Banco Santander México, S.A. (BSMX) on Q1 2021 Results - Earnings Call Transcript

Banco Santander México, S.A. (NYSE:BSMX) Q1 2021 Earnings Conference Call April 29, 2021 10:00 AM ET

Company Participants

Héctor Chávez - Executive Director, IR & MD, IRO

Didier Mena - CFO

Conference Call Participants

Ernesto Gabilondo - Bank of America Merrill Lynch

Operator

Good day, everyone, and welcome to Banco Santander México's First Quarter 2021 Earnings Conference Call. Today's call is being recorded. [Operator Instructions].

I'd now like to turn the conference over to Mr. Héctor Chávez, Managing Director and Head of Investor Relations, who will make some opening remarks and introduce today's other speakers. Please go ahead.

Héctor Chávez

Thank you, Operator. Good day, and welcome to our first quarter 2021 earnings conference call. We appreciate everyone's participation today. By now, you should have access to our earnings press release and the presentation for today's call, both of which were distributed yesterday after the close of the market and can be found in our Investor Relations website.

Presenting on our call today will be Didier Mena, our CFO; and Rodrigo Brand, Executive General Director of Public Affairs.

Before we begin our formal remarks, please allow me to remind you that certain statements made during the course of the discussion may constitute forward-looking statements and are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties, including COVID-19, that could cause actual results to materially differ, including factors that could be beyond the company's control. If you want explanation of these risks, please refer us to our filings with the SEC and the Mexican Stock Exchange.

Didier, please go ahead.

Didier Mena

Thank you, Héctor. Good morning, everyone, and good afternoon to those of you participating from Europe. I hope you and your families are managing to stay healthy and safe.

While the pandemic continues to weigh on our results, this quarter, we continue to make progress on our strategic initiatives while maintaining a strong balance sheet and ample liquidity. Loan volumes reflect difficult year-on-year comps, mainly in corporates, in line with market trends and soft demand conditions. Mortgages and other loans continue to perform extremely well as we continue to grow above market and gain market share with prominent originations.

We have fully absorbed the negative impact of the pandemic, maiden consumer loans, credit cards and SMEs and are well positioned to support our customers in the recovery pass ahead. While loan volumes in these segments show year-on-year contractions, we expect a gradual turnaround from here.

Deposits also reflect difficult base effects, many in corporates as companies liquidity needs have normalized compared with year ago levels. By contrast, individual demand deposits continue expanding above 20%, underscoring the success of our loyalty and customer acquisition strategy.

In terms of asset quality, NPLs have started to decline, benefiting from improving conditions for our customers, together with write-offs taken mainly in the segments, mostly impacted by the pandemic such as consumer, credit cards and SME loans. Although provisions increased this quarter due to specific corporate exposures, we estimate that cost of risk has peaked and should start declining from here.

Before moving on to review our business environment and performance for the quarter, please note that reporting company recently announced that it intends to launch a tender offer for 88.3% of outstanding shares that it doesn't currently own in Santander México. Our parent company also stated that it intends to list Banco Santander México from the Mexican Stock Exchange and the New York Stock Exchange as well. For information about this pending offer, please refer to Banco Santander's press release that was issued on March 26.

The charts on Slide 4 show the gradual improvement in GDP expectations, fueled by prospects of a solid economic performance in the U.S., coupled with a gradual recovery in domestic demand. Though Mexico is showing some signs of a pickup in domestic demand, job creation has been very modest. Even considering the 250,000 jobs created this quarter, less than half of the total jobs lost due to pandemic have been recovered so far.

Population mobility has recovered after January spike in COVID cases, reaching its highest level since the start of the pandemic. While the vaccination roll out in the country has been slower than planned, as this process accelerates in the coming months, economic activity could recover at a faster pace.

Given current economic conditions, inflation could temporarily remain high above [indiscernible] Bank target range. We forecast inflation of around 5% for 2021, with the Central Bank maintaining the investment rate at around 4% by the year-end.

The combination of a modest rebound in economic growth, lower employment and low interest rates continues to present a challenging outlook for our business this year. However, we're optimistic and trust that the worst is behind us, and we are well positioned to contribute to the turnaround of the economy supporting our customers.

On Slide 5, you can see that system loan volumes contracted nearly 2% year-over-year, the weakest performance since 2002. The decline was mainly driven by consumer loans, which have not contracted this much since the 2009 crisis. This coincided with a gradual reduction in corporate loan demand, following high precautionary volumes at the first signs of the pandemic in the first quarter of last year.

By contrast, system deposits remained strong, expanding 11% year-on-year, with demand deposits up close to 20% year-on-year, likely reflecting a prudent behavior by households and companies as well as lower rate environment.

Please turn to Slide 6, where we would like to give you an update on our strategy. Our strategic priority is to become the best bank in customer experience in Mexico through innovation and digitalization. In line with Santander Group's strategy, we strongly believe in the transformation of the collections and payments industry, leveraging the group's global platform named Avonex.

As part of this initiative, we have been working on relaunching our merchant business through GetNet México, a business we formally partner with Elavon. With this, Mexico becomes the first country to launch the GetNet global payment platform, developed jointly between Santander México, Spain and Brazil, bringing best-in-class service to our customers and access to new payment solutions developed globally.

We aim to provide best collection solutions in the country. Currently, GetNet México is the second largest merchant in POS and affiliations in the market. In addition and as part of our ongoing digitalization process, this quarter, we introduced Sandi our new customer virtual assistant. This tool will encourage self service on digital channels by explaining numerous optics about daily operations, including credit and service payments, account statement downloads, car claims and among others.

Digital conversion is crucial for our goal of serving customers anytime, anywhere and anyhow and becoming a more customer-focused bank whilst reducing any digital technological gap with our main competitors. Currently, Santander has been the bank with the highest growth in digital customers over the last 2 years, reaching close to 5 million digital clients expanding by 11.4% year-over-year. Progress on this front is very important for us, with digital assets representing 48% of total sales, up from 30% a year ago.

Our focus on secure lending on mortgages and other loans is showing excellent results. These products are key for us due to the potential to generate loyal customers. In other loans, we're expanding our business organically and rapidly, achieving more than 6% market share as of February, growing the portfolio 4x compared to a year ago. These results are fueled by our alliances with top automakers, the most recent being with Honda, which is producing excellent results together with the alliances that we already have with Mazda, Suzuki, Peugeot and Tesla, among others.

We have surpassed MXN 10 billion mark of loans outstanding. If this trend proceeds, we expect to move up the ranking to be among the top 3 players in the next 18 months from our current position of #5.

We plan to double our market share in the midterm with the goal of reaching our natural market share of 13% to 13.5% in the next couple of years. In mortgages, our dynamism has been remarkable as well as our originations grew by 68% year-over-year in March. This performance reflects the success of our Hipoteca Plus and Hipoteca Free products as well as very effective cross-selling campaigns. These strong results support our position as one of the top mortgage originators of the market.

Including the impact of the runoff portfolio during the last 12 months, we have achieved the highest absolute growth in the market, with MXN 1 or MXN 4 of the system mortgage portfolio granted by Santander.

Regarding our cost of funding, we continued to advance in improving the mix of our demand deposits by expanding retail deposits and reducing their costs. The share of our individual deposits to total deposits increased by 332 basis points over the last 3 years to 34.2%, in line with our strategy of attracting retail customers. This positions us closer to our medium-term goal of achieving a more balanced deposit mix in line with best-in-class peers. This better mix is contributing to lower our cost of funding over time.

Our discipline and profitability focus, when pricing corporate and deposits, has allowed us to reduce over the last 12 months, the gap with the market in our cost of deposits to only 30 basis points as of February.

Turning to Slide 7. Total loans contracted 8% year-on-year, but increased nearly 2% sequentially, mainly reflecting the significant increase in corporate balances in the first quarter of last year, when corporates to under contingent credit lines to prepare themselves for the pandemic. This effect has been not only in our bank, but also in the entire banking system in Mexico and in many other countries.

Given the constraints of the current economic environment and with an eye on maintaining asset quality, we continue focusing on more defensive segments, such as mortgages, payroll and other loans, where we have been gaining market share. This sluggish economic environment pre-pandemic that was exacerbated during this health crisis had a significant impact on our credit card and SME business.

In the fourth quarter of '19, these products combined represented 19% of our total loans, contributing with more than 30% of the net interest income of our loan book. By contrast, in this quarter, the share of these products fell to 15.6% of total loans and contributed with 26.7% of net interest income.

On Slide 8, you can see that individual loans are growing above 7% year-on-year on the back of mortgages and other loans, while credit cards and personal loans remain weak. This performance is in line with our strategy as we continue to focus on secured products.

Since 2018, well before the pandemic started, we began shifting our origination of consumer loans from personal loans to payroll loans, seeking lower risk and increased loyalty. At the same time, in our credit card business, we ceased placing credit cards in the open market and focus only on cross-selling to our customer base.

Robust performance in individual loans has allowed us to gain 105 basis points of market share over the past 12 months. Mortgages have proven defensive despite current conditions. In fact, we grew mortgage loans over 19% year-on-year organically. This approach has also allow us to attract more high-quality customers that we then convert into local customers with our Hipoteca Plus offer.

In addition, during the first quarter, we launched a market substitution campaign. The goal is to get payroll customers with mortgages in other banks to bring it to Santander, honoring the interest rate with no presale, no notary fees and a rate that can be as low as 7.75%, if they join our Hipoteca Plus offer.

In March, around 84% of originations came from our Hipoteca Plus product, which helps drive cross-selling further products as well as new customer loyals. Our digital onboarding platform for mortgages in Hipoteca line has been critical joined the pandemic and a game-changer as it helps streamline processes to minutes that we can take days and without the need to visit any branch.

During the first quarter of this year, 75% of mortgages were processed through this digital platform. Like mortgages, our auto loan origination not only reached historical high in March, but we also expanded the portfolio almost by 4x compared to a year ago.

Credit cards, personal and loans posted a negative performance affected by weak demand and higher than normal charge-offs this quarter. We expect a gradual recovery in the following quarters as we have left behind the negative impact of the pandemic in these segments. Actually, March was a very good month for credit card transactionality, which increased 25% year-on-year and 28% sequentially. We're encouraged by this performance and anticipate that we could start seeing sequential growth in credit card balances going forward.

Turning to Slide 9. Growth in loyal and digital customers continue demonstrating solid progress in this key area of our strategy, achieving year-on-year increases of 11% and 15%, respectively. We have also focused on digital conversion while increasing digital transactions and sales. This quarter, sales via digital channels accounted for 49% of total sales, a significant increase compared to 30% in March 2020.

Digital monetary transactions also spiked, reaching 40% of our total with mobile transactions accounting for 96% of total digital transactions versus 92% in 2020. In addition, mobile clients grew 17% over the last -- over the past 12 months to over 4.8 million, driven by our campaigns and incentives through digital channels.

As shown on Slide 10, commercial loans decreased 16% year-on-year and increased 2% sequentially, reflecting the exceptional high base effect I mentioned before, as corporate and mid-market loans had a significant increase in March of last year when companies drew under committed lines of credit to face the uncertainty caused by pandemic.

Loans to government and financial entities increased 5% year-on-year and 18% sequentially, driven by a lower comparative base as we had prepayments from PEMEX and CFE during the last quarter. Big corporates and mid-market companies registered important year-on-year contractions, but remained relatively stable sequentially.

SME loans registered 7 sequential quarterly contraction as this segment has been the most affected by the pandemic, resulting in larger-than-normal charge-offs this quarter. Excluding these charge-offs, the contraction with the portfolio would be similar as in previous quarters. The downward trend is also related to our reduced risk appetite in the current economic environment. Nevertheless, we are confident that the worst is behind us as GDP growth expectations are improving, which could lead this segment to present a positive performance for the rest of the year.

Moving on to funding on Slide 11. Total deposits decreased 5% year-on-year after exceptionally high growth during the first quarter of last year, when corporates use their credit lines and left that liquidity on the bank's balance sheet.

As in previous quarters, there was a shift between demand and time deposits due to lower interest rates that favor the former. Demand deposit growth from individuals stands out at 24% year-on-year, supported by our continuous efforts to attract this type of deposits. This marks the fourth consecutive quarter with year-on-year growth above 12%. With this, we have been able to reduce the cost for demand deposits by 93 basis points year-on-year, giving the markets decrease.

Although we're satisfied with this result, we continue working to further reduce our cost level as we make additional headway improving our deposit mix while lowering the cost of our commercial deposits. With respect to term deposits, we also see some room to improve our funding cost under the same strategy.

Turning to Slide 12. We continue maintaining very strong capital and liquidity positions as Héctor sector just as previously noted, sorry. Our liquidity coverage ratio stands above 300%, representing a substantial buffer and well above the regulatory threshold. Our net loans to deposit ratio was below 90% for the second consecutive quarter, reflecting our structural strong liquidity position.

We also remain very comfortable with our debt profile, given manageable debt maturity. Our capitalization ratio increased to 19.73%, while core equity ratio increased 375 basis points to 14.81%, reflecting capital accumulation due to the restrictions on paying out dividends. Even though the timing for paying dividends is not yet clear, we welcome CNBV's recent views that reduce uncertainty in this matter.

As you can see on Slide 13, our NIM contracted 103 basis points to 4.42% for the quarter. This was a result of lower interest rates, along with lower balances with high-yield segments, partially offset by lower interest expenses for deposits during the quarter.

Please turn to Slide 14. Net commissions and fees increased 4% year-on-year, supported by a solid performance in the credit cards as the economy starts to rebound and to a lesser extent to investment funds and insurance. Encouragingly, investment banking activity has started to recover taking financial advisory fees to pre-pandemic levels.

Turning to Slide 15. Gross operating income declined almost 3% year-on-year to 28% decline in net interest income, partially offset by a solid increase in market-related income and an recovery in net commissions and fees.

Moving on to asset quality on Slide 16. You can see that our NPL ratio increased 17 basis points sequentially to 2.9%, reflecting the additional MXN 3.8 billion right offs made through the quarter, mostly related to our credit card, consumer and SME portfolios. Year-on-year, our NPLs still reflect the impact of the pandemic. These higher charge-offs are the product of the nonperforming portfolios originated from the [indiscernible] payment programs that in the third quarter of last year. With these charge-offs, we have left behind most of the impact of the pandemic in our retail portfolio.

On the other hand, provisions in the quarter went down 37% year-on-year as some corporates in the retail and entertainment sector have shown some difficulties winter payments, although remaining current. Our cost of risk for the quarter stood at 3.15%, a 50 basis points year-on-year increase. Although provisions increased due to specific compound exposures, we anticipate that cost of risk should start declining from here.

Turning to costs on Slide 17. Administrative and promotional expenses rose only 1% year-on-year, mainly driven by higher IT-related expenses as we continue migrating our operations to the cloud, enhancing our ATM software and reinforcing our cybersecurity tools among other technology investments.

To a lesser extent, depreciation and amortization costs as well as IPAB costs also contributed to the increase. This was partially offset by lower administrative expenses and flat personnel expenses as we maintain tight cost controls. Thus, the efficiency ratio stood at 46.6%, a level we consider can be maintained for the rest of the year.

Turning to profitability on Slide 18. Net income decreased 39% year-on-year to MXN 3.3 billion, mainly due to higher provisions and soft net interest income. Return on average equity was 8.2%, 724 basis points below the year ago level. Note, however, that we had been able to make a dividend payment in line with our usual distribution practice, which was paying the excess of core Tier 1 ratio above 11%, ROE for the quarter would have increased by 92 basis points.

Before going into the Q&A session, let me share with you some closing remarks. We continue securing our strategy with focus and discipline, and we remain firmly on track to be the best bank in customer experience through innovation and digitalization by significantly enhancing the breadth of our products, digital offerings and our distribution network, but we are tracking individual deposits at a solid pace.

Moreover, we keep focused on strengthening customer loyalty of active customers through cross selling, improving customer service quality and increasing satisfaction levels by leveraging both the new tools and methodologies as well as enhancing operating processes. The sum of all these actions is allowing us to build a much stronger franchise in what continues to be a challenging economic and market conditions.

This concludes our remarks. We're now ready to take your questions. Operator, please open the call for the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Ernesto Gabilondo with Bank of America.

Ernesto Gabilondo

My question is on the creation of provisions for specific corporate. With information circulating in the media, we have seen Santander has exposure to [indiscernible] México, Alsea, [indiscernible] and Cinepolis. So just wondering if those are the corporates increase you created higher provisions or is there another corporate in which I know that you cannot disclose the name, but maybe the type of sector or industry?

And then very quickly on my second question, what will be the next steps for the cash tender offer? You mentioned that it could happen between second quarter, third quarter of this year. But when we use as a reference, the timing of the tender offer that happened 2 years ago? And just to double check, you will not pay dividends after the transaction is done, right?

Didier Mena

Ernesto, thank you for your questions. Regarding provisions, you're right in the sense of also not having the possibility to disclose individual names, but definitely are in the entertainment industry and in the retail industry all the one-offs that we reported this quarter.

If we add up all these one-offs, it's slightly above MXN 2.2 billion, okay? It's north of 30 -- almost 32% of the entire provisions that we made this year. And this has to do with our internal rating models. So this is not just a gut feeling, its due to certain deterioration in these names in their financials. Still, as I mentioned in our remarks, they are not nonperforming, but these clients with public information, they are undergoing restructuring processes. And according to our methodology, that requires making these provisions.

Now moving on to your question on the tender offer process. A few days ago, we received some comments from the CNBV, regarding the documentation that needs to be approved in order to -- for the CNBV approve the tender offer. It's not the only comments that we're expecting, but we are very pleased that we got these comments a few days ago. We're in the process of making those changes, and we continue to expect that the transaction can be closed either at the end of this quarter or most likely during the third quarter of this year.

Now regarding dividends, as you probably are aware, a few weeks ago, the banking commission made an updated recommendation in terms of dividend payments. And there's still some uncertainty associated both with timing and with the amount of business that we can pay out in the short term. And let me elaborate on that.

The recommendation made by the CNBV states that you can pay out or banks can pay out up to 25% of the combined net income of 2019 and 2020. That, for us, is slightly above MXN 10 billion, okay? However, in CNBV's communication, they reflect that if you already made some payments associated with this -- well, mainly with 2019, and if you make these payments during 2020, then you need to take that out. However, as is written, it's not clear if the dividend payment that we made on December 2019, according to our practices of paying dividends twice a year, the dividend payment that we made in December of 2019 was associated with the earnings of the first half of 2019.

We paid out roughly MXN 5.5 billion, back then, okay? So given that the CNBV's communication, it states explicitly the restriction or taking out what you paid in 2020, and we made this payment in 2019. We have asked that question to CNBV to clarify, going to the spirit or what we interpret the spirit of CNBV's communication. We think that the restriction applies regardless of when the payment was made. That's our assumption. So we are asking the question just to make sure that we are not misreading the communication that was sent by CNBV.

So summarizing, if restriction applies in a spirit, we will have the capacity to pay close to MXN 5 billion in dividends. If the communication, we should treat it explicitly, we could be paying or have the capacity to pay slightly above MXN 10 billion in dividends.

Now timing is uncertain because for locally systemic banks, the CNBV also included in this communication that we need to be compliant with TLAC. You are proposing to that the Mexican banking system adapts TLAC in a relatively short period of time, starting in the first quarter of next year and with a gradual implementation during the 6 quarters.

So given the fact that they are suggesting or recommending banks to pay out dividends, only if they are compliant with this trajectory of further requirements associated with TLAC with a regulation that's still not in place, that brings some uncertainty. So we are currently in discussions with CNBV just to figure out exact whether we can make payments right now and if what the restriction in terms of amount, whether we -- it's MXN 5 billion or MXN 10 billion. So we're exactly in that process.

Now stated in Grupo Santander press release on March 26, if there's a dividend payment before the tender offer is executed, then that dividend payment or the price that they are offering, what they have offered, should be adjusted by any dividend that is paid out in this -- before the offer is concluded. So that's in a nutshell, Ernesto, where we stand.

Operator

[Operator Instructions]. Our question comes from the line of [indiscernible] with Scotiabank.

Unidentified Analyst

My question is related to loan growth expectation and how that relates to the change in economic growth expectation. So at the end of the fourth quarter, when you were discussing the results, you were expecting GDP growth of 3.2% for 2021. And now I think that the expectation that you showed is of 4.5%. So given that change, what is your expectation in terms of loan growth for 2021? And what segments do you think will be driving -- will still be more or has that changed?

Didier Mena

Sure. As noted in my remarks, we think that we feel encouraged with certain trends. Obviously, this -- the higher expected GDP growth that's associated with how the U.S. economy is performing. That's definitely great news.

If you look at -- and in order to answer your question, we definitely need to break it down, break our loan portfolio in individuals and commercial. In individuals, we continue to expect a solid performance in mortgages and in other loans. And in credit cards, as also mentioned in our remarks, we think that there's a positive trend associated with what we saw in last months, the more than 20% increase in transactionality.

So the levels that we have in our credit card portfolio slightly above MXN 50 billion. Most likely, that's close to the bottom that we're expecting to see. There is one thing that might bring an additional contraction, we're seeing in our loan portfolio, in our credit card loan portfolio, those clients that pay their balances in full have increased through time.

If we compare to, let's say, first quarter of last year, clients that paid their balance in full was 26%. Now, that's 31%. Okay. That's a significant increase. So -- and part of it has to do with the -- how cautious households have been so rather than leveraging under credit cards, having excess liquidity, and we can see that through how deposits have been growing over the last 12 months, then they're using less their credit card to finance their need, okay? So that's something very important to have in mind.

And this number, if you look at the last 4 years, is by far the largest percentage that we have in trends that are paying their balances in full, okay? So we see loan to individuals continue growing, and we reported a 7.2% year-on-year growth. We think it's likely that it's going to be at those levels or slightly above that for the rest of the year, okay?

Now what is still uncertain is what happens on the commercial side. Also as noted in our remarks, even though we have year-on-year significant decreases in corporates, in SMEs, when you look at sequential performance, mid-market and corporate companies are relatively flat. The only significant contraction associated with write-offs is SMEs. The absolute contraction in SMEs is the largest that we have ever had. And the SME loan portfolio similar to the levels we had at the end of 2015. So that's the size of the impact that pandemic is having in this segment.

So we think that if during the next or during this quarter, the second quarter of this year, we see a loan demand picking up mainly in mid market companies and corporate then there's some likelihood that we will end up with a positive growth rate during the rest of the year. But as said, I think that it is still unclear how our customers will demand loans for the rest of the year. But I think that we are more optimistic than we were one quarter ago, mainly associated with the improved expectations in terms of GDP growth and how the loan portfolio has performed during the first quarter of the year.

Operator

[Operator Instructions]. There are no further questions left in the queue. I'd now like to turn the call over to Mr. Héctor Chávez, for any closing remarks.

Héctor Chávez

Thank you, Operator. And thanks to everyone again for joining Santander México on this call. As always, we wish to attain an open dialogue with you. So if you have any additional questions, please don't hesitate to call or e-mail us directly. Please stay safe. Have a great day.

Operator

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.