before. And the last one who is worthy [ph] is going to be on the next – that may be in the next two weeks. Then know the deterioration; at the end, we’re starting to do something. And in your second –

[Pedro Moreno:]

I’ll take this, Marcos. Yes, talking about sensitivity of our net interest margin to the variations in the interest rate, just let me say first of all that the impact of the drop of the interest rates in the last year and in the last months has affected us 3.4% of the growth of our net interest margin. In other words, this will be growing without this effects [ph] above 8%. And looking forward for next year, sensitivity 400 basis points variation is around MXN1 billion in positive. If interest rate goes up, our interest margin will benefit in MXN1 billion.

[Philip Finch:]

Thank you, Pedro. And how long would that take to come through, would it be over a 12-month period?

[Pedro Moreno:]

Well, the –

[Philip Finch:]

That MXN1 billion.

[Pedro Moreno:]

Our expectation is that this will happen gradually during 2015. So we are thinking 75 basis points at the end of the year. So in the average [ph] of the year will be around 35 to 40 basis points.

[Philip Finch:]

Right. Thank you, Pedro. Thank you, Marcos. Very helpful.

[Pedro Moreno:]

Welcome.

[Operator:]

(Operator instructions) We’ll go next to Ernesto Gabilondo with BBVA Bank.

[Ernesto Gabilondo:]

Hi, good morning, Marcos, and thanks for taking my call. I just have a couple of questions. The first one is regarding your expectations in your ROE in which you had previously guided 20% for 2016. Are you still expecting this figure to be achievable in that year? And for the second one, when are you expecting to have a similar year-over-year growth in your own portfolio versus your net interest income? We have recently seen that you have launched the small and medium enterprise product at the rate of 7.5% which we believe it’s below the industry levels of 10%, 12%. Can you elaborate on which are the strategies behind? Thank you.

[Marcos Martinez Gavica:]

Well, our ROE, and we have said that in the next two years, we would like to achieve the 20% and we still think that is possible. At this moment, we are in the lowest index but it’s the combination of the factors that we have said and the loan growth of the economy. But before that, besides of that, there are some aspects that are affected temporarily – are net income. Let me give you some of the ideas or the items that are impacted, that there are five at least. One is the subordinated debt and bigger than extraordinary MXN1.3 billion that we made last year. Of course that is what’s very good for the shareholders and is what – a big efficient operation in terms of taxes. But it’s impacting us and it will be – if the impact is on this year because it’s the first year that the cost is there and the money of the dividend is not with us. In the future, it will not affect. The second one is that absolute, as I said before, the low interest rates but as you know, this will change and interest rate will be increasing starting we think in June or July of the next year. Other one is the branch expansion that we – in which we are involved and that increases our costs significantly and we are finishing. We are finished this year with 190 branches and only remain for the next year 10 or 12 more branches. And then other parties, the growth of our portfolio, especially the thinnest [ph] and the middle-market that as you know with a new methodology almost expected [ph], you have to create in advance new provisions. And while we are growing 25% in SMEs and 17% in middle-market, we have been forced to increase our provisions in this year that is affecting us. But it will be normalized for the future. And finally, we have a tax rate last year of 15% and this year it will be around 20%. Then as you see, there are many factors impacting the net income of this year. And of course, the evaluation or in the near future, all of them will be absorbed and the LOE will be improving constantly and we think in the third year it will be around 20%. And the other question is – and the SMEs – we have been very successful with the strategy of the SMEs because besides of giving them an aggressively loan with – will result in terms of quality. What we have done better is not to have only just one program for all the SMEs but special packages for different kinds of SMEs that’s helping them to be more efficient in the operation in June. And while we are doing that and giving them a better interest rate loan when they took the whole package, not only we are improving the profitability but besides of that, we are having the transactionality of the company and that’s why the demand deposits are growing 20% of that segment. But besides of those, while SMEs is suffering, some of them because of the economic environment, when we noticed that some of them are having problems with some banks but giving us preference to our bank because we are the bank where they have the operations. And we have noticed that because we are having to put in non-performing from SMEs that are in a covering position with us because of the normal activity. That’s why we are very confident besides of the 50% of the guaranteed from Nafinsa.

[Ernesto Gabilondo:]

Thank you very much, Marcos.

[Marcos Martinez Gavica:]

And the pricing at the , because I forgot you asked for that, the 7.5% [ph], that is special for Nafinsa and is 4.5% in dollars has a special form from Bancomext. And we are starting at 7.5% for – the average of our loans are around 18%, 12%.

[Operator:]

We’ll go next to Tito Labarta with Deutsche Bank.

[Tito Labarta:]

Hi, good morning and thanks for the call. A couple of questions. First just in terms of your loan growth, you’re still guiding around 15% loan growth. So just with asset quality deteriorating and I understand there were some special items this quarter that potentially could improve, but how comfortable are you in growing above the system, given the economy still hasn’t fully recovered, you’re still seeing some asset quality issues? And also in terms of I guess your ability to get to the 20%, are we to look at earnings before taxes as been declining and the tax rate should still go up a bit more? So I just want the kind of long term outlook. I understand you still feel confident in about three years. But is that maybe just a little too aggressive just given the trends that we’re seeing or do you expect the significant improvement in the economy is really going to drive this? And if that improvement doesn’t come, what do you think can be the potential downside to kind of the three-year forecasting you’re guiding for? Thank you.

[Marcos Martinez Gavica:]

Well, what we’re expecting in the next future is that the Mexican economy will recover and to grow at a very different pace. We are expecting Mexico to grow around 4% next year. And in two or three years, growing around 5% as a result of the recovery of the United States economy and the impact of the reforms that are starting to have some results in the economy but in two, three years it will be notorious affected in a better behavior of the economy the reforms impact. Then while we see that the Mexican economy will grow much better than it is doing at this moment and that we have been able to grow, as you see, 17% while the economy is sad [ph] and the financial system is growing less than 10%, maintaining the quality, we are confident that we can grow around 20% to maybe a little bit more in the special products and segment that we wanted to do it without any problem in the quality of the new portfolio. And if we do that and we finish as we almost have done with the expansion of the – with the branches, the cost will come back very near to the inflation rate. And on that combination, of course around inflation and the loan activity growing 20% and if we commit the fee business growing in a double-digit because of the impact, especially that the recovery of the credit card operation on the one hand. And on the other hand, because of the investment banking opportunities that are starting to appear because of the new projects in the economy is on that combination of factors, we think that we can reach the 20% of EOA and maintaining the asset quality.

[Tito Labarta:]

Okay, fair enough. Maybe just a little shorter term kind of for next year what type of ROE do you think you can get to?

[Marcos Martinez Gavica:]

Sorry?

[Tito Labarta:]

For next year, what type of return on equity do you think you can reach next year?

[Marcos Martinez Gavica:]

I think we are going to give you that guidance in the next meeting next quarter. We are not ready to do it at this moment.

[Tito Labarta:]

Okay. Thank you very much.

[Marcos Martinez Gavica:]

Thank you.

[Operator:]

We’ll go next to Jose Barria with Bank of America.

[Jose Barria:]

Hi, good morning, Marcos and Hector. Thanks for taking my question. I just want to go back to your comments on the consumer segment. I want to just understand from you if you think this is more of a demand or a supply problem. In other words, are you willing to lend and you’re just not seeing the demand you talk about, lower usage from clients but this has been a very weak sector – segment not only for you but for the system. And I’m just wondering when we can expect that to turn around. That would be the first one. And the second question is on homebuilders. You’ve given us quite a bit of detail here on the specific exposure to the clients and we appreciate that. I wanted to know if you could tell us a little bit more about what has already been provisioned and had there been any changes to your expected losses in a positive or negative way in those exposures. Thank you.

[Marcos Martinez Gavica:]

Well, talking about the consumer segment, it’s not a problem of an offer. It’s a mix. As maybe we explained this before, when the year started, the people of the government or the treasury, they make a declaration saying that with the fiscal reform, they were able to do and they will want to do is to supervise their consumer in the credit card. And that in their balance, they can ask you to demonstrate where are the funds, where are coming the funds to pay that balance. And because of that declaration that of course is not – the government is not able to do because they don’t have the systems to do it, the impact in the people was that they became afraid of using the credit card because of that fiscalization. And they started to prefer the cash than the credit card. That is bad news for the bankerization of the system and a bad news in terms of the modernity of the country. And what we think is that because it was only a declaration but nothing has happened. And people is starting to use again the credit card and we’re thinking if the next future, it had to be normal day use of the credit card instead of the cash. And when that happen, you will see a different growth in the critical business. On the other hand, there is a weakness, still weakness in the consumer that is – those in the same in some of the companies. That reflect that the weakness of the economy is still affecting the individuals and not [ph] the company. But as we are starting to see, the Mexican economy is starting to grow. Then, this will help to the consumer and capacity to take again more credit. And in the second one, Pedro is going to give you the figures for the homebuilders.

[Pedro Moreno:]

Yes. Actual total exposure at the third quarter yearend [ph] is MXN4.9 million. This represents only 1.1% of our total portfolio. And approximately around 65% of this portfolio are some kind of warranties, so collaterals. And as we already said, we considered that we have provision 100% of the expected loss for this segment, so we’re willing to spend any additional impact [ph] in our results. On contrary, as soon as this companies will start to be performing again, we’ll generate net interest margin but now, they are not.

[Jose Barria:]

Okay. And do you have any info you can share with regards to reserved amounts or you’re not providing that to the market?

[Marcos Martinez Gavica:]

The reserves are on this exposure. It’s these are 50% of the total exposure, but not disclosing exactly the amount.

[Jose Barria:]

Okay. Okay, that’s good enough. Thank you very much.

[Marcos Martinez Gavica:]

Welcome.

[Operator:]

And we’ll go next to Marcello Telles with Credit Suisse.

[Marcello Telles:]

Hi. Good morning, gentlemen. Thanks for your time. I have two questions. The first one regarding the SME portfolio – I mean you’ve been growing very well in the segments. And how comfortable are you with the performance of asset quality going forward? I mean do you – we see one of your competitors having asset quality issues in the SME segment. So far, you seem not to have any meaningful editeration [ph] on that but you’re also growing in a high pace. I mean what is the chance that at some point we might see provisions picking up for that segment as well given that we’ve seen that happening in other markets in America that usually have high growth in the SME portfolio and all of a sudden the JNP [ph] also start to pick up after a while and then you might have to pull back. So do you see any risk in that regard? And the other question, I know they already asked about your level of ROE in the future, but I mean a lot of that has to do with sort of the effect of tax rates you’re going to have. I know your guidance is up to 28% if that’s the tax rate. But you’re like below 20 this quarter. Probably for the year, you’re going to be around 20% as well. So I was wondering, what sort of tax rates can we work let’s say in 2015? Do you think 24% is feasible? Do you think you can keep the low effective tax rate you have today? Thank you.

[Marcos Martinez Gavica:]

You’re welcome, Marcello. Well, as we have said, we are very confident here on the SME operation that we can maintain, continue growing at the pace that we are doing it without deteriorating the quality of the portfolio. And it’s for the reason that the way we told you [ph] and we have been with regard the asset quality for the last four years, growing that space even more and maintaining the quality of portfolio. Maybe, the competitor that you are mentioning give you an explanation. And it’s not my position to talk about what they are doing, but because their behavior is very different in their portfolio than ours, I can tell you that it was as we know because they make an internal plan to go in very fast, but they put bat controls. And some of their people made very bad loans trying to hold and to achieve the budget they had and to collect the bonds. But at the end, they – regarding the bad portfolio with the consequences that you are seeing. But it was because they took the wrong controls with the not very well aligned incentives. In our case, control is one of the most important thing that we do all the time. Then we’re just seeing in our case with the normal operation for a long period of time. And what you see with them is a normal operation with a mistake in control in a very, very aggressive intent that they give to get a better position with the SME. And in the other question, the taxes, where you are right that we have the skills, room between a 20% and 28% tax rates and it will be normalizing in the next future and they will continue flavor of what can happens. And that’s why we’re seeing – one of the aspects why we are seeing that the 20% will be achieved more in the current year than in the next year. And I don’t know Pedro, would you want to tell more about it.

[Pedro Moreno:]

Yes. Well, we are displaying it still [ph]. We are in the process of normalizing taxes and we don’t have any differed taxes already. So all the improvements are due to tax management. In here, we have been very successful. As I already said, we make some investments in Sun Securities with cash benefits that are not contributing so much to the net interest income bat to the bottom line of the profitable [ph] account. These advantages will continue next year. And we aspire to achieve the 28% in two years’ time. So next year, 2015, we will be readily approaching that and 2016 will be up then the target. This is, again, I insist, it is a question of management of taxes. Nothing to do with reserves. And we will continue managing. So this is part of the business. We have taxes in our culture as part of our management and our strategies.

[Marcello Telles:]

Thank you for your answers. I appreciate it.

[Operator:]

And we’ll go next to Daniel Abut with Citi.

[Daniel Abut:]

Good morning, mine is just a good follow up question because I think you mentioned in some of your remark, that you are still working with Samsung [ph] about 12% real GDP growth for Mexico next year and in that context, you should be able to continue to grow your portfolio about 15% base that we are seeing this year. Some people that share that optimism and instead of fear [ph] are starting to question it given the impact of oil prices. And as we all know, Mexico’s [indiscernible] that I will do that. I was wondering what kind of assumption for oil prices adding value in that 12% expectation and if oil continues to get down, how sensitive would be your expectations for that and therefore we could end up seeing the 2015 that is better than this year but not as much as we would have hoped for?

[Marcos Martinez Gavica:]

Well, Rodrigo Brand, our economist is here in the meeting and he’s going to answer these questions.

[Rodrigo Brand:]

Thank you, Marcos. I will take us – Marcos mentioned in the beginning of his presentation is that we’ve seen a quantity [ph] of the U.S. economy will continue to support the Mexican economy from the external point of view. But also, we will expect that as long as employment continues to get strength in the coming months and we expect of discov [ph] reforms in terms of disposable income for individuals and company, it’s also fully incorporated in the economic agenda. We expect that the Mexico assumption will start to revamp. Regarding prices, we are keeping an eye on the evolution of these prices. Nevertheless, we think that oil prices have a significant effect in terms of public finances. But nevertheless, we do think that there are some positive effect of having lower oil prices that will tend to compensate this reduction. In one event [ph] lower energy prices means more disposable income and with this, we think the added economic activity will tend to catch with the negative effects of oil prices. Oil prices represent around 40% of public finances of government revenues. However, we know that the government has already hedged on most of its exposures. So we don’t see a significant effect in the short term. Perhaps in the next couple of years, if the situation remains, we will continue to watch it. However, it’s also important to mention that if these lower oil prices remain in the next couple of years and the energy reform starts to have some kind of impact and new projects are developed, so there are some different effects. So overall, we don’t think in the short term it would have a significant effect in the economic activity.

[Daniel Abut:]

Thank you. But your assumption, your base case assumption of 4% real GDP for next year is assuming that oil price stay at the current level of about $80?

[Rodrigo Brand:]

Yes. It’s around $80.82 which is more of less the case because as I’ve said, that the most important factor in public finances are hedged at around that level. So more or less, we feel comfortable with the level that it is right now.

[Daniel Abut:]

Thank you.

[Operator:]

And we’ll go next to Saul Martínez with JP Morgan.

[Saul Martínez:]

Hi. Good morning, everybody. Most of my questions have been asked. Maybe more specific I guess, more of a technical question on your net interest income. Obviously, we saw 3% sequential growth. When I look at the details on your release page, 15 of y our release, it seems like gas yields came down for the most part. And what really drove the sequential increase was that the was pretty sharp reduction in funding cost for sales and repurchase agreements and securities loans. On the other hand, that same line item when your income statement rose from 6.17 to 7.88. So it seems like the pickup in you NII really has to do with that line item, loan yield came, all your other funding cost did come down as well. But can you help to explain what is embedded in those two line items, why the repo – it seems like spreads on your repo transaction seemed to have increased or am I misreading that?

[Rodrigo Brand:]

What we think is these are going to, scrap [ph], Saul, the repo response most to the funding of the treasury than to the rest of the balance sheet. Our repo strategy depends on prices, depends on volatility. This is not a long term, non-medium term depos, these are 95% of them are daily. And the only reason for this to move depends on the closing clear responses [ph], liquidity in the market and filter that [ph] the happens in the last days of the month or the quarter. Has nothing to do with the conclusive strategic of reducing depos in favor of other funding sources. With [indiscernible], it’s a different line. The balance sheet in the P&L which is the profile pack [ph] as you know what you reported is excluded from paying a profile pack. But this is included in the expenses. In terms of net interest margin, you are right, we are benefiting for a healthy level of our demand deposit. And our optimization of the cost of our term deposits, a combination of these two strategies is making quite a good improvement in our cost of funds. And on the other hand, in the net interest margin, in the part of the income, we are affected by mainly by the recuperation we made at the end that Marcos already commented. And they have in mind that we before $1.3 billion with zero source in terms of funding. And now we have a much more funding with the subordinate rep [ph] that swapped this costing at 9%. So this is really the combination of things. This in fact is super important in the growth of our BMDR [ph] of our net interest margin. That’s what enabled debt [ph], if you compare the first nine months of the year 2013 with the first nine months of 2014, this impact is MXN1.3 billion in this record [ph] which is like 8% of the growth of our total revenue [ph] at this period. So it’s very sensible. And what Marcos intend to say that this is not happening next year because the comparison will be the same basis.

[Saul Martínez:]

Okay. Maybe we can go over this outline because what I’m seeing here is if I look at the breakdown, you had a MXN200 million reduction on interest cost in premiums on sale and repurchase agreements and securities loans and you had 100 million and more reps, 70 million increase on interest in premium on sales repurchase and security on the income line. So it’s roughly a MXN350 million win which basically explains why NII grew, excluding those two items, NII was flat. I’m not exactly sure what is embedded in those that’s – if there is – if that’s sort of your core NII, if that really – those numbers are really reflecting the funding strategy or is there something sort of unusual on those numbers that is benefiting the net interest income.

[Rodrigo Brand:]

As I said, it has nothing to do with our core business strategies related to the treasury funding of the positions as far as the very short term depends on the volatility and the circumstance of project, very punctual moment. And I think it’s a very technology point, so it will kind of take us a lot of time to discuss it. And I’m very pleased to go deeply on this question after the conference.

[Saul Martínez:]

Okay. That’s fair enough. Thank you very much.

[Operator:]

I will go next to Arturo Langa with Itau BBA.

[Arturo Langa:]

Hi. Good morning. I wanted to understand better the strategy and in the shift of the mix of the deposits and if you could just give us more color and example of a specific campaign that maybe we could follow on this especially on the SME funding to improve the mix. That would be very helpful. And on my second question, I wanted to understand kind of Santander Group vision for Mexico and if there is anything that we can learn or read from what has happened with Santander Brazil recently. And that would be very helpful. Thank you.

[Marcos Martinez Gavica:]

Well, as we have told you, demands and deposits for the bank is an objective, a very important objective because we are underrepresented especially in the demand deposit of individuals where our market share is around 10% at the moment, that compares bad with the 15% that we have market share as a bank. And on the other hand in the company’s demand deposits, it’s very important because either [ph] the result of the transactionality of the companies that are in the – when we went [ph] – we get the transactionality of the company, we feel that we are creating a commercial banking franchise, a strong commercial banking franchise. And what we are doing with the SME for example when we talk about the packages is we put some advantages for the company if they were with us then make them more efficient. Then they give you an example. For the gas stations for example, they have very special process with payment to receive the gas. And they have to cover some really [indiscernible] levels and some other documents. They have a special procedure. And on the other hand, permits is important to have the security that the money is going to be with them when they give their gas to the gas station. But we have a special process for them and make very simple for [indiscernible] and for the gas station to work the bank. And that’s why a lot of them are coming to the bank and buying our package. And doing that, we are becoming the main bank of these companies, of these gas stations businesses. Or if you for the schools for example, we have a special process for the payment for the field of the alums [ph] or that for buying the utility that they had – that they need for the classes. That makes very easy for the schools to administrate the cash flow and for the parent, the [indiscernible] and get the different things and to pay the fee for the school event. Going back, while we are taking advantage of the market and it’s being a big attracted to work with us and that’s why I told you before that with the SMEs working with us, they take a lot of care of the relationship with Santander more than with their [indiscernible] of the banking system. And on the individuals, the combination of the new branches and the new offer in the [indiscernible] in the high level income of the clients in the branches, is working very well and that’s why we are collecting growing around 20% in both SME and in individuals, the demand deposits. And we’re following that with, I think called the same experience that we had during this period of time. And the parent house has, I’m saying again, that Mexico is strategic and one of the most important units for the group. And not necessarily because of the percentage that we represent of the total net income of the group we represent. We are around 8% of the net income of the whole group. But they say one of the unit with the highest potential of growth and they see Mexico being very important country, more important than it is today in them, in the future. And they are very glad with the development of the franchise.

[Arturo Langa:]

Thank you. That was very helpful.

[Operator:]

We’ll go next to Martin Lore [ph] with Atkinber Securities [ph].

[Martin Lore:]

Yes. Good morning, Marcos, Pedro and Rodrigo, I have two questions. Because [indiscernible] doing in the first quarter, so what’s the minimum level of coverage that you feel comfortable with and where do you see this indicator going forward? The second question is referring your press release that some of your clients experienced from delayed [indiscernible] execution of projects which why [indiscernible] ration one top. Could you please elaborate on these [indiscernible] delays?

[Marcos Martinez Gavica:]

Well, concerning the first question, the coverage ratio at the end is as I said mathematically sound. There is nothing that we really manage. We apply a complete methodology of reserves and the coverage ratios and result. And we are now available 100%. Excluding the homebuilders [indiscernible], we’ve, as I said before, it’s an important part of our non-performing loans. It’s like one third [indiscernible] is only 50%. I’d imagine that this is affecting lots of coverage ratio. [Indiscernible] we are closer to 150% which is very above the average of the Mexican industry. But anyhow, [indiscernible] the coverage ratios or most of the American bonds or the European bonds. So we feel comfortable being in 100%. And this is not the [indiscernible] we are targeting. And the second question?

[Rodrigo Brand:]

And the second one, let me give you an example of one of them. It’s a company who worked for Pemex. And Pemex is giving them a new contract extending the contract for two years more that it has before. And even the transition of the process of finishing back new contract. And because this is in better condition was the company [indiscernible] is to give the credits in the new terms, then the renovation of the [indiscernible] doesn’t have any problem on the opposite. It’s a good news for the company and for us. But the role of the commission says that if you have got innovation, never mind the [indiscernible] or not. You have to put it [indiscernible] until you receive three new payments. You’ll also see that the renovation was not because the company was in trouble but because of businesses reason. And they want to be sure because [indiscernible] that the reason was the second one. And the way that they assured or they think they assured that it is the case is receiving through payment. And that’s why we are telling you that we are not worried about it. And then maybe the activity of the country is beginning to be more aggressive. Some other clients will fuel them. That makes renovation and [indiscernible] to do is because it’s business. What we are going to do and what we will intend to do is work directly with you to give you the confidence that it is not a threat and there this is not because we have a bad portfolio.

[Marcos Martinez Gavica:]

Okay. Thank you very much.

[Operator:]

And we’ll go next to Gustavo Lobl with BTG Pactual.

[Gustavo Lobl:]

Hi. I have just one quick question regarding fee income. You’ve already explained how capital markets fees are in the pressure to the environment. But I was just wondering, what is a normalized level of fee income growth? This has been one major tailwind for decision banks. And when you look at your performance in terms of fee income, it’s not growing that fast. So I was wondering what’s the normalized level that you see and when do you expect it to resume growth once again, maybe [indiscernible] again or maybe if you could elaborate a little bit about that. Thank you.

[Marcos Martinez Gavica:]

Well, if you see the light of commission, you will notice that in – when we have a bad performance, it’s in the greatest cost and it is because [indiscernible] told you about the fiscalization and people that’s preferring to use case instead of the credit card have the transactionality has been below than the one before. But this is not something that is effectively seconded. But the whole financial system. And we are hoping that it will be better in the future. And the other two lines, I will let into the investment bank operation. You see the capital markets and securities and the financial advisory. And it is just because the way that the markets has been that it was not going to be a good time for any company, for example, for the IPOs or the follow ons [ph], the market has been almost completely closed during the whole year. And even though, we have a very good pipeline, we are waiting for the right time to do it. And the company is waiting that too, for example, we were ready for two IPOs and two follow ons last month. But with the behavior of the market, the prices, the reference of the prices were very bad for them. And they are waiting. They are waiting until maybe until the beginning of the next year or December that the markets became better than they are doing now and to go out. And in the financial advisory, it’s the same. We have [indiscernible] there. And we’re executing some of the debt deals that the market is ready and is good for them and the prices on that specific market. But either way, it’s not the appropriate time. And that’s why you see a bad behavior of other lines for either way. You see that the performance is a very good one.

[Gustavo Lobl:]

Okay. Thank you. Thank you, that’s clear.

[Operator:]

And due to time constraints, that does conclude today’s question-and-answer session. If you had a question, the company will contact you after today’s conference. At this time, I would like to turn the conference over to Mr. Hector Chavez for additional or closing remarks.

[Hector Chavez:]

Thank you very much for joining Santander Mexico. I look forward to maintaining and open bottle with you. You are welcome to visit us in Mexico. If you have any further questions, please don’t hesitate to call or email us. Please have a good day everyone and thank you very much for your interest.

[Operator:]

That does conclude today’s conference. Thank you for your participation.