Banco Santander-Chile (NYSE:BSAC)
Q2 2014 Earnings Conference Call
August 4, 2014 10:30 AM ET
Robert Moreno – Manager, IR
Raimundo Monge – Director, Strategic Planning
Tiego Batista – Itau BBA
Tito Labarta – Deutsche Bank
Frederic de Mariz – UBS
Ladies and gentlemen welcome and thank you for joining the Second Quarter 2014 Banco Santander-Chile Earnings Call. My name is Ryan. I will be your operator on the event and all participants are on listen-only mode. (Operator Instructions) As a reminder, we are recording the event for replay. Now I’ll pass the call to your host for today, Mr. Raimundo Monge.
Thank you very much and good morning ladies gentlemen. Once again and welcome to Banco Santander-Chile second quarter 2014 results conference call. My name is Raimundo Monge, Director of Strategic Planning, and I'm joined today by Robert Moreno, Manager of Investor Relations.
Thank you for attending today's conference call in which we will discuss our performance in the second quarter 2014. Following the webcast presentation, we will be happy to answer your questions.
Before we get into more detail regarding our results, we will briefly give you our latest update on the outlook for the Chilean economy in 2014 and 2015. In mid-2013 the economy has shown signs of deceleration driven by lower investment levels. For 2014, we are expecting GDP growth of around 2.9% with internal demand decelerating to around 2.5%.
The inflation rate measured by the variation of UF and inflation linked unit and the most relevant indicator for the bank should rise to levels above 4% in 2014 and return to around 3% in 2015.
AS a result, we expect the Central Bank to cut interest rates an additional 25 basis points this year to 3.5 despite the higher inflation and to store increase in them in 2015. We also continue expect a rebound of the economy in late 2014 or early 2015 with GDP growth reaching approximately 4% in 2015.
This rebound in the economy is going to be driven by a combination of various factors. First of all, the outlook of growth of Chile’s main train partners, China, the US and the Eurozone continues to strengthen. In fact, the weighted average GDP growth of Chile’s main trading partners continues to de-revise upward. This should be positive for the contribution of Chile exports growth to GDP.
Export growth as measured in GDP figures should expand at around 6% in both 2014 and 2015. Regarding investment which represents 25% of GDP, in 2014 we are expecting a contraction of 2.6% followed by a recovery of close to 4% in 2015.
This will be driven by two main elements. First of all is the strong investment that are expected in infrastructure and in the energy sectors. Second, we believe that the various reforms that are being discussed in Congress, such as tax reform, will be resolved via broad based compromises resulted in a rebound in investor confidence.
Finally, conception will continue to grow at around 4% in 2014 and 2015 as the salary pool there is the number of people actually working times the average salary is expected to keep growing and the government expenses will increase with the additional resources collected with the tax reform.
All in, this should represent a relatively supportive market environment for banks. For this reason, loan growth should continue to be – growing between 8% or 9% in 2014 and 2015. Deposit growth has slowed as the high inflation and low interest rate environment has led to a greater flow of funds to money market funds.
The profitability of the Chilean banking system is also stabilizing due to a more normalized inflation and interest rate environment.
Now, we will review, how the bank continues to move forward in a strategic objective and the commercial results achieved in the quarter. During the quarter, the bank saw relevant advances in several of its strategic objectives fueled by its transformation project.
The evolution of our quarterly results reflect the high inflation rate but also solid recurring results in various business segments. These has been achieved with an increased use of our customer relationship management platform CRM, improved quality of service, strong growth of corporate transaction service such as cash management and by reaping the full benefits of our revolver trading models.
The evolution of our asset quality indicators also show that we are slightly ahead of the rest of the finance decision in making the necessary adjustments to come front on better footing the short-term slowdown of the economic growth. At the same time, our capital levels remain robust.
All the above should allow us to continue to achieve an optimized balance between our medium-term return on equity and our cost of capital. By maximizing these relations, we will be able to expand shareholder value.
In the second quarter of 2014, total loans increased 1.5% Q-on-Q and 10.2% year-on-year. In the quarter the bank continued to expand the loan book among those clients and segments with the highest risk-adjusted return in an economic environment that remains healthy but with growth decelerating.
Lending to individuals increased 2% Q-on-Q and 11.7% year-on-year. The bank focus on expanded loan portfolios in the higher income segments while remaining more selective in the lower income segment. Loans in the high income segment which are mainly distributed, through the Santander’s select network increased 2.4% Q-on-Q and 15.9% year-on-year.
In the lower income segment, the bank loan portfolio decreased 3.2% Q-on-Q and 11% year-on-year continuing the loan mix shift started several quarters ago. Lending to small and middle size enterprises SMEs expanded – was almost flat Q-on-Q in the quarter.
In this period, the bank proactively decelerated loan growth in this segment stressing growth among SME clients, backed by strong levels of collateral including state guarantees and/or clients with a high level of cash management and transactional businesses which generates higher levels of revenue for the bank with a lower risk profile.
These allow us to generate ROEs in the mid-20s range in this segment. In the second Q of 2014, the middle market segment loans increased 1.1% Q-on-Q and 7.1% year-on-year. In this segment, growth rate remained positive but the bank did experience a slight reduction in loan demand in line with the lower growth of investment in the economy.
This segment is still generating increasingly higher levels of business volumes in other areas such as cash management which has helped to drive the rise client deposits. In the large corporate segment, loans increased 6.7% Q-on-Q and 16.2% year-on-year. This segment has a relatively volatile evolution of loan growth due impart to large transactions are not recurring between one quarter and the next.
Interest in this segment has also been rising; this can be observed in the 29% year-on-year increase in net interest income in the quarter. The funding mix continued to improve. Total deposit fell 1.8% Q-on-Q an increased 2.5% year-on-year.
In the quarter, the bank continued to focus on increasing cheaper retail deposits and low volume deposits from home fin sources. This was reflected in the 1% Q-on-Q and 9.2% year-on-year increase in non-interest bearing demand deposit compared to a decrease of 3.4% Q-on-Q and 1.2% year-on-year in time deposits.
We continue to increase the proportion of core deposits that is taken account plus retail and middle-market time deposit and to maintain a stable level of long-term wholesale deposits.
In the beginning of the year, core deposits have gone from representing 76% of our deposit to 79%. The bank is also gradually adapting the liquidity standard as required by local regulators in line with Basel 3 which should be implemented by the bank in the next few years.
Specifically in 2014, the bank has eliminated time deposit from short-term wholesale sources which has decreased 16.8% since the beginning of the year. This deposit will have a low weighting under the new stable funding ratio and liquidity coverage ratios that will be gradually adopted by Chilean banks.
This change in mix also has a positive effect in our cost of funds and maybe into the margin. These short-term whole deposits were brokerage to our asset management partners, also benefiting fee income.
As of June 2014, the bank has 3.5 million clients which increased 5% compared to June 2013. Despite the ongoing reduction in the client base in the lower end of the consumer market, the client entering the bank are also of a better risk return profile given the effectiveness of the CRM at pre-approving clients are cross-selling them more rapidly.
Our Select Client segment, basically the high end of our retail customers has grown more than 9% in the same period. In the second Q of 2014 the bank also renewed its co-branding agreement with Chile’s main airlines LAN until August 2020 which benefits more than 600,000 credit card holders.
As the year progresses we expect this to gradually improve the results from fee income. The transformation project is also resulting in a favorable evolution of consumer loan asset quality which is a key element of our strategy to obtain higher margins net of provision.
This is due to various initiatives the bank has been carrying out since 2011. The portfolio mix has changed improvements in credit risk models; let’s focus on growing via pre-approved loans and finally the revamping of our collection process.
The results of these efforts are reflected in the evolution of impaired consumer loans. Consumer loans, non-performing loans plus renegotiated consumer loans. Especially, when compared to our competitors.
Since June 2012, impaired consumer loans in the Chilean banking system excluding Santander Chile have increased 50% compared to a decrease of 15% in the case of Santander Chile. The bank also concluded the second quarter of 2014 with strong capital ratios.
Our core capital ratio reached 10.7%, one of the highest among our main peers with a Basel 1 ratio of 13.9%. The ultimate goal for strategy is to maximize the difference between our ROE and the cost of technology.
Today, we calculate to have one of the best relationships between core capital and recurring ROE among our main peers and one of the highest credit rating in the banking world.
Now, we will explain the evolution of results which also show favorable trends. In the second Q of 2014, net interest income increased 11% Q-on-Q and 40% year-on-year. The net interest margin NIM in the second Q 2014 reached 6%. This high margin level was fueled by a higher inflation rate as the bank has more assets than liabilities linked to inflation and also due to an expansion of client NIM which exclude the impact of inflation.
Client NIMs reached 5.5% in second Q of 2014, compared to 5.0% in the first Q of 2014. This was mainly due to a proxy pricing spread in various segments, the improvement in the banking structure – funding structure, sorry and default in the short-term interest rate that also lowered funding cut. These deposits had a shorter duration than loans.
Asset quality was relatively stable in the quarter. Net provision for loan losses increased 3.4% Q-on-Q and decreased 3% year-on-year in the second quarter. The bank’s total non-performing loans ratio reached 2.9% and the coverage ratio reached 102.3% by the end of June this year.
The cost of credits reached 1.55% in the second quarter compared to 1.53% in the first Q and 1.79% in the second Q 2013. Net provision in consumer loans which represents half of the total provision expense decreased 3.7% Q-on-Q and 11.2% year-on-year. The red chart shows how consumer loans decreased 32% year-on-year.
At the same time, net provision in residential mortgage loans increased 13% Q-on-Q and decreased 65.9% year-on-year in the quarter. The non-performing loans ratio in mortgage lending has remained relatively stable for an extended period. Growth in this product has been centered on mortgages with loan to value ratios below 80%.
The Q-on-Q rise on mortgage in non-performing loans is mainly due to the bank stricter stance on renegotiating overdue mortgage loans and not at this deterioration of asset quality of this product. As a result, the evolution of the impaired mortgage loan’s ratio improved from 5.73 in the first quarter to 5.56 in the second quarter.
The impaired mortgage loan ratio is a broader measure of asset quality and mainly includes non-performing and renegotiated residential mortgage loans. Provision expenses in commercial loans increased 11.5% Q-on-Q and 28.2% year-on-year.
The increase in net provision expense in commercial loan was mainly due to number one stronger loan growth that led to higher loan loss provision as the bank internal provision model recognized provision when launch is granted and number two, higher provision expense in the SME segment due to a slight deterioration in asset quality as economic growth decelerated in the quarter.
The bank has proactively lowered growth in SME segments and it’s focusing loan growth in the short-term in the corporate and middle market segments in which risks are lower margins are rising and funding is improving.
As a result of all the points described above the bank is achieving a central aspect of our strategy to obtain higher net interest margin net of provision expenses. In the second Q of 2014 the bank’s net interest margin net of provision reached 4.5% compared to 4% in the first quarter and 3.1% in the second quarter of 2013.
In terms of cost, productivity continues to rise as usage of complementary channels such as internet, home banking, POS payment and an automatic bill payment, continue to increase with minimal duration in personnel and the branch network. In the second Q of 2014, the efficiency ratio reached 36.4%.
Discount fell 0.6% Q-on-Q and 1.5% year-on-year. The 11.6% Q-on-Q rise in expenses was mainly due to number one, seasonally low expenses in the first Q and number two the effect of a higher inflation rate of expenses. On a year-on-year basis, operating expenses increased 8.1% with personnel expenses rising 8.8%.
This rise was mainly due to higher consumer inflation adjustment and salaries mentioned above and the increasing variable incentives due to positive operating results recorded by the bank’s different business segments. The 10% year-on-year increase in administrative expenses was mainly due to number one greater business activity that has resulted in higher system and data processing costs and number two the effects of higher inflation of our cost which are inducted to inflation such as rent and others.
At the same time, the bank closed five payment centers as part of the ongoing process of seeking greater efficiencies in the Brick and Mortar distribution network. The bank also continue to optimize the ATM network in order to adjust to new security procedures and to remove unprofitable machines.
All of the above has resulted in a record high net income and ROE fueled impart by higher inflation but also reflecting the strong operating income from our business units which has no relation with inflation.
The total operating contribution for our business segments increase at an annualized rate of 16% Q-on-Q and 10% year-on-year in the second quarter of 2014. Net income reached a record quarterly level of Chilean pesos of 159 billion and ROE was 26.7% in the quarter, one of the highest in the last three years.
If we were to exclude the impact of inflation, we calculate that our normalized ROE with inflation in scenario of 3% a year is in the range of 19%, 20%. To conclude, we think the bank’s performance reflect the higher inflation, plus positive performance in most business segments. The transformation project is boosting our commercial activity. Loan growth has been solid and the funding mix continues to improve.
Net interest margin net of provision expense continue to rise as assets quality is relatively stable especially in consumer lending. These are bottoming out led by promising trends in client growth. The bank’s productivity and efficiency is also improving.
At this time we will gladly answer any questions you might have.
(Operator Instructions) our first question comes through from Tiego Batista with Itaú,
Tiego Batista – Itaú BBA
Hi I Raimundo and Robert. Thanks for the opportunity and congratulations for the results, very good results. I have few questions. The first one regarding the asset quality. We saw during this quarter some NPA ration increased in the Chile especially in mortgage and on for commercial loans.
You already explained a bit about it, but what are your expectations regarding the overall delinquency ratio going forward? Will this go down in the Chilean economy? How do you expect your delinquency ratio to be going forward?
And my second question is regarding your loan growth, specifically on this middle market. We saw that that few portfolios posted a very small loan growth, so my question is, this was more that Chile’s strategy is to become more restricted in the credit origination to the segment or it was an issue of a smaller demand from those companies?
Okay, well, regarding the first part or the first question asset quality, as we stated in the call, we haven’t seen a delinquency level deteriorating except for some slight deterioration in the finish which is something that you would expect given that those segments are the most – the one that most ratably reflect the weaker operational environment.
However, there – there are many realities among SMEs and we have been focusing our activity in those SMEs that have either collateral or high levels of transactionality because remember that, at the end of the day, we are focusing our metrics in terms of results in terms of profitability.
So, although you could be growing less than before profitability in that segment has still maintained in the mid-20s range as we put in the call. So, up to now, we haven’t seen asset quality is deteriorating across the board and the only exception is in some of the SMEs that we operate.
In the case of mortgages which has – the other one that grew, as we put in the call, we are basically being more straight in terms of renegotiating those clients that have some delaying in the payment. But total figures have been very stable for many months. Prices of houses have keep on rising even secondary houses are starting to increases at a greater pace and that’s why we don’t expect losses to change in a meaningful way.
And then on the consumer side, which also is a element that typically moves more rapidly or deteriorating in a weak operational environment, we have seen actually an improvement in asset quality which is probably a reflection of the changes we have been done in our revelation process all our process and also a reflection of improved mix that we have been – as you might recollect, we have been growing to a large extent in the safer segments.
The other macro that although the economy is growing closer to 3% today, we haven’t seen job destruction and the salary pool that is a metric that we follow, there is a number of people actually employee times is salaried growth is still having a relatively a positive growth.
So that’s why we think that, up to now there is no room to believe that the asset quality should decelerate in a meaningful way for the end of the year and if it is accurate, the expectation of the market that the economy will rebound by early 2015. We think we are relatively comfortable with asset quality levels being similar or not meaningfully worse than today.
In terms of loan growth, if the other side of the coin except for SMEs where we are putting into some extent the brakes and we are putting – being more careful and more focused on SMEs. In the case of SMEs is to a large extent, our decision to be more prudent. In the case of middle markets, I would say that’s more a demand condition. Companies are in a wait and see attitude given the difference before or under discussion many of them are saying, okay, let’s wait and see what’s going on and that’s why the fact that we are very close to be finishing the tax reform with the final draft of the tax reform that will eliminate we think a source of concern that has been in the last three four months going on.
And companies will go back to normality in terms of expectations. Given that you will have new rules but at least the rules will be a norm. Up to now the discussion has been producing a lot of noise. Today that there is a three year agreement between the different parties, things will settle down.
And that’s why the general consensus is that the economy, once the tax reform is fully addressed the consensus is that the economy should be bouncing by the end of the year early 2015. So we expect a renewed demand on the middle market by the end of the year and the case of SMEs it will depend on asset quality and whether we can grow with good quality clients and basically.
Tiego Batista – Itaú BBA
Okay, thanks a lot.
Next question is from Tito Labarta with Deutsche Bank.
Tito Labarta – Deutsche Bank
Hi, good morning, Raimundo. Thanks for the call. A couple questions. Just first, in terms of expenses, we saw a pick up in the quarter, you mentioned a little bit related to just the impact of inflation but I just want to get a sense, how much is that kind of impact expenses and how should we think about this going forward? Is it just kind a one-time spike this quarter?
And then kind of slowdown for the rest of the year. Just want to get a little bit more color on that and then a second question on fee income, you mentioned should be bottoming soon, the growth rates have been negative, but just when do you think you see the growth there again, and how much growth can you expect in fees going forward? Thanks.
Yes, in terms of expenses, the basic guidance between – of course growth of 5% or something around 5% we think it can be maintained throughout the year. This quarter was abnormally high because we have the full impact of a salary adjustment that you adjusted once a year, yes, on a relatively low comparison base compared to the second Q and the first Q of the year where there are some seasonal elements.
So if you take the year-on-year growth 2013 vis-à-vis 2014 closer to 5 or something like that. We don’t have a plan to expand expenses in the year because we are basically taking advantage of the synergies and economies of scale to be – provide the transformation project and that’s why this should be seen as a short-term blip and we don’t expect cost to increase the levels we saw this quarter.
In terms of fee income, again the basic advise we’ve been given that this year fee income shouldn’t be not a drag butt also not a – it’s vibrant. However, by the end of the year, given that we are increasing especially in the retail part and the use of products, you can see that in terms of asset management, in terms of credit card fees et cetera that are bouncing we expect these to be marginally positive and definitely will be a driver for 2015.
One – what different changes that we – in regulation that we have seen are completely taken into account. Today, the only pending element which common to all banks is some changes in the insurance part and that’s why you see the recollection line is going down like 15% or so which is simply a one-time change again.
The rest of the line is you look them one-by-one, you see some rebounding – rebouncing of the growth because product uses is increasing and the cross-selling of clients has also been increasing and that’s why it’s done for that we will see relatively healthy growth on a sequential quarter basis, but it’s mixed because of this implementation of insurance guidance.
So, this year, we don’t expect fees to be a definitive driver but shouldn’t be a drag and next year growth of upper single-digit or something that, in line with client growth which is a good proxy of growth of these in time.
Tito Labarta – Deutsche Bank
Great thing, that’s very helpful. Thanks, Raimundo.
Next question is from Fred Mariz with UBS.
Frederic de Mariz – UBS
Hi, good morning everyone. Good morning Raimundo. Thanks for the opportunity. A couple of questions on my side and the first question is more about inflation which obviously had a big impact on the margin and you mentioned in your press release that you are expecting inflation to come down in the third and fourth quarters.
Can you tell us a bit more about why you expect this sharp deceleration? Is there any specific driver for this trend? Second question is on the regulatory side, you mentioned the negative side on the regulations that obviously we heard about potential changes in the credit growth in Chile and I wanted to hear from you if you think this could have a positive impact for Santander, for the banks in the country and if it’s relevant in the short-term? Thank you.
Okay, in terms of inflation, our view is that, it will decelerate basically because, well, the economy is growing less rapidly and also because the element that fueled inflation in the first half which was mainly the depreciation of the peso, and oil prices that are stable or trending down and that’s why expect inflation to come down to a more normalized level in the second half.
The only surprise or the in terms of having high levels of inflation will come if the peso keeps on depreciating lately has been depreciating again is basically because of the perception that in the US rates will come higher because of the elimination of tapering et cetera and also because in Chile, rates are coming down. So the interest rate arbitrage or difference has broaden and that is reflected in the currency.
That can have a second effect in inflation and the other is, that with the representation of the tax reform, there can be a pass-through of the higher taxes to the final products of companies and service et cetera. Although the central scenario is slower inflation, we could see surprises depending on how fast is the pass-through of the depreciation of the currency and the pass-through of high taxes – in prices.
But it’s difficult to note for sure at this moment and that’s why for planning purposes, we are prepared to using – to use a lower inflation in the second half compared to the first. In terms of changes of regulation, as you correctly point, they are a good news and bad news.
I would say that most of the more or less technical change in regulation have already passed and are to a large extent price, I would say the only pending implementation of our non-technical or partly thought a regulation is the final implementation of the maximum rate which is still has like 18 months to go.
As you might remember their idea is to bring rates to a level between 35% and 38%. Today, it’s closer to 42.2%, the – what’s the maximum rate?
Like 42%, so, we still have a boon to tighten the rates. That has been less bind in that – as we originally thought, because we have been reducing the exposure to the low end a little bit faster than growth we were expecting and that’s why, that’s not been fully visible but it’s a negative ratio of overall margin.
And then the remaining reforms are neutral or positive. The Basel 3 recommendations we think, brings positive banking practices to the Chile market. There we are probably one of the most advance banks in terms of implementation.
The other is the implementation of the credit bureau which has been dragging for sometime because of the different elements are to be taken into consideration but definitely this is good news for all the providers.
So, we will say that going forward, if you take the plus or minuses, we don’t foresee an impact at what we have seen in the last three or four years concerning regulation, There would be good pieces of regulations and other that les would. But, all in all, it shouldn’t be as negative as what we have seen in the last two, three years.
And there has been a layered to banks to be very concerned about efficiency et cetera that what’s triggered our efforts to improve our performance and improve integrity of the business through the CRM and through this so-called transformation project.
Frederic de Mariz – UBS
Okay. Thank you very much. And just a follow-up on the credit bureau, where do we stand now? Is there any new news on this topic?
No, there has been – the last announcement is that they have been moving forward, but there are many other priorities in the legislative agenda. So this is not a top priority and therefore you will be moving but very slowly. The focus today, the tax reform and some other reforms are big headlines. This is our secondary issue for the economic agenda.
Frederic de Mariz – UBS
Sounds great. Thank you very much.
And we have no other questions.
Okay, well thank you all very much for taking the time to participate in today’s call. We look forward to speaking with you again soon. Have a good day.
Everyone, thank you for your time. You may disconnect and have a great day.
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