Banco Bilbao Vizcaya Argentaria SA (BBVA) Q4 2016 Results - Earnings Call Transcript

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Banco Bilbao Vizcaya Argentaria SA (NYSE:BBVA)

Q4 2016 Earnings Call

February 01, 2017 3:30 am ET

Executives

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Analysts

José Abad - Goldman Sachs International

Alvaro Serrano - Morgan Stanley & Co. International Plc

Francisco Riquel - Alantra Equities Sociedad de Valores SA

Carlos Cobo Catena - Société Générale SA

Andrea Unzueta - Credit Suisse Securities (Europe) Ltd.

Stefan R. Nedialkov - Citigroup Global Markets Ltd.

Rohith Chandra-Rajan - Barclays Capital Securities Ltd.

Daragh Quinn - Keefe, Bruyette & Woods, Inc.

Sofie Peterzens - JPMorgan Securities Plc

Mario Ropero - Fidentiis

Mario Lodos - Banco Sabadell

Carlo Digrandi - HSBC Bank Plc

Adrian Cighi - RBC Europe Ltd.

Ignacio Cerezo - UBS Ltd.

Juan A. Tuesta - JB Capital Markets Sociedad de Valores SA

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Good morning, everyone, and welcome to the Fourth Quarter 2016 Results Presentation of BBVA. I'm Gloria Couceiro, Global Head of Investor Relations. And here with me today are Carlos Torres, Chief Executive Officer of the Group, and Jaime Saenz de Tejada, our Chief Financial Officer. As usual, Carlos will begin with a presentation of results, a few words on the successful deployment of our strategy and some highlights by business areas. We will move straight to the Q&A after that.

Let me take the opportunity to remind you that, as it was the case in the last quarter results presentation, we will be conducting a live Q&A. We would appreciate all the participants to try to make the calls from landlines and avoid using the speaker phone so that we can hear you as better as possible.

Now, I will hand over the call to Carlos. Good morning, Carlos.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Good morning, Gloria, and thank you. Good morning, everyone, and welcome to BBVA's fourth quarter and full year 2016 audio webcast. I can say that we have had a good set of results in the quarter and in the year. Bottom line in the quarter of €678 million impacted, as you know, by the provisions we had to make for the mortgage floors claims. Excluding this item, the results in the quarter would have come out at €1.1 billion, almost, €1,082 million.

And as you can see, during the year, we have maintained a strong upward trend over the quarters. We started off low, you might remember in the first quarter because of the impact of the oil price and seasonal effects. But then we had extraordinary second quarter with some items like the Visa disposal there and finished off very strongly in the third and this fourth quarter, save again for the impact of the mortgage floor clauses provision.

For the entire year, the bottom line came up to €3,475 million, again, good results despite the fact that it was a tough environment in 2016 again because of the low rates and softening growth in some of the geographies where we're present as well as some unusual provisioning. Excluding the corporate operations that we also had last year and the impact of the mortgage floors, we grew slightly in the year from €3,857 million to €3,879 million, which is very good news because it means we have been able to absorb a significant impact of the FX depreciation, which was in fact €415 million net impact coming from that, net of hedges, I mean.

The highlights for the results in the year are the positive performance of the net interest income which grew by 7% in constant euros versus 2015. Secondly, the effective cost control efforts that we have put in place, we have been commenting during the whole year how important this is as a priority, and we're satisfied with the results so far. We have positive operating jaws, efficiency rate over the year has improved by 51 basis points to 51.9%.

Third, the asset quality indicators are also improving. Cost of risk year-to-date of 0.84%, 22 bps down from last year. NPL ratio, 4.9%, coming down by 48 basis points. And finally, we have strong capital generation in 2016, 58 basis points to a solid 10.9% Core Equity Tier 1 fully loaded ratio at the end of year, thanks to the strategic focus that we have also put during 2016 on capital optimization, which is also bearing fruit.

The yearly numbers that you can see in this page, I already mentioned €3,475 million net profit. That represented a growth of 31.5% versus a year ago in current euros. But that was, of course, affected by the negative impact we had in 2015 of corporate operations, mainly the additional stake we took in Garanti and the associated loss that we took then. If we consider Garanti on a like-for-like basis and we exclude the FX impact, results in the group have grown by 3.6% versus prior year, also taking out that extraordinary effect of the corporate operations in 2015.

As you can see, we have good trends in both revenues, which grow at 7.7% versus a year ago, and in costs as well which grow at 6.6% resulting in a pre-provision profit of €11.9 billion, growing at 8.9%, again, with Garanti like-for-like and in constant euros. The impact of the floor mortgage clauses provision has been partially offset by lower impairments and by lower restructuring costs in Spain. And as I already mentioned, excluding the mortgage floors, the bottom line grows significantly. In fact, in constant euros, it grows at 15.6%, again, with Garanti like-for-like.

I would also like to highlight before we go down into the details of the profit and loss account the shareholder remuneration policy. As we have seen, we have the intention to implement the shareholder remuneration policy that we already announced in October 2013, which is to move to a 100% cash dividend.

The last scrip dividend would then be paid in April of this year with the intention of paying €0.13 per share with the scrip dividend, which will be our last. And then we would be moving to a 100% cash dividend with the intention of maintaining that payout in cash that we announced of 35% to 40% of the results obtained in each financial year.

Also, we'll be moving to two payments per year. Tentatively, those will be in October and April instead of the current four ones. And with all of this, we align our dividend with our results in a clear, sustainable and predictable way so that the dividends will grow as our earnings grow. We also avoid further dilution with scrips that no longer enjoy the tax benefits that they have had for retail shareholders.

The quarter, back to results, the fourth quarter itself consolidates the trend that we were seeing in prior quarters. First of all, the net interest income grows at 7.4% in constant terms versus the same quarter of 2015. And we have here better performance in all of the countries, all of the geographies. In fact, the NIM improves in the quarter in all of the geographies without exception.

Secondly, efficiency improves with positive operating jaws. They were flattish in the third quarter. So gross income growth grows at 7.7%, while costs at 6.6%, and a quarter ago, those were 7.0% and 7.2%, respectively. So, good opening of the jaws.

Asset quality indicators show a sound risk profile with quarterly cost of risk decreasing 35 bps versus a year ago due to lower impairments. And finally, the capital ratios, I already mentioned, remain strong, 10.9%, fully loaded ratio; 12.18%, phased-in, which is the requirement and – is the terms in which we have the requirements set; and the leverage ratio of 6.49%. And this strength in capital ratios is despite quite heavy market-related impacts in the fourth quarter. Now, I already mentioned that prioritizing return on capital is one of our key focus areas. And for the coming year, we maintain our target of 11% Core Equity Tier 1 ratio.

The fourth quarter numbers in more detail. Profit of 678% (sic) [€678 million], an 18% drop versus a year ago in constant terms, impacted by the mortgage floors. If we net out the provision, then the result would be €1,082 million with a growth rate of 15% in current euros, 29.5% in constant euros. I would highlight from this page the growth rates of gross income. You can see 9.7% in constant terms versus the growth rate of the operating expenses, 4.9%. It's very visual here that – how the jaws are widening in the quarter.

If we look a bit more detail into the revenues, the gross income, that is – has the highest net interest income of the last few quarters of the series, €4,479 million, growing at 7.4% versus a year ago. And you can see it's quite a remarkable trend over the year. Net fees and commissions growing by 2.5% even though fees in the quarter are down 1.4% due to lower market-related fees in our Corporate and Investment Bank.

Those are not very good numbers. Here, it's really an area of focus especially in our Spanish business to improve our fees. And we expect to do that in 2017. It's critical given also the low interest rate or negative interest rate environment in the Eurozone. Net trading income was also strong, €413 million. Going back to more normalized levels, we had positive one-offs in the second quarter, the Visa disposal, CNCB in the third quarter.

In this quarter, the net trading income is impacted negatively, in fact, due to a reclassification between NTI and other income and expenses in Venezuela related to a change in an accounting criteria of how we value the U.S. dollar portfolio that our bank in Venezuela owns. So, instead of going through the bolívar and then back to euros, we go straight. And therefore, we have less net trading income and also less correspondingly negative effect on the other income and expenses – or positive effect on other income and expenses, netting that out. And the total for that in net trading income in the quarter is €99 million.

And then in terms of gross income, it's solidly growing at 9.7% versus a year ago. In the entire year, the growth of our revenues, as I already mentioned, is 7.7%.

Moving on to costs. I already explained in our presentation a quarter ago that I have put costs as a clear management priority for all of our businesses and all of our areas, management areas. We are focused on improving efficiency everywhere. It's not only about cost reduction, but it's also about gaining operating efficiencies in processes in our distribution model, really embracing automation, et cetera.

The good news is that I'm very satisfied with the results. I already mentioned the evolution of expenses in the year is good, positive operating jaws in the quarter, costs increasing below earnings, efficiency improving to a 51.9%, coming down 51 basis points, significantly below the peer group average at 66.2%. And we have some examples here of the ongoing efficiency initiatives.

I would highlight in Spain that we have brought forward, as announced, the cost synergies associated with the CatalunyaCaixa integration. Those have started to materialize already in the fourth quarter and they will be fully materialized in 2017. We not only have been closing branches and reducing head count, but also optimizing our corporate structure, reducing legal corporate expenses, incorporating also Uno-e and Depositary Bank, et cetera.

I would also highlight big cost reduction efforts in the U.S. We have been reducing our staff in our Corporate and Investment Banking business. We have also been optimizing our branches, reducing positions through attrition in the retail network and exiting some markets in the commercial business in the U.S., closing down some LPOs, some loan production offices, in places out of market in Seattle, in San Diego, in Columbus, really also, as a result of our increased focus on profitable growth, but that has allowed to reduce costs as well.

And then in Mexico, in Mexico, of course, we have invested heavily in years past in the Ulysses program, Experiencia Única, in our branches. Now, we see a lot of the competitors are following behind maybe what we did three, four, five years ago. But now, in Mexico, we're reaping the fruits. We are also taking additional measures to reduce cost and increase our efficiency, both in the network also by promoting the use of digital channels, do-it-yourself, which is taking a big part of the load of the increased transaction load, and other initiatives in the corporate center, reducing staff levels there, optimizing cash management movements, well, many other initiatives, as you can see in other regions, which I will now comment on right now, but would be happy to take your questions.

With that, that evolution of revenue and cost, the operating income reached over €3 billion in the quarter, grew by 15.5% versus a year ago, supported, as you can see on the right, by a solid growth rate in Mexico, 22.8%; also in Spain, 17.2%; double-digit growth in the U.S., 11.9%; a bit lower in Turkey, 6.2%. We had, in Turkey, lower net trading incomes, and we were impacted by the lira depreciation on expenses that are denominated in U.S. dollar. And we had a slight drop in South America, 3.2% drop, also the impact of high inflation in the costs was noticeable in the quarter in this region.

Moving on to the asset quality, very good news in general, positive trend in the global risk metrics throughout the year. Impairments, €993 million, lower than the prior quarter. As you can see, it's the lowest in the time series, decreasing 8.1% versus the same quarter last year.

The cost of risk, you can see that comes down in the quarter to 0.8% due to better evolution pretty much everywhere. In Spain, though, there has been a reallocation from loan loss provisions in the banking activity to increase provisions in the real estate foreclosed assets in order to better reflect the risk profile of the two portfolios, no material impact of that reallocation at the group level. But that's what also explains partially the drop in the cost of risk. If you see the cost of risk, including the real estate impairments, which is the dark blue line in the chart, the improvement trend is maintained, but it's smoother, down to 0.9%.

NPLs decreased by €2.4 billion in the year to €23.6 billion, and the NPL ratio decreases as well to 4.9%. Coverage is down to 70%, affected mainly by that reallocation of provisions to real estate foreclosed assets that I just mentioned and out of sort of the credit NPLs. But overall, as I say, strong key asset quality indicators.

In capital and looking at the evolution of the fully-loaded ratio, we have been able to grow our fully-loaded ratio by 58 basis points since December of last year, reaching that 10.9% at year-end. In the quarter, it has come down by 10 basis points. We had a contribution of 19 basis points of net earnings, impacted, of course, by the floors. Dividends take out 7 basis points, and then we have in others of 22 basis points. That has a lot to do with the evolution of markets. On the one hand, the steepening of the yield curve and the rising rates since September, and on the other hand, the appreciation of the U.S. dollar since September.

Both of these effects, though, are positive for our business and they're positive for our P&L going forward, but they do have a negative impact on the Core Equity Tier 1 fully-loaded ratio because of the higher value of our exposure to U.S. dollar risk-weighted assets and because of the mark-to-market of the available-for-sale sovereign portfolios.

It's also worth mentioning that, this quarter, we achieved the regulatory equivalence in Turkey, and that added 15 basis points, and that allowed us to compensate the negative impact of the mortgage clauses, the mortgage floors clauses. That effect is partly included in the net earnings, as I just mentioned, but also, that provision has increased our capital consumption associated with operational risk. And that's in the others bucket.

Going forward, I already mentioned that we maintain our 11% target for 2017. And as always, I would like again to highlight the high quality of our capital. We remain as the bank with the highest risk-weighted asset density, 53%, and the highest fully-loaded leverage ratio, 6.5%, of our European peer group.

In addition to the good results, it's also good news on the transformation strategy on our progress, on our journey. Quickly, as in prior quarters, we have grown our digital customer base, our digital sales, and we are delivering on the customer experience front in this quarter. Digital customer growth base is up to 18.4 million customers, growing 20%, with a 38% penetration on our total customers. Mobile customers grew even more by 38% and are up to 12.4 million customers, a 25% penetration.

Digital sales, remarkable progress everywhere and in every quarter and pretty much doubling the numbers we had a year ago, like in Spain, 17% versus 8%; Turkey, 26%; South America, 15%; and Mexico, 11.9%, we only had 6.2% a year ago; or in the U.S., 19.9% versus 9.3%.

We also like very much the results of our Net Promoter Score surveys that we do every six months in the open market, asking customers and non-customers whether they recommend the bank. So, we measure the Net Promoter Score. And we're happy to say that, again, we are number one in 7 of our 11 markets. We want to be the number one in all of them and we're working hard to do that.

This is the improvement, and the fact that we reached that level is very related to our digital efforts. I think Spain is a very good example. That's why we're zooming in some metrics of the Spanish NPS survey. If we look by channel, for example, we are number one versus our peer group in the four main channels through which our customers interact. And I would like to highlight the mobile app. It's really all about being mobile first, and there we've made a great effort in 2016. Not only are we number one with a 63% Net Promoter Score, but we have improved that score by 20 points in the year. So, going up from 43% to 63% in just one year.

And we have done that by introducing improvements every quarter. We have been talking about working in agile and having improvements in customer experience, new products, new functionalities to improve that experience every quarter. Let me share a few of those in different geographies.

In Spain, for example, this last quarter, we were the first bank to launch a digital onboarding process, fully digital on the mobile. It only takes less than five minutes to digitally become a BBVA customer fully onboarded with a working account that you can immediately fund. Thanks to advanced biometrics techniques, it's an easy process, fast, completely do-it-yourself, and it's a good example of those quarterly improvements that I'm talking about. So, this was launched this past November.

Another good example is in Mexico, our digital auto credit. So, in Bancomer, you can simulate auto credit from your mobile phone. You can make the application from the mobile phone and this is open both for our customers, Bancomer customers as well as non-customers, non-clients that can do the simulations and actually buy that credit loan from their mobile phone.

Another good example. In Turkey, we have implemented a new mobile platform to empower our sales force. We launched what we call STEP, which really takes our customer relationship platform and makes it 100% mobile. So, our staff can literally take the bank with them, the workplace. But beyond the workplace, the bank in the tablet or in the mobile phone, so they can serve their customers independently of location, independently of time. They have a complete view of the daily to-dos. They can run their schedule without having to come to the branch and really improving efficiency.

We have gone from almost 200 screens in a traditional banking platform that we have at the branch. So, basically 15 tabs in the STEP customer profile that are enough to do anything that you might want to do with the customer. Effective customer service, saving time, supporting additional sales at the customer, what the customer wants to be really. And these are just three examples.

But as you can see in this page, we have delivered many more. These are just the ones that we launched in the fourth quarter. These are really the small things, the revolution of the small things for our customers, really focused on helping our customers interact with the banking in easy way and helping them make their best financial decisions they can make in their life or in their business. This is really what's behind the Net Promoter Scores, being able to launch such improvements.

So, as you can see beyond the good financial results, we had great progress in our transformation journey. You might recall that we have defined more than a year ago six strategic priorities that really want to make our purpose to bring the edge of opportunity, bring it to life, really people supporting businesses in their financial decision-making, creating opportunities for people.

And those six priorities have been the focus of our work this year in 2016, quickly going one by one, new standard in customer experience. I already just mentioned how we deliver new products, new functionalities every quarter improving customer experience and how we measure that through NPS. Digital sales, we're growing our digital and our mobile customer base and our digital sales rates as well.

New business models, we own Simple as you know. Simple is growing very well, acquiring customers now, more than 30,000 per month with very low cost of acquisition, with rising NPS, over 50%, it's 54% their NPS. Atom is well above plan. The mobile-only bank launched in this year, this past year in 2016 in the UK where we have almost a 30% stake. We acquired Holvi in the year. We acquired Openpay recently in Mexico, a leading online in-app payment platform. We're developing and growing internal ventures of different types, our open platform initiative, et cetera. So, as a result of those new business models, we will have strong new revenue streams.

Fourth, capital allocation, I've insisted quite a lot in our calls, quarterly calls, so you know how important this is to ensure that we assign capital where there is return and this has helped generate those 58 basis points and we're on track to achieve our goal of maintaining that 11% in 2017.

Unrivaled efficiency, I've already mentioned the ongoing cost control efforts throughout the footprint and the culture that we have of monitoring cost and reinventing how we do things; also leveraging technology, automation, robotics to do that; transforming our distribution model, our operations with our new operating system. And as a result, we have seen those positive jaws in 2016.

And finally, our talent pool, our people are a first-class workforce. We are creating a purpose-driven, agile organization. We're working in a different way, project-based, much more dynamic, much more collaborative, people from different departments working together, much more results-oriented. Also happy with the progress there.

Moving on to the business areas. In Spain, banking activity, net profit in the quarter were negative €24 million impacted by the mortgage floor clauses provisions. Excluding that effect, we have strong growth of 19.9%, also in the year 21.2% due to the lower impairments and restructuring costs.

And the trends in the P&L continue. We have pressure on revenue, pressure on core revenue. We have a decline in net interest income of 2.9% versus a year ago. This is in line with the guidance that we shared in October, and it has to do with the negative rates with the lower activity and the decrease in spreads due to the Euribor and also the lower contribution of our securities portfolio.

Fees are down by 6.5%, affected by, I already mentioned, by the Corporate and Investment Bank and market-related fees. Our commissions here do not include, however, the ones associated with insurance that our competitors do include in this line, and we actually report them in the other income and expenses. If we were to include them as our competitors do, the decrease would be of 2.9%. Still not good numbers, and as I already said, we'll be working on that.

But overall, it's a challenging top line in Spain. Good on the cost control efforts; expenses decreasing quarter by quarter by 2.4%. And the growth in the year of 4.4% has to do entirely with CatalunyaCaixa integration. Otherwise, they would be actually coming slightly down. Impairments are lower, partly because of the reallocation of provisions that I mentioned earlier, which show in higher provisions. But overall, the trend in impairments is positive. I already mentioned the mortgage floor affecting the bottom line, which for the entire year came out at €912 million.

Activity, lending continues to drop 2.9%, driven mainly by the public sector and residential mortgages. Consumer portfolio, however, you can see is growing nicely. Although it has low weight in the total portfolio, it's growing at 15.5%. Customer funds, good performance of – good growth of demand deposits with a good mix, good change in mix. Also, growth in mutual funds and pension funds, which is a change from other quarters.

Key ratios in Spain, good focus on price, but the environment is difficult. So, our spreads have actually come down to 1.8%, 3 basis points down, mainly and entirely due to the Euribor repricing that more than offsets the positive, the good spread management that we have had.

Risk indicators are good. NPL continues to improve 5.8% reduction of NPLs of more than €2 billion in the year to €11.8 billion. Cost of risk improves significantly; in fact, it's zero in the quarter due to the reallocation of the loan loss provisions that I mentioned. But as I already mentioned also, it's good underlying trend as well in impairments, even excluding that reallocation of provisions. The coverage decreases mainly as a consequence of this reallocation of provisions already mentioned; it decreases to 53%.

And then in terms of costs, I mentioned very good news in the quarter, down 2.4% changing the prior trend. We started to materialize the synergies from CatalunyaCaixa after the integration in September and we will fully achieve those in 2017. Remember, those were €200 million. And costs will continue to be an area of focus in Spain in 2017 as everywhere else.

Real estate activity. We have increased impairments due to the other side of the reallocation that I mentioned before, mainly in the land portfolio, which is the portfolio we have provisioned further. These are very liquid assets with very limited market references to estimate fair value, and other coverage in the land portfolio has increased from 67% to 74%. And the total coverage for real estate assets increased from 59% to 63%.

Due to the increased provisioning levels, the losses in real estate activity have been higher, €595 million. Without the reallocation, they would have been €459 million versus the €496 million that we lost in 2015. We have decreased our exposure. Net exposure went down to 10.3%. It was down by 16.8% in the year. And we continue to see better dynamics in the market with demand and price both behaving well and increasing.

Here, we're working on reshaping our sales strategy, trying to be more proactive in reducing the exposure to go faster, reduce it as soon as possible using all available channels, provided also that we achieve the right price so as to maintain economic value of the assets. But we will try to go faster.

Overall, in Spain, net attributable profit was €304 million loss in the quarter, affected by the mortgage floor clause provision and also by the fact that this quarter, we have the contribution to the deposit guarantee fund, which we don't have in other quarters. In the year, the overall in Spain profit was €360 million including the mortgage floor provision. Excluding that, it would have been €720 million, 22.2% growth.

Moving on to the U.S. Quarterly results, €157 million, up 29.3%. Upward quarter-on-quarter trend. Sound recovery from a very weak first quarter because of the oil and gas. Strong performance of recurring income in the quarter and in the year in terms of NII mainly due to asset repricing and focus on profitable segments. We had some raises in interest rates and commissions supported by the CIB business.

Costs also very well down, 0.6% in the quarter. Positive evolution of impairments. The best quarter of the year, reflecting better performance of the oil and gas portfolio on the back of higher oil prices. And overall, net profit, €459 million, down 11.5% basically due to higher provisioning mainly in the first quarter.

Activity. Slight decreasing activity, 1.7% down in loans, mainly mortgages. Also, we're searching for profitability and loan growth. That's our key strategy. We really want to invest in maximizing the return of our capital. Customer funds grew by 1.7%.

Key ratios. Spreads consistently going up quarter-by-quarter, over the year from 3.1% to 3.3%. Here, we're being successful in repricing and taking advantage of the rising interest rates. Good outlook in the year as our balance sheet has very positive sensitivity, as you know, to interest rates are going up.

Risk indicators, very good this quarter. Risk profile improving. NPL ratio down to 1.5%. Low NPL rate entries. We have some sales portfolio. We have some recoveries in the quarter as well, mainly in oil and gas and basic materials. And that leads to high coverage level, 94%. And as you can see, cost of risk, a very low 0.1% in the quarter. And overall, in the year, 0.4%, better than we expected.

And in terms of cost and efficiency, still ways to go. It's not where we like it. But the cost efforts during the quarter made the expenses behave well. They came down by 0.6% versus a year ago. And, clearly, efficiency will be a management priority in the U.S., and there's room here to improve from the levels where we are at.

In Turkey, an outstanding quarter and an outstanding year of our Turkish franchise of Garanti. Despite the very complex environment, we had net profit of €144 million attributable profit in the quarter, growing 26.4%, improving also quarter-by-quarter, 4.2% growth versus the third quarter. Good evolution of NII, 15.5% in the quarter, 10.6% in the year.

We actually had higher growth, but we had a change in the way we account for the swap costs. Before, we are used to account for them in the net trading income and now in NII. So, on a comparable basis, the NII growth would be 28% in the quarter and 21% in the entire year. Commissions are down. They're down 12.6%, very much impacted by commissions that we have to pay in U.S. dollars this quarter. Expenses growing in line with inflation, 7.8%, versus a year ago in the entire year and maintaining positive jaws. But we were impacted in the quarter by the depreciation of the lira on some dollar-dominated costs. Good evolution of impairments and excellent bottom line, as I mentioned.

Activity, solid growth 17.2% growth in loans. Depreciation also has an impact on this, but the underlying growth in lira loans is also very strong and, as you can see, in deposits as well, 15.1%.

Key ratios, customer spread, 13 bps up in the quarter, excellent price management offsetting the increase in the cost of deposits. Solid risk indicators; sound asset quality; NPL, 2.7%. Cost of risk coming down to 0.3%. Here, we have had a reallocation of provisions from retail to unfunded wholesale commitments, which are not included in the cost of risk that you see. The year-to-date cost of risk including the unfunded would be around 1%, so even better than expected. Coverage remained stable at 124%.

As for efficiency, we finished the year with 40.8%. So it's good cost evolution trend with a growth rate of 7.8%, very much in line with the inflation of costs despite the high growth and wide operating jaws, and that's why we were able to reduce our efficiency from 45.9% to 40.8%, clearly better than the peers as well in Turkey.

Moving on to Mexico. An excellent quarter again and an excellent year in Mexico, €556 million net profit growing 9.9%; NII growing 11%. Other income and expenses impacted by a positive one-off of €93 million in the insurance business because of some regulatory changes on technical reserves. But excluding this positive one-off, the gross income would grow double digit as well, 10.6% in the quarter.

Costs are under control, I already mentioned, widening jaws, 5.4% growth of expenses in the quarter. And in Mexico, as we have mentioned in the past, the main headwind is really the FX. The peso has depreciated very significantly in the year, 17% also since the Trump election in the U.S. We have a negative FX impact in current euros. But I remind you that we have good coverage levels in the peso. Our 2017 P&L is covered 50%.

Activity, activity growth at high levels, double-digit, in line with our expectation despite some slowdown in the macro. 13.3% growth in loans, 8.4% in customer funds mainly in demand deposits, so maintaining a good mix.

Key ratios, spreads, good evolution, plus 28 bps to 10.94%, quite impressive. The rate hikes are starting to translate to higher yields. Stable risk indicators, NPLs 2.3%; year-to-date cost of risk better than expected, 3.4%; good coverage, 127%. Gaining efficiency even though it's the best in the group, 35% versus 56% of the Mexican banking system, excluding Bancomer.

Wide open jaws in 2016, remember they were flat a year ago. No doubt, Bancomer is the leader in Mexico, best profitability, ROE, ROA and NIMs, outstanding efficiency, improving – even gaining distance to the peers. And we are confident that Bancomer will continue to deliver solid growth going forward despite the environment.

Finally, South America, €188 million net profit in the quarter, down 3.6%, impacted by high operating expenses due to the exposure to inflationary economies. €771 million net profit in the year, which is up 1.1% in constant terms. Good evolution of the core revenues. NII growing at double digit, supported mainly by Argentina, Venezuela and Peru. Fees, up 3.5%. I already mentioned the change in accounting criteria in Venezuela, which affects net trading income and other income and expenses in opposite ways. Cost growth was impacted by, what I mentioned, the inflation.

And in terms of activity, you can see that growth is decelerating, but still strong, 7% in loans, 14% in customer funds. Spreads evolved nicely in the year, up 23 bps to 6.50%. We had recovery in Argentina and lower cost of deposits in Colombia, and to a lesser extent in Peru. Risk indicators with a slight deterioration in the NPLs to 2.9%. Coverage, 103%, due to the macro environment. And year-to-date cost of risk has been better than the guidance we've provided, 1.1% in the year, positively impacted by the one-offs in Chile, Colombia and Peru.

And finally, efficiency, good efficiency levels, affected by the inflation, but 46.7%, also impacted by dollar-denominated expenses as a consequence of the depreciation of the local currencies. And just finalizing – I'm sorry, I've taken a bit more time than I wanted, it's wrapping up a good year, good 2016 in financial results despite the challenging environment, and as I say, significant progress on deploying our transformation strategy.

Let me give a bit of color on how we see 2017. We expect resilient results despite macro uncertainties that we certainly have around the world. In Spain, the main drivers of our P&L will be the reduction of provisioning and the cost control efforts. Again, we will be achieving fully the synergies coming from CatalunyaCaixa, and on top of that, we have additional efficiency measures we're working on.

In the U.S., NII growth, thanks to our positive interest rate sensitivity and the likelihood of rising rates, very important, our focus on profitable growth, very important as well to improve efficiency. We have a new CEO in the U.S., Onur Genç. He's very clear on the priorities there.

Mexico and Turkey, despite challenges, clearly these are franchises that will deliver solid growth in the local currency. We have significant hedges in place in Mexico, I already mentioned, 50% of the expected results. In Turkey, 70%. Regarding capital, the 10% depreciation of each of those currencies would impact our core equity Tier 1 fully-loaded ratio by 2 bps each, negative, of course.

South America, we hope to see macro recovery in our footprint and that should be supportive of loan growth. And overall, our diversification remains, we believe, a source of strength, competitive advantage in this uncertain world. We will maintain a solid balance sheet, 11% fully-loaded target for the capital ratio. Strong risk indicators once again.

And then, we are going to be continuing to progress on our transformation: stepping up customer experience efforts through quarterly improvements, quarterly, and new functionalities; digital sales also to non-customers; leveraging data and technology to support our customers in their lives, in their business, in their decision-making; launching and growing disruptive business models; and adopting a lean operating model. Overall, these levers will help us improve along the six priorities also in 2017.

And no more from me. Thank you very much. I give the floor back to Gloria. Gloria?

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Carlos. We are now ready to move into the live Q&A session. For the sake of time, I would like to ask all of you to limit yourself to one question per caller so that we can attend as many participants as possible. So, first question, please?

Question-and-Answer Session

Operator

Good morning, ladies and gentlemen, the Q&A session starts now. The first question comes from José Abad from Goldman Sachs. Please go ahead.

José Abad - Goldman Sachs International

Hello. Good morning. Thank you very much. Congratulations on your numbers. Only one question then, which has to do – obviously, in light of the potential changes actually in the trade and migration policies by the new U.S. government, how is the bank thinking now the potential impact of these changes?

On two of the key regions that you operate, one being Mexico where we've seen already an increase of around 10 basis points in Q4. We've seen also some slowdown in loan growth in competitors, particularly Santander, México and Banorte. And the other region being the U.S., given that actually you have a relatively high market share in the remittances business. So, therefore, any impact on immigrants here that impact your business there. So, I would appreciate any guidance that you could give us in terms of actually loan growth, cost of risk and revenues in these two geographies. Thank you very much.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Okay. Thank you, José. Thank you for the congratulations as well. No doubt that the situation in the U.S. associated with the election and the messages coming from the new administration have already had an impact on Mexico through the depreciation of the peso, as I already mentioned, mostly.

And we have already indicated in past meetings that the economy was decelerating. We just saw the numbers of the quarter yesterday, 2.2% growth, 2% for the year 2016. Going forward, we are seeing lower growth in Mexico, around 1%, but then we expect the economy, which is young, vibrant, to continue to grow afterwards.

It is uncertain what the policies will do to Mexico. Of course, they're talking about NAFTA maybe being renegotiated. They're talking maybe about tariffs at the border. They're talking about things that will have an impact on trade potentially or they could have an impact on foreign direct investments.

Given all of that, which are things that I think the market is factoring in, it is also true that the U.S. and Mexico are very linked economies, and they have a trade among them of more than $500 billion and such linkage will not be stopped going forward, no matter what we believe, so that, to the extent that prospects for the year's economy are also more positive given the stimulus that the new administration seems keen to introduce around the fiscal policy of various types, it is true that if the U.S. economy goes well, we believe Mexico will be doing well as well. They're just so linked.

In terms of our prospects and our guidance for the year, again loan growth will be lower but decelerating to high-single digits, we believe, with NII growing in line with that. Fees and commissions, around mid-single digits. We will continue to improve our jaws, so expenses will grow less than revenue in 2017 for Bancomer. We're looking at asset quality that will be relatively stable around the 350 basis points. And all of that would give a bottom line, which is high-single-digit growth.

And then the FX, as you know, we have coverage hedge of around 50% of the P&L for 2017. So, those would be the numbers for Mexico. The U.S. would be the other side of the coin. Things are looking in the U.S. more positive with the rising rates and with pickup in volumes. So, for us, that would mean slight loan growth. We would continue to focus on profitability over capital.

So, focusing on the more profitable segment, we would be changing our mix more towards retail, consumer loans and secured loans. And with all of that, NII would be growing around high-single digit. We, as you know, have very high sensitivity to rising interest rates. And the cost of risk would be around 50 basis points, so slight uptick, but explained by the change in mix primarily.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, José. Next question, please.

Operator

The next question comes from Alvaro Serrano from Morgan Stanley. Please go ahead.

Alvaro Serrano - Morgan Stanley & Co. International Plc

Hi. Can I just clarify – a question on revenues in Spain. Can you just talk about why the fees were so weak in Q4 and explain why? And also, the guidance for NII in 2017 and medium-term given the shape of the curve? And the other, just one clarification what you just said around – can you repeat what are your guidance for Mexico provisions, please? I didn't understand it. Thank you.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

So, Jaime, do you want to answer the first one?

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Sure. First of all, on fees, it's true that quarter-on-quarter, fees went down by 3.2%, the main reason being the capital markets business. Quarter-on-quarter, they are down by €18 million. That in itself explains fully then the reduction because the rest of the fees and commissions have behaved well. Mutual funds and pension plans fees have gone up by almost 6% during the quarter.

On the NII line, we are expecting similar behavior as we've seen in this quarter. We're expecting flat NII going forward for 2017. We're expecting a similar trend in volumes, still reduction in public sector portfolio and slight reduction also in mortgages, but strong increases both in consumer and in the commercial side. We are guiding for flat spreads during 2017. The ALCO portfolio will continue to decrease its contribution. As you've seen in the quarter, the size of the portfolio has decreased significantly in the year, around 24%. But NII will be impacted positively by both reduction in wholesale costs, funding costs, as well as the impact of the TLTRO.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

And on Mexico, sorry that – maybe I explained it wrong. But it's very simple. Cost of risk, we expect to be 3.5%.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Alvaro. Next question, please.

Operator

The next question comes from Francisco Riquel from Alantra Equities. Please go ahead.

Francisco Riquel - Alantra Equities Sociedad de Valores SA

Yes. Hello. Thank you for taking the question. I wanted to ask about the guidance in terms of capital. I understand the volatile nature of the AFS portfolio and the currencies. But if we leave that aside, if you can please clarify a bit more on the guidance, in terms of the organic capital generation that you expect. Any regulatory headwinds, the impact that may come, IFRS 9, et cetera? Or also if you are leaving yourself some room for M&A opportunities so that you maintain the flat capital ratio. Thank you.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Thank you. Our guidance on capital is very simple. It's the same one we have been giving for more than a year, which is to maintain an 11% core equity Tier 1, which was our target for 2017 and we have been hovering around those levels for the last two or three quarters. We have volatility. You've seen that over the quarters, given how market moves and affect our AFS and our FX, we do have a hedging policy that covers most of the excess over the natural protection. So, the impact of FX, it's reduced. I already mentioned in the call that it's a 2 basis point sensitivity to 10% depreciation of the lira and similarly with the peso.

And beyond that, we do have regulatory developments that are underway; IFRS 9 and Basel IV in particular. Basel IV was delayed. The meeting that was the Head of Supervision and Governor (sic) [Governors and Heads of Supervision] meeting that was set for January, as you all know. So, it's uncertain when that will be clarified. You know that BBVA has a strong position versus other banks in most of the things that are being discussed.

And regarding IFRS 9, it's too early to know what impact would be on capital. As you know, IFRS 9 would not be over the cycle having a meaningful impact, although it would be a way to recognize losses faster when the cycle goes down and then free up provisions faster when the cycle goes up but overall, shouldn't change things. And then, it's not clear either how that will impact capital, if there is need for more or less provisioning associated with that. We are also well-prepared in the sense that we're well-provisioned versus the incurred losses right now.

I don't know if I'm missing anything. Jaime, if you want to add...

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

No. I think that if you take the yearly perspective, we've increased our core Tier 1 ratio by 58 basis points, as you said in the call, in 2016. Out of that, almost 90 basis points come from net earnings. We have paid 32 basis points in dividends. And the other bucket which, as you said, changes every quarter on a yearly basis, it's only a positive of 1 basis point. So, with some volatility, as you said, if you take one year perspective, I think what it clearly shows is the focus that we have on capital, on profitability and the recurring nature of our growth rate.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Yeah. I think that would be the most important thing to highlight. And we have mentioned this repeatedly as well. Return on capital is one of the key priorities. One of the key areas of focus in the way we manage the bank in the whole cycle from planning and budgeting to really and then executing, including the admissions of operations, that should have prices that are reflective of the right returns on capital.

And by doing that, by focusing that way, we have been able also to be more conservative in our expansion of risk-weighted assets. And we will continue to manage in that way. We are not planning excesses of capital to then be used to M&A. So, we're not doing that. We're not planning that. That's not in the cards at all.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Paco. Next question, please.

Operator

The next question comes from Carlos Cobo from Société Générale. Please go ahead.

Carlos Cobo Catena - Société Générale SA

Hello. Thank you very much for the presentation. Sticking to only one question then, I will ask on mortgage floors. You've disclosed some worst case scenario of around €1.2 billion total impact of the mortgage floor activity, but you are providing for around half of that pre-tax. How confident are you that we won't have new top-ups of that reserve and could you elaborate a little bit on the risks that you are covering? Are you providing as well for the mortgage loans that have matured already or this is not covered? Thank you very much.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Thank you, Carlos, for your question. What – as we always do, we think we're taking a very conservative approach to accounting for these risks. As always also, we have an independent opinion from a third party that has analyzed the experience in many other instances, in which clients have asked for similar things with the bank and it's based on that experience that the independent auditor has suggested us to provision €577 million. We feel very confident and comfortable that that is the right provision to account, as of the end of the year, and we will not be expecting any further adjustments. The details of the calculation are very complex as they are – a lot of assumptions have been made, and I don't think it's worth it to get too much into detail.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Carlos. Next question, please.

Operator

The next question comes from Andrea Unzueta from Credit Suisse. Please go ahead.

Andrea Unzueta - Credit Suisse Securities (Europe) Ltd.

Hi. Good morning. I wanted to go back to Mexico. I understand the visibility here is limited for you as for anybody. But if you could comment a bit on the worst case or more negative scenarios that you, I'm sure, are contemplating as a possibility and the impact that that would have both on volumes and provisions. And really quickly, in the U.S., if you could comment on your expectations for cost of risk going forward given that the quarter was low. Thank you.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Thank you. Thank you for the question. It's hard to comment on a worst case scenario because then one sends may be the wrong signal. I would reiterate what I said. There are uncertainties but there is also a bright lights ahead, given the size of the economy, the youth of the economy and how vibrant it is and how competitive it is. And we believe there are also automatic correctors, including the currency that has depreciated so much that, right now, Mexico is even more competitive to export to the U.S. than it was just a couple of months ago. And that dynamic is hard to stop, so that acts really as quite as a protection in the sense for the activity there.

Cost of risk, for us, it's much more associated with the revolving. And given the strength of the domestic economy, one can consider that that could go higher, yes. But on the wholesale front though, things are, we believe, more stable in the sense that the Mexican book, it's limited in its exposure to the foreign currency. It's what – 15% or less in our case. And the companies that take such loans have natural protection and have behaved very well. So, we don't see much risk there.

So, overall, as I said, we expect Mexico to slow down to around 1% growth in 2017, the economy. That would have an impact on our loan growth decelerating to high-single digit but we do see the cost of risk will continue to be around 3.5%.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Yes. I think, Carlos, that the biggest buffer that we have in Mexico against any potential change in the macro expectation is the very significant customer spread that we enjoyed in the franchise. We have a customer spread of 11% and that offers a huge buffer to any potential asset quality deterioration that we currently are not expecting.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Yeah. There's another question, I think, on the U.S. cost of risk, 50 basis points.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Andrea. Next question, please.

Operator

The next question comes from Stefan Nedialkov from Citigroup. Please go ahead.

Stefan R. Nedialkov - Citigroup Global Markets Ltd.

Hi, guys. Good morning. If I may ask two half questions for a total of one question. The first half question, so to say, what is the hedging benefit that you saw in 4Q in millions of euros? And my second question, just looking at the Q-on-Q loan growth in Mexico, in euro terms I must say, corporate loan growth was very strong. Could you give us some color? Was it mostly multinationals or through domestic corporates? And how does that corporates loan growth break down into FX lending versus peso lending? Was FX lending growing a lot more or a lot less? And any additional color would be greatly appreciated. Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Okay. The hedging gains from the depreciation of the currencies, as you know, are accounted at the Corporate Center. It is true that we had a very good quarter in terms of net trading income at the Corporate Center and part of it had to do with the trading gains.

We do not disclose the actual number, okay, but just to give you some sense, in this line, we've also included €17 million coming from the sale of 0.22% of CNCB, okay, as opposed to the €75 million that we made in the third quarter. So, that gives you, I think, a good idea on more or less the size of the FX gains that we've accounted on the fourth quarter.

Regarding the volume growth in the quarter, we've seen a very strong quarter-on-quarter growth in Mexico that's reached around 4%. And it's mainly driven by two factors: very strong performance of the credit card business, it has grown in the quarter alone by 4%; and also on the commercial segment that has grown around 5%. Those have been the most significant drivers of volume growth in the quarter. The year-on-year rate, as you know, is almost 13%.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Stefan. Next question, please?

Operator

The next question comes from Rohith Chandra-Rajan from Barclays. Please go ahead.

Rohith Chandra-Rajan - Barclays Capital Securities Ltd.

Hi. Good morning. I'm going to stick with Mexico and Turkey, if that's okay. Just back on the hedging, actually, thank you for the update in terms of how much of the 2017 P&L is hedged for both. And for Mexico, it sounds like the hedging has increased from, I think, it was previously 40%, now it's 50%. It would be really helpful if you could tell us or give us some indication of the FX levels which of those hedges have been taken out to help us get some understanding of how that impacts the 2017 P&L? And for Turkey, are you able to give us some similar earnings outlook expectations in the same way that you gave us for Mexico, please?

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Jaime, do you want to comment on the FX levels?

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

We do not disclose, we've never had, and I don't think we will, the hedging levels under which we hedge our exposure. As you rightly pointed out, our P&L coverage right now stands at 50% for Mexico. In the case of Turkey, it's a little bit higher. It's around 64%. And as Carlos said during the call – the presentation, sorry, the impact on core capital remains at more or less the same levels as the end of September, around 70% in both jurisdictions. A little bit higher in the case of Turkey, something around maybe 84%, 85% and around the 70% mark in the case of Mexico.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Regarding the outlook for Turkey, I would defer mostly to what our CEO there, Fuat Erbil, mentioned yesterday in their announcement, which is that, certainly, we do have an environment which is more uncertain given things that are going on in the country, both domestically and in the surrounding region. And that has had an impact, of course, in the FX depreciation that Jaime was commenting on. But regarding loan growth, we continue to see around double-digit growth decelerating from the very strong 17% in 2016, but still around high single digits or double-digit growth in loans with NIMs flat.

And in terms of cost of risk, with a risk of deterioration, but we're seeing around 110 basis points for 2017 versus around 90 basis points or 87 basis points in 2016. But, as I say, given the environment, there might be a risk of additional deterioration in that number, but that's what we're planning for.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Rohith. Next question, please.

Operator

The next question comes from Daragh Quinn from KBW. Please go ahead.

Daragh Quinn - Keefe, Bruyette & Woods, Inc.

Hi. Good morning, and thanks for taking my question. The question on the outlook for Spanish loan growth. You highlighted you expected loan growth to be flat in 2017 with a recovery in corporate or commercial lending. Just curious, given the further decline in loan growth we've seen through the year in your numbers, and at a sector level, the ongoing decline in new business lending, particularly in corporate loans, and just if you could provide some color around your outlook for loan growth. And just a very quick comment on provisions in the Spanish real estate division, when do you expect that to go to zero? Thanks.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Okay. Thanks. Thanks for the question. I think we commented already on the Spanish loan growth. And we think we're going to see a 2017 which is going to be very similar to what we have seen in 2016. So, flat volumes, so a bit better there, but just flat performing loans overall and similar trends by segment. Jaime commented that the leveraging continues in mortgages despite the high growth in new production, but still not reaching the levels of the amortizing book, and deleveraging as well in the public sector. And that will be compensated with growth in the rest of the portfolios in consumer and in commercial.

Regarding the real estate, I mentioned in the call that, here, it's really a trade-off in a sense on how fast we want to run it off. Right now, the business as usual would be a runoff of the real estate portfolio, excluding our land holdings that would happen in a period of around three years' time. And that run-off would be done with positive results in the sale of assets that we have seen in the last couple of years already. We've been making in excess of €100 million profit in the sales of the portfolio on a running basis.

Now, this could be faster than those three years if we increase wholesale sales. Good example is this last fourth quarter, you've seen that, apart from the reallocation of provisions to the real estate portfolio to the land that I mentioned, we also have in the fourth quarter numbers some one-off charges that are associated with wholesale transactions that, in fact, are still in the making. But one of them, for example, is in the news today, Testa Residencial, we are contributing quite a significant portfolio of holdings. And there's a slight loss there that's already recorded in the fourth quarter. And we have others that have similarly been booked in the fourth quarter, but have not yet been executed.

If we accelerate that, there could be a faster period in which we reach zero, as you were questioning. And we think that, by doing that, in fact, we could minimize the total loss, but that might imply that we have higher losses in 2017 than with a more gradual approach.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Daragh. Next question, please?

Operator

The next question comes from Sofie Peterzens from JPMorgan. Please go ahead.

Sofie Peterzens - JPMorgan Securities Plc

Yeah. Hi. Here is Sofie from JPMorgan. Quick question, could you remind us what the 100 basis point increase in rates across all the regions, what impact it has on BBVA, and also give specifically for each country what it means? Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Okay. On 100 basis points increase, we'll have a positive impact of around a little below 10% in the euro balance sheet. This is significantly down from the numbers that we shared with the markets at the end of the third quarter. We are changing certain assumptions on the evolution – on the stickiness on checking account and time deposits, taking into account the huge movements that we're seeing between both lines.

In the case of the U.S., sensitivity is down to 6%, okay? For every 100 basis points increase, NII will go up by 6%. After the increase in rates that we've experienced the last few quarters, we are closing a little bit this sensitivity. And the situation in Mexico and Latin America remains more or less the same. For every 100 basis points increase, we have a positive sensitivity in Mexico of around 2% and along those similar lines in South America.

The only country, the only business, as always, where we have negative sensitivity is in Turkey. And for every 100 basis points increase, our NII will go down by between 5% and 5.5%.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Sofie. Next question, please?

Operator

The next question comes from Mario Ropero from Fidentiis. Please go ahead.

Mario Ropero - Fidentiis

Hello. Good morning. My question is on the net interest income of Spain. Did it include the income coming from the TLTRO-II cost savings? If not, when are you expecting to include these and what should be the impact from that? Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Mario, we have not included any revenue coming from the TLTRO. We are expecting to start accruing during 2017 and probably in the first quarter, okay. But no numbers whatsoever in 2016 figures.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Mario. Next question, please?

Operator

The next question comes from Mario Lodos from Banco Sabadell. Please go ahead.

Mario Lodos - Banco Sabadell

Hi. Good morning. Thank you for taking my questions. I'm sorry to come again from – to the NII on Spain and just this consequent question on my colleague, Mario, is I don't understand so much the performance of the NII in the fourth quarter, taking into account that the customer spread fell quarter-on-quarter, but the net interest income grew in the quarter. How is that possible, taking into account that the ALCO portfolio has been reduced by more than 20% of the year?

And the other question, if I may, is about the net interest income in U.S. Again, just quite a difference between the net interest margin increase quarter-on-quarter against the customer margin increase. Can you explain a little bit more how come the net interest margin is increasing by nearly 15 basis points with almost no changes in the balance sheet compositions? Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Thank you, Mario, for your questions. Yes, you're right. In the case of Spain, there's one missing piece, and the missing piece is the reduction in wholesale funding costs that we've been experiencing. This was also the case in the third quarter and remains the case in the fourth quarter that had a very positive delta. And then, always in the fourth quarter, we tend to have an increase in NPL recoveries, and that always affects positively the NII line.

In the case of the U.S., you're also right with the question. Customer spreads increased by 5 basis points in the quarter alone, 20 basis points year-on-year. It is true that NIM is positive and remains maintaining the positive trend. In the case of the U.S., the ALCO portfolio has grown by around €1.5 billion, more or less, during the year. So, we have a slight increased contribution from the ALCO portfolio, but we've had a one-off impact as of the fourth quarter. And we've had a reclassification of €18 million of other income to the NII line. And these are interest rates received from our reserves in the Fed.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Mario. Next question, please?

Operator

The next question comes from Carlo Digrandi from HSBC. Please go ahead.

Carlo Digrandi - HSBC Bank Plc

Yes. Good morning. I would like to go to slide 25 where you have the real estate activity. I understand the way the impairment reallocation has been happening, but the question is more, can you give us an idea about the dynamics of the net attributable loss to the real estate activity? It looks like the more you reduce foreclose and the exposure, the more losses you have. Probably, in reality, this is not the case. And maybe given the fact that you have a reallocated provision, the trend should reverse. How do I square the circle here? Can you give us an idea to understand what is going to happen over the next few years as long as you continue to reduce net exposure? Thank you.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Well, I think I commented earlier, so let me try to do it again. So, in a sense, we have a running activity of selling property more on a granular basis that is generating actually profits as we sell it, and that would take about three years to run off. Now, if we accelerate sales by selling the more illiquid assets or we do it on a wholesale basis even – like we have done in 2016 with Metrovacesa and we're doing now with Testa Residencial. Those are two good examples. Those are operations that do have some loss when we do them. It's around €27 million, I think, in the Testa Residencial case for several hundred million euro portfolio value.

If we do more of those, we would be cleaning up the book, in a sense, getting rid of an exposure that is not a core business. It's not something we want but something we inherited as we foreclosed. We would be getting rid of that portfolio faster.

So, that is really the main dynamic, and that is the main trade-off, speed versus recording the loss or taking a longer time and doing it in a more granular basis. You have to understand also that there is assets in that portfolio that are not so liquid. They don't have a clear market to know what the market price is, and that happens more as you tend to look at assets that are less developed, assets that would be sold through wholesale counterparties, like the examples I'm giving.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Carlo. Next question, please?

Operator

The next question comes from Adrian Cighi from RBC. Please go ahead.

Adrian Cighi - RBC Europe Ltd.

Hi there. This is Adrian Cighi. Thank you. I have a follow-up question, please. I might have missed this. But can you provide your view on the outlook for the cost of risk in Spain? Thank you.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Yeah. I don't think you missed it. It's going to be, we believe, less than 40 basis points excluding the real estate, which I just commented on. So, it's a slight uptick from the 32 bps we had in 2016, which of course were affected by the reallocation of provisions, the 2016 numbers. So, quite stable, 40 basis points.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Adrian. Next question, please?

Operator

The next question comes from Ignacio Cerezo from UBS. Please go ahead.

Ignacio Cerezo - UBS Ltd.

Yeah. Good morning. I have a question on Mexico. If I were to look at the loan spread of the country, it has been coming down quite steadily as rates have been rising. So, the customer spread is up, but the lending spread actually down significantly. If you could give us some color in terms of how much of that decline is attributed to competition? Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Okay. I don't know if we have the same numbers. But what we've discussed in previous calls is that, although we do have that positive sensitivity, not that much, 2%, as I mentioned before, to increase in rates, it tends to be negative at the beginning, okay? And we need at least four months for that positive sensitivity to kick in.

As rates have been continuously going up during the year, it has taken us a little bit longer to benefit from that positive increase in rates. And we started to see that in a more significant fashion in the third and in the fourth quarter, where loan deals increased 13 basis points and 35 basis points, more or less, respectively. So, we've seen a significant increase in loan deals in the last two quarters.

What remains impressive is that, even if rates have increased by over 250 basis points, the stickiness and the high quality of our funding sources in Bancomer has allow us to increase only our funding cost by 9 basis points. And that what explains the significant increase in customer spread during the quarter.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Ignacio. We have time for one additional question. Next question, please?

Operator

The last question comes from Juan Tuesta from JB Capital. Please go ahead.

Juan A. Tuesta - JB Capital Markets Sociedad de Valores SA

Hi. And thank you very much for taking my question. My first question will be on the wholesale funding side. If you could share with us what are going to be your wholesale funding issues, expectations for the coming years in regards to the upcoming MREL regulatory requirements. Should we expect to see BBVA using Tier 3 or senior non-preferred instruments for the purpose of fulfilling the buckets? And also, if you could give us your expectations, on general terms, on wholesale funding cost evolution in the coming years? Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Okay. We do not have yet sufficient clarity on what our MREL requirements are going to be. We expect to have that feedback from the SRB during the first half of 2017. But of course, we do expect some convergence between MREL requirements and TLAC. So I think we are starting to have a better idea on both the amounts and the eligibility of instruments where we've seen significant progress the last few months.

I think that, clearly, to do a senior non-preferred as qualifying MREL debt is an option. We are studying that possibility. As you know, we also have the Tier 3 possibility open, but we would like to issue an instrument that is as harmonized as possible with the rest of our European counterparts and, clearly, the senior non-preferred will, hopefully, be the way forward.

Wholesale prices, I think the dynamic still is for maturities to be more expensive than new transactions. We have a significant amount of maturities in the next three years at over €20 billion. A good portion of those are concentrated during 2017. So, even if we have a pickup in cost from MREL-eligible debt, I do still believe that the wholesale funding cost will continue to drive the NII going forward.

Gloria Couceiro - Banco Bilbao Vizcaya Argentaria SA

Thank you, Juan. We are now running out of time. So, as you know, the IR team will remain available to answer any questions you may have. So, thank you, Carlos. Thank you, Jaime. And thank you, everybody, for participating in this call.

D. Carlos Torres Vila - Banco Bilbao Vizcaya Argentaria SA

Thank you.

Jaime Sáenz de Tejada - Banco Bilbao Vizcaya Argentaria SA

Thank you.

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