Banco Santander Mexico, S.A.

Good day, everyone, and welcome to Banco Santander, Mexico's first quarter 2020 earnings conference call. Today's call is being recorded. Following the speaker's remarks, there will be a question and answer session. I'd now like to turn the conference over to Mr. Hector Chavez, Managing Director and Head of Investor Relations. He'll make some opening remarks and introduce today's other speakers. Please go ahead.

Thank you. Good morning and welcome to our first quarter 2020 earnings conference call. We appreciate everyone's participation today. By now, everyone should have access to our earnings press release and the presentation for today's call, both of which were distributed after the market closed yesterday and can be found on our investor relations website. Presenting on our call today will be Hector Grissi, Executive President and CEO, Villar Mena, our CFO, and Rodrigo Brand, Executive General Director of Public Affairs. We will begin with a discussion of the actions that we have taken to help mitigate the risks related to the COVID pandemic. Next, we will briefly review our first quarter results, and then we will be happy to answer your questions during the Q&A session. Before we begin our formal remarks, allow me to remind you that certain statements made during the course of this discussion may constitute forward-looking statements which 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. For an explanation of these risks, please refer to our filings with the SEC and the Mexican Stock Exchange. Hector, please go ahead.

Thank you, Hector. Good morning, everyone, and good afternoon to those of you in Europe. Thank you for joining our earnings call this morning. I hope you and your families are healthy and safe. We're entering an unprecedented times, a moment that is testing our flexibility and ability to act swiftly in every aspect of our business. During this call, we would like to spend most of the time discussing the actions we have taken to address and mitigate the impact of COVID-19 pandemic on our business. However, We will also give you a brief summary of the most important trends and metrics of the quarter. The materials that we usually present every quarter that will not be covered during our call can be found in the annex of this presentation. Should you have any questions associated with those materials, we can address it during the Q&A session. Over the past six weeks, we have been implementing a series of measures to help protect the health and safety of our employees, the well-being of our customers, as well as maintain business continuity. Before discussing in more detail these protective measures, let me underscore our conviction that Santa Fe, Mexico is well positioned against the current and growing impact of the COVID-19 pandemic. Our agile and experienced management and operational teams, our conservative origination standards, and our prudent financial management have allowed us to build a very strong balance sheet in recent years. Once again, We ended another quarter with stable asset quality and low levels of cost of risk and MPLs, thanks to our prudent growth strategy and strict origination criteria. In addition, the successful execution of our medium-term strategy that investments we have made in IT and digitalization over the past three years have enhanced our ability to serve our customers at a time when social distancing is required nationwide. Turning to our financial results, we delivered a very solid first quarter with no material impact from the COVID-19 pandemic in our P&L. However, not surprisingly, loan and deposit volumes began reacting to the new environment. Until mid-March, retail and commercial loans, as well as deposits, behaved very much in line with past trends. However, during the last two weeks of the month, when the stricter lockdown measures were implemented to mitigate the pandemic, commercial loans registered a significant spike, resulting in 12% year-over-year growth in our total loan portfolio at the end of the quarter. In turn, due to this activity among our corporate customers, commercial deposits increased significantly, expanding total deposits by 15%. Despite the sudden increase in loan demand, our capital and liquidity positions at the end of the quarter remained at high levels, underscoring the strength and resilience of our values. Please turn to slide four to review the recent actions we have taken to address the current health crisis. Since late February, we have been focused on three key priorities. First, warranting the health and safety of our employees. Second, ensuring the well-being of our customers. And finally, strengthening business continuity. Very early during this COVID-19 pandemic, we began implementing a business continuity plan that triggered global and local protocols to help prevent the spread of the coronavirus by halting non-essential travel, limiting the number of people at gatherings and group events, guaranteeing service from critical suppliers, and enhancing sanitization measures at branches, corporate offices, ATMs, and contact centers. We established work-from-home protocols and divided and assigned teams to alternate workers' schedules at our sites. Branch employees were separated into teams, with 50% of them alternating between the branch and home. These protocols will remain in place for as long as the current health emergency continues. Further, additional IT resources have been channeled into remote operating tools, taking cybersecurity into consideration. As of today, approximately 90% of corporate employees are working from home, while only essential personnel are working on-site. Approximately 93% of the bank branches are open, and 91% of our ATMs are working normally. In turn, the bank's digital channels and contact centers have been operating normally and are servicing our customers well. We have been also actively promoting customers the use of digital channels with very successful results. To support our customers, we launched a debt relief program offering deferred payments for individuals and SMEs. I will elaborate on this program in a moment. Also, together with two other financial institutions, we will participate in the federal government's small business support program. We will leverage the expertise we have developed through our financial inclusion program, TUYO, to assist the government in distributing the funds at no cost for the beneficiaries. In addition, we are offering our customers zero interest payments for purchases at online supermarkets, pharmacies, laboratories, and hospitals, while our health insurance products offer coverage for COVID-19. On slide five, we outline the details of our debt support program or individuals and SMEs that I've mentioned before. Since the program was launched on March 26, March 26, over 400,000 customers have registered in the program. The breakdown of clients that have enrolled in the program by product is as follows. 5% are SMEs, 10% are mortgage clients, 40% are personal, payroll, and auto loans clients, and 60% are credit card clients. As of Monday, April 27, The total loan book under this program has reached 122 billion pesos. Through this program, we expect to help customers who encounter liquidity problems by deferring the payment of the loan installments for up to six months without any penalty or cost. Now, turn to slide six for an overview of the measures taken by the federal government to support the debtors and Mexico's financial system. First, in order for banks to continue supporting loan demand, the authorities have put in place temporary measures that, one, allow banks that fall below the minimum regulatory liquidity ratio level of 100% not to have consequences, and, two, exclude the impact of the volatility experienced in March from the liquidity ratio. This will provide financial institutions more flexibility in managing their liquidity and avoid generating distortions in the financial markets, while servicing customers more swiftly. In our case, our LCR reached 136% at the end of the first Q in 20, well above the regulatory minimum, and it is anticipated to increase when taking into account the benefit of the senior notes that we issued a couple of weeks ago. Second, to support banks' capital, the regulator recommended banks to preserve capital but not pay in dividends associated with 2019 and 2020 results. In our shareholders' meeting held on April the 28th, shareholders obtained to approve the dividend payment for as long as there is a lack of visibility into the impact of the pandemic on the bank. The decision will be revisited in October of this year, taking into consideration the situation prevailing on such date. Also, banks will be able to use their capital conservation buffer of 2.5% without triggering any corrective regulatory measure. These two actions will allow banks to continue supporting loan demand with greater comfort. Third, the CNBB issued temporary accounting rules allowing banks to offer retail borrowers and SMEs a grace period of four to six months on their loans. This is intended to help clients recover their cash flows and avoid default. Clients that enroll on the relief program will not be reported to the credit bureau And these restructured loans will not require provisions nor will be considered non-performing during the grace period. Fourth, the central bank announced ten actions to provide liquidity to the financial markets for up to 750 billion pesos. Most of these actions have focused on enhanced liquidity in the secondary market and allow banks to monetize certain assets in order for them to increase lending to SMEs. The central bank is expected to release soon the rules of this program. In addition to these measures, the federal government has announced very limited fiscal support for the economy in order to mitigate the impact of the pandemic, focusing its efforts on granting loans to a large number of small businesses. This support program is significantly smaller than those of which other developed and emerging economies have been implementing to speed the recovery from this pandemic. Please turn to slide seven for details on the actions we are taking to support our community, which are focused on awareness, support, and funding campaigns. The bank has launched continuous communications campaigns to update our employees on the pandemic and encourage people to stay at home, together with an appreciation of campaigns aimed at healthcare professionals. More than 55 million from our Santander Universidades program have been channeled to support digital learning platforms, scholarships, and emerging research initiatives. Finally, the bank has launched a fund to collect employee donations to aid those in need, and will double the amount collected to make the donations of medical equipment. To conclude, I wish to emphasize again that we are operating from a position of strength as we enter in the crisis period, given our strong liquidity and capital position and healthy asset quality. Also, the step we have taken to protect our employees and the robust digital platform that we now have in place will ensure that we continue delivering the high levels of customer service that distinguish our rank. Further, our aim is to emerge from this crisis as a stronger organization. Now, let me turn the call to Didier, who will review the most important trends and metrics of the quarter. Thank you very much.

Thank you, Hector. Good morning, everybody. Please turn to slide A for an overview of our recent loan and deposit performance. Our loan book increased 12% year-on-year and 9% quarter-on-quarter, finishing at levels much higher than we had been expecting for all of 2020. The rapid expansion of our loan portfolio was due to a 16% increase in commercial loans as large corporate mid-sized companies and government entities reopened their credit lines, generating significant increases in each of these segments. Compared to first quarter of last year, Loans in these segments expanded 28%, 17%, and 19% respectively. Note that approximately 30% of the expansion in commercial loans was related to the 22% depreciation of the Mexican pesos, which affects U.S. dollar-denominated loans that make up 12% of our loan portfolio. In contrast, SME loans increased 5% year-on-year and 2% sequentially, registering the third consecutive quarter of a sequential contraction in the back of a weakening economic environment even prior to the COVID-19 outbreak. At the same time, individual loans registered 6% year-on-year growth, with mortgage and payroll loans each expanding a solid 8% year-on-year. Our credit card portfolio is the only retail segment that began to display a negative impact from COVID-19 pandemic as it contracted 3% quarter-on-quarter due to lower usage and lower balances during the last two weeks of March. As you can see in the graph on this slide, our deposits reflect the results of several campaigns to compensate for the significant increase in corporate loans in March. Total deposits expanded 16% year-on-year, as individual deposits rose 9% and corporate deposits by 19%, both compared with first quarter of last year. This represents a 17% sequential increase, a rate we haven't seen since the fourth quarter of 2008. On slide nine, let me go quickly through the main items in our P&L. Net interest income expanded nearly 3% on the back of lower interest rates, which declined 119 basis points compared with year-ago levels. Modest growth in high-margin segments also contributed to soft NII growth. Provisions increased almost 20% year-on-year due to the implementation of our internal risk model for mortgages. Income grew 6% year-on-year, supported by a solid 10% expansion in cash management fees, 6% growth in insurance fees, and a solid double-digit expansion in investment banking fees. The lowered usage of credit cards mentioned previously and the negative effect of the PAYSOS depreciation on fees Paid were the main drivers of a 4% year-over-year contraction in credit card fees during the quarter. In turn, heightened market volatility and high client volumes allowed us to register a solid $883 million in market-related income. Our expenses grew nearly 6% year-over-year as our three-year investment program is now behind us. Depreciation and amortization charges related to these investments contributed to the quarter's increase in expenses. With this, our efficiency ratio improved 86 basis points year-over-year to 43.95%. All in all, we delivered net income growth of 2% compared to last year's quarter, supported by fees of market-related income that compensated for the softer net interest income growth that reflects lower interest rates, lower growth in high-margin loans, and a material non-recurring increase in provision. Our ROE was 15.48% in the quarter, 92 basis points lower than a year ago. Please turn to slide 10, where I would like to elaborate on our asset quality and relevant lending exposure. As of today, it is difficult to assess the extent of the pandemic's impact on asset quality, as it will depend in part on how long social distancing restrictions will remain in place, and the magnitude of the expected contraction of economic activity, but also on the effects that the debt relief programs would have on our retail and SMEs customers. I would like to highlight the solid position that we currently have to face this scenario. On the retail front, we have been focusing on the fencing segments of the market, such as mortgages and payrolls. Our mortgage portfolio has a loan-to-value ratio of 69%, and according to previous experiences, customers tend to prioritize their home mortgages in economic tantrums. With our SME book, 68% of the portfolio has guarantees issued by NAFINSA, one of Mexico's development banks, which allows us to share the risk with them. On the commercial side of our business, we have a diversified portfolio with limited exposure to some of the most vulnerable segments, such as export import transportation, hotels and restaurants, oil and gas, and automotive industries. As of the first quarter of this year, only approximately 9% of our loan portfolio is related to these sectors, which includes our PEMEX exposure. Additionally, our stable cost of risk and MPL ratio over the last several quarters reflect a healthy portfolio that stems from our prudent origination standards and which also positions us well during these emerging crises. In response to the economic effects of the pandemic, We are proactively monitoring our credit portfolio and have implemented credit risk plans that were integrated with a broader commercial strategy. As you can see on slide 12, we have strong capital and liquidity positions, as Hector noted earlier. At the end of March, our bank's common equity tier one ratio stood at 11.1%, which is significantly in excess of the 8.2% minimum requirement established for banks of our size. The decision taken during the shareholders' meeting to postpone dividend payments for 2019 does allow us to further strengthen our capital position. In terms of our liquidity, our first quarter liquidity coverage ratio reached 136% at the end of the quarter, averaging 125% over this quarter, despite the significant spike in commercial loans that we discussed previously and without taking into account the senior notes that we issued a couple of weeks ago. Moving to slide 12, I just want to remind you that on April 13th, we withdrew our full year 2020 guidance. Our fundamentals remain strong, and first-quarter results have been tracking to the earlier guidance and were not materially affected by the pandemic. However, given the unprecedented nature of this health crisis and the uncertainty surrounding its duration and impact on our operating and economic environment, we expect that our 2020 results will likely be affected. When this degree of uncertainty eases sufficiently and we feel that we are in a more comfortable position to offer reliable performance guidance, we will do so consistent with our ongoing commitment to be transparent with shareholders and the rest of the financial community.

We're now ready to take your questions. Operator, please go ahead.

Ladies and gentlemen, we will now be conducting a question and answer session.

If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line from the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. We do ask that in the interest of time, you please limit yourself to two questions. Our first question comes from the line of Jason Mullen with Scotiabank. Please proceed with your question.

Hi. Thank you for the opportunity to ask questions. My first question is related to what you show on page six of your presentation, the support measures for COVID-19 by the government with their corresponding fiscal impact. And the number for Mexico that you're citing here, It looks very low relative to the other countries that you've put here. Do you think that the Mexican government needs to increase their fiscal support? Will it be enough really to get Mexico through this crisis is my first question.

Thank you. Hello, Jason. Yes, I mean, that's a number. Your computer right is pretty low compared to the different countries emerging markets and other developed economies in the world, as we have said. I don't believe that the government basically will change their strategy at this point. The President basically has been very keen on maintaining fiscal discipline, and he doesn't want to incur in a big fiscal deficit, even though the Mexican economy has sustained a little bit more of what we have. At this point, I don't have any indications from my connections and talking with Orman that we will have more support. So that's something that will have to come up later on, and we'll keep you posted of what happens. But at this point, it is what it is.

Thank you. And my second question is on the capital markets, particularly in the fixed-income market. You just did a transaction. How are you seeing those markets functioning now? Do you think that market prices for, I mean, we've seen certain market players show dramatic increase in yields. I would actually say look distressed. Are you seeing that in the marketplace? Is that a concern where you're seeing companies that were raising money at, I don't know, 8% now looking at their bonds trading at 30% plus?

I mean, look, it has been a very complicated situation. At the beginning of the crisis, we saw a huge lack of liquidity, which basically Banco de Mexico has been trying to change, given the amount of liquidity they're injecting into the system. But the important thing is that I believe that it's going to be hard for companies to access the capital markets unless we have a more clear scenario in the future. So I think it's quite important for the government to help us in that sense. We have been talking to the Secretaria de Hacienda in that regard, and they understand the situation. We have also talked to Banco de Mexico, and they're working on that. I mean, they're concerned on that particular issue, and they understand that there is a lot of corporate paper that is coming into the market that is coming due in the next few months and that we need a market in order to support it due to the fact that the bank market will be very, not very big, but will be limited to cover all what is basically coming due. So, but I believe that the authorities understand that and they will give the correct incentives for the market basically to open again. I mean, I'm talking about the peso market, not the international market, okay?

Just to compliment on what Hector mentioned, Jason, there's a significant difference in what we are seeing in local markets relative to international markets. Large corporates in other geographies, I would say, have two avenues to access liquidity. First is issuing corporate bonds. And then the second is relying on their relationships with banks. And what we saw in March was very strong issuance of investment-grade companies, I think was the record issuance in that month. And in Mexico, local capital markets are very, very quiet. There was very limited interest in March. So basically, large corporates in Mexico are reliant in banks for their liquidity needs. So that, in my opinion, puts some pressure to the banking system, and it's critical for the system that capital markets start working back again. I think that the central bank has taken some measures. We hope that they start impacting the functioning of these markets because it's critical for the economy.

Thank you, Didier. Thank you, Hector. Appreciate the call.

Thank you. Our next question comes from the line of Ernesto Gab Alondo with Bank of America. Please proceed with your question.

Hi, good morning, Hector and Javier, and thanks for the opportunity to ask questions. My first question is on long-growth. We noticed an important pickup, but I think it was mainly driven by the peso depreciation in your dollar-denominated portfolio, but also from companies withdrawing the credit lines. So I'm just wondering, how do you see the trend continue during the next quarters? Do you think we can continue to see this kind of growth, second quarter, but then by year-end to really show deceleration in terms of growth? Are you focusing in your clients, providing them with liquidity, or are you financing new projects? And then my second question is on your cost of funding. Just wondering how much do you think it can be increased by the recent big debt issuances that you mentioned. And then just a very quick last question in provision charges. We have seen different management strategies among the Mexican banks in how to provision this year. So I don't know if you are evaluating to create provisions based on expected losses, or are you going to see higher provisions by year end and first quarter of next year?

after the grace period thank you thank you ernesto i mean first of all um in terms of the long growth yes you're right i mean some of it grew because of the evaluation of the peso but i mean the majority of the growth in the portfolio is because of the big clients and medium-sized companies basically pulling uh mainly their their their lines and their committed lines As you know, I mean, there's a lot of experience in the Mexican business community in this type of crisis, and people, what the first thing they do is basically is protect their liquidity and to access their credit lines due to the fact that they believe is the best way to manage themselves during a crisis. So we have taken a look of the outstanding lines that we have, and we don't see a growth in the second quarter as much as we had before. I mean, we believe that, I mean, the worst is over in terms of the amount of big credit lines coming out of the system and is now more stable. And this is what we foresee. Not a lot of new projects. The majority has been that. And some of the big projects, as you know, are on hold because of the pandemic. So we'll see how the market reacts in the next few months when we start to getting out of the pandemic and the economy starts to move again. So we'll see exactly what's going to happen. On the second and third question, please, I will ask Didier to answer that.

Hi, Ernesto. Regarding the impact in our cost performance associated with the recent insurance, Let me put this in perspective. We issued 1.75 billion U.S. dollars. It's roughly 42 billion pesos. That represents 3.8% of our interest-bearing liabilities. Our interest-bearing liabilities in the first quarter have a total cost of 4.95%. So, the issuance that we did was at 5.375%. We have, you know, needs in U.S. dollar-denominated loans. So, the impact that it has is, I would say, it's marginal as, you know, few basis points in terms of the overall impact. Now, regarding the provisions, as we discussed earlier, The banking commission is allowing Mexican banks to, let's say, postpone or classify all the loans that enroll in the relief programs to treat them as performing, and therefore do not have the necessity to create a provision, okay? So we're starting to analyze the behavior of those clients that are enrolling in these programs to have a better understanding as to what will be the need to create provisions when the program ends, okay? So we were still evaluating where to make additional provisions, or let's say excess provisions in anticipation of when these programs end. But I think that the most important item in our view is to analyze the, you know, how deeply affected or not will be our clients as a consequence of the pandemic. And once we know that, you know, make the necessary provisions accordingly.

Thank you. And is your corporate portfolio entering into this relief program or it is excluded and then you can create provisions based on expected losses for this portfolio?

No, I mean, the majority of this portfolio is behaving very well. I mean, there is, as always, some companies are not in the best shape, but, I mean, we don't foresee any big restructurings right now on the big corporates and on portfolios. In the midsize companies, there are some companies under stress, and we are working with them to help them out. The majority are some of the companies that are basically completely closed and need some, basically, time in order to be able to pay the loans and, I mean, due to the fact that they're completely on hold because of the crisis.

Perfect. Thank you very much, Hector and Ilya.

Thank you. Our next question comes from the line of Marcelo Tellez with Credit Suisse. Please proceed with your question.

Hi. Hello, everyone, and thanks for the time at ODDA. Is it possible to share with us if you have done any sort of like stress test analysis, you know, regarding the current situation, how should we think about, you know, the impact for you and for Max in general? if you compare this crisis to the crisis in 2008 and 2009.

Hi, Marcelo, how are you? There is a regulatory requirement associated with doing stress tests. So yes, we have definitely done some stress test analysis associated with potential scenarios. And the current, let's say, we provide several scenarios to regulators. So the one that is more adverse has a GDP contraction of 8%. And the downgrades of the sovereign and Pemex and CFE So I would say that it's a very, let's say, severe scenario. Probably, I would say, even more severe than what we are expecting right now in the pandemic, okay? And with those numbers, I would say that if the bank continues to comply with certain rules in terms of capital position, our liquidity position. We still have, obviously, in this scenario, there's a significant impact in terms of profitability, but we would still show profits, and I would say that a significant level of profits. So there will be a significant contraction, but still you know, generating profits. So we have those, you know, scenarios at hand, Marcelo. I don't think that they, you know, we can use them fully to, let's say, understand exactly what's going to happen with the pandemic, but definitely it's a good point of reference just to understand, you know, certain magnitudes. You know, one of the things where these, you know, uh scenarios defer to what we're seeing right now is that in all of these cases there's a contraction in in long growth a significant contraction in long growth and at least what we've seen you know at the start of the pandemic is that uh and as shown in our first quarter results there was a significant increase in in in long growth uh for the rest of the year we would expect still a marginal increase in demand from corporates and mid-sized companies, a contraction in the retail portfolio, but overall probably the loan portfolio could stay at levels that we're seeing right now. So I would say that's probably the most significant difference to the scenarios that we currently have with the regulators. So I would say that there's a higher impact in terms of the contraction of net interest income associated with lower volumes in the loan portfolio.

Thanks, Lidia. Just one follow-up question, if I may. Regarding the decision not to front-load, you know, provisions right ahead of the expected iteration, what is the framework that you are considering in terms of, you know, when to provision and how much to provision? Do you have a goal, like a minimum goal in terms of for your core equity tier one that you don't want to go below or how, you know, the parent companies you know, desire, you know, to keep a higher, you know, common equity until one plays out there. So if you can just help us understand a little bit the rationale for not doing front-load provisions at this point.

Hello, Marcelo. How are you? This is Hector talking to you.

Hi, Hector.

I mean, as you can understand, I mean, we're in a very difficult scenario to basically be able to really tell you what's going to happen. I mean, it's all going to depend. I mean, how deep is the pandemic? How long are some of these businesses closed? And we have done, as Divya has told you, I mean, a very deep analysis of how deep can this go. I mean, but what I can tell you is it's very complicated to predict. So it's not that easy. We're trying to basically be very harsh in the way we're managing this. But Didier can basically, and his team are working hard on this.

Yeah, you know, just to complement on what Hector mentioned, and Marcelo, we don't have in mind, you know, like a goal in terms of a core tier one ratio. You know, I think that's, at the end of the day, you know, an end result. You know, whatever we do gets reflected in the core tier one ratio. You know, I think that our policies associated with asset quality and with provisioning, you know, has to do with understanding the expected loss that, you know, we have throughout the portfolio and the probability of default, okay? So it is probably, in our opinion, better to wait and see what's the real magnitude. of asset quality duration than to make an assumption right now as to how bad it can get, you know, because in our opinion, you know, this six-month holiday payment period will definitely help some clients, and they will definitely have, they will be in a position to pay back

Thank you.

Our next question comes from the line of Carlos Gomez with HSBC NY. Please proceed with your question.

Hello and good morning. First, congratulations on the bond issuance. I think it was the first in the sector after the pandemic and the first one done on a work from home condition. So I think that was quite impressive. I want to ask about the SME sector where you have a large presence Obviously, we don't know how long this is going to last, and we don't know what the impact is going to be. But when talking to some of your peers, they tell us that they expect a nonlinear effect. So if it lasts two months, there will be some losses. If it lasts three months, there will be more. But if it lasts longer than that, it will be significantly worse than in other circumstances. Do you share that view? Do you have a view as to how much, how long your SMEs can last and when we could see losses escalate if the situation prolongs for too long.

Excuse me just a moment. I apologize.

So, Sam, may you repeat your question, please?

Yes, of course. My question is, how long do you think that the SME sector can sustain with lockdowns without significant losses? Meaning, at what time would you expect losses in the SME sector to escalate after two months, three months, four months?

Thank you. Apologies, ladies and gentlemen. We're experiencing technical difficulties. Just a moment. . . . Welcome to Minds Are Live. Hello?

Just a moment, ladies and gentlemen. We will need to reconnect our speakers' lines. Just a moment.

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Apologies, ladies and gentlemen, the speakers are reconnected. Hello, I'm sorry for the interruption.

We got disconnected. We can, I don't know if you heard the last answer for Marcelo.

Yes, we heard Marcelo's answer.

Mr. Carlos Gomez from HSBC, can you please repeat your question?

Yes, sure. Good morning. My question to you was about the SME sector and whether you, when do you expect the SME sector to hurt and losses to escalate if the lockdown lasts for more than two months, three months, four months? Do you have a timeframe in which you would start to worry more about it? Thank you.

Hi, Carlos. I think that the most vulnerable segment, not only in our loan portfolio, but I would say in the economy, is particularly SMEs. And, you know, going back to the point that Hector was making in terms of the, you know, how low is the fiscal stimulus that the Mexican government is putting together, I think this is, in this segment is where it's going to be more badly felt. We think that every week is critical for some SMEs. the largest employer in the country. So it is worrisome. It is worrisome, I would say, from a banking system standpoint. I think that we have a relatively sound position because last year we started to increase the guarantees that we use associated with these loan portfolios. So we increased the coverage in this portfolio going from 32 to now 69%. So that's good in our case. But definitely, we are extremely concerned with the lack of enough stimulus associated with SMEs. We have continuously voiced this to the government. still in discussions with the different regulatory agencies in order to try to put together something that is stronger than what has been offered so far. I think that in our case, given the fact that close to 50% of clients in our SME portfolio have involved the program, the debt relief program, we think that we're going to get to know exactly the magnitude of the effect, I would say that five, six months from now.

Six months from now. Okay. Thank you very much. And again, congratulations on the bond issues. I think you didn't hear that before. Thank you. Thanks, Carlos.

Thanks. Thank you.

Our next question comes from the line of Domingos Salazina with JP Morgan. Please proceed with your question.

Thank you. Hi, Hector and Grace as well.

Thank you for taking the question. I'm not very familiar with the taxing in Mexico or like what exactly is the advantage. You guys are sounding to me very cautious, like, you know, unprecedented crisis, you mentioned we are concerned. And when we look at provisions, you know, coverage ratio was Not stable-ish. You know, they grew 19% provisions a year.

You basically didn't do anything... Domingo, we cannot hear you very well. Is there a way that you can speak a little louder, please?

Sure, sure.

Thank you, Domingo.

Put my headset again. Is it better now?

Yeah, it's better. Thanks. Okay. Sorry about that. No, so my question is... I'm not very familiar with maybe taxing implications or not, but basically, you guys are coming out very cautious. You mentioned an unprecedented crisis. You mentioned that you're very concerned about the crisis. And yet, when we look at your provisions, for example, we only saw them growing 19% year-on-year coverage ratio, about flattish. You know, some banks in Mexico doing similar, some, you know, like in Bursa, are growing 90 plus percent provisions. And you mentioned in your remarks that you think it's better to wait to see the implications before doing provisions. My question is, why is it better to wait? Do you have tax benefits? Because the risks are clear. The more you kick this forward, the more you have to backload potentially massive provisions in the year-end. So I understand when you say it's better to wait, that you elaborate a little bit why it's better. That's question one. And the question two I have is, did the parent company, Santander Spain, provide any guidance or any expectation as far as when to do preventive guidance? I'm asking this because we saw very large provisions done in Europe, in Spain, 1.6 billion post-tax euros, and we're not seeing that in Brazil nor in Mexico. So my question is,

Did Centro de Espain recommend anything as far as provisions go? Hello, Domingo.

Regarding your question as to why it's better to wait, I think it has to do with making the provisions, understanding exactly what the magnitude of the impact, rather than making an assumption as to how bad can be affected the loan portfolio. I think it has to do with that. And if you look at our... But you can reverse, right? I'm sorry to interrupt, but you can reverse. You can do, and then if you don't use it, you reverse it back, or you gradually consume it, right? You could do that. Yes, you're right. We can do that. However, we don't feel comfortable right now with the information that we have in terms of the size of the provision that we need to put forward. And most likely, If we do it right now, we're going to end up not really making an accurate estimate. We might end up under provision or over provisioning. Rather than doing that, we think it's it's better to wait, you know, and see exactly what the magnitude of the deterioration. What is for sure is that it's going to get, you know, asset quality will deteriorate, you know, and we have a strong capital position. We're starting this, we're entering this crisis also with a sound profitability, so I think that we have room to sustain any deterioration of our asset quality. We think that the best thing to do is to understand better the magnitude of the impact. That's basically what's driving us not to make any anticipated provisions right now. Now, in terms of your second question, I think that our corporate didn't provide any guidance in terms of making provisions or not. I think that they're making some general provisions, but we were not asked whether to increase or not I think that there is also independence in that regard or autonomy in that regard, and we follow, let's say, our local regulations and also the information that we have.

Okay. Very good to know the independence point because we were getting questions on that. Thank you.

Thank you. Our next question comes from the line of Lemar Salah with Barron's. Please proceed with your question.

Thank you very much for taking my question. It's Lemar Salah from Barron's here.

I've got two questions. So the first question is on portfolio, which is put for grace period. I just want to understand, out of that 16% of your loan book, which is put for grace period, what was the net interest income contribution of that portfolio? And perhaps you can also, for SMEs, explain and guarantee what that guarantee entails. Is it guaranteed on MPLs or interest for that SME? And when you look at the technicality of this balance sheet being put for a grace period of six months, what do you expect beyond that six months? How does that work in terms of balance sheet functionality? And my second question is with respect to your capital ratios. I think, you know, the capital ratios are solid. I do like the fact, you know, that you have different payments for foreseeable future. But I just want to understand, you know, I mean, drop by one percentage point. And I think, you know, in the disclosure, it says, like, you know, higher risk-weighted assets. Perhaps you can explain, you know, what kind of risk-weighted assets move north and whether, you know, the effect impacts

had any material impact in terms of ketamine capital CET1 dropping down. So, thank you.

So, regarding your first question, you know, and how the SMEs guarantees work, you know, there's, let's say, a first-loss guarantee with Nafinza. So, we share basically the loss that we have you know, if there's a client that comes past due. So we just have to, you know, there's a process that we need to file with Nafinsa in terms of making sure that, you know, the SME was fully compliant with all the guidelines that we have for this program. And once we show to Nafinsa that this particular SME is not making their loan payments, then we get reimbursed 50% of the losses that this particular client has. We pay a premium for that, okay? So that premium has been moving, let's say, depending on the the specific time where we negotiate this with Nafinza, but it has been as low as 3.5% and as high as 5.5%. Okay? So that's how the DSME currently works. And hi, Lama. This is Eko Chavez. Just to follow up on your first part of the first question, the way it works is that with the deferrals on the payments of both capital of interest on this four or six months, the interest is still taken as accrued towards the NII of the bank.

We don't have a flow of interest, but we do reflect it in our P&O. And to that point, just if I can, follow up.

So, I mean, 60% of that loan book is up for grace period.

How much of NII does it generate per quarter? That's 16% of loan book. Given that it's a mix of SMEs, loans, and mortgages, we still don't have the calculation.

We still are receiving some of the additional registrations as of today, and we still have some other that we have to do. it is, we still have to calculate, but we don't know how much of net interest income that accounts for.

Because again, it's a completely different mix of loans. Okay, perfect. But you know what I mean?

Yeah. You know, just on, so you can't also, I mean, can you give me also the LTV, you know what I mean, adjustment on that book and potentially the average duration expansion? I mean, average duration expansion is roughly six months. Let's take it six months. I just want to know, like, you know, me, would I have those calculations in front of you? What is the average duration of that?

You know, I mean, 16% loan book and, you know, I mean, LTV adjustment. So, pre-COVID LTV level and post-COVID LTV. If you could share that, that would be fantastic. Oh, yeah. We'll take into that account for the next call. They do need all the details.

I think that when we have

full amount will, of course, keep track in the next call of how that portfolio is behaving.

Perfect.

Thank you. Our next question comes from Juan.

Sorry. There is a follow-up on the capital. Yes. Regarding your question on capital ratios, you know, Definitely, if you look at the composition of our risk-weighted assets, two-thirds of them are associated with credit, 26% are market-related risk, and 7.5% are operational risk. What we saw in this first quarter associated with the volatility in market and with the depreciation of the peso, that risk-weighted assets associated with the market risk increased more than what we saw on our credit risk. We think that if you look at how this could perform over the following quarters, we are not expecting a significant increase in terms of credit risk from now, marginally, I would say. There's a chance that we can still experience volatility in the financial markets throughout the year. So this breakdown, I would say, could be similar, you know, going forward. I think that, you know, the impact that has loan growth in our capital ratio, it would not be that significant in our expectation. I think that the capital ratio will have some pressure associated with market risk and also with some, you know, the impact that we could see in terms of, you know, some financial instruments losing a certain value, you know?

Thank you. Our next question comes from the line of Guillermo Diego with Santander Bank. Please save your question.

Sure. Hello, Guillermo.

Thanks for the call. And as you mentioned, the initial expectation of the market, we would have seen some long growth contraction. But we have seen the other side. We have seen a long growth, as you mentioned, pulled by the same client. So obviously the cost of risk is difficult to measure. And at the same time, also a strong deposit growth. So just wondering, we have seen previous periods of stress in Mexico, 2009 with the virus, H1, the NAFTA negotiation, Trump, the new president. And it seems that the reason someone would buy your stock, the stock of a big bank is diversification, the strong capitalization, the deposit base, your market share. So not just being for the quarter or just the next six months, because nobody knows the real number of the provisions. What is the long-term strategy of the bank? We have seen the bank invest for plans of five years and more, and obviously the current stock price, when you are trading below book value and with the deep discount that you are trading, obviously the market is implying a strong hit over your long growth, which doesn't seem feasible right now. So not just watching for the quarter, but watching for the long term. What is your view there, Didier?

Thank you. Let me give you an overview of what we're looking at and what we're thinking. I mean, right now we are most convinced that this is not going to be a V in terms of the economy going down and then right back up again, okay? We have been already in a situation in which the economy was in recession. before entering the pandemic, okay? And we knew that and we were basically taking precautions in terms of that. So we were very, as you saw, our portfolio didn't grow as much as in some other institutions because there were some parts of the portfolio that we decided to be more prudent in the way we were growing the total portfolio, okay? So we understood that we were entering into low part of the cycle, and we were basically preparing for that. Secondly, our strategy basically has been very keen on getting new clients to the bank. New clients to the bank is a key part of the strategy because if you compare our bank in size versus our peers, the amount of individual clients that the bank has is less than the one our peers have. So our strategy basically is going to continue in exactly the same way, to attracting new clients, individual clients, and to attracting deposits, okay? Because our cost of funding, as we were just discussing, is actually above our peers because of that. Okay, so our strategy works even in a complicated situation in the economy, as in... normal situation of the economy. So we're going to continue with our strategy in the long term. In the meantime, basically, we are basically taking decisions of what are we going to do with our portfolio and where are we going to grow the portfolio. In the parts where we grew the portfolio is in the big corporates that are strong, that have enough liquidity, and that we don't foresee that we're going to enter into a problem. Because the Mexican companies at this point, they have very good position in terms of the long-term debt that they have. They don't have, I mean, short-term maturities, and they're not over-leveraged. I'm talking about the majority of the big Mexican corporates. The medium-sized companies as well, they're in a good position. Probably the worst or the more complicated one are the SMEs that we have just discussed at length and that we have the portfolio on. very well guaranteed by Nafin at this point, so we are not so much concerned about that portfolio, and we also were very prudent in the way we were managing that portfolio. Okay, so in that sense, I believe that the bank is in a good position to sustain the period of crisis as we are to pass through the next few months and maybe up to a year. and both our main strategy is going to continue to be the same we are of course i mean decreasing cost we are taking the provisions and and we are basically operating on on a stressful environment but we are very well prepared for that okay you are right we are training below tangible book value and we i mean we acknowledge that but i mean i believe that the bank has very good capabilities of being profitable even in these current times.

Sure. Thank you.

Thank you. Our next question comes from one of Brian Flores with Citibank. He's here with a question.

Hi. Just a quick follow-up on the proportion of the portfolio that is involved in the relief program. Do you have any expectations on where this number might end? And the second question is just if you could elaborate a bit on what you mentioned regarding the mortgage portfolio and the trends that you're seeing there. Is this something that you believe is recurring or more of a one-off for the quarter? Thank you. No.

The clients that have enrolled in the relief program, you know, please just, you know, to put things in perspective, The clients that are eligible to join these programs are individuals, so individual loans, and SMEs. That comprises close to 50% of our loan portfolio. If you look at the breakdown of those clients that have showed interest in joining, the view of the loan portfolio of those clients is close to 120 billion pesos, as Hector noted earlier. We are just a few days. Well, actually, it ends up today, you know, the deadline to register. So we, you know, I understand that other banks have extended, you know, the period of enrollment. We are not considering that. So we think that the numbers that we're sharing with you are relatively close to what we're going to get to see. So we're not expecting a significant increase from the numbers that we show to you. Regarding the mortgage portfolio, if your question is associated with the provision that we made this quarter, we disclosed it a couple of quarters ago that there was coming this change in model that we're using, and it was just pending regulatory approval, which we already have.

So, we made that, and that's one good point. Okay? Very good. Thank you.

Thank you.

At this time, there are no further questions. I'd like to turn the floor back to management for closing comments.

Thank you, operator. Thank you, everyone, and once again for joining Center for Mexico on this call.

As always, we wish to maintain with you an open dialogue, and we have open invitation to visitors in Mexico anytime or to any type of call. If you have any additional questions, please don't hesitate to contact us. Have a great day.

Thank you. Ladies and gentlemen, this concludes today's silent conference. You may disconnect your lines at this time. Thank you for your participation.