Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México
Q4 2021 Earnings Call Transcript

Published: 4 Feb 2022

[Operator:]

Good day, everyone, and welcome to Banco Santander México's Fourth Quarter 2021 Earnings Conference Call. Today's call is being recorded. Following the speakers' remarks, there will be a question-and-answer session. I'd now like to turn the conference over to Mr. Hector Chavez, Managing Director and Head of Investor Relations, who will make some opening remarks and introduce today's other speakers. Please, go ahead.

[Hector Chavez:]

Thank you. Good day and welcome to our fourth quarter 2021 earnings conference call. We appreciate everyone's participation today. By now you should have access to our earnings press release and the presentation for today's call both of which were distributed yesterday after the market closed and can be found on our Investor Relations website. Presenting on our call today will be Didier Mena, our CFO. But before we begin our formal remarks, allow me to remind you that certain statements made during the course of the discussion may constitute forward-looking statements, which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties, including the COVID-19 pandemic, that could cause actual results to materially differ, including factors that could be beyond the Company's control. For an explanation of these risks, please refer to our filings with the SEC and the Mexican Stock Exchange. Didier, please go ahead.

[Didier Mena:]

Thank you, Hector. Good morning, everyone, and good afternoon to those of you participating from Europe. I hope you had the opportunity to enjoy the holidays and my best wishes for you and your families in 2022. Our results for the end of the year showed that second half was a much healthier operating environment, where we were able to boost business dynamics by designing and launching innovative products and services as part of our strategic priorities. This is in line with our mission of contributing meaningfully to the progress of people and businesses in our country. During the fourth quarter, we continued with a strong balance sheet and liquidity position. We also started to see positive performance in total loan volumes, mostly boosted by commercial loans, with corporates and government loans increasing close to 18% and 14% year-on-year respectively. In individual loans, we continue outpacing the market, supported by sustained market share gains in mortgages and other loans. In consumer, we are now seeing signs of a sequential recovery, especially in credit cards, as economic activity starts to gather speed, coupled with the effort we have made within our commercial network as well as through the campaigns we have launched throughout the year. In terms of deposits, we continue growing at a solid pace, improving our funding mix by favoring demand deposits over term deposits. In fact, our current deposit mix with 72% demand and 28% term is one of the best plans we have ever had. Also it's worth to highlight that the contribution of individuals has increased considerably in both demand and term deposits. Currently, the contribution of individuals in total deposits represents close to 39% compared to 24% in 2016. On the other hand, our individual and corporate demand deposits continue expanding at high single-digit rates year-on-year, underscoring the success of our loyalty and customer acquisition strategies, as well as our focus on lowering our funding costs. In terms of asset quality, NPLs continued their downward trend, reflecting a prudent risk management, which resulted in a healthy loan portfolio, along with an improvement in the country's economic activity. Further, we're pointing to a more normalized level of provisions and cost of risk, as our operating environment becomes healthier. As for profitability, our ROE was shocked by an environment of limited growth in volumes, along with still low interest rates and higher provisions as a result of the additional reserves that we had to build throughout the year. On the bright side, we're optimistic as we are expecting to see a turnover from this point forward on the back of a better operating environment, stronger loan demand and higher interest rates, coupled with our efforts to maximize profitability along 2022. Also during the quarter, our parent company Grupo Santander increased its ownership in our bank to slightly more than 96%, which leaves 3.8% of ownership with minority shareholders. The charts on slide 4 show that GDP is expected to continue recovering in 2022, but at a slower pace than in 2021 as the fiscal and monetary stimulus in the US is likely to be gradually withdrawn, but while domestic demand continues to improve. According to the Mexican Institute of Social Security, 2021 registered the highest trust increased ever with more than 846,000 jobs created. As for now we have recovered pre-pandemic formal employment levels. Macro indicators have also shown better performance with most of the economy's components nearly achieving pre-pandemic levels. Industrial activity and private consumption have been recovering gradually. By contrast investments have been lagging due to reduced business confidence. Additionally with inflation remaining high and above the Banco de Mexico's target range, we forecast inflation of 4.3% for 2022 and 3.8% for 2023. We're expecting a high reference rate of 6.75% for 2022 and 7.25% for 2023. That said, we are more optimistic about the outlook for 2022, while remaining well-positioned to contribute to the economy's turnaround supporting our customers whose loan demand is starting to strengthen. Net volumes in December continued to improve increasing roughly 5% year-over-year after four consecutive quarters of negative annual growth. The year-on-year growth was mainly driven by the improvement in consumer loans which started to show sequential recovery hand-in-hand with economic rebound and partially offset by corporate demand levels are still soft, but showing positive signs. System deposits continued their strong rebound growing close to 6% year-on-year with demand deposits increasing 9% year-on-year. Please turn to slide 6 where we would like to give you an update in our growth strategy. Our strategic priority remains the same provide the best customer experience in Mexico's financial services sector leveraging the latest digital tools and improving processes to accelerate our technological transformation, while we continue positioning the bank as a market leader in value-added products that attract and retain additional loyal clients. With that in mind, I would like to point out some milestones that we achieved throughout 2021. In other loans, we continue to rapidly expand our business gaining close to seven percentage points reaching a market share of over 12% as of December. These results are fueled by our alliances with leading automakers in the country together with our Super Auto Santander platform which integrates the commercial and insurance offerings in one place allowing us to provide online pre-approval in less than 10 minutes. All-in-all, we are the fourth largest player in the market. And if we maintain this pace of growth, we will soon move up the ranking and be among the top three players. As a reminder, our goal is to achieve a natural market share of 13% to 13.5% and we aim to accomplish this in the coming months. In mortgages, our strong performance reflects the success of our products Hipoteca Plus and Hipoteca Free as well as our Hipoteca Online platform and the redesign of the customer's journey whereby we eliminated significant pain points in the application and approval process. These strong results support our position as the second largest mortgage originator in the market allowing us to gain market share. Digitalization of our products and services remains a priority and we continue investing in technology. This includes collaborating with Fintechs and other tech companies to introduce faster and more convenient digital tools and functionalities that enhance the customer experience increase customer engagement and drive more transactions. Furthering our progress on this front, it's very important for us with digital sales representing 56% of total sales, up from 41% a year ago. We also had 5.5 million digital clients as of December, increasing 10% year-on-year. In addition in early September, we launched our new and innovative credit card LikeU. This card is 100% digital, one of the safest in the market, and is designed for any type of customer, allowing each client to tailor the card according to their individual preferences. It is worth mentioning that LikeU is the first card in Mexico based on the concept of financial demand which means that the customer only pays for the benefits they need. Our goal for 2022 is to almost double account acquisition focusing on the profitability and health of our portfolio. Also this year, we will attack the open market with strategies that allow us to grow the portfolio with sound asset quality. Since its launch, we have issued over 354,000 LikeU cards, exceeding our own expectations. Currently, 93% of LikeU cardholders remain fully digital, while 70% have also requested the plastic version, illustrating the higher adoption level of a digital product. We are quite happy with the results and market acceptance of the credit card so far. Another milestone we're proud to share with you thanks to the progress in implementing the bank's ESG practices. Santander Mexico was the only bank in the country included in the S&P Sustainability Yearbook 2021. Additionally, we were granted the Industry Mover emblem for surpassing this score we obtained in 2020 and representing the strongest improvement in the financial sector. Also it is worth mentioning that we were once again included for a consecutive year in the Sustainability Yearbook 2022. Besides International Finance Magazine recognized us as the Best Financial Inclusion Bank and the Most Socially Responsible Bank in Mexico. In addition we are glad to mention that we were selected as a member of the Dow Jones Sustainability MILA Pacific Alliance Index for the second consecutive year. For Santander, being sustainable means taking into account the communities where we are present, the people and companies that make them up in order to generate continuous and profitable social progress at an economic, environmental, and ethical level. All these recognitions are proof of our strong commitment to sustainability and responsible banking agenda, not to mention our experience and good practices that are based on ESG benchmarks. As part of our mission and promoting financial inclusion, through Tuiio, we offer financial products and services to low-income sectors in Mexico. The majority of our customers are women entrepreneurs who are not part of the formal economy and who are generally excluded from formal financial institutions. The Tuiio customer support model currently comprises 84 branches enabling us to directly support our customers where we have served to more than 279,000 clients. In addition, our customers have access to an online savings account that is opened remotely by consultants, offering users mobile and online banking tools. We also launched new medical support services, helping contribute to the culture of prevention and facilitating access for our customers to specialist doctors', dentists and laboratories. Our goal lies firmly and support Mexican families, ensuring they have the information and tools they need to manage their resources properly and taking firm decisions in order to improve their economic well-being. We will continue making progress on this front, as we remain committed to further operationally integrating the criteria, policies and internal processes that drive the social and environmental performance as part of our mission. Turning to slide seven. Total loans increased 6.9% year-on-year, outpacing the system and posting a 4.9% increase sequentially, underscoring our solid performance in consumer and credit card loans. Going forward, we expect to start seeing a better trend in these segments, as our risk appetite increases, along with our ongoing efforts to drive mortgage and other loan growth. In addition, commercial loans are anticipated to strengthen due to the expected improvement in the economic environment. All in all, we expect to start seeing an upturn in higher-yielding segments. We would support margin expansion, while maintaining sound and sustainable asset quality, reflecting a portfolio that exhibits good behavior. On slide eight, you can see that individual loans are growing close to 10% year-on-year on the back of mortgages and other loans. While credit cards are starting to reverse their negative trend, reflecting a strong sequential growth. Our mortgage portfolio continues to expand at a solid pace, 16% year-on-year organically, almost doubling the market's growth rate. During the fourth quarter, around 56% of originations came from Hipoteca Plus product, which helps drive cross-selling of other products as well as build customer loyalty. In addition, Hipoteca Online, which is our digital onboarding platform for mortgages. We have been able to process 95% of our mortgages completely virtually, allowing us to be more efficient in terms of response times and eliminating the need for our customers to visit a branch, all resulting in a much better customer experience. At the same time, credit cards are recovering growth, expanding almost 6% quarter-over-quarter. This encouraging performance is driven by our latest credit card launch LikeU. Thanks to the launch. We recovered sales and card activity reasons with strong improvements in both acceptance and trough. Currently, almost 11% of total billing comes from LikeU credit cards. Also, it is worth mentioning that November was the best month in terms of billing, increasing 37% month-over-month. We consider that our campaigns and the benefits offer when using the LikeU credit card during and well-being had a positive impact, seeking greater usage of the LikeU card. Through this new payment and credit value offering, we're confident, we will acquire a significant number of users with our customer base, allowing us to grow steadily and organically in this market segment and do so without compromising prudent risk management. Likewise, within Consumer Products, autos has been showing strong growth. In just four years, Santander has positioned itself almost on par with our largest competitors. It is worth to mention that the last quarter, the gap that we had with the number three player was 456 basis points and now has been reduced to 172 basis points. We continue with this strong pace. We will be the top three player during this year. By contrast, personal payroll loans are still affected by weak demand conditions while also reflecting our cautious approach. Turning to Slide 9. Solid expansions in loyal and digital customers continues, achieving year-on-year growth of 7% and 10%, respectively. In this highly competitive environment, we have maintained our focus on digital conversion, while increasing digital transactions and sales. Further, the ratio of loyal customers continues to grow. With loyal clients, now representing 41% of active clients versus 39% in the fourth quarter of 2020. The evolution of this ratio has been positive throughout the last years as in 2019, it was standing at 33%. This clearly reflects our consistent improvement within our breadth of products and services aiming to be the number one bank of our clients. On the other hand, I'm proud to share with you that our new Santander mobile app is being tested with friends and friendly and we're expecting to do the official launch very soon. With this new app, we will be offering a variety of options from every day checking to more specific needs, all in all waiting to have one of the best apps in the market, providing the best customer experience. During the fourth quarter of last year product sales via digital channels accounted for 56% of total sales, a significant increase compared to 41% a year ago. Digital monetary transactions also maintained an upward trend reaching 43% of our total with mobile transactions accounting for 97% of total digital transactions versus 94% a year ago. In addition, mobile clients grew almost 10% over the past 12 months to over 5.2 million, driven by our promotional campaigns and incentives through digital channels. As shown on Slide 10, commercial loans increased 5% year-on-year, driven by a pickup in corporate and government loan growth. As we have discussed in prior calls, during 2020, companies drew under committed lines of credit in the face of uncertainty caused by the pandemic. Since the second quarter of 2020, we have seen normalized demand and of credit and recently a pickup in demand. During the year, corporate loans increased at a double-digit rate year-on-year and sequentially by 18% and 24%, respectively. Loans to government and financial entities also increased at a double-digit base, 14% year-on-year and 10% on a sequential basis. On the other hand, mid-market companies posted a soft 3.5% year-on-year increase and remained flat on a sequential basis, signaling company's still cautious approach to investments. SME loans remain affected by current circumstances. However, they are beginning to perform better and we're putting more focus on alliances and campaigns to support the recovery of SME loan demand. We expect to see portfolio expansion going forward reflecting our growing risk appetite in this segment. Moving on to funding on Slide 11. Total deposits increased 2.4% year-on-year and 2.2% sequentially. As in previous quarters, there continues to be a shift between demand and time deposits, due to the decreasing interest rate environment experienced in 2021. Nevertheless, we started seeing a sequential increase in time deposits, driven by the recent hikes in the reference rate over the last couple of months. Demand deposits from individuals increased 8% year-on-year supported by our ongoing efforts to attract this type of deposits. As a result, we have been able to reduce the cost of our demand deposits by 51 basis points year-on-year beating the market's decrease in funding costs. Although, we're satisfied with this result, we continue working to further reduce our funding costs as we make additional headway toward improving our deposit mix, while lowering the cost of our commercial deposits as well, in line with our strategy of focusing on prioritizing individual loans and foregoing certain expensive corporate deposits. As a result of this strategy our total demand deposits from individuals have increased considerably during the last five years in both demand and term deposits, standing at 37% and 43% respectively, resulting in a 39% contribution of individuals to total deposits. Turning to slide 12, we have maintained very strong capital and liquidity positions. Our liquidity coverage ratio stands at 228%, representing a substantial buffer and far above the regulatory threshold. Our core equity Tier 1 and capitalization ratios as of December 31st are 14.84% and 21.56% respectively. Significantly above the minimum requirement established for systemically important financial institutions. On September 15th, the bank issued $700 million in subordinated notes, which gave us the opportunity to capitalize favorable market conditions. On December 8th, the bank announced its intention to pay in full the $500 million in AT-1 notes issued back in 2016 which were actually paid on January 22 of this year. This decision was made, as we remain committed to manage efficiently our capital base. The impact of executing the call of these instruments is around 130 basis points in our total capital ratio. Also during this quarter anticipating rate hikes the bank issued two spreads one for MXN6.5 billion at a fixed rate of 8% for seven years and another one for MXN3.5 billion at a variable rate of 5.3% for four years. Both transactions were priced at spreads -- at the best spreads we have issued. Our net loans to deposit ratio was 93% for the quarter, also reflecting our strong structural liquidity. As you can see on, slide 13, our net interest income decreased 1.4% year-on-year reflecting a combination of lower interest income from its investment in securities and higher interest expenses for demand deposits partially compensated by lower interest expense for time deposits. Net interest margin decreased four basis points year-on-year to 4.46%. We expect to start seeing an improvement in NIM as higher margin segments within an upturn coupled with higher interest rates. Please turn to slide 14. Net commissions and fees rose 1.1% year-on-year and 7% quarter-on-quarter, mostly driven by a solid performance in financial advisory services combined with higher investment funds commissions as well as growth in insurance fees. On the other hand, credit card fees decreased 10% year-on-year due to bonuses and rewards that were paid to our customers in the quarter. Going forward, we expect a better performance in credit card fees as our ambitions for the LikeU credit card are to increase monthly average billing, while achieving a better composition of income. Turning to slide 15, gross operating income increased 2% year-on-year, mainly due to fee growth and to the solid performance in market-related income, as our market team was able to capitalize on rising interest rates coupled with exchange rate volatility. On a cumulative basis, gross operating income decreased 3.3% year-over-year reflecting a higher base of market-related income and lower net interest income. Moving on to asset quality on Slide 16. You can see that our NPL ratio showed a significant decrease of 90 basis points year-over-year to 2.18%, a level we have not seen since early 2020 with relevant improvements across our loan book. In addition, given the expected improvement in the economic environment, we expect to see the portfolio exhibit healthy behavior during 2022. Provisions in the quarter declined 2.2% sequentially as to corporates prepaid exposure they had with us. However, provisions increased 36% year-on-year reflecting the low base in the fourth quarter of 2020. Going forward we expect to keep provisions at more normalized levels, despite increasing our risk appetite in credit cards and SMEs. Our loan portfolio continues to perform well with our cost of risk standing at 2.9% remaining practically flat when compared with a year ago. Looking ahead, we do not see any deterioration that could impact any of the loan portfolio they make so the cost of risk should remain below 3%. Turning to costs on Slide 17. Administrative and promotional expenses increased almost 14% year-on-year. It was mainly driven by the impact of the recently enacted outsourcing law and changes in the Mexican legislation regarding the profit sharing benefit paid to employees locally known as PTU. We have been reserving just one month wage and now due to the regulatory change we shall pay as a limit of three monthly wages. The impact of these changes add to MXN 959 million. Excluding this impact our administrative and promotional expenses for the quarter would have increased 5.2% year-on-year which is less than half the actual growth and 3. 3% for the full year. It is important to highlight our commitment to our IT transformation. Prior to the execution of our investment plan IT expenses represented 9% of total expenses and now they represent 14%. The combination of a soft gross operating income and the significant increase in administrative and promotional expenses resulting in a deterioration of our efficiency ratio which now stands at 56%. It is worth mentioning that the impact on expenses related to PTU and their sourcing law only impact the fourth quarter of last year. We feel confident about the dynamics of the business and our disciplined cost control. Therefore, we expect to maintain cost growth below inflation along the year. Turning to profitability on Slide 18. Net income decreased 4% year-on-year to MXN 5.2 billion mainly due to lower fees and higher expenses, partially offset by solid growth in market-related income and lower provisions. The net income increased 8% quarter-on-quarter supported by solid net interest income lower loan loss reserves and a lower effective tax rate. Return on average equity was 12.9%, 181 basis points below the year ago level. We are accumulating capital for the regulators recommendation to limit the payout of 2019 and 2020 earnings. In fact, if we didn't have the current excess capital our ROE would be 130 basis points higher standing at 2.40% versus 11.13%. November 5, we paid the remaining dividend amount associated with the restructuring improved by the banking regulator in Mexico. This represented in $0.28 per share, a total of 1.9 billion. Turning to guidance for this year on our next slide. We're expecting annual loan growth between 8% to 10% with stronger performance in the retail segment as we have reviewed over the presentation, but also with a gradual uptick in the commercial business. Total deposits in turn are expected to increase between 6% and 8% as we continue with our focus of improving our funding costs by bringing to the bank more deposits from individuals, while trimming the cost of our corporate deposits. We expect asset quality to remain healthy despite our higher risk appetite in some business segments with cost of risk between 2.7% and 2.9%. In terms of costs, we're looking for an expansion between 3% and 4%, as we continue investing in strengthening our digital capabilities. As for the tax rate, we're anticipating it to lie between 24% and 25%, considering the still high inflation rate expected for 2022. Taking all into account, we forecast net income to grow between 10% and 12%. Before going into Q&A, let me share with you some brief closing thoughts and perspectives. Our strategy will continue to focus on strengthening client loyalty and increasing digitalization for products and operations, keeping intact our ambition to become the bank providing the best customer experience in Mexico. We will continue working on our many growth initiatives, making new investments in the bank's transformation, mainly in IT and digitalization, while seeking efficiencies in other business lines. Although, we have made progress in the operational transformation of our bank, again this year, we're nevertheless mindful that we must pick up the pace. This concludes our remarks. We're now ready to take your questions. Operator, please open the call for the Q&A session.

[Operator:]

Thank you. And ladies and gentlemen, at this time, we will now be conducting a question-and-answer session. Our first question comes from Tito Labarta with Goldman Sachs. Please state your question.

[Tito Labarta:]

Hi. Good morning, Didier and Hector. Thanks for the call. A couple of questions. I guess, first, any – can you give any guidance in terms of your expectations for margins and remind us your sensitivity to higher rates and also fees. If any color you can give on that in terms of guidance for the year? And then second question, I guess, in terms of capital dividends and also potential Banamex acquisition, which is for sale. Any update on dividend payout and what you can expect there? And then if – could you use any of that excess capital to potentially buy Banamex? Would a Banamex acquisition come more from Spain as opposed to Mexico? Any color you can provide on that in terms of how you guys would consider potentially looking at Banamex? Thank you.

[Didier Mena:]

Hi, Tito. Regarding margins, we're assuming NIM expansion around 5%. But let me share with you that in my opinion, we are being either extremely cautious or conservative in that assumption. I think that if high-margin segments performed well during this year. I think that there is some potential upside there. And just to give you very basic sensitivities, 10 basis points of NIM represents an additional 1 billion pesos of net income, okay. So I think that you all can make the numbers whether we can have a higher NIM than 5%. And that could provide a potential upside relative to the guidance that we are providing, okay. In terms of the sensitivities to an increase of 100 basis points that's around 500 million pesos to 600 million pesos. Just remember that that assumption implies that there is a parole shift in interest rates and that we do not think it's just how the balance is positioned right now. I think that we -- depending on how fast interest rates increase, we can follow several strategies to get more exposure to floating rates relative to fixed rates, okay. So -- but as of now without doing anything the sensitivity is as I mentioned, okay. Now moving on to capital and dividends. We are in ongoing discussions with the CNBV. And the latest conversation that we had was probably two weeks ago. We as a banking association proposed to withdraw the restriction that they imposed on just paying out or having a payout of 25% of 2019 and 2020 earnings. Our recommendation is based on the strong levels of capital ratios that the banking system has standing at 19.4%. There was some concern for regulators that if the banks pay out higher dividends that we would compromise supporting loan growth. And we provided evidence that that's not the case. We could have very, very strong growth, 15% to say a number, pay out 100% of earnings of last year with the current profitability that the banking system has. The impact all-in-all would be close to 70 basis points in the total capital ratio, okay. So it's in my opinion it's not that material. I would actually told them that it would represent a very good signal to the market if they withdraw this restriction. I think that -- and this is completely informal and by this I mean that they can change their views, because they haven't published it what's their final recommendation. But my impression is that they would come up with still a restriction that is higher than 25%. They mentioned during the call that they were thinking of looking at pre-pandemic levels. And they actually pointed out to what the banks paid during 2014 to 2019. If my numbers are right, that's a payout close to 50%. But they mentioned something that, I'm not sure, if they're going to provide this facility that they would recommend this for the entire banking system. However, you might recall that every single year banks have to provide sensitivities to certain scenarios in our solvency. It's called the capital sufficiency exercises. And in that exercise, the banking regulator provides a couple of scenarios, a base case and stress case, and also management provides two scenarios, base case also and a stress case. So -- and there's projections in these scenarios. So, what the regulator tries to do with these exercises is to look at the solvency, the bank's solvency through time with these different scenarios. And they ask you to provide with a certain guidance or assumptions in terms of dividends. So every single bank had to provide what their dividend assumption for 2022 that would make them compliant with capital regulations in Mexico, not only for this year but consistent through time, okay? So, regulators mentioned that some banks and actually some systemic banks, were proposing a much higher payout ratio than what they were having in mind for the entire system. But that a significant part of the banks around 90% were below the recommendation -- the level that they were thinking of. So with all this, I would say that they -- well, they actually mentioned that if a bank is proposing a higher payout ratio than what they recommend they will be open to hear what the bank has to say in terms of the reasons of supporting a higher payout ratio, okay? So, if all this turns out to be what they end up doing, our actions would be to provide evidence that we can have a payout ratio of 100% of last year's earnings without really compromising solvency not only for this year for the years that are considered in these scenarios. So that's the latest on dividends. Regarding Banamex as you probably assume we are interested. We will be patiently waiting for the process to start. We have always said that we are open to look at any potential opportunity to consolidate the Mexican market. We consider ourselves one of the best candidates to consolidate the Mexican banking system. We have said this for years. And we have looked at different opportunities, not of the size and relevance of Banamex, but our approach regarding M&A in my opinion has been consistent. We are not basing our strategy on M&A. Our strategy has been defined and we're executing it and I think that we're making progress on it. But definitely we have the fiduciary duty to look at this opportunity that could change the banking landscape in Mexico. Regarding how to finance, it in case that we acquire it, I think that there are different alternatives. And I think that it's too early to make analysis as to what's the best alternative to make this acquisition. All I can say is that we will look into all different potential alternatives and we will propose in the case that we end up participating and in this transaction we will propose what's best for our shareholders. But those decisions are made with the information that happens at that time. So, I think that it's -- in my opinion, it's not worth elaborating more than that because market conditions could be different now from what they are when this potential transaction closes that I think that's going to take some time by the way.

[Tito Labarta:]

Great. Thank you, Didier. That's helpful color. Maybe just a follow-up on that just because there was also some comments in the news one about I guess the government maybe prefers a Mexican bank to acquire Banamex. I mean have you heard that with that rule out Santander in any way? And I think also Ana Botin was saying that they would not issue shares to acquire it. But I don't know if that's at the sustained level maybe you could still do it at the Santander Mexico level. And as you said it's early. So, I appreciate you may not answer to that but just any color you can provide I would appreciate. thank you.

[Didier Mena:]

Yes. Obviously, I have read that government prefers a Mexican bank or Mexican shareholders to buy Banamex. My opinion is that nationality of capital is less relevant than who manages the bank. I think that we have -- we can point out different cases in the Mexican banking history, we're not necessarily the best management teams or the management teams were experienced were actually given the opportunity to acquire banks. I think that in the Banamex case, that's even more important than just looking at whether it's Mexican or is the foreign origin capital. That's my view. I don't think that they would rule out any potential bidder for this just for the sake of nationality. I don't think that it's in the best interest of the banking system, the economy even the process, I think that if city rolls out foreign players, they will end up with very limited potential interested parties. And I'm not sure that they would go that way. I think that the regulator or the Mexican government should be more focused on other things. And as mentioned management. And also if there is any potential concentration in certain products and segments, there's an antitrust commission and that commission should be very clear in terms of what are the implications of higher concentration in the market. And also let me emphasize, that I'm not sure whether the government officials that have mentioned concentration as an issue. If they have in mind that this is not something that happens in Mexico. We're not unique in that regard. If you look at banking sectors across the world not only in Latin America, you get to see that the top three, five players concentrate a significant part of the market. I think that that tells you that the banking sector benefits from economies of scale. Probably one of the outliers of big economies the US but for historical reasons of having different regulation that promoted banks in every state rather than national charters. But look at Canada, look at France, Spain, the UK, the Peru, Colombia, the Chile, Argentina, Brazil, it's all over. So I don't think that that's a fundamental reason to opposing one of the largest players such as ourselves. Banorte being candidates to consolidate the market. Now regarding how to finance this as mentioned and I think it's way too early. We are interested. We don't know if the conditions that it expects for the transaction would be reasonable. We are still waiting to see, what's exactly what they're up for sale. We have a very basic understanding across -- according to what they disclosed, but we need to do the homework. And once we do the homework, then the next step would be to look at different alternatives of how to finance this. And I think that Ana Botin, what she mentioned was that there is a strong preference of not issuing a group's shares. I think that she has a point. But I think in my opinion we have to wait until the process advances. And if we end up becoming the winner of this process, I think that we will definitely look at every single alternative and propose what's best for our shareholders.

[Tito Labarta:]

Great. That’s very helpful. Thank you, Didier and good luck with the quarter.

[Didier Mena:]

Thank you.

[Operator:]

Our next question comes from Jorg Friedemann with Citibank. Please state your question.

[Jorg Friedemann:]

Hi. Thank you very much. Can you hear me well?

[Didier Mena:]

We can hear you well, Jorg

[Jorg Friedemann:]

Perfect. Thank you, Didier. Good morning and thank you for taking my question. My questions are related mostly to the guidance. On the tax rate, I confused that I got a bit surprised with the very high effective tax rate in light of the still high inflation rate expected for this year. I am seeing here in the annexes that you are expecting inflation at 4.3% and you revised upward. I just was curious, if you are reflecting this 4.3% already in the tax rate guidance because when I look into the historical levels for the taxation you get lower rates or tax rates historically, even with low levels of inflation. So this is my first question and then I can come back to the next. Thank you.

[Didier Mena:]

Yes. Our assumption and the very basic rule of thumb that we have shared with you in the past is that for every 100 basis points of inflation there's 100 basis points benefit in terms of reducing the effective tax rate. So if inflation ends up being close to 4% then assuming a tax rate of 24% to 25% that could be reasonable and that's what we have in mind Jorg.

[Jorg Friedemann:]

Okay. Okay. No, that's perfect. When I go into expenses and sorry, if I'm not super familiarized with the Mexican legislation regarding the PTU payment. Just wondering if this is recurring because of course, this was an important impact during the year of 2021. But taking into consideration, the carryover of inflation in the investments overall that you have been doing and how effective you have been right in terms of cost cutting on administrative expenses. Just wondering, how you think you can achieve 3% to 4% OpEx growth this year, if personnel might be under pressure or not? And if you have more space to cut administrative expenses?

[Didier Mena:]

Yes. First on the profit sharing, it's non-recurring. So basically what we reflected in the fourth quarter of last year is that's a one-off. That's almost 1 billion pesos, okay? That has to do with in the outsourcing law there's – or associated with the change in the outsourcing law, there's a provision in terms of a cap that now companies have to provide for sharing profits with employees. And that increased from one to three months worth of salary, okay? So that's basically the origin of that expense, okay? And it's non-recurring. You mentioned all the initiatives and efforts that we've been doing over the last few years in order to I would say have a more robust infrastructure. Just to make a point there, in the last quarter of last year, our IT expenses were slightly above Ps. 2 billion. In 2016, all year, our total expenses in IT were Ps. 2.5 billion, okay? So we are now spending on a quarter almost what we were spending a year, okay? If you look at the compounded annual growth rate in IT expenses over the last five years that's close to 20%, while our total expenses including IT have grown 9%, okay? So yes, I think that we have shared with you in the past that we were lagging in terms of IT capabilities, infrastructure, certain issues associated with cybersecurity. And I think that we're getting to a point where we'll start seeing the benefits of all those investments. As mentioned in our remarks, we are already testing our new app and just to have -- or just to be in that position implies that you have to invest heavily in different types of systems and capabilities, okay? So IT will continue to be a priority for us, even with higher adoption in terms of the digital transactions because of the pandemic. That's the path that we will continue working, okay? You know us well. We have a very straight and -- we're very disciplined in terms of cost control. I recognize that there might be some pressure in terms of employee compensation. However, we made a salary increase in September of last year. So I think that we are well positioned. We think that the way that we have managed the pandemic with our employees has also positioned ourselves in a very good standing. And I think that our employees recognize the flexibility. We have acted promptly in terms of protecting scale of not only our employees for our clients as well. So I think that we have goodwill in that regard. So I'm not that concerned regarding a potential impact of employee compensation. I would say that we think we're confident in achieving a 3% to 4% increase in expenses. We should start seeing as well eliminating some of legacy systems that have been replaced with the investments that we've made during the last five years. So that would be a source of cost reduction going forward.

[Jorg Friedemann:]

No. That's perfect. Very clear. Thank you very much. And my last point here, Didier, is with respect to how to reconcile your dynamics of loan growth with asset quality. I mean, you have been great in terms of asset quality. This quarter was very good and you are back to the pre-pandemic levels of NPLs. At the same time, you have shown a very strong appetite for higher risk loans such as auto, in which we have been growing a lot and gaining a lot of market share, but more recently also credit cards. So how should we think loan growth in different segments this year? And how should we expect NPL to evolve, not cost of risk, but NPL? Thank you.

[Didier Mena:]

I think that there are probably two trends that have opposite effects, Jorg. On one hand, we still have some pandemic impacts in our asset quality metrics, okay? And until we get to, let's say, clean that up to get to a more normalized levels, we will continue seeing some benefits in that regard, okay? Now, that's -- let's say, that's the positive trend. Then the negative trend is, as you rightly pointed out, our appetite to be more exposed to higher risk segments implies a higher NPLs. So we think that for this year, those trends offset each other. So we're expecting NPLs to be relatively at the levels that we're seeing right now.

[Jorg Friedemann:]

Perfect. Thank you very much. It’s very clear. Thank you very much.

[Didier Mena:]

We'll monitor that, as always, Jorg. And see whether we accelerate our pace in growth or we are more cautious. I think that we are continuously monitoring asset quality on a proactive basis.

[Jorg Friedemann:]

That’s perfect. Thank you and good luck this year.

[Didier Mena:]

Thank you, Jorg.

[Operator:]

Thank you. Our next question comes from Alonso Garcia with Credit Suisse. Please state your question.

[Alonso Garcia:]

Hi. Good morning, everyone. Thank you for taking my questions. I just wanted to ask about how you think is the recurring level for the other operating income line? I mean, how recurring or not is this around MXN 800 million gain recorded in the fourth quarter, which was related to the accounting contracts. I mean, I know this the business you are seeking to grow. So just wanted to know how should I think of this line going forward because of these accounting contracts. Thank you.

[Didier Mena:]

Hi, Alonso. I'll pass it on to Hector to comment.

[Hector Chavez:]

Yes. It is -- Hi, Alonso. This is Hector. This is a one-off certainly. And normally the recurrent quarterly other income is negative in the order of MXN400 million to MXN500 million per quarter.

[Alonso Garcia:]

Understood. Thank you. And if I may just a follow-up on your loan growth of 8% to 10%. I mean, you mentioned you expect retail to continue in growth. But if you could provide more specific figures on the different products, I mean, how should we expect auto loans to perform. On one hand you are continuing to gain market share, but there are some issues on the auto industry worldwide. So I just wanted to see how that should impact in your numbers. Also credit card had a strong fourth quarter that had it's going to be this year. So if you could provide some color on a product-by-product basis that would be useful? Thank you.

[Didier Mena:]

I think that our individual loans should continue outpacing loans to corporates based on to two things or three things, I would say, Alonso. First, the most relevant product in individual loans is mortgages, and we have had very strong performance over the last years. And given how we changed the entire customer journey, how we digitize the process and we offer a tailor-made product for customers as well. And we expect that to continue. There are some products that are in our pipeline in terms of bringing other alternatives for customers. We'll probably to talk on this during the next few quarters. But it's to say that the mortgages will continue to be a very strong support for loan growth to individuals. We expect more than 10% loan growth to continue. Then on other loans, if we look at it on a percentage basis, it still looks very, very high. What I can say is that different to the mortgage market, auto loans in the system are contracting, okay? And the growth that we are having is at expense of the largest players contracting. The way this market works alone so is -- or I would say, the banking market associated with other loans is that you partner up with good manufacturers. So any change in the, let's say, the preferred financing option for manufacturers then has as a consequence a change in market share. And we have been quite active in pursuing alliances with the manufacturers to be the preferred option for the clients. So that's what you're seeing there. We're growing significantly despite that the market is contracting and despite that auto sales are contracting as well. But that's why we were seeing those numbers. I would say that auto loans in terms of percentage could be growing probably around 40% to 50%, okay? Then credit cards, I think that we're probably at the inflection point and we expect certain recovery in that regard. One thing that has impacted us in terms of loan balances, as we have mentioned as well in prior calls is the fact that the percentage of clients that are paying their balance in full has increased significantly over the last four, five quarters, and that continues to be the case. So despite that, there's a higher usage of our credit cards, we are not seeing that reflected in our loan portfolio, okay? We think that, this year, probably loan growth above 6%, 7% should be achievable, but it will all depend on whether the percentage of clients that pay their balance in full go back to normalized levels. I think that the excess liquidity that households or certain households had in the pandemic might be come to a more normalized level. And with that, I would say that, probably the leverage will become higher and use their credit cards as a financing mean, okay? I think that, the SMEs will see a slight recovery, even though our appetite is quite strong in this sector. We still see very light demand, okay? And I would say that, on the remaining segments, we are optimistic in what we're seeing over the last few months in terms of loan demand from corporates. So we would expect loan growth pretty much in line with the overall guidance that we provided.

[Alonso Garcia:]

Very clear. Thank you very much.

[Operator:]

Our next question comes from Yuri Fernandes with JPMorgan. Please state your question.

[Yuri Fernandes:]

Thank you, Didier, Hector. I have a question regarding competition. In the last cycle in the last high-cycle in Mexico, we saw more driven consumer loans, not fully re-pricing, I guess, due to competitive dynamics. So my question now is, do you expect this hiking cycle to be slightly different in dealing that makes, they have more pricing power, less competitors to look to, I don't know, increase rates on markets and especially more to the customer because I guess for government loans and loss, it's easier on that, and it's more attached to the rates. But I don't know, what to expect for all those other products. And if I may, just a quick follow-up on expenses guidance, three to four growth seems very good if we assume inflation close to five this year. But if you can provide us a bit more color --

[Hector Chavez:]

You're breaking up.

[Yuri Fernandes:]

Can you hear me now? Can you understand me now?

[Didier Mena:]

Hello, not much. We heard clearly about competition and rates, but the other question that you were trying to make, we couldn't hear.

[Yuri Fernandes:]

Oh, sorry, let me try again. Just if you can on where the cost efficiency will come from? Because personnel is about 40% of total expenses – and I guess, G&A and IT, there are additional like the depreciation and IT are additional 25, right? So, how to deliver below inflation and G&A for 2022? Thank you.

[Didier Mena:]

Regarding competition, you know, I would say it all depends on where interest rates end up. I would expect rational behavior from competitors. And we all have to have profitable products. Obviously, you can stand temporarily below, let's say, certain thresholdprofitability in certain products. But you can do that on a sustainable basis. So if interest rates we're expecting that they will go up by 125 basis points during the year. So I think that that increase should translate in repricing in our key products. That's something that it's already been discussed. I think that we are waiting to see how the new governor of the Central Bank acts. We have a Board meeting next week. So depending on how they act in terms of the level the magnitude of interest rate increases, okay? Now regarding cost efficiencies. I would say that it's -- there's not a single line item that will make the magic okay? It's basically the discipline that we have in every single front. We've been like that all the time. We're looking at every single item in expenses. I was mentioning this -- the turning off certain legacies I would say that that would provide certain benefits in IT expense line item, okay? But Yuri there's not a single thing that would make a significant contribution. It's just discipline.

[Yuri Fernandes:]

Yeah. Perfect. Thank you very much, Didier.

[Operator:]

Our next question comes from Carlos Lopez with HSBC. Please state your question.

[Carlos Lopez:]

Thank you for taking my question. First one I know you have said this already the 1 billion in expenses from the outsourcing law. That's a one-off, but we should expect extra expenses every quarter. Can you repeat that? Second, can you give us an update on the digital side? In the last quarter you gave a good explanation as to one should be working for the digital past traditional bank. Any changes there? And are you launching a different brand in Mexico anytime soon? And finally on the Banamex transaction if and when it happens one of the elements that has to be considered is the pension fund. Therefore do you under no circumstances consider owning that asset, or is there something that is on the shipping? Thank you.

[Didier Mena:]

Hi, Carlos. Regarding the one-off associated with the profit sharing that's a one-off, okay. Then the -- on our digital front, we have discussed in the past our work on Openbank. And that's Openbank is let's say the digital bank that the Santander Group has in several geographies in Europe particularly in Spain has recently been launched in Argentina. And we are doing here the homework in terms of what's the best structure to launch it. I think that this is not something that will happen this year. I think that it's more a 2023 project to be implemented, okay. We're still considering what's the best alternative there, I think that it provides significant benefits for certain types of clients. And it, obviously, has to do with the time to market. I think that what Openbank has shown is that with different core systems leveraging on the latest technology. You can provide a more simple, better customer experience in a more -- in a reduced time. So I think that that's quite compelling. So we're just considering whether that's the best route or continuing with a significant transformation that we're undertaking in the bank, but I think it's good to have those alternatives. I would say that. But don't expect that to happen this year, Carlos. Now, regarding Banamex, you might recall that Santander used to own pension funds in Latin America. And the group decided to divest them many, many years ago. So I don't know. We'll do our homework. And I think that there are -- as in every single transaction there are some pros and cons associated with having or not a pension fund in Mexico. I think that on the regulatory front, probably most of the risks that we were looking in this industry probably they have already materialized. We probably -- I just don't expect significant reduction in fees more than what we have seen so far. So I don't think that -- and actually the reform that was implemented last year in terms of a higher contribution by employees and companies that will provide significant growth in assets under management. So that's definitely a positive. But I think it's quite early for us to have a strong view Carlos, whether we'll be interested in owning the pension fund or not, but we'll definitely look at it very, very closely.

[Carlos Lopez:]

That’s clear. Thank you so much.

[Operator:]

Thank you. And our next question comes from Carlos Legarreta with GBM. Please state your question.

[Carlos Legarreta:]

Hi, thank you for taking the question. The first one is on deposit dynamics. I mean, I think it's very understandable that you are favoring demand deposits versus term deposits. But how are you managing to materialize this, particularly in an interest rate environment where rates are going up?

[Didier Mena:]

Well, that's a great question, Carlos. You have to understand the contribution of individuals to both demand and time deposits, okay? Because, we're coming actually from a very low base five years ago. And deposits from corporates are obviously more expensive and more sensitive to movements in interest rates. So, on one hand, it's benefiting us that we are having a higher contribution of individuals to demand deposits, okay? So that's quite positive. And no matter how low or high our interest rates, demand deposits from individuals give a very low yield, okay. Now, demand deposits from corporates that's another , okay. And actually what we saw in the last quarter or last year is that, some large corporates deposit in Santander, a significant part of their excess liquidity and that actually had a negative effect in when you look at the cost of phones, the rate that we’re paying in demand deposit, that’s actually the reason why it went relatively fact because of those corporates making those deposits. I think that we have to provide alternatives and provide a good experience have the -- not only the digital channels, but also the branch network and the ATM network working appropriately, so that we can have a higher percentage of deposits from individuals, okay? We're happy with where -- how things are going just to point out in demand deposits. When we started this strategic plan and investment plan, demand deposits from individuals were 25% of total demand deposits. And now it's almost 37%. That's quite good. But when you look at our peers, they are more in the 45% to 50% area, okay? So, we will continue with these initiatives to strengthen our capabilities to attract and retain retail customers. So that's the way to have a better funding mix, regardless of the interest rate environment. And we're obviously sensitive given our higher exposure to corporate deposits in terms of what happens to interest rates. So, I would say that that's a second order impact that we have. But the most relevant in terms of providing a sustainable quite cost-effective deposits, is having a more balanced mix in the regions relative to corporates.

[Carlos Lopez:]

That's very helpful. Thank you. And for the follow-up, you mentioned in the press release an investment of 11 billion. That's for infrastructure and digitalization. And you mentioned that that is an all-time high investment I guess. I was wondering how does that compare to the 2021 figure, and if you could provide us some idea as to where this money would be invested? If this is basically still a catch-up against your peers, or is that would set you ahead of them?

[Didier Mena:]

I would say that it would be ahead of our peers. I think that we have great competitors. I think that there's still a component of catch up. Most of these investments are going into our IT and digital initiatives. It includes not only OpEx but also CapEx okay? So that's very important to have in mind. And I don't know Hector if you could provide an additional color on that.

[Hector Chavez:]

Sure. And it is the highest we've had. But it's around between 3% to 5% higher than the investment we made in 2021. So, it's what we call the actual outflow of expenses that we did do as Didier was mentioning. Some of it is including actually personnel expenses, that's OpEx then we have hardware and software, which is CapEx. That's around 4 billion of the 11. General expenses on IT, is around 6 billion and 1 billion of personnel expenses related to development. So again, it's a mix between CapEx and OpEx.

[Carlos Lopez:]

That’s very helpful. Thank you so much for that. Very clear.

[Operator:]

Thank you. If there are no further questions at this time, I'd like to turn the floor back to Mr. Hector Chavez for any closing comments.

[Hector Chavez:]

Thank you, operator, and thanks everyone once again for joining Santander Mexico on this call. As always, we wish to maintain an open dialogue with you all in the financial community. If you have additional questions, please don't hesitate to call or e-mail us directly. Until our next earnings call, please stay safe and have a great day.

[Operator:]

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you again for your participation.