Banco Santander, S.A.

to Banco Santander's conference call to discuss our financial results for the first half of 2023. Just as a reminder, both the results report and presentation we will be following today are available to you on our website. I am joined here today by our CEO, Mr. Héctor Grissi, and our CFO, Mr. José García Cantera. Following their presentations, we will open the floor for any and all questions you may have in the Q&A session. If you would like to ask a question, please press star five on your phone. With this, I will hand over to Mr. Grissi. Hector, the floor is yours.

Thank you, Begoña. Good morning, everyone, and thank you for joining us. Let me share what we will focus on today. First, I'll talk about our half-one results on the context of how we are progressing with the strategy we outlined our investor day. Jose will then review our financial performance in greater detail, and then I'll conclude with a few closing remarks. Despite the challenges the financial system experienced at the beginning of the year, Q2 was another strong quarter for Santander, demonstrating the strength and resilience of our strategy and unique business model, even in times of market volatility. We delivered a record profit of €2.7 billion, an increase of 14% compared with Q2 in 2022, thus plus 17% in costs and euros. In the first half of 23, profit was $5.2 billion, up 7%, supported by robust customer revenue growth. Revenue increased double digits year-on-year, supported by all regions and global businesses. Global and network businesses are contributing around 40% of total group revenue. Our numbers of customers grew by 9 million year-on-year, taking the total to 164 million. And loans increased by 1% and deposits by 5%. The group continues progressing towards a simpler and more integrated model through One Transformation, the program that is accelerating our structural model change to drive efficiency improvement and growth in profitability. As a result, our efficiency ratio improved 1.3 percentage points year-on-year to 44.2%, and our net operating income were double digits. Our return on tangible equity, ROTE, rose 80 basis points year-on-year to 14.5%, while our earnings per shares improved 13% year-on-year, supported by greater profit and share buybacks. At the same time, our strong balance sheet with solid and sound capital ratio, liquidity at comfortable levels, and robust credit quality contributed to solid profitable growth, value creation, and shareholder remuneration. These results allow us to deliver value creation in terms of TNAP plus EPS year-on-year of 11%, of which represents an increase of more than $6 billion in the first six months of the year. Moving on to the income statement, firstly, remember that as we usually do, we are presenting growth rates both in current euros and constant euros. This quarter, there was no material difference between them. As I have just mentioned, profit increase in the first half supported by, first of all, a strong line performance with all the regions and global businesses growing. Cost in line with our expectations, growing 1% point below the rate of inflation. double-digit growth in net operating income to approximately $16 billion, which demonstrates the strength of our results, and low-loss provisions normalizing in land with our expectations. These trends resulted in our highest quarterly profit on record, 4% higher than on Q1, even after the following impacts net of taxes recorded in Q2. The SRF contribution of more than $200 million An additional Swiss mortgage provisions in Poland of 140 million and one-offs in Brazil of 137 million. Jose will go into more detail on all of these points later on. This was a great first half that makes us confident that we will deliver our 2023 targets. Good business dynamics are translating into double-digit revenue growth. Our efficiency ratio improved as a result of good cost control and revenue trends. Our cost of risk remains contained in line with our target of keeping it below 1.2% at year end. CET1 was 12.2 after profitably growing our businesses organically. and at a comfortable levels allowing us to accrue funds to meet our shareholders remuneration targets of a 50% payout. Our ROTE also grew year-on-year to 14.5% on track to reach our target at what would already be close to 15% if we don't analyze extraordinary banking tax on revenue earned in Spain. As we announced at our investor day, we have entered into a new phase of value creation that will help us grow TNAP per share plus DPS at the double digits during or through the cycle. I'd like to spend a couple of minutes updating you on the progress of our transformation plan now that we are six months down the road from our investor day. We are transforming the bank in the right way because we are structurally changing our model to improve both cost and revenue. We are making great progress in the implementation of One Transformation, creating a common operating model and technology for our retail business across our entire footprint to better serve our customers and to improve efficiency and to increase the size and profitability of our customer base. We are delivering across the three pillars of One Transformation. In simplification, we already have reduced 5% our number of products, nearly 400 fewer products in 2023. We are progressing in our digital self-service model, increasing the availability of products and services in our digital channels, and reducing the use of our contact center by 17%, just alone in the first quarter of 2023, compared with the same period last year. We are digitalizing the onboarding process end-to-end in Mexico. This initial pilot has resulted in a 36% growth in digital accounts per month compared to those in 2022. and we have already captured around 70 million in savings so far in the U.S. from transformation and simplification initiatives. As you can see on the slide, the initial efficiencies for one transformation and the impact of our good sprint management in a context of higher interest rates, which our CFO will cover later in depth, have already contributed 85 basis points in efficiency improvements. Our global and network business keep continuing contributing to the group's profitability and have already delivered another 43 basis points. Multi-Latinas and multi-Europeans, our initiatives to better serve our multinational corporates and SMEs through regional coverage model are growing at a very high rate, with revenue increasing by more than 70% year-to-date. In asset management, we have progressed to enter the alternative business, starting to serve upper market and institutional segment, and has reached more than 2 billion commitments already. In payments, we have deployed GetNet in Portugal and Argentina in the first half, and we expect to launch in the latest in Chile in the second half. In auto, we're increasing managing OEMs and retail relationships globally, expanding our partnerships in Europe to LATAM and the U.S. We have recently onboarded new partners in the U.S., leveraged the existing agreements in Europe, which are expected to materialize in around 4 billion of new business per year. We have also deployed a new parent regional leasing platform in two markets, and more countries will be added throughout 2023 and 2024. Finally, our global technology capabilities have already resulted in 36 basis points improvement in the efficiency ratio. Our global approach to technology has allowed us to capture $80 million in savings this year, mainly driven by, one, efficiencies from the recent development and deployment of gravity in three countries, which has contributed with $31 million in savings in the first half, and new global agreements with vendors, which represent around $40 million in cost reduction year-to-date. The actions that we are beginning to carry out as a part of one transformation, which we are expanding across the group, are starting to be reflected on cost and on operational efficiencies. As you can see on the slide, simplification has already driven significant improvements in our cost and revenue proactive customer ratios. The solid progress we are making with the process digitalization and automation to capture efficiencies enables us to spend less time on operations in branches and turn the branch network into a powerful sales and advisory channel. Portugal has already taken out most of the operational activities from the branches, freeing up branch employees so that they can spend more time supporting customers and commercial activities. We're extrapolating this to other of our ranks. In only six months, through one transformation, we have already reduced the number of operational FTEs per million customers by 3%. We are already deploying global tech platforms to improve customer experience, leverage economies of scale, and extend best practices. Open Digital Services, as we call it, ODS, our cutting-edge front-end platform, allows us to deliver a best-in-class omnichannel experience to our customers, at the same time that Gravity, our award-winning core back-end platform, drives significant efficiencies versus mainframe technology. We have integrated both in the U.S., so we will operate it on an end-to-end cloud-based retail technology stack, core and omnichannel, which is already tested and will result in significant improvements in service quality and customer experience. Our global and network businesses continue to contribute to this new phase of value creation. In CIB, we continue growing strongly after record performance in 2022, beating the market. Our global presence has allowed us to grow at 24% year-on-year, well above the average of annual growth target of 10% for the period 2022-2025. because, first of all, we can provide a one-stop shop service to our clients across all geographies, thereby capturing cross-border flows, and because we bring CIB products and services to our wealth, retail, and commercial clients across the group, and vice versa. As a result, revenue related to these two concepts, which we call network revenue, grew 27% year-on-year to $2 billion. Wealth management and insurance grew 25% year-on-year, well above our target, and this has been boosted by the benefits obtained from the Santander Network effect. A fundamental part of our value proposition in private banking is our unique combination of local presence and global reach. Our customers can move and transact easily from one country to another, and that's the reason why customers have $50 billion in assets under management booked abroad, 10% higher than one year ago. Our payments business is also growing very strongly. Two years ago, we began to move our payments business onto scale global platforms, and as of today, our Payments Hub platform already manages a significant part of all payments in the Eurozone, and we are progressing in other key countries such as Brazil, Mexico, and the UK. We are in the process of expanding our Cards platform across the group. delivering real-time digital processing capabilities to our banks, accelerating our business growth, as well as generating operational synergies of around 100 million per year during the next two years alone. First delivery of the platform will be live in Brazil by the second half of 2023. In auto, we continue to prioritize profitability over market share growth in a context of rising interest rates. Our transformation plan, which is making us much more efficient and increasing contribution of our global and network businesses, is helping us reach our 2025 profitability targets across all regions and businesses. As I mentioned earlier, the Group's ROTE rose 80 basis points year-on-year to 14.5%. and would be around 50% if we did analyze the extraordinary banking tax in Spain, which is in line with the group's targets for 2023 and 2025. Jose will now go in more detail to the group's first half performance. Please, Jose.

Thank you, Hector, and good morning, everyone.

Tailwinds and Latin America driven by growth in volumes and fees.

Digital consumer bank benefited from massive repricing actions and gains on financial transactions due to FX hedges. We also saw a strong performance across businesses. The only exception was auto, The result of lower leasing income in the U.S., which as in previous quarters, was affected by an increase in the share of end of leased vehicles repurchased at the dealership. Revenue at the corporate center also improved at nearly $400 million due to higher liquidity buffer remuneration and a lower impact from FX hedging, which negatively affected revenue last year. Most of our revenue growth came from NIII. ...which continued its upward trend, increasing 6% in the quarter alone, driven in particular by Europe. We see upside potential for further growth in the coming quarters. First half 2023 was 15% higher year-on-year in constant euros... with positive sensitivity to raising rates mainly in Europe and Mexico, and volume growth in auto, North America and South America, which more than offset negative interest rate sensitivity in Brazil, Chile and auto. In terms of profitability, we have improved our margins every quarter since the first quarter of 2021. We continue to actively manage our credit spreads to make the most of the higher interest rate environment. Gains on credit yields outweighed higher funding costs, thanks to our disciplined deposit remuneration strategy adapted to each country's specific needs. In Europe, we are strictly managing deposit costs, especially in Spain and Portugal, where there is excess liquidity in the system and much lower credit demand. The UK has a more competitive environment in line with our expectations. In LATAM, deposit rates are more directly linked to market interest rates, which implies negative sensitivity and will benefit margins when rates start to decline over the next few months. Finally, in the U.S., deposit betas are higher due to the heightened competition following the collapse of Silicon Valley Bank. All in all, net interest income sensitivity to interest rates has resulted on $500 million above the assumptions that we shared during our investor day. Therefore, we are well on track to meet our double-digit NII growth guidance for 2023. Turning now to fees, in an environment of low fee growth in general as a result of subpar loan demand, weaker activity, consumer activity, and higher margins, our net fee income grew at 4% in the quarter compared with the same quarter last year and 5% in the first half year-on-year. CIB and PagoNext are leading the way in terms of growth. CIB is increasing its share of leading roles and mandates, And PagoNext continued to expand total payment volumes, which rose 25% year-on-year, and transactions 32%. We also had a very good performance for cards, with turnover increasing 9% year-on-year, with fees growing 20%. Retail banking also continued to grow well, primarily driven by an increase in customers and transactionality. Wealth management and insurance grew less as customers moved to lower-risk fixed-income products with lower fees and margins. However, we saw volume improvements in both private banking, net new money of $6.5 billion, and Santander asset management over $3 billion net sales. Auto performance year-on-year was affected by the new insurance regulation in Germany in the first quarter, but recovered significantly in the second quarter. In terms of costs, our transformation efforts that Hector took you through earlier are paying off. Despite initial investments, costs in real terms are growing below the rate of inflation across most of our footprint, reflecting the savings we are beginning to generate and our strict cost control. This, in turn, is reflected in efficiency improvements led by Europe, which improved seven percentage points thanks to strong revenue gains, together with a 2% fall in costs in real terms. As a result, group efficiency is already at the bottom end of our target range, where we expect it to remain for the rest of the year. Credit quality remains robust across our footprint. The non-performing loan ratio remains stable in the context of unexpected soft lending and strong labor markets as unemployment is a key driver of credit quality. Of note were the positive trends in Brazil, driven by the more selective lending policies that we introduced a year and a half ago. We said in the fourth quarter of last year that we believe the Brazil-NPL ratio had already peaked, and trends so far this year support that view, having improved almost 60 basis points year-to-date. In terms of cost of risk, we remain comfortably on track to meet our 2023 target to remain below 1.2%. Spain continues to perform well, with a 12-month cost of risk down 16 basis points year-on-year, supported by the quality of the loan book and improving macro conditions. Normalization in the U.S. continues, but is more resilient than anticipated. Brazil remains elevated due to the unsecured individual borrower's portfolio, but we are seeing signs that cost of risk has stabilized. Brazil's 12-month cost of risk at the end of June was 4.74%, but if we annualize the first six months, that improves to 4.5%. Mexico is increasing from low levels, mainly due to a changing mix towards unsecured loans, which require more provisions up front, and obviously is more profitable. Other units, such as the UK, Portugal, and the Digital Consumer Bank, are rising, but from a very low base and should remain below or in line with through-the-cycle averages. Moving on to our balance sheet structure. As we have discussed in previous presentations, our credit portfolio is well diversified by segment, product, and country. Moreover, our balance sheet is low risk. The portfolio is highly secured with quality collateral and has low average loan-to-values. Loan growth year-on-year was flat in constant euros as growth in auto and consumer was offset by falls in CIB, mainly in Spain from very high levels in 2022... Mortgages driven by early repayments in Europe and slowing demand from corporates also in Europe. We saw positive dynamics in North America, South America, and DCB. On the other hand, deposits continued to grow well, up 4% year-on-year, following a 3 billion increase in the second quarter in constant euros, reflecting new customer capture with more than offset mortgage prepayments. We saw growth across the bank, concentrated mainly in time deposits as customers seek higher rates. Our deposit base is diversified and highly stable. Using LCR criteria, 75% of our deposits are transactional, which are stickier, and a high proportion of our deposits from individuals are covered by deposit guarantee schemes. We have not seen any unusual movements in deposits in the year to date following market turmoil, particularly in the U.S. In fact, deposits in the U.S. grew in the quarter and remained flat this year to date, which implies that we are gaining market share in deposits, and with an average cost which was well below our main competitors. Mutual funds have begun to recover up 4% year-on-year following a year of instability in 2022. To close, let me cover capital. Our fully loaded capital ratio remained at a comfortable level of 12.2%, backed by a strong organic capital generation, which was, again, 10 basis points net of dividend accrual in the quarter. We accounted for the buyout of the minority Checolis in Mexico, which cost four basis points in terms of capital. We also had a series of other small positives and negatives this quarter that almost offset each other. We continue to focus on profitable growth opportunities, which is reflected in a front book RORWA of 2.9%, up from 2.5% in the first half of 2022, which is equivalent to a return on tangible equity in excess of 15%, so in excess of the current group return on tangible equity, which will support profitability going forward. Additionally, we continue to increase balance sheet mobilization and the percentage of risk-weighted assets with positive economic value added, progressing well towards our investor day target of 85 in 2025. This increased profitability will help us continue to build capital over the next few years, and we are confident our capital ratio will remain above 12% even after taking into account the final implementation of Basel III on January 1, 2025. Let me turn it back to Hector for his concluding remarks.

Thank you. Thank you, Jose. In summary, Q2 of 23 was another strong quarter supported by customer growth, doubled revenue increase, and also backed by strong performance by all the regions and businesses. We are accelerating the structural change to a simpler and more integrated model through one transformation, spreading the initiative all across the group, which is driving efficiency improvement and also profitable growth. A rock-solid balance sheet and robust credit quality are contributing to growth, value creation, and shareholder remuneration. In summary, we have a very strong first half of the year, and we are confident that we will achieve our 2023 targets and remunerate our shareholders in line with our 50% payout policy. supported by our global and network businesses while we continue with our structural model transformation. We see upside potential for further net interest income growth in the coming quarters, as tailwinds in Europe and Mexico are expected to remain, and inflation and interest rates in our largest Latin American countries seem to have peaked or nearly peaked, resulting in a positive outlook for margins in the next six to nine months. Cost of risk is normalizing in line with our expectation in a context of unexpected soft landing of the economy and strong labor markets. We continue to see resilient customer and corporate behavior in most of the geographies. Group grottes reached 14.5% in the first half, and we expect to close above 15% at the end of the year. All in all, our TNAF Plus cash dividend is growing at a double digit, well on track with our target of average growth through the cycle. And now we would be happy to take any of your questions. Thank you.

Let's open the Q&A session, please.

To ask the question, please press star 5 on your telephone. We already have the first question from Carlos Peixoto from CaixaBank BPI. Please go ahead.

Hi, good morning. Thank you for taking my question. First question would actually be on Brazil. Margin stabilized quarter on quarter, still a bit under pressure year on year. I was wondering what type of evolution you expect for the rest of the year and also on cost of risk, what's the outlook there? Then the second question was actually on capital. So basically the capital generation in this quarter was only three basis points, a bit below the run rate you have discussed in previous quarters. I reckon that this partially has to do with the Mexico minorities incorporation, but I was wondering how do you see this evolving throughout the rest of the year and also what is behind the increase in RWA's in this quarter. Thank you very much.

Thank you, Carlos. What I'll do is I'll ask the first question on Brazil. We'll give a comment on capital, and then Jose will tell you a little bit about what's going on with increasing RWE. Okay? In terms of the Brazil margin quarter-on-quarter, as we said, basically, is explained by the following. On loans, since 2021, we have become much more conservative and grown volumes very selectively, changing the loan mix to lower risk. So we mainly got out of credit cards, went on to consignado, auto loans, and mortgages. On deposits, also the fast increase in rates has meant a rapid rise in the cost of deposits, as well as a change of the mix on the deposits. Rates are staying higher for longer, has prevented that the cost of deposit from coming down, impacting NII. Remember that in Brazil we have negative sensitivity to rates, okay? So Brazil NII in the second quarter of 23 is already flat, okay? As we said, and Jose was very precise on that, the worst seems behind us, and we're already seeing a reduction on the average cost of deposits, and we also see an improved customer spread. So we expect NII in the second half of 2023 to be higher than the first half of the year, leading to a flat NII in the year with a substantial improvement in 2024. In terms of the cost of risk, Not only the macro outlook is improving, but since 21, as I explained, we've been very selective in the approach of the new lending extension and focusing to more secure and high-rate customers, as I explained. This is showing good results, and we believe the worst, as I said repeatedly, is behind now. Cost of risk in the second quarter is already improving versus the first quarter, and the vintages are showing really good performance, as we have seen. So we don't expect cost of risk that will deteriorate in Brazil in 23 versus 22, excluding the one-off, which implies staying close to around 4.6%. And then, to be on capital, to be very precise, we expect to generate at least 10 basis points of organic capital on average per quarter, with the current shareholder remuneration policy that we put in place. As a result, we will be on track to meet our target to be above 12%, even when the final implementation of Basel III comes into effect on January 1st on 25, okay? And with that, I don't know, Jose, if you can comment on RWAs, please. Yes, thank you.

So, morning, Carlos. You're right, loan growth was zero, but risk-weighted assets grew more or less 2%. Half of that growth is due to FX. as we consolidate the Latin American basically the peso and the Brazilian-based assets into the group. Of the other half, half of the other half, so a substantial amount corresponds to a stock finance. And this is due to the recovery of the new auto business in Europe. This will eventually translate into auto loans. So this is obviously short-term that will eventually lead to higher profitability going forward. When we look at the outlook, as Hector said, we don't expect any significant changes. regulatory or supervisory capital impacts in the second half of the year. We see no inorganic charges in the second half of the year. Obviously, it looks like the available for sale portfolio valuation also will stay relatively stable. We see improving profitability, as we have mentioned, particularly driven by higher NII in the second half. and risk-weighted assets that should be probably under control. So net-net, we see a stronger capital, organic capital generation in the next couple of quarters, again leading to a capital that will remain well above 12% every quarter and building up sufficient capital to be above 12% post Basel III.

Thank you, Hector. And Jose, can we have the next question, please?

Next question from Alvaro Serrano from Morgan Stanley. Please go ahead.

Hi. Good morning. Thanks for taking my questions. A couple of questions, please, from my side on U.S. and Spain. U.S. has obviously done much better in provisions. I know you've touched on it, Hector, but maybe you can give a bit more detail as to why the provision was so low in the quarter. Is it collateral? Is it default rates? And when you think about the rest of the year, maybe you can update us about the guidance. What do you expect in costs of risk for the full year? I think you gave us some color in Q1, maybe an updated view or the moving parts there. And the second question on Spain, deposit is much more stable this quarter, previous quarter. I wonder if you can give, again, a bit more color on the deposit migration remuneration and when would you expect NII to peak in Spain? I'm extrapolating Spain-Portugal, which I assume it's the same dynamics. Thank you.

Thank you, Alvaro. Okay, let me give you our look in the U.S., okay? And I explained it. It's basically the same dynamic I explained you on the first quarter, okay? Credit provision, as you know, decreased. as credit quality is remaining robust and credit near-charge of actually what we call realized losses show better than anticipated performance. And this is basically on the back. Use prices continue to be strong, okay, as I explained, and declining at a slower pace than we previously anticipated. The change in auto loans portfolio mixed over small prime. Remember that I told you that before 2018, we had a lot more subprime than prime, and the change on the mix has helped. Also, we have robust and better than expected labor market in the US, okay, which is sustaining that, okay? And auto customers that are delinquent, exactly as I was explaining in the first quarter, for more than 90 days are rolling into charge of status at historically low levels, okay? Normally, they were above 90, 95%. Last quarter, they were around 59%. This quarter, around 67%, okay? So it's still much better than we expect and much better than it was before. actually happening pre-COVID, okay? And in 2023, we expect cost of risk to continue under normalization at around 2%, and after two years of artificially low figures, given COVID, et cetera. As I was saying, normalized levels should be below pre-pandemic. Cost of risk at around... If you remember, pre-pandemic was around 285. It's never going to get there, okay? Because of the change of mix and what I was explaining, okay? In terms of... The Spain, okay, in Spain, the deposits, I mean, continue to be stable, okay? At around, we have around 299 billion, okay? We have excess liquidity in Santander, Spain. LTD is around 78%, as is the case for the whole Spanish system, that is around 80%. Quarterly decline is most linked to CIB deposits, flat in retail in the quarter despite the early repayments of mortgages. Okay, 60% compared to the same period of 2022, and the increased volume of deposits moving of balance sheet products. Also, what we see between the first half of 23 versus the first half of 22 is plus 0.9%, okay? So we have a different change of the mix with time deposits going up at around 61% up year-on-year, while demand deposits are going down around 5% on the back of the higher rates, given by the growth of CIB, which allows us to maintain also and maintain a stable net liquidity position, okay? In terms of what I was saying, NII, we don't expect to peak yet. I mean, we have still revisions, and I will have Jose explain to you in detail exactly how we see NII evolution in Spain.

Morning, Álvaro. Let me talk about the corporate center, Santander SA, more than Spain, because this is going to give you a better view of our euro sensitivity to rates in Spain. So we have assets of 330 billion, 60% floating, 40% fixed. This fixed includes the ALCO, which is 27 billion that we've been buying recently, with an average duration of six years and an interest rate of over 3%. We also have intra-group transactions, etc., money markets that are fixed, but these are very short-term, so they will reprice as short-term Euribor actually goes up. Of the floating, 200 billion, 65 billion will reprice or reprices with 12-month Euribor. We expect if we use today's 12-month URIBOR compared with the average of the first half, so let's assume that the URIBOR remains flat in the first half of next year, we have at least 50 basis points pick up in the repricing of this part of the portfolio next year. And then we have 30 billion with reprices with a six months, 40 billion with a three months, and 65 billion with one month. We would still expect significant repricing upwards in the first half of next year as interest rates in Europe may go up once or twice, but as they stabilize, we will still have significant repricing of a big chunk of the portfolio in the first half of next year. Obviously, the asset yields are expected still to expand well into 2024. Obviously, margins will depend on the cost of deposits, but as Hector said, we are not seeing any pressures today to increase the remuneration of retail deposits. We are already paying almost Euribor for CIB deposits, institutional deposits, but we don't see any pressures on the retail side of deposits, which means that probably the peak in net interest margins will not happen until well into 2024 in the Eurozone.

Thank you, Alvaro, for your questions, and Jose and Héctor for the answers. Can we have the next question?

Well, for the next question, please.

Next question from Alondra. Please go ahead.

Wanted to ask about NII in the UK and in the US. If you can please update your guidance in the UK. I see lending is weak, falling. The local mortgage market is declining. Asset spreads are low. The deposit beta is still relatively low. How do you see all these dynamics going forward on the NII? And also in the U.S., you are gaining market share, but are you gaining new clients or are you paying up for deposits? How do you see the beta compared to the local peers and also in absolute terms going forward on the NII there in the U.S.? Thank you.

Thank you, Francisco. Let me give you the details. Let's talk first about the UK. NII was up double-digit in the first half of 2023. It was driven mainly by higher rates and the strong focus on money in spreads and profitability, although the UK tends to be more competitive than other European markets, as you know. So we're putting profitability ahead of market share. And we have a lower risk appetite, but we're expecting good performance to continue, leading to NIM expansion. So we expect it to stabilize towards the second half, 2023, with a high single-digit growth on higher rates, and despite the lower volumes that we have because of what I just explained about profitability. In the second quarter, NII was flattish. Okay? Higher yields on loans did not offset the higher cost of retail funding and the slowdown in new originations. Okay? In terms of the betas, Jose will tell you afterwards that I tell you about what's going on in the U.S. In terms of the U.S., Overall, as you have seen, has gone better than expected, even the change is mixed towards prime, as I explained in detail. Lower yield, but also better risk profile, and the lower credit provisioning is helping us. NII is flattish in the quarter and year on year on funding pressures on the wholesale retail. As you know, a lot of this is funded by wholesale as well, and a common trend across the sector, which has been partially offset by higher yields that we have. Sometimes the U.S. betas are above what we expected but lower than the average of our peers, just to give you exactly what's going on. And we expect NII to be down mid-single digit on lower originations and also the higher funding pressure, again, in line with the peers. However, given the strong behavior that we have on the labor market and seeing the performance on the first half, the U.S. NII could do better than we expect, okay? U.S. NII is not the only one that has done better. Cost of risk and profitability are also better than expected in the country, okay? So, José, you can comment on the betas, please.

In the UK, when we look at the cost of deposits today relative to the level of rates today, that's around slightly below 30%. It's increasing slightly in the quarter three percentage points. We still think that that will continue. So the UK is a market with less excess liquidity than Spain, for instance. So we would expect, as Hector said, that margins probably... They were stable in the second quarter relative to the first, and we would expect them to remain more or less flattish in the third and probably slightly going down from there. In the U.S., as Hector said, we kept our deposits flat. paying less than our regional bank competitors. The beta in the U.S. is 36.8%, up two percentage points quarter-on-quarter. So after the spike that we saw in February-March, the betas in the U.S. have remained very stable, and we are actually increasing deposit market share at a lower cost than our competitors.

Thank you, Paco. Can we have the next question, please?

Next question from Ignacio Largui from BNP Paribas Ex-Same. Please go ahead.

Thanks very much for taking my questions. I have two questions. One is on the Spanish loan book. You could update a bit on the trends that we have seen in the quarter. Year on year, I do see an 8% decline. if you could elaborate a bit on what are the dynamics there and what we should expect going forward. And the second question is a bit at a group level. If I just look to the first half, cost of risk is around 106 basis points. You are sticking to the guidance below 120. Is there any region besides the U.S. where we could see some deterioration in the second half that makes you keep that conservative guidance? which would imply a run rate of around 135 basis points, 140 basis points in the second half to make the 120.

Thank you. Let me tell you a little bit about what's the dynamics on the Spanish loan book, and then Jose will talk about your second question. In the Spanish loan book, the dynamic that we have seen is quite clear. We have seen low demand of credit, which is impacting us a little bit. Mainly, also, we have seen an increase on the... uh prepayment mainly on the mortgages okay because of the increased rates remember that a lot of a big percentage of our portfolio is some viable rates and floating rate so in that sense that's the dynamic that we have seen and also we have seen due to the increased rates uh the corporates and the sms being more cautious in new credit demand okay and the dynamics we can we lived throughout the year continuing that way let's see what happens at the beginning of the year and also if we can see more confidence a little bit and investment. Okay, but now we see the dynamics in that way. Please, José, on the second one.

Good morning, Nacho. Cost of risk. Well, we see cost of risk normalizing in the U.S., as we discussed. Also in Mexico, where we are seeing, you know, the normalization of the cost of risk as we change the business mix. In auto, it will very much depend on the amount of loans that we are able to sell, but it should remain stable in the second half of the year. So we feel very comfortable that we will beat our 1.2% guidance for the end of the year. We expect it to be better than the 1.2% that we gave as a guidance.

Thank you, Nacho. Can we have the next question, please?

Next question from Sophie Petersens from JP Morgan. Please go ahead.

Yeah, this is Sophie from JP Morgan. Thanks for taking my question. So, could you just explain the difference between your reported net interest income, which was 10.5 billion, and the underlying 10.7 billion? What explains the 200 million delta, and are there any more one-offs in net interest income that we should be aware of coming in the short term? And then the second question would be on the capital headwinds. You mentioned that you expected to remain above 12%, but could you just outline what capital or core equity year one headwinds you are expecting in the coming quarters or at least on the year end? And also if you could remind us what the bottom four impacts are. Thank you.

Okay. Thank you, Francois. So Jose will explain to you the NII evolution. On capital, let me reiterate exactly what I said, and then Jose can expand a little bit. So as I told you, we expect to generate at least 10 basis paints of organic capital on average per quarter, okay? And that is included with the current remuneration policy that we have, okay? So as a result, what I told you, we will be on track to meet our target to be above 12%, also with the final implementation of Basel III comes into effect in 2025, to be precise on that point. Jose will comment a little bit more on that and explain to you the NIA evolution.

So, Sophie, hi, good morning. As I said, we don't expect any significant headwinds from any of the three big components that could affect capital. Regulatory or supervisory charges, inorganic charges, or other charges, basically market-related, pensions, intangibles. We don't see significant headwinds. head wings in the second half of the year. In terms of Basel III, we have seen the proposal. It's still a proposal, so we need to wait to see exactly how the regulation is approved. We still think we will have an impact of between 40 to 60 basis points, probably, and again, depending on how this is finally written, probably towards the lower end of that range if things are confirmed when the final proposal is approved. In terms of the accounting, well, I think Investor Relations will give you more details about this. It's pretty detailed, but In the first half, there is no impact, no adjustments between net interest income, statutory, and underlying zero. What happened in the first quarter is we had a positive adjustment of $211 million. And we have reversed exactly the same amount in the second quarter, which, by the way, in terms of the 20 billion, it's a very small amount. So no adjustment to NII in the first half. What we added to underlying in the first quarter was reversed in the second quarter. There are other adjustments in the P&L, but basically netting out, in most cases, what happened in the first quarter in the second quarter. But investor relations will give you all the details, line by line, of the differences between the first and the second quarter. Thanks, Sophie.

Thank you, Sophie. Can we have the next question, please?

Next question from Marta Sanchez Romero from Citi. Please go ahead.

Thank you very much. My first question is from the digital bank. Could you please provide an update on your strategy for gathering deposits here? You've raised roughly $3.4 billion year-to-date. That seems to be below what you had planned a few months ago. Your non-deposit ratio is running at 200%. So how much more deposits do you expect to get? And where do you feel like you need to put rates in order to be to be more successful in Northern Europe and Germany. The second question is a follow-up on mortgages in the UK. You are shrinking pretty fast, $4 billion per quarter. When do you expect to stabilize that book? Thank you.

Thank you, Marta. Okay, on the strategy, the open bank is quite clear, okay? And we just don't have open bank as the only vehicle to raise deposits. We have some other vehicles also we have in some of the other different countries, okay? We believe that the strategy is right, and the one that we're managing at OpenBank is going along our expectations, and we believe that we're going to continue to manage that accordingly, okay? And in some other different initiatives that we have, for example, in Germany and some other places, the strategy has been proving very successful, and we don't believe we need to basically continue raising rates depending on what the market reacts to it, okay? So we're going to be moving it according to the market. In terms of mortgages in the UK, I was very specific about what we're thinking in terms of profitability, okay, and the way we're managing the portfolio. First of all, we've been very cautious in the way we manage, and our risk appetite is being very prudent in the way we're managing the UK, okay? If we see that there is a change of... of how we see the market, then we'll adjust at the point. But right now, we're concentrated in the two things I told you. First of all, profitability and being cautious on the risk appetite there. If we see one of these changes, then we'll adjust in any way. I don't know, Jose, if you'd like to comment a little bit more.

In the digital consumer bank that now includes Open Bank, we have 60 billion in deposits, like you said. And I think we obviously manage that to maximize profitability. So it's not only a question of the amount of deposits, but the question is managing the margins in a business that has negative sensitivity to rates. And I think we've been very successful. If you compare this figure to what it was a couple of years ago, and you look at margins and interest rate sensitivity management, I think you have to look at the whole picture, and I think we've been very successful in managing interest rate sensitivity in a business that has naturally negative sensitivity to raising rates. Thanks, Marta.

Thank you, Marta. Can we have the next question, please?

Next question from Andrea Filtri from Mediabanca. Please go ahead.

Yes, I have a question. I wanted people to get more familiar with H2SB. Can you go into the different geographies? And particularly, you've given a lot of detail on an AI in a lot of countries. Can you do the same for Brazil, please? The second question is on Spain. if you could split the drivers of NII there between fit of increases in interest rates of deposit beta and the ALCO portfolio contribution. Thank you.

Okay. Thank you, Andrea. Let me explain a little bit the NII in Brazil, and then Jose will give you the details of the drivers of NII and the betas in Spain, okay? Yeah, in Spain. To start, I mean, Brazil and AI, okay? Performance in recent quarters is playing, first of all, on loans. Since 2021, I've been very specific on that. We have become very much conservative, and we have changed the mix, okay? And we have grown volume selectively, changing the low mix to lower risk. On deposits, the fast increase in rates made a rapid rise in the cost of deposits. We expect NII in the second half of 2023 to be higher than in the first half of the year, leading to a flat NII in the year with a substantial improvement in 2024. If we see that the rates basically start to come down, because it's very important to understand that Brazil has negative sensitivity to the rates, we should gain traction and we're going to maintain a cautious stance, but we believe that we can go back to the market. And we believe that the facial rates could fall in the second half, bringing the cost down in retail funding. And then in the drivers of NII in Spain, And also, we'll give you more details. Spain is one of the countries that has benefited most from the higher rates. We continue to see strong growth in clients. Just in the first half of the year, we have 300,000 more active clients. NII in Spain is up around 57% in the first half of the year, and 60% just alone in the second quarter. It's mostly supported by repricing of the loan portfolio. The higher yields remain contained on the cost of deposits. So we have been managing very well in that sense. We expect double-digit growth for NII in 2023. And regarding the peak of NII in Spain, there are several things to consider that Jose already explained to you. Assets will continue to reprice at least during the first half of 2024. Clients, which we expect, will continue to grow. And betas, which will be key, we're still seeing a rational competition with low betas for individuals in a system which remains highly liquid, okay? So as of today, we don't expect much high remuneration on the foreseeable future.

Hi, Andrea. In Spain, we have 27 billion. 21 billion is a structural long-term health to collect with an average duration of 7.7 years and a yield of 3.3%, 3.4%. Then we have 6 billion, which is more associated with short-term liquidity management, average duration of 1.2 years and yields slightly below 3%. We expect to continue increasing the amount of the ALCO portfolio in Spain to gradually reposition the balance sheet towards a lower positive sensitivity. Because as interest rates start reaching a peak, we don't want to run a balance sheet with such huge positive sensitivity to rate. So one way of doing that is not the only. We are also taking other measures. But one way is obviously increasing the ALCO portfolio. In terms of betas, the beta for deposits in Spain is 17.8%. If we exclude CIB, by the way, this is three percentage points higher than in the first quarter. If we exclude CIB, the beta is 9.5%. The beta in CIB is around 60%. So I think I've given you all the numbers to figure out exactly how we see the betas and the NII going forward. Thanks. Thanks.

Thank you, Andrea. Can we have the next question, please?

Next question from Britta Smith from Autonomous. Please go ahead.

Yeah, hi there. Thanks for taking my question. Could you give a bit more color on the NRI increase, the absolute NRI increase in Spain, Q&Q? The customer spread was up less in the previous quarter, but NRI was up a lot more. And then secondly, could you also update us on the net interest income sensitivity in Brazil over one year and two years? And lastly, on the 500 million rate benefits that you see more so than previously, can you give us an idea as to where you see them and how much of that has been recognized in the current run rate? Thank you.

Okay, so let me go backwards here. Yeah, in the first half, the sensitivity was more or less 500 million, higher than the guidance we gave at Investor Day. We would expect more or less a similar amount in the second half, in euros. So relative to the figures we gave at Investor Day, the interest rate sensitivity in euros, due to the fact that obviously rates are higher and we are seeing better betas, remember, The debate as we used to give that sensitivity at Investor Day in euros were around 30%. We are below 20% right now, and it's already half of the year. So we would expect another 500 million more in the second half, over a billion higher than what we mentioned at Investor Day. NII sensitivity in Brazil, I'm going to give you the rest of the currencies as well. So if today we had 100 basis points parallel shift upwards, we would make 1.1, 1.2 billion more in euros, 200... and 50 million more in the UK, flat, slightly negative in the US, and 100 million less in Brazil. I think we gave you all the details to understand the NIH sensitivity in Spain, but we can take it offline if you want a more detailed analysis, but I think we gave you all the details. I gave you the composition of the balance sheet by by repricing on the asset side. So I think that's sufficient, I think. But we will take it offline.

Thank you, Britta. Can we have the next question, please?

From Carlos Cobo Catena from Societe General. Please go ahead.

Hi, thank you very much for taking my questions. Just a quick follow-up from me on capital. You mentioned the stock finance impact. Could you please quantify that in terms of stock and one single specific impact on risk-weighted assets, just to clear that out from other impacts? Thank you.

Okay, so the stock finance is seasonal. It tends to go up in December, which is the peak in the year, Then it goes down in March, goes up a little bit in June, and then same in September to peak again in December. This year, the increase in June was higher than we expected. We are talking around $6 billion in total risk-weighted assets from stock finance in the first half.

Thank you, Carlos. Can we have what I believe is the last question, please? And if anybody wants to add another question, please press star five on your phone. Thank you.

Next question from Fernando Gil de Santibáñez from Westinburg. Please go ahead.

Thank you for taking my question. Two questions, please. One is in Poland. What do you expect in terms of... mortgage provisions related to which funds come forward. If you can comment on that, I think this will help a lot. And the second one is on RWA growth. I'm looking at U.K. figures and Poland figures. I'm looking at loans, loan growth, and FX impact, and it seems like RWAs are increasing faster than that. And if you can comment on why it's happening that in those particular regions, it will help a lot. Thank you very much.

Okay, sorry, Fernando, what you said at the beginning was mortgage provisions in Poland? Yeah? Okay, so, Fernando, let me tell you exactly how we are in Poland, okay? Up to today, okay, and with the extra that we did, okay, we believe that is completely adequate, okay? We're talking about that in the blended PROVISIONS THAT WE HAVE, WE ARE PROVISIONED UP TO 58% OF THE OUTSTANDING THAT WE HAVE. AND WE BELIEVE THAT'S ENOUGH TO SUSTAIN EXACTLY WHAT NEEDS TO BE DONE OVER THERE GIVEN THE DYNAMICS THAT WE HAVE SEEN IN THE MARKET AND IF YOU BASICALLY change into slotties when these mortgages started, they'd be about there, okay? So I believe that we're at the right point, and we believe the provisions at this level is completely adequate, okay? On the second, I will have Jose give you the answer. Thank you.

As I explained, long growth year-on-year was zero. Risk-weighted assets increased 2%, half of which is FX. And I can take you through the composition of risk-weighted assets by country, but half of the risk-weighted asset inflation has to do with FX. Of the other half, we had some positives and negatives. As I said, we have contraction in the UK. We have contraction in terms of risk-weighted assets, ex-stock finance in auto, slight contraction in Europe, and then we had the stock finance expansion in Europe and also risk-weighted asset growth both in XFX in Mexico and in Brazil.

Thank you, Fernando. I'm unclear if there are any further questions.

We have a question from the line of Ignacio Cerezo from UBS. Please go ahead.

Hi, good morning. Sorry, it's just a quick follow-up on Brazil. If you can give us a little bit more color or at least ballpark magnitude of the substantial growth of NII you're expecting in 24, the sensitivity to rates Jose was mentioning suggests probably around 1% for a 100 basis points decline. So just trying to understand basically what kind of magnitude in terms of acceleration of NII you are expecting next year in Brazil. Thank you.

Okay. Thank you, Ignacio. I will answer the first part of your question, and then Jose will help me out with the rest, okay? This is sensitivity. What I told you is that we believe that the worst is over in Brazil, okay? And we're starting to see a little bit more growth in the portfolio, okay? So we're changing that around. We're starting to basically go back... to the open market, which you know in 21 we decided basically to come out of it given what we saw in the core environment. So at this point, we believe that Brazil is going to be able to turn around, and also we see that the rates are going to be helping us out because we believe that the rate in August should start coming down. So in that sense, we don't know exactly how the trends are going to work, but we see that this is coming much better than we expect. And we see that we're going to end up the year basically flat-ish to where we started.

Hi, Nacho. We believe interest rates in Brazil will start coming down in August. They are at 1,375. Our central scenario is for rates to end the year at around 12, 12 and a quarter, and then probably below 10 by the end of next year. So NII, when you look at sequentially quarter on quarter, NII probably will be flattish in the third, but it should increase in the fourth and more so into next year. And the exact sensitivity, I mentioned the sensitivity to a higher rate, but the sensitivity in Brazil... to a 100 basis point. But this is a parallel shift. I insist, a parallel shift, which is not what will happen probably, because what we will see is lower rates in the short end of the curve, but flattish in the long end of the curve. But through a parallel shift, a drop in 100 basis points will generate 140 million higher revenue in Brazil. Thank you, Nacho.

Thank you, Nach. I believe there are no further questions. So thank you, everybody, for your attendance. And the investor relations team is at your disposal for any other questions that you may have. Thank you very much.