Banco Santander-Chile (NYSE:BSAC) Q2 2016 Earnings Conference Call July 29, 2016 11:00 AM ET
Raimundo Monge - Director, Strategic Planning
Nicolas Riva - Citi
Carlos Macedo - Goldman Sachs
Welcome to the Banco Santander-Chile Second Quarter 2016 Earnings Conference Call. [Operator Instructions]. And now I would like to introduce you host for today's conference Raimundo Monge, Director of Strategic Planning. Sir, please go ahead.
Okay. Good morning ladies and gentlemen. Thank you very much for attending the call. My name is Raimundo Monge and I'm Director of Strategic Planning at the Bank and I'm joined today by Emiliano Muratore, our Chief Financial Officer; and 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. Let us start our call with a brief update of the outlook for the Chilean economy.
According to market consensus the economy should manage to grow this year close to 1.7% and recover something will be 2% and 2.4% in 2017. Although the mining sector has been weak there are other sectors are showing positive growth trend such as non-mining exports. The communication sector, utility and infrastructure.
Unemployment which until now has been resilient has shown lately the weaknesses and for this reason there shouldn’t be any interest rate hike this year. Inflation could also stabilize below 4%, a level that Central Banks feels comfortable with finishing this year with a level close to 3.3% to 3.5%. Loan growth in the banking system remains relatively stable. As of May, loans were growing at 8% year-on-year, as affected the growth rate of mortgage loans has been [indiscernible] but the positive growth of most non-mining sectors and the stability of employment has kept long term eProject spend [indiscernible] rate.
Asset quality has been improving, a reflect of loan growth of investor segment and a health corporate loan portfolio. For the entire year 2016 we continue to expect loan and deposit growth of around 7% or 8%. Now we will give further details into the implementation of our strategy and how it's benefiting our client activity on results this quarter.
Net income attributable to shareholders in the second quarter of 2016 decreased 17.1% year-on-year and total CLP116.3 billion, 3% in an ROE of 17.1%. As announced in last quarter's earnings call result in the second quarter included a onetime expense of CLP10.8 billion. Excluding this onetime charge the banks adjusted net income would have been CLP124 billion for the period and the adjusted ROE to reach our higher level of 18.3%. At the same time 2Q '15 figures were positively impacted by a relatively high inflation rate while in the second quarter of this year we had a more normalized quarterly inflation rate, these also track our stability as [indiscernible] in Chile has more assets than liabilities linked to inflation.
On the positive side, our business segment net contribution expenses is 15.5% year-on-year this metric includes all revenues, provisions and costs related with our clients excluding all non-prime revenues and expenses especially the impact of inflation. We think this keeps the better understanding of the underlying recurring profitability of our franchise and the thorough execution of our business strategy.
In terms of strategy the bank made important events [ph] this quarter in all of our four strategic objective. As seen in this slide, our strategy has circled around number one focusing our growth on those segments with higher risk adjusted returns, second, increasing client loyalty through an improved client experience and quality of service. Three, continuing our ongoing commercial transformation by extending the banks reaching the banking capabilities. Four, optimizing our stability and capital use to increase shareholder value with time. The rest of this webcast we will review the usual figures but at the same time we will give a little bit more color on the developments regarding customer activities and our digital banking capabilities which are helped into to boast our recurring results.
Regarding our first strategic objective, during the second quarter of '16, loans increased 1.8% Q-on-Q and 8% year-on-year, with high yielding retail lending expanding 2.6% Q-on-Q and 12.7% year-on-year. Consumer loan growth accelerated in the quarter and increased 2.4% Q-on-Q and 6.1% year-over-year still less by growth in the higher income segment.
Residential mortgage loans expanded 2.7% Q-on-Q and 16.5% year-on-year. As expected the growth rate with residential mortgage loans has begun to decelerate. The bank also continue to focus growing our mortgages with loan to value below 80%. Loan to smaller mid-sized enterprises SMEs also accelerating in the quarter and increase 2.7% Q-on-Q and 11% year-to-year. A sound management of risk and an important [indiscernible] revenues are accompanying the growth of loans to SMEs and therefore this segment continues to grow [ph] ROE despite lower economic growth. Loan growth in the middle market and in our large business unit has been less for us impart due to lower rates demand but at the same time given or commercial lift, given the commercial effort has been put under non-lending activities such as cash management, fees and tertiary services which boast revenues with very little capital use.
Loans to individuals increased 12.7% Q-on-Q and 13.2% year-on-year but with very different trends by sub-segments, loans to high income clients attended by our Santander select network increased 21.3%, loans to middle-income earners attended by our traditional brand network increased 7.9% while loans to the low income segment decreased by 11.1% year-on-year. These reflect the banks focus on driving growth in those areas with the higher risk adjust return and is in-line with Chile's slower economic growth.
The Bank's strategy of focusing equally on both lending and non-lending businesses has also led to solid deposit growth. Total deposit increased 2.2% Q-on-Q and 10.3% year-on-year. Time deposit increased 2.2% Q-on-Q and 11.3 year-on-year, this growth came from our customer segments as well as wholesale deposits from situational sources.
The higher levels of liquidity in the local market led to improvement in spreads earned over deposits from wholesale investors. By this Santander Chile continues to be one of the bank with the lower exposure to short term wholesale deposit as a percentage of total funding. Non-interest bearing deposits increased 2.2% Q-on-Q and 8.7% year-on-year. This sustained growth is a reflection of our strength and cash management and services with companies and our focus on non-lending activities with our customers both retail and cooperate. Despite the most selective approach to loan growth we’re gaining market share close [indiscernible] the Chile market. The first five months of the year we increased our market share in terms of total loans by 40 basis points with a rise in share in consumer, mortgage and commercial loans.
In total deposits our market share went up by 60 basis points with rises in both demand and time deposits. As a result of all the above client net interest income increased 1.5% Q-on-Q and 6.3% year-on-year. As a reminder decline in net interest income -- net interest margin from our business segment and exclude among other things the impact of inflation.
Client NIM were stable at 4.8% for the third quarter in a row despite growing in less riskier segment, these has been a direct result of rise in asset spreads and an improvement in our funding needs. Total net interest margin which reached the 4.6% in the quarter should also remain relatively stable going forward as we expect inflation 4Q will be similar to current levels.
The change in the asset mix continue to improve asset quality. The second quarter of '16 the non-performing loans ratio improved to 2.2% from 2.5% in the previous quarter and 2.7% in the second quarter of '16. Total impaired loans, our broader [indiscernible] that includes non-performing loans and renegotiated loans, improved 10 basis points Q-on-Q to 6.3% and 40 basis points since the end of 2Q of 2015.
Total coverage of non-performing loans in the 2Q of '16 reached a 140.9% the highest levels since 2008. The cost operating in the quarter was 1.3% compared to 1.2% in the first quarter and 1.4% in the 2Q of '15 and in-line with our previous year guidance. Provisions for loan losses increased 7.1% Q-on-Q and 2.3% year-over-year in the second quarter. These Q-on-Q writes provision for loan losses was mainly due to higher provisions expenses in consumer loans as the bank continued to push forward its strategy of lower exposure to the low end of the consumer loan market.
You can take an active quality of charge off and bolstering coverage ratio in the low return segment. This implies that a greater amount of consumer loans due to charge-off's even though asset quality trends are improving. We should help to stabilize [indiscernible] our cost operating in 2017. The improvement in asset quality was visible in all products. The consumer loan NPL ratio improved 20 basis points Q-on-Q to 2.1% while the coverage ratio of non-performing consumer loans reached 307% as of June 30, 2015. At the same time the commercial NPL ratio reached 2.3% compared to 2.7% in the first quarter of '16. While the ratio of commercial non-performing loans, coverage ratio of commercial non-performing loans reached a 144% as of June 30. Mortgage lending, the non-performing loan ratio mortgage loans decreased to 1.9% in the 2Q from 2.2% from the first quarter.
The coverage of mortgage NPLs also increased to 41% as of June 2016, the highest level since 2008. Regarding our second strategic objective the bank continued to increase customer loyalty which is a key strategic goal as it creates sustainable and long term value for our shareholders. Loyal customers among high income earners, defined as clients with at least four products for meaningful usage and profitable level increased 8.7% year-on-year. The same indicator for SMEs and the middle market clients rose 12.8% however let it be safe that still our relative 15% of our customer base meets our defined loyal standards reflecting the large potential we have operated growth.
Several initiatives are driving this pricing loyalty. One of the most important is the improvement in customer satisfaction, we’re aiming to become the leader in customer satisfaction among our peer group, so for me we have almost closed the gap and we have already tied up our main competitor in an industry-wise survey. Our CRM has been a key tool to help not only to push our commercial activity but increase equality and speed of our service. This has been our campaign by a profound cultural indoctrination based on Santander's simple, personal and fair culture which we feel will help to really place the customer at the center of our strategy.
The second major initiative which is helping the boast customer loyalty is improving what we call customer journey. We have map out and defining [indiscernible] how will we relate to -- and treat our customers from the very moment in each day their relationship with us. This implies defining and developing an attention model at every point of contact with the client. This is an ongoing process which is also boasting our loyalty going forward.
Greater customer loyalty is driving fee growth, fee income increased 9.6% year-on-year in the second quarter of '16, we see in retail banking 5.6% and in the middle market they rose 17.2% year-on-year. The driver of fees in this segment was our core product such as credit and debit card fees as well as checking account fee. In the global corporate banking these increased 101% year-on-year due to the recovery of the investing banking activity following a relatively weak performance in 2015. Another key strategic objective has been receiving our ongoing commercial transformation, by extending our [indiscernible] capability. These with the sense 360 degrees review of our product, attention model, channels and prospects to better align them with the needs of our customer.
As part of these efforts, since 2013 we have been engrossed we have been engrossed in an ambition project of redesigning and testing new distribution model. Three years ago we took the first steps at performing our branch network away from a modeling reaching an important percentage of transactions carry out added little value and cost relatively high to our branch network more focused on profitable client activity. They are same people who enter our branch, eight are non-client performing unprofitable transactions that’s just paying bills. By 2019 our aim is to transform our network into two business centers with a more intelligent layout in which employees are engaged creating value and hopefully removing all unprofitable transactions out of the branch.
So June 2016 we already have 45 branches under our new model. These branches have already begun the most profitable product in the network. This has been a campaign by a total production in the number of branches especially in the low income segment and among payment centers. These process of branch closure plus the improvements in connectivity will help to fund our investment program. As we said in the recent shareholder meeting, we expect to invest approximately $140 million per year in 2018 in this process which should boast customer loyalty, productivity and efficiencies.
[Indiscernible] from transforming the brick and mortar branch layout, we’re expanding our digital banking capabilities, so as of June 2015 we had 2000 digital clients up 7% year-on-year. Until now our strength has been in internet banking in which we have 8.5% market share twice the level of our main competitors. Certainly our focus is on expanding more phone banking. In the first half we launched the second version of our bank app [ph] which has more functionality than it's more personal. At the same time we launched Click 1, 2, 3 which allows clients to pay consumer loan less than five minutes through app or the webcast with no paper work whatsoever. This was a key product that will help us to accelerate consumer loan growth in the quarter as already mentioned. This transformation has already boasted [indiscernible] is we started this process we have closed 65 branches and the total volumes per branch has grown 61%, we believe that this trend should continue in time contributed into increased operation and excellence and contain cost growth. The second quarter here for example, operating expenses increased 4% year-on-year, the lowest quarterly year-on-year growth in the last seven quarters.
Personnel salaries and expenses increased 5.1% during the period for 2Q, 2016, also the lowest rate in the last seven quarters. The bank has been reducing high level management position in order to mitigate personnel cost growth. These process has [indiscernible] greater severance payment including the one-time recognized this quarter.
Going forward the growth rate of personnel expense that should continue to decelerate as result of this cost cutting measures become visible. Administrative expenses decreased 2.7%, we saw this is due to three main reasons, first the appreciation of [indiscernible] outsources IT cost are denominated in foreign currency. Two, general cost cutting efforts and three, greater efficiency or distribution network as previously described. Finally, our client risk strategy should optimize profitability and capital and increase shareholder value in time.
In the first half of 2016, net income excluding the onetime severance expense already mentioned grew 6% year-on-year represented on an adjusted ROE of 18.2% slightly ahead of our previous guidance. The net contribution of our business segment was the driving force behind these positive results rising 11% during the year in the first half.
Retail banking network solution rose 11%, middle market net contribution was up 12% while corporate banking net results grew to 10% in the same period. The bank also concluded the first half with strong capital ratios, the core capital ratio of which 10.1% and the bank EIS ratio was 13%, the growth of risk weighted asset was 4% year-on-year, half of the growth of the 8% growth loans. The bank has being implemented a series of initiatives to control he growth of non-productivity risk weighted assets.
The bank also paid its final dividend in April equivalent to 75% of 2015 earning. The dividend yield was 5.3% considering the share price at the close of the record day in Chile. By this increase in payout the bank's core capital ratio increased 10 basis points year-on-year due to the bank's high ROE and controlled roles of risk weighted assets.
With this dividend, last share price application since the end of 2014, the APR price in Santander Chile outperformed several of our main LatAm peers reflecting the positive result, our strategies bring to shareholders despite being a relatively challenging period for bank.
In summary during the quarter the bank continue executing it's strategy and maintain a solid client business moment. Our ROEs has been moving between 17% and 18% we have maintained steady growth of client revenues and volumes coupled with better service and loyalty indications. We have also been able to gain market share both in the lending and deposit business. Asset quality keeps improving and cost growth starting to decelerate given the different initiatives the bank has implemented. This shows our strategy is allowing us to succeed in the current mico-environment while saving the foundations for long term growth.
At this time we will gladly answer any questions you might have.
[Operator Instructions]. Our first question comes from Nicolas Riva with Citi. Your line is open.
My first question is on asset quality, so the NPR ratio improved 30 basis points quarter-on-quarter across all the segments, that looks very good. Now your NPLs came down in pesos of CLP73 billion and you wrote off CLP50 million for the NPL, for pension, what's actually negative CLP23 billion. However if you still booked CLP83 million, way above the NPL formation. My question really is why did you book this number of loans loss provisions, for example if I look at your coverage ratio now it's 140% which is high relative to your history. So maybe you’re been conservative in case the economic deteriorates but again my question would be why this level of loan loss provisions given improvement in NPR.
And then my second question on operating expense is you booked a CLP10 billion for this one time severance payments in the second quarter, but if I take that out your OpEx actually went down 2% year-on-year so what is behind this decline in operating expenses year-on-year and also if you’re going to be see more headcount reductions and more around payments in the third quarter? Thank you
Okay. Concerning to the first part there are two things there, number one is that as you the regulation has changed in many aspects, to some extent it's forcing banks to set provisions in many cases by passing your internal models that was the case in a large corporate lending where you’ve to set a minimum provision regardless of the status of the clients, it also happens with mortgages that’s knowing this year we started with a new provision model that you’ve to provision according to the standard models [indiscernible] or your internal model whomever is more conservative and accordingly we have guidelines that we have to follow that sometimes topple [ph] your provisions levels with the reality of your non-performing loan formation. So that is part of [indiscernible] that we’re forced to take provisions that they are probably not anything they need it. So that’s one element.
And the second element is that we have been as we have commented in the press release we have been forcing [indiscernible] in the low-end of the consumer market in anticipation of further deterioration of the macro conditions especially employment. So it's a mix set of prudents, we’re ready to take a provisions when you’ve the revenues to do so and secondly the regulations that are in some cases forcing us to set provisions that we think we don’t need it and that’s why the coverage ratio has been trending up. So it's something that -- at the end it's no problem to be conservative especially given that the macroenvironment is not at the stated level that most economies believe it should be in the economy. So that’s why it's prudent and regulation.
In terms of OpEx, I don’t know how you do the calculation but it gives you the sense of the trough [ph]. We allow operation expenses stated -- focusing which is the lowest level close to seven quarters or more, it's a combination of 3 or 4 things, one is as we comment through the call is the fact that we have been laying off especially senior management since the second half of last year and that has an effect in our ongoing growth rate. The second is dividend gain, because all this tools that we have implemented, foreign models, the CRMs and the new format that we’re implementing in the branches are improving efficiencies, productivity of our people and contact with client. And thirdly is a the fact that our expenses, our some expenses are linked to the U.S. foreign currency and given the fact the quarter is official appreciated that to some extent reduced the growth of our operating expense which from the bottom-line perspective is neutralized by the gains on the trading gains, we have hedged U.S. dollar position across our entire balance sheet.
In this line you see that -- so it's a combination of many initiative we have taken to control cost and also the fact that all the investment we have done in this IT and market intelligence are apparently starting to pay off.
One follow-up, Raimundo the CLP172 billion in operating expense is for the second quarter, is including the CLP10 billion for the one-time difference payments? It is right?
No. The severance expense was booked in other operating expense, it's not on the--
Okay, so that’s why you said that your operating expenses were up 4% year-on-year. Okay, understood. Thanks.
That’s right, we will be talking about the specific line for operating expenses that exclude this one-time--
Our next question comes from [indiscernible] with Scotiabank. Your line is now open.
I wanted to understand a little bit about the reversal that you registered in the mortgage segment about 4.3 billion and I wanted to understand what caused this reversal and if we should expect further reversals in the coming quarters and also going back to the question of severance payments, 10 billion, I wanted to know if we should expect further one-time expenses coming up until the end of the year. Thank you.
Okay, in terms of the reversal the mortgage business is, as you know we have model that our and sometimes the health of the loans is improved and that’s why sometimes you see reversal, there is timing -- last number of the quarter has been [indiscernible].
So it's not been unusual, we have been -- we’re moving into the upper end of the market the mortgage and the fact that we’re limiting those to zero, mortgage -- loan to value higher than 80%, at the end it represents -- you’ve a younger or better quality mortgage portfolio that’s resulting that so it's nothing really very important to mention -- it's sometimes happen our overall portfolio improves.
And incorporate as well, one more point, we’re also improving our recovery, so we’re doing a number of things to try to stabilize and not to have a track because of the mortgage -- remember that the [Technical Difficulty] is very low yield, low risk as well, that’s why no surprises sometimes we have different provisions because you simply improve your commercial effort and recovery effort as well. In terms of [Technical Difficulty] we don’t foresee that for the remaining of the year but of course it's something you normally do to get rid of [Technical Difficulty] but we don’t foresee extraordinary programs, but the one we concluded in second quarter.
So just one follow-up on the provision. I was under the impression at the end of last year that a level more reasonable for provisional expenses would be about a 100 billion, and you provide me wrong in the first and second quarter so I wanted to get some feedback how do you see this line? 1.3% cost of credit is reasonable going forward?
Yes, what happened is that if you back up a little bit we have been changing the mix for the last 3 or 4 years away from the low-end into the upper end and that has an impact in your gross already which is what we have seen in the last few years -- this margin has been trending down especially declining within this margin trending down be you’re originating new business at lower prices than the old portfolio. And then eventually you see that the spreads of the new business starts -- it's deemed the same or [indiscernible] which -- that moment by the end of last year, second half end of second half. So now on that’s what you see our net interest margin has been fairly stable, has been 4.8 in net interest margin in the last three quarters in a row reflecting that the suites of the mix is logical and concluded and as a consequence from now should be relevantly stable or pricing it your mix is a little bit better.
While the provision inside, the same movement as we expected but lag in time because of course the marginal growth that you originate doesn’t have a meaningful impact in provisions except once time passes and that’s why we think the downward trend on the cost of credit still has room to improve upon going forward. We have been hinted that probably next year should be something close to 1.2, 1.3 so we think there is room but of course the negative element is that the macro conditions have been weak so there are two clashing forces, one positive that the origination model that we’re using and the mix effect has been dominating but of course this is assuming our central market scenario in which the economic bounces, they are a little bit -- regarding their latest approach we have seen in the last years in -- or something similar, so again there are two clashing forces, one is beneficial because the new business much better in terms of quality and the [indiscernible] have a very quarter improved. However the negative force [Technical Difficulty] really soft and as a consequence -- we don’t know final result will be. We think that there are still room to improve and we recall that next year provision expense will be relatively low and as a consequence cost of very good will go down 10 to 15 basis point but again it's something that with more open due to the more uncertain marketable securities that we might face.
[Operator Instructions]. Our next question comes from the line of Carlos Macedo with Goldman Sachs. Your line is open.
Couple of questions, first question, the success that you had in implementing this new select model has been pretty impressive, have you seen any response from your competitors, are they trying to pursue similar models, are they going out of their way to retain their clients? I mean what has been the response? Because at this point you’ve enough of a track record there to show your success. Second question, I will ask after your respond to my first.
[Technical Difficulty] has been quite successful. We have been fortunate that -- only changes and [Technical Difficulty] but at the same time what we’re basically leveraging in a very successful product, in credit card has been very successful and as a consequence we had a number of many clients that have in the credit card, today through a new [indiscernible] mode you can offer them -- more growth supply of product with very high quality service and the CRM also have failed in the process. So we think we have a right approach for tackling this more demanding consumers, model, in terms of competition of course you see that the competitors are trying to have a credit card are comparable to ours but probably note it's as comprehensive as the one we have or things like that. So we have to rush things to get and the way to do that is basically by getting new ideas and new tricks and as we talked in the call these customer journey [ph] the starting point are usually the high end of customers and there we learn how to response etcetera and the CRM is more or less the same. It's a tool that is very nicely fitted for more demand in customers and also for more comprehensive clients that not only have a loan or a credit card but also have insurance, mutual fund etcetera. So if you want to know what's going on with the risk, but at least in our case we think we have a proven model that is delivering goods results and now the challenge is how to kind of move down market with what we have learned in the other market.
Now second question, you highlight that you’ve 45 branches in the new model and you aim to push out more branches in this model because obviously they are a lot more profitable and makes sense. What are the costs associated with expanding and building out these branches, is it something that we should expect to see your expense line in the next 2 or 3 years?
No, because today the bulk of the kind of one-time expense have been assumed most of the changes are related with the IT investments simplifying your process, [indiscernible] to the largest sense. From now on what you can start doing is changing the format of the brands for cost involved but it's not meaningful and that’s why we think that we can't contain the cost growth by financing most of the new investment and expenses, replacing expenses does that was really incurred or by releasing square feet, the branches we closed and replacing by the new square feet of branches where it's needed, so tune in. So we don’t foresee a net increase given that most of the heavy investments have already been done in the last 2 or 3 years.
I'm showing no further questions at this time. I would like to turn the call back to Mr. Raimundo for closing remarks.
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.
Ladies and gentlemen thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great weekend.
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