Grupo Financiero Santander Mexico SAB de CV (NYSE:BSMX)
Q1 2016 Earnings Conference Call
April 27, 2016 10:00 AM ET
Héctor Chávez Lopez - Managing Director, Head of Investor Relations
Héctor Grisi Checa - Executive President and Chief Executive Officer
Pedro José Moreno Cantalejo - Vice President of Administration and Finance
Philip Finch - UBS
Carlos Macedo - Goldman Sachs
Tito Labarta - Deutsche Bank
Jorge Kuri - Morgan Stanley
Arturo Langa - Banco Itau BBA SA
Domingos Falavina - J.P. Morgan
German Velasco - BBVA Global Markets Research
Diego Ciconi - Scotia Corredora de Bolsa Chile S.A.
Victor Galliano - Barclays Investment Bank
Good morning, everyone, and welcome to Grupo Financiero Santander Mexico’s First Quarter 2016 Earnings Conference Call. Today’s call is being recorded, and after speakers’ remarks, there will be a question-and-answer session.
For opening remarks and introductions, I would like to turn the call over to Mr. Hector Chavez, Managing Director, Head of Investor Relations. Please go ahead, sir.
Héctor Chávez Lopez
Thank you. Good morning and welcome to our first quarter 2016 earnings conference call. We very much appreciate everyone’s participation. By now, everyone should have access to our earnings release and the company’s presentation, which were released this morning before the market opened.
Speaking during today’s call will be Héctor Grisi, Executive President and CEO. Also joining us are: Pedro Moreno, Deputy President of Administration and Finance; and Rodrigo Brand, Deputy General Director of Public Affairs and Communications; all whom will be available for the Q&A session.
Before we begin our formal remarks, allow me to remind you that certain statements made during the call 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 at the SEC and the Mexican Stock Exchange.
Let me now turn the call to Héctor Grisi. Héctor, please go ahead.
Héctor Grisi Checa
Thank you, Hector. Welcome to everyone. Good morning in Americas, and good afternoon in Europe. Thank you all for joining in our first quarter 2016 earnings call. This is actually my first one complete quarter in front of the bank. And allow me to start today call by highlighting the results.
I believe we had a solid start to the year with performance across key metrics in line with our annual expectations. While results are below our long-time growth, we believe we remain focused on the implementing the strategies, that will enable us to drive increased profitability.
As you will know, our goal is to become the market leading in profitability and growth in Mexico. To achieve this, we need to increase customer [indiscernible], reduce attrition and strengthen returns on capital and consolidate the leaderships in key markets.
Let me give you an update on the initiatives we are taking as we pursue this objective. First, we are focused on the strengthening our retail business. This is key if we are to become our clients’ primary bank, which is our main objective.
We are organizing this business, which includes investments in IT such as upgrading our CIM [ph] and digital platforms, and introducing multifunction ATMs to change the way we approach the market.
And Santander has excellent products and a strong marketing capability to recognize the need to address churn and boost client loyalty, which requires sharp focus on becoming a client-centric bank and we are committed to this [indiscernible] and look forward to updating you on our plans in the next earning calls.
Second, in terms of capital allocation, over the past couple of months we have been conducting in-depth assessments over the returns of our risk-weighted assets. Behind these assessments is a disciplined philosophy not only indulging on transactions that meet our thresholds of return, we will not pursue growth for its own sake. Profitable growth remains our core focus.
We have started to implement some initiatives in this direction. For example, Santander Mexico holds a leading position in SMEs and mid-markets offering unique products and services tailored to this type of companies. Reflecting to our risk-based pricing approach, we have increased rates in these sectors. Similarly, in the corporate and mid-market segments, where we are seeing solid competition, we do not sacrifice profitability to growth.
Third, we are reinforcing our leadership in Global Corporate Banking. Aside from our objective of stronger capital returns and greater revenue diversification through higher fees, a renewed focus on investment banking will create additional synergies with our retail operation. We are not delivering to our full potential and this is a business that has a much lower contribution to earnings than historically.
As the first step, this month we appointed Jorge Arce, as new Head of Global Corporate Banking in Mexico. Arce brings more than 25 years of experience in investment and corporate banking. Most recently he served as CEO and Chairman combined of the Board of Deutsche Bank in Mexico. In his new role Jorge will lead our Global Corporate Banking restructure.
Santander aims to be on Mexico’s top three corporate banks within the next 18 months. Our plans also include improving our offering to multinational companies, consolidating the project finance operation and increasing our focus on transactional products. While we will continue to primarily be a commercial bank, we are confident these initiatives will allow us to increase revenue contribution from these areas.
Further strengthening our corporate structure this month we also appointed Didier Mena, Chief Financial Officer, effective May 2. Didier brings more than 20 years of experience in senior management position in both corporate and financial sector in Mexico. In his new role he will report to Pedro Moreno, Vice President of Administration and Finance. Pedro will elaborate on our results in a few minutes. But before that we’ll discuss our performance and market trends.
Let me give you some color on market trend for the quarter. System loans as of February, the most recently available public data published by CNBV increased by 14.7% year-on-year. This is slightly above the 14.4% increase reported last December, supported by strong consumer loans mainly personal and payroll.
We have seen a robust performance in several indicators like retail sales, domestic car sales, formal employment, consumer confidence and low inflation, which we believe are supporting demand for consumer loans. System deposits continue to decline.
Moving on to Santander Mexico. We expanded our loan book 14.4% year on year in line with the market with contributions from both retail and commercial loans. Let me give you some color on their performance.
Individual loans were up 15%, consumer loans excluding credit cards is strong growing by an impressive 27% year on year. Growth was driven by heavy consumer demand and our strong commercial efforts allowing us to gain 97 basis points in market share in that period.
Credit cards rose 14% year on year, significantly above the market growth. We remain focused on developing new products to target the open market while we are maintaining our credit standards. For example, this quarter we launched the Santander Aeroméxico co-branded credit card. This partnership has a 10-year exclusivity, and we expect to issue more than 15,000 cards in the first year alone. In just two months we have issued 60,000 cards, a result that we consider a success. This milestone will help to further expand our share in the [indiscernible] segment of this market.
Mortgages expanded at a slightly lower pace this quarter, writing 115 year on year. We are keen to increase competition with some players implementing a [indiscernible] customer acquisition strategy with low rates and fees. But we maintain our commitment to profitable growth and we have fine-tuned our scoring standards in line with our focus on efficient capital allocation using risk-based credit approach.
In addition, the sharp depreciation of the peso in the last few months impacted in this market and some of the real estate transactions in Mexico, as you know are dollarized. In this market, we are concentrated in the mid to high income segments. This is a broad market for us, for we hold a strong position and we remain focused on maintaining a good understanding of our clients’ needs and being prompt to response.
On commercial loans, we grew at slower rate, 14% year-on-year. In addition to our heightened approach to returns on the risk-weighted assets, we are also observing high competition across all segments. For example, corporate loans posted the sharpest slowdown, up 4% year on year this quarter and falling 11% sequentially. In addition, to our focus on profitability, some AAA corporates repaid their loans which is typical in this volatile segment. But they are also taking advantages initially in bonds due to the low rates.
In SME loans we are slower paced, 12% year on year, in addition to lower demand in a more challenging environment. We’re seeing increased activity from players who have previously been sidelines. We also increased rates [for some quotes] [ph] in line with market averages which impacted growth. This is a core market in which we will continue to strengthen our leadership position while maintaining mindful of [recent titles] [ph].
Middle-market loans posted a good performance, up 16% year on year and we have strong niche that we have centered [indiscernible]. In terms of funding, deposits rose 13% year on year, above market, and seasonally flat sequentially. Growth individual demand deposits remain solid at 17% year-on-year. There is room to grow individual deposits to close our market share gap and improve our cost of funding. We are working on several initiatives and expect to provide an update in coming months.
With that, let me turn the call over to Pedro, who will go over our P&L and I will then discuss guidance and afterwards we will both be happy to respond to your questions. Thank you very much.
Pedro José Moreno Cantalejo
Thank you, Héctor. Good morning, everybody, and good afternoon to those in Europe. Moving to liquidity, our loan to deposit ratio stood slightly above 100%. And our coverage ratio, LCR ratio, well above regulatory requirements, 119%.
In addition to the senior notes that we issued last December, in February we issued a two-year Ps.3 billion senior notes with a very efficient rate and strong demand, which contributed to further strengthen our liquidity position.
Capitalization, capitalization remains solid at 15.41% with core tier 1 above 12%. As we continue to implement efficiency measures to offset the impact from the recent changes in regulatory capital requirements in Mexico, and the ones that are still to come.
Moving to the P&L, net interest income grows 18% year on year and 2.4% sequentially. This is a very good [with new] [ph]. In March, we reached a record net interest income surpassing the Ps.4 billion mark in a single month.
The loan portfolio excluding credit cards contributed to the 20% year on year increase in net interest income. The contribution from credit cards is gradually improving and growth however remain slow at 24.9%, reflecting a higher share of customers that prefers to pay their balances in full instead of revolving.
Our strategy to work our securities portfolio at attractive profitability levels by leveraging the recent interest rate increases has contributed to the result with a very [indiscernible] 53.8% year on year increase in interest income. Net interest margin for the quarter stood at 4.86%.
Talking about commissions and fees, this rose 9.4% year on year. And have in mind that for the comparable basis, we’re excluding the reclassification of the NAFIN’s quantities paid. Commissions and fees rose 6%.
Insurance fees rose 5% reflecting the solid growth in consumer credit related, also the online platform for care insurance and life insurance products contributing growth, which more than offset the regulator restriction we are suffering tied to sales as well as weaker SME demand for credit-related insurance.
Credit card fees remain flat year on year reflecting the higher reward cost. Some of the fees paid in connection with the business are dollarized, and were affected by peso depreciation. Starting next quarter, we should also see the impact in paid fees from the new credit card launch of last month.
Volatile market conditions continue impact investment banking fees. We have an attractive pipeline to execute when the conditions recover, which will contribute to fees. And as Héctor said, we shall see improvements in this area as we have strengthened our investment banking operations.
Let me also highlight the important contribution from cash management fees, up 9% during the [end of year] [ph], while mutual fund fees grows 8% year on year reflecting a better price mix.
In summary, the gross operating income grows 14.2% year on year, driven by strong performance in our [indiscernible]. Keep in mind that our market-related businesses have contributed only 4% of the total operating income.
In fact [total gains] [ph] feel 13% year on year, but still reached the low-end of our estimated quarterly average around [Ps.700 million] [ph]. But they doubled compared to the previous quarter. We should also see improvement in this area as we have strengthened our investment banking operations.
In terms of asset quality, the non-performing loan ratio declined across the board during the year and sequentially reaching 2.97%, below 2% first quarter in many times. In particular, commercial nonperforming loans fell 38 basis points sequentially. As we are recognizing charge-offs of certain loans to companies in the oil and gas sector that were past due more than 18 months.
Loan growth reserves rose 27.9% year-on-year, reflecting several things. First of all, solid volume growth in credit cards and consumer loans, which requires, as you know, a higher level of provisioning. And additionally, provisions for mortgages, resulting from a change in the methodology, where some portfolios will be written down in 36 months instead of the 48 months, also impacting reserves. This is a more conservative policy that we decided to apply.
Maintaining this conservative approach, this quarter we also made some provisions in connection with companies in the oil and gas sector, and other corporates that have been on watch-list. Cost of risk remains relatively stable, at 3.45%, which is within our expected range [indiscernible].
Moving to cost, operating expenses for the quarter rose 7.8% year-on-year and 7% sequentially. Note that excluding the IPAB impact we paid for deposits, costs increased 7.2%, within our guidance range of 6% to 8% growth. Remember that our cost guidance excludes [indiscernible]. The increase in personnel expenses at this quarter reflects hiring of staff that was previously outsourced, with the aim of increasing efficiency on this operation. This also resulted in a deduction in other expenses.
Costs were also impacted by the amortization of the IT preliminary [ph] investment plan which has started last year. Given that a portion of our costs are dollarized, the depreciation of the peso is also driving the increase in expenses. Note that sequentially the quarter reflects an accrual inflation and other loan expenses as we aim to achieve more predictable and stable for month of the year. This is a common purpose that we are following in the last years.
Efficiency for the quarter improved 240 basis points year-on-year, going down to 42.4%. Excluding IPAB, efficiency for the quarter was very close to 40%. To recap, our recent core earnings more than offset lower market-related revenues and higher loan loss reserves, enabling a rise in our quarterly pretax profits of 10.4% year-over-year. Return on average equity is stood at 12.10% and was relatively flat year-on-year.
Now, before opening the floor for Q&A, let me turn the call to Héctor Grisi, who will discuss the guidance for the year.
Héctor Grisi Checa
Thank you, Pedro. Moving to our guidance, we reaffirm our outlook for the year and when I - what was provided on our year-end call. This quarter, we have started to see softer loan demand in the commercial segment on the back of higher interest rates and a more challenging global environment that we have seen. We continue to maintain a disciplined focus on profitability, as competition intensifies. And while we don’t expect significant changes in the competitive environment for individual loans, we remain cautiously optimistic with respect to the recovery in consumer confidence.
With our renewed focus on profitable growth, we expect to deliver improved performance in 2016, with pretax earnings growth ranging between 8% to 12%. I am committed to delivering our goals and look forward to providing more detail on our various exciting growth initiatives on the next earnings calls.
We are now ready to take questions. Please, Operator, go ahead.
Thank you. [Operator Instructions] our first question is from Philip Finch of UBS. Please go ahead.
Good morning, everyone. Thank you for the opportunity to ask the couple of questions. The first one is regarding the cost of risk which you highlighted as going up five basis points in the quarter. Given the change in the internal policy of the write-off for mortgages, if this hadn’t have happened, how much lower would provisions and cost of risk have been in the quarter? And related to this, looking ahead, should we view this as a one-time adjustment or is this going to be a recurring theme, going forward?
And my second question is also asset quality related. We’ve seen a number of announcements and measures by the Ministry of Finance and Development Bank. So, now, how do you view credit risk related to Pemex and its suppliers? Thank you.
Héctor Grisi Checa
What I would like to do is, I’ll let Pedro to answer the first question, and then I will tell you on the Pemex.
Pedro José Moreno Cantalejo
Well, the impact of the mortgage anticipation of the charge-offs amounts to Ps.450 million. This is a one-off impact for the stock. Then the point is that we will be more conservative in the future, because instead of in 48 months we expect this have to go before. On the other hand we will take more profits when we take in the [indiscernible]. So it will be a tradeoff, and that’s a more conservative approach, that has impacted mainly in this quarter.
In terms of Pemex…
Héctor Grisi Checa
In terms of Pemex, let me tell you, we have - I mean, If I understood correctly the question, you were basically saying what the Ministry of Finance actions have - how they have impacted them, it’s correct?
Héctor Grisi Checa
Okay. The first situation - okay. The first situation is mainly to tell you that we like the approach that the Ministry of Finance have taken over the Pemex situation, in which basically they have acknowledged the situation and they have acted in consequence, which I believe is quite important that they have done that.
We believe that the action taken have helped the situation quite a lot. I mean, Pemex’s price has lowered since the ministry has expressed the measures that basically were said on [indiscernible] last week. In that sense, what we can tell you about what we are doing in the bank is we’re reviewing our position with Pemex.
We believe that still the credit situation is okay with them, at least on the short term for one to two years. We believe that the company is in a good position in that sense. We believe that once the company resolves the situation with the working capital they should be okay. We are not worried of our positions with Pemex. But we are reviewing the situation that we have with the suppliers in which we are looking at that detail. And at this point, we are not worried to have a negative situation that worries us at this point.
Thank you. The next question is from Carlos Macedo of Goldman Sachs. Please go ahead.
Thank you. Good morning, Héctor, Héctor, Pedro. A couple of questions. One is a follow-up on Philip’s question on asset quality for Pedro. You said that the one-time impact on mortgages was Ps.450 million this quarter. So we could presume that adjusting for that your provisions would have been flat, or actually lower, quarter on quarter, more reflective of the improvement in NPLs.
Is that a good way to look at it, going forward? I mean, your guidance is still 3.4 or 3.3 for cost of risk, but if you adjust for that one-time on the mortgage book it would have come in much lower this quarter. Just trying to get an idea of what to think about on the provision line, going forward, given the fairly substantial improvement in asset quality.
Second question is on margins. Margins were a little bit lower sequentially and basically haven’t moved much with the higher rates. What should we - you don’t give a very specific guidance on the margin side. What should we expect on margins going forward with the rates being higher? Should we expect a bigger reflection, or a more substantial reflection of the higher benchmark in Mexico in the second quarter or will that be diluted by funding or by some other - or by mix or by something like that?
Pedro José Moreno Cantalejo
Well, first question talking about asset quality. Yes this was right. The quarter has been good for the rest of the businesses. Have in mind that there is a mix effect, as we are going much more in credit cards and consumer loans. It means for provisions with the methodology of [expected loss was much higher] [ph]. If we continue with this path, we expect the provisions, simply for methodology, to grow. In addition to that, have in mind that in April we are starting a change in the methodology from the CNBV affecting credit card business.
Apparently, [indiscernible] because we are in the impact, [indiscernible] that will be reflected in the bank’s equity. But then, in the following months, as much business we do, more provisions will be needed. So, for the time being we maintain our cautious guide in the cost of risk between 3.3% to 3.5%.
Talking about margins, well, you remember the interest rate increases happens in this first quarter, 50 basis points and 25 basis points happened at the year-end 2015. So, this is improving, and it will give these benefits slightly comparison with the previous year for the coming quarters, as well. As I said, and on contrary, we are supplying [ph] provisions for the better mix in terms of high-yield businesses that will contribute also to improved interest rates.
On the other hand, as Héctor explained at the beginning, we have seen lots more competition, especially in SMEs and other core businesses that are making but the spreads are really tight, so slightly [indiscernible]. So, overall, we are expecting to this range for interest margins to continue in a very good trend, to meet double-digit [indiscernible].
Héctor Grisi Checa
I’d like to add some to Pedro comments, just let me tell you one thing. Is that we will - as I said in many occasions during the presentation, we are focused on profitability and we will be - we’re not going to follow the market [indiscernible]. The market basically decides to continue pressing down the margins. So, we will basically focus on basically maintaining the profitability and maintaining our margins as much as possible.
Okay, thank you. Thank you so much.
Thank you. The next question is from Tito Labarta of Deutsche Bank. Please go ahead.
Hi, good morning, and thanks for the call. A couple of questions, also. First, on your corporate loan portfolio, we saw a big decline in the quarter. I think you mentioned that there were some prepayments there. But just wanted to understand a little bit what happened there and how you see that going forward? Also, if you can maybe comment on the increased competition you’re facing and how you see that could put some pressure on loan growth?
And then, second question, I guess may be more specifically for Héctor. You’ve been on the job for a full quarter now and, you can argue, in a pretty decent environment for Mexican banks with good loan growth. Asset quality is doing well. Yet profitability continues to be, say, a bit below average. I know you had some additional provisions this quarter. But just thinking longer term, what do you think it’s going to take to get that ROE up to that mid-teens level? And how long you think before you can get there? Just wonder after being on the job for a few months how you see that evolving and then kind of your thoughts for the long term? Thank you.
Héctor Grisi Checa
Okay, thank you. On the first question, one example here is that competition has increased quite a lot. You will see a lot of participants competing in the corporate market. And what we are doing is basically, as I told you, we are not willing to go below, what we believe we should price the risk. We’re basically in a strategy of concentrating of lending on the risk, not following the market.
And we have had some prepayments and some big transactions that we had on the books, some of them particularly because our clients is having to issue bonds on the long-term basis, taking advantage of the rates. And that basically created a big repayment before the end of the quarter. It’s not something that worries me. I think the corporate market has always had cycles. And what we are basically doing is we will keep our power dry in the moment that the market gets a little better, and we’ll be ready to serve our clients the moment that we believe is the right thing to do know. What I am basically trying to do is, trying to tell you is that, with risk-weighted asset we need to - we’re not planning to basically use our balance sheet on a cheap basis.
We have to take care of our balance sheet. And we don’t want to put things into our books that we later we’ll regret. So we’re basically trying to be very cautious in the way we manage the balance sheet on the long-term basis, given the risk-weighted asset situation. Okay. So we’re going to be very - I mean, don’t care if I [indiscernible] cheaply to appropriate on a short-term basis, but I don’t want to do it on a long-term basis if it’s unprofitable for the bank in any way.
In that sense, we’ll be very consistent about it. And what you said about increased competition, I mean, that really is. Banks are - when things get complicated in some other parts of the world, you see some of the international banks coming back into Mexico. And they [indiscernible] will take positions. We have seen that. You’ve seen the Japanese banks coming in very aggressively, also the Korean banks and some of the older banks that are coming back into the Mexican market.
You will see some of these banks also opening offices in the Mexican market. And that basically is keeping us in the important names. And as you can see then that’s the result of it.
In terms of being for the first four months in the bank, there is - I believe what I continue - first of all, I have a great team, and I’m very confident that we will basically deliver on the strategy that we have presented. I feel more confident now being on top, I’m also the chief. And nevertheless, it’s still little time in order to basically be completely sure about how we’re going to manage the strategy.
What I can tell you is that in order to increase profitability, first of all, we need much more clients and we need to increase our positions on deposits. If we don’t do that, we’re not going to be successful in increasing the margins. So we need much more clients, and that’s exactly what we’re planning to do.
The only way to do that is basically to come out with important programs, which we are going to do in a few months, in which we’re going to get new clients to the bank. And we’re going to basically change our strategy from focus [ph] to client-centric as I said, in which we will now try to increase loyalty and increase our transactionability [ph] with the clients, okay?
If we don’t perform on that, for sure we’re not going to be in the numbers we want to be in terms of ROE. I believe that on the long-term basis that’s the only way. I believe the bank is very, very strong on SMEs; very, very strong on the corporate side. So I think we’re okay in that. But we need to get these guys cheaper funding in order to leverage up.
Okay. Thank you very much. So just to clarify back on the competition, so you said, mostly you’re seeing it from international banks coming back into Mexico. What about some of the, I guess, local, I mean, even though some of the local banks are also international, so I’m thinking, I guess, specifically Banamex; are you seeing more competition from some of the big guys there?
Héctor Grisi Checa
Yes, you’re completely right about it. I mean, Banamex is getting back into the game. And you also see HSBC coming back and increasing their numbers and increasing the amount of fees they are taking. On personal loans, you have also newcomers to the market. That’s the one, probably Inbursa is an important player which is increasing their positions in personal loans. So, I mean, competition is everywhere.
Great. Thank you very much.
Thank you. Our next question is from Jorge Kuri of Morgan Stanley. Please go ahead.
Hi, good morning, everyone. Two questions if I may? The first one on market share on consumer credits, you pointed out a 143 basis point gain in credit cards; 97 basis point gain in payroll, auto, and personal loans. To what extent that reflects sort of like the past, where you had less aggressive competitors and going forward those numbers are going to be more difficult to achieve or is this more specific given your initiatives, et cetera and we may continue to see this going forward? That’s the first question.
Second question is on the margins. I am having a tough time figuring out why your margins were flat, 4.8 a year ago, 4.8 now - 4.87%, 4.86%, sorry. You did see a pretty meaningful improvement in the mix with a significantly larger - with significant growth, sorry, in consumer credit, up 27%, and credit card, 14%. Rates are higher. I understand you’re saying something about competition, but if I look at Banorte, for example - and I know the mix is different, et cetera. But if I take out their insurance and pension business, their margins went up 30 basis points year-on-year, and they did not have mix improvement anywhere near what you guys saw.
So, I’m trying to understand - you’re sort of like blaming everything on competition, but is there any way you can be bit a more transparent about it, I mean exactly what type of products you’re seeing? Pricing pressure? What level of pricing pressure? Why you see banks like Banorte expanding margins without the same level of improvement in mix versus you? Is it more you versus other type of banks competing? Just a little bit more clarity on that. Because I think that’s probably what was more surprising about the quarter, is the fact that, given what’s happened on the balance sheet, what’s happened over interest rates in Mexico, your margins are flat? Thank you.
Pedro José Moreno Cantalejo
Well, it’s a very wide question, Jorge, but let me say, first question, talking about expansion of our business in credit cards and consumer loans, I will say that you are right in the sense that this will continue, I think we are doing much better than the past. We are, as you have seen this quarter, launching new products, and we are safely catching up positions we had in the past, but with a very different approach. We are improving the mix, as you said, in high-yield businesses, but what we are applying now is a risk-based pricing approach.
We are calibrating our models, but we notice that we have an opportunity to improve the net of provisions margin in these businesses. This is what we are trying to do right now. And as a final consequence, to improve the return on our risk-weighted assets, this is the main target where we are focused right now. Maybe this will mean a little bit reduction in the spreads of these products. But on the other hand, and in the midterm, we will for sure notice also an improvement in the cost of risk of these products, so this is the first idea.
And the second one, which explains why maybe other competitors have increasing the NIMs more than we do, even with the improvement in the mix, is because have in mind that part of the improvement in our net interest income is coming from our security position in balance sheet.
I always said we were waiting for better conditions in the market in order to review our ALCO position that’s what we did. So, we are contributing with a very low capital consumption asset. We have interesting margin, but nevertheless this margin is lower than the others of our loan portfolio.
This is the explanation why even growing net interest income as much as the asset base is growing for the securities, the NIM remains flat, which is a good news having in mind this increase in the assets that are not capital consumption assets, as I said. That will provide for us in the future an improved in the NIMs once these interest margins will consolidate. So I believe these two effects explains like what you’re very well not be seeing in the metrics.
All right. Thank you. That makes it clear. Thank you, Pedro.
Thank you. The next question is from Arturo Langa of Itau BBA. Please go ahead.
Hi, good morning. Thank you for taking questions. I think most of my questions were answered, but I just wanted to ask on taxes. We saw taxes that were below guidance this quarter. And maybe this could mean that the guidance of 25%, more or less, is a bit high considering the first quarter? I just wanted to see your thoughts around that? Thank you.
Héctor Grisi Checa
Well, I think this is good news. Always when you are paying less taxes it’s good. Yes, we are following our strategies, and we benefit for the repo-amount [ph], the inflation adjustment to the tax balances this quarter. And also we continue with our strategy of investing in some securities with a high tax yield return. So these two things explains why we are slightly below our guidance, which is good. 23.7% nevertheless is higher than the one we had last year, as we already predicted, but a good news and only due to the good tax management of the banking [ph].
Okay. Thank you.
Thank you. Our next question is from Domingos Falavina of J.P. Morgan. Please go ahead.
Hi, good morning. Thank you for the opportunity also. My question relates a little bit to the asset quality side too. When I look at the provisions, I just want to get a general sense from you, when I look at your provisions I notice coverage going up. I understand there is a little bit more of charge-offs related to mortgage.
But even when I adjust and I try to look at the new non-performing loan formation, it seems to me that the new NPLs were about Ps.3.3 billion, which is very similar to what you had about a year ago. And yet, the provisioning levels came up significantly, about 28%. It almost seems to me like you took the opportunity to overprovision a little bit or to shore up and you could have provisioned a little bit less.
Does that make sense? Are you looking at your asset quality and seeing very good trends and being extra conservative? How should I think about the new NPL formation vis-à-vis your provisioning level?
Héctor Grisi Checa
Okay. That is a very good question. I mean, if you look at the mortgages, you’re right. And the thing and where we are basically getting a little bit much more complicated is in credit cards, as Pedro was telling you. I mean the situation in credit cards, we have increased the amount of provisions in credit cards, we do first of all to increase them. We are getting market shares in that as you can see. And Pedro was telling you the mix [indiscernible] into much more high-yield you need to do a little bit more provisions. We are calibrating the models to really see what’s happening there, but the main situation is credit cards where you have seen that we have increased the amount of provisions.
But you’re doing before the NPLs come, right? It’s more of a precautionary approach than in reaction to it?
Héctor Grisi Checa
I mean, it’s not that we are being conservative. It’s basically what the model right now is basically showing us that we have to provision. And we are recalibrating the model, but at this point this is what it is. I mean, we have reviewed our situation. And that’s the type of our company, the credit card business, and that’s why we - as you can that the provisions have gone up on so much quarter versus year on year.
Okay. And my second question, if I may, is also related to NII, but less so thinking on competition and more thinking on the breakdown of the NII. We basically notice here a good improvement on the interest income component, but the problem is that you seem to have had a couple of, what seemed to me one-offs in terms of expenses related to the interest expense side.
Does that make sense, when you look at certain lines in here, like an example, credit instruments issued growing almost 50% or certain demand deposits growing more than 20%? Does that strike to you as something that came a bit above what you expected too or no?
Héctor Grisi Checa
Well, the most important contribution to the net interest margin came from the asset side of the business. Spreads are much higher in the loan book than in the deposits with the actual rate in Mexico of 3.75%. And nevertheless, you are right, as much as we are growing in deposits we still have finally an improvement in the cost of funds. On the other hand, we are trying to make our balance sheet a little bit more long in terms of liabilities.
As I mentioned in liquidity page, we have issued two senior notes, two years and three years. So this is a temporary tweaking the cost of funding. But on the long run, if the interest rates continue to going up it will mean a saving in the cost of funds.
So it’s a combination of both things. We are fighting increasing, as Hector says, our demand deposits and from individuals starting to have a cheaper cost of funding. But this is slower than the advantage we can have in the loan book. We continue to do well in credit cards and consumer loans.
Okay. That’s very clear. Thank you.
Thank you. The next question is German Velasco of BBVA. Please go ahead.
Hi, good morning. And thank you for taking my call. I have a couple of questions. The first one is related to the loan growth. We saw a big slowdown in the SME’s growth rate in this quarter. Can we expect a recovery in next quarters or they will be at similar levels as of this quarter?
And the second question, in terms of margins, the NNI increased 18%, whereas total loans increased 14.4%. Is this a consequence of the price increase and the portfolio mix that you are carrying out? And the higher NNI growth, in comparison with the one in the loan portfolio, will be sustainable for the next quarters? Thank you.
Héctor Grisi Checa
Thank you for the question. I mean, first of all on SMEs it’s exactly what we were telling. I mean, we are approaching - I mean, we were adjusting our risk-based models, and we actually increased rates a little bit in some of our clients and we got payback. And we are calibrating the models. And once we have those models calibrated, I believe in SMEs that we’re going to have a slightly different behavior of the portfolio.
And right now, what we’re telling you, we’re experimenting a little bit on what we’re doing in the margins over there, and that’s why you see a little change of the trend of the portfolio. On the NII question, please, Pedro?
Pedro José Moreno Cantalejo
Yes, so, German, just to complement also what Hector said for SMEs, have in mind that for us SMEs is not only a loan book model. It’s also a very important segment for us in deposits and in [indiscernible] and fees. And these two businesses are doing very well.
Yes, talking about NII, yes, you’re right, there is an important contribution from the security book. If we continue at least in the coming quarters, couple of quarters, because we have started to review our [indiscernible] position in the last quarter of last year. So it will guarantee for us an important contribution of this deal for the coming couple of quarters. That’s what I said at the beginning. Maybe this 18% is not sustainable at year-end, but mid-double-digit very achievable.
Okay. Okay. Thank you.
Thank you. The next question is from Diego Ciconi of Scotiabank. Please go ahead.
Hi, good morning. Thanks for taking my call. I just wanted to get some more color on the reason behind the high level of charge-offs in the period. I calculated an annualized ratio of 4% of average loans, which is a lot higher than the 2.5% to 2.7% that you usually post. Would you please elaborate a little bit more on that?
And also, has the high level of provisions in this quarter been in any way related to the high level of charge-offs or were these charge-offs only related to loans that were already provisioned?
And one last question, on loan growth. You have been growing loan growth - loans a lot higher than guidance, with a special focus on government loans. So I wanted to understand a little bit how you look at growth going forward, in the different segments and when do you expect to converge to the guidance? Thank you.
Héctor Grisi Checa
Okay. In terms of the charge-offs, what we did is basically we had a couple of Pemex contractors that we have some particular situations and were already 18 months due, and we decided basically to do the charge-off. At this point, we believe it was the right way to go, and that’s why we did in charge-offs. In terms of what you were saying on provisions, it was mainly what I said it was the consumer side. It was basically was we did on the mortgages and we did on the credit cards. Okay. So those were the two points which already explained on what happened there. There is no Pemex charge-offs shown, also, no Pemex extra provisions for this quarter in any particular supplier.
We are, as I said at the [older conference call questions,] [ph] at this point, we are not worried about the Pemex exposure that we have. We have around Ps.50 million of exposure there, and I believe there is no something worries me in that. In terms of other companies’ exposures, we’re talking about Ps.17 million [ph] in total and Ps.50 million in oil and gas related, and we are very confident of what we have and nothing that could be of alarm at this point, or at least that we have reviewed.
And we are really reviewing in detail what we have over there. In terms of the growth, what we’re doing is basically taking a little bit of advantage of what’s happening in the market. And what has been happening in the different areas that you have seen where we have taken on growth is because we saw an edge to do that, and mainly in personal loans and the credit card side, where we did a where we did a deal with the AeroMexico cards which has been a success.
And if you see what we’ve been doing, we are working in a basically very precise model in terms of capital allocation and in terms of risk-weighted assets, and we are basically allocating capital where we believe we have the best option. In terms of what you’re seeing, in terms of the growth of the portfolio, we also want to change the mix a little bit. If you see our competitors, they have a much better mix and that’s why we have variable margins and that’s what we have been trying to follow. But we have a very well, I mean understood strategy in that sense and that’s why you have seen our risk-based pricing in that sense where we have basically calibrating our models in that sense.
Okay, I mean, I believe also that on the long term given the size of the portfolio at this point, we should be lowering a little bit of growth of the portfolio. It’s not the same to grow from a low rate and to grow from a higher base. And that’s exactly what you are seeing, and that you grew at 17%, and now we’re down to 14.4%. So I mean that basically shows you three points below what we were growing last year.
Sure. Makes sense. Thank you.
Thank you. Our next question is from Victor Galliano of Barclays. Please go ahead.
Thank you. And thanks for taking my question. My main questions have been answered, but perhaps you could give us a bit more color in terms of your strategy? In particular, you talk about really beefing up the retail side of the business and going off that growth in that area much more. Can you talk to us a bit more about the channels, how well developed everything is in terms of your branch network, or whether you’re looking more aggressively at areas like mobile banking and leveraging off what the group might have done in other countries? Thank you.
Héctor Grisi Checa
Okay. The strategy is a little bit complicated because we have different ways of approaching it. First of all, what it was taking, I mean, the bank - and this is known to all of you - has an important gap in terms of clients versus our competitors, and we need to increase our best [ph] based on new clients. And we choose - we are going to be coming out with new initiatives in that sense to grow client base.
It’s a fact that we need more clients, and we have to get more clients in order to basically grow in every single part of the business. So one part of the strategy, and we will, as I said, coming out with new initiatives in that sense. That basically will enable us to do three things. First of all, increase the client base; second, increase loyalty; and third, increase transactionality. If we don’t do that, we’re not going to be successful on the long term. And this bank needs that in order to be successful and to be reliable in terms of margins and in terms of profitability.
In the second part, we also believe that we are punching below our weight in what we do in the corporate side and in the investment banking side. This bank with the platform that it has, it should basically be much better than that. And as I said, in the next 18 months we’re going to grow that business, and we’re going to be in top three in the Mexican market.
I forgot to tell you, on part of your question, on going back to the commercial side that we believe we are okay with the amount of branches that we have. I think it’s a correct platform. We may do some rationalization in terms of opening up in some of the places that we are not, and closing up some of the branches that are not doing well. But this is going to be a minor - I mean, it’s not going to be something important as we - such as we did in 2013, 2014.
So it’s not going to be in that sense, and we will be coming out with some new products on the digital side and some other things that we believe are going to be much more ahead of what’s happening in the Mexican market. So, I’m thinking of a little bit of experiences that have happened in some other parts of the world, which we are basically relying on them for details that [indiscernible].
I don’t know if that answers your question or you want me to be more precise on some of the points?
No, that’s very helpful. Thank you.
Thank you. [Operator Instructions] Okay. We have no further questions. I would like to turn it back to Mr. Chávez for any closing remarks.
Héctor Chávez Lopez
Well, thank you to all. With that we finish our conference call for the first quarter of 2016. Please feel free to contact us if you have any more questions or comments.
Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.
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