Banco Santander Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 26, 2023

There are 13 speakers on the call.

Operator

Good morning, everybody. Welcome to Banco Santander's conference call to discuss our financial results for the first half of twenty twenty three. Just as a reminder, both the results report and presentation we will be following day are available to you on our website. I am joined here today by our CEO, Mr. Hector Rigvisi and our CFO, Mr.

Operator

Jose Garcia Cantera. Following their presentations, we will open the floor for any and all questions you may have in the Q and A session. With this, I will hand over to Mr. Grisi. Hector, the floor is yours.

Speaker 1

Thank you, Begonia. 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 at our Investor Day. Jose will then review our financial performance in greater detail and then I'll conclude with a few closing remarks.

Speaker 1

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 record profit of EUR 2,700,000,000 an increase of 14% compared with Q2 in 2022, thus Plus 17% in constant euros. In the first half of twenty twenty three, profit was €5,200,000,000 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.

Speaker 1

Our numbers of customers grew by €9,000,000 year on year, taking the total to €164,000,000 and loans increased by 1% and deposits by 5%. The group continues progressing towards a simpler and more integrated model through 1 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 percent And our net operating income grew double digits. Our return on tangible equity, ROTE, Rose 80 basis points year on year to 14.5 percent, while our earnings per shares improved 13% year on year supported by greater profit and share buybacks.

Speaker 1

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 TNAF plus EPS year on year of 11%, of which represents an increase of more than EUR 6,000,000,000 in the 1st 6 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.

Speaker 1

As I have just mentioned, Profit increase in the first half supported by, 1st 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 EUR 16,000,000,000 which demonstrates the strength of our results and loan loss provisions normalizing in line 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 €200,000,000 and additional Swiss mortgage provisions in Poland of €140,000,000 and one offs in Brazil of €137,000,000 Jose will go into more detail on all of these points 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.

Speaker 1

CET1 was 12.2% after profitably growing our businesses organically and at a comfortable levels allowing Also to accrue funds to meet our shareholders' remuneration targets of a 50% payout. Our ROTE Also grew year on year to 14.5 percent on track to reach our target and would already be close to 15% if we don't annualize extraordinary banking tax As we announced at our Investor Day, we have entered into a new phase of value creation that will help us growth TNAP per share plus EPS at double digits during the 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 6 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 1 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 increase the size and profitability of our customer base.

Speaker 1

We are delivering across the 3 pillars of 1 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 a Lund in the Q1 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.

Speaker 1

And we have already captured around €70,000,000 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 inefficiency improvements. Our Global and Network business keep continuing contributing to the group's profitability and have already delivered another 43 basis points.

Speaker 1

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 rates 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 EUR 2,000,000,000 commitments already. In payments, we have deployed GetNet in Portugal and Argentina in the first half and we expect to launch in 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.

Speaker 1

We have recently onboarded new partners in the U. S, leveraged the existing agreements in Europe, which are expected to materialize In around €4,000,000,000 of new business per year, we have also deployed a new pan regional leasing platform in 2 markets and more countries will be added throughout 2023 2024. Finally, our global technology capabilities have already resulted in 36 basis points improvement in efficiency ratio. Our global approach to technology has allowed us to capture €80,000,000 in savings this year, Mainly driven by: 1, efficiencies from the recent development and deployment of gravity in 2 countries, which contributed with €31,000,000 in savings in the first half and new global agreements with vendors which represent around €40,000,000 in cost reduction year to date. The actions that we are beginning to carry out as a part of 1 transformation, which we are expanding across the group, are starting to be reflected on cost non operational efficiencies.

Speaker 1

As you can see on the slide, simplification has already driven significant improvements In our cost and revenue per active 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 6 months, through one transformation, we have already reduced the number of operational FTEs per 1,000,000 customers by 3%. We are already deploying global tech platforms to improve customer experience, leverage economies of scale and extend best practices.

Speaker 1

Open Digital Services, as we call it, ODS, our cutting edge front end platform, allows to deliver a best in class omni channel experience to our customers. At the same time that Gravity, our award winning core vac and 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 omni channel, 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.

Speaker 1

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, We're 27% year on year to EUR 2,000,000,000 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 local reach, a global reach.

Speaker 1

Our customers can move and transact easily from one country to another and that's the reason why customers have EUR 50,000,000,000 In assets under management booked abroad 10% higher than 1 year ago. Our payments business is also growing very strongly. 2 years ago, we began to move our payments business onto scaled global platforms. And as of today, Our Payments Hub platform already manages a significant part of all payments in Eurozone and we are progressing in another key countries Such as Brazil, Mexico and the U. K.

Speaker 1

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 For around €100,000,000 per year during the next 2 years alone. First delivery of the platform will be live in Brazil by the second half of twenty twenty three. 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 more much more efficient and the 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 will be around 50% if we didn't analyze the extraordinary banking tax in Spain, which is in line with the group's targets for 2022 sorry, 2023 2025.

Speaker 1

Jose will now go in more detail to the group's first half performance. Please, Jose.

Speaker 2

Thank you, Hector, and good morning, everyone. And Latin America driven by growth in volumes and fees. Digital Consumer Bank benefited from asset 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.

Speaker 2

S, which as in previous quarters was affected by an increase in the share of end of leased vehicles repurchased the dealership. Revenue at the corporate center also improved, up nearly €400,000,000 due to higher liquidity buffer remuneration Most of our revenue growth came from NII, which continued its upward trend, increasing 6% in the quarter alone, 1st half twenty twenty three 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 Q1 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, first, thanks to our disciplined deposit remuneration strategy adapted to each country's specific needs.

Speaker 2

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 The U. K. 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.

Speaker 2

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 €500,000,000 Turning now to fees. In an environment of low fee growth in general as a result of sapar 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.

Speaker 2

CIB and PagoNEXT are leading the way in terms of growth. CIB is increasing its share of leading roles and mandates. Ampaconext 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.

Speaker 2

Wealth Management and Insurance grew less as customers moved to lower risk fixed income products with lower fees and margins. However, we saw volume improvement in both Private Banking, net new money of €6,500,000,000 and Santander Asset Management over €3,000,000,000 net sales. Auto performance year on year was affected by the new insurance regulation in Germany in the Q1, but recovered significantly in the Q2. In terms of cost, our transformation efforts that Hector took you through earlier are paying off. Despite initial investments, Cost in real terms are growing below the rate of inflation across most of our footprint, reflecting the savings we are beginning to generate on our strict cost control.

Speaker 2

This in turn is reflected in efficiency improvements led by Europe, which improved 7 percentage points, thanks to strong revenue gains, together with a 2% fall in costs in real terms. As a result, core efficiency is already at the bottom end of our target range, Well, we expect it to remain for the rest of the year. Credit quality remains robust across our footprint. The The non performing loan ratio remains stable in the context of unexpected soft landing 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.

Speaker 2

We said in the Q4 of last year that we believe the Brazil NPL ratio had already peaked and trends so far this year support that view, 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 borrowers portfolio, but we are seeing signs that cost of risk has stabilized.

Speaker 2

Brazil's 12 month cost of risk at the end of June was 4.74%, but if we annualize the 1st 6 months, That improves to 4.5%. Mexico is increasing from low levels, mainly due to a change in mix towards unsecured loans, which require more provisions upfront and obviously more is more profitable. Other units such as the U. K, Portugal and the Digital Consumer Bank 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.

Speaker 2

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 first in North America, South America and ECB.

Speaker 2

On the other hand, deposits continued to grow well, up 4% year on year following a €3,000,000,000 increase the Q2 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, the year to date following market turmoil, particularly in the U. S.

Speaker 2

In fact, deposits in the U. S. Grew in the quarter and remained flattish 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.

Speaker 2

Our fully loaded capital ratio remained at a comfortable level of 12.2%, year, backed by 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 shareholders in Mexico, which cost 4 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 ROADWA of 2.9%, up from 2.5% in the first half of twenty twenty two, 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 the percentage of risk weighted assets with positive economic value added, progressing well towards our Investor Day target of 85 in 2020 part.

Speaker 2

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.

Speaker 1

Thank you, Jose. In summary, Q2 of 2023 was another strong quarter supported by customer growth, double digit 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 1 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 2022, 2023 targets and remunerate our shareholders in line with our 50% payout policy, 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 6 to 9 months. Cost of risk is normalizing in line with our expectation.

Speaker 1

Customer and corporate behavior in most of the geographies. Group Rotes reached 14.5% in the first half, And we expect to close above 15% at the end of the year. All in all, our TNAV Plus cash dividend is growing at a double digit, well on track with our target of average growth through the cycle. And now we will be happy to take Any of your questions? Thank you.

Operator

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

Speaker 3

We already have the first question from Carlos Peixoto from CaixaBank BPI. Please go ahead.

Speaker 4

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?

Speaker 4

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 3 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 RWAs

Speaker 1

Thank you, Carlos. What I'll do is I'll ask the first question on Brazil. We'll give you a comment on capital and then Jose will tell you a little bit about what's going on with increasing RWA, okay? In terms of the Brazil margin quarter on quarter, as we say Basically, it's explained by the following. Our loans since 2021, we have become much more conservative and And growing volumes very selectively, changing the loan mix to lower risk, okay?

Speaker 1

So we mainly get 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, okay, NII, remember that in Brazil, we have negative sensitivity to rates, okay? So, Brazil NII In the Q2 of 2023, it's 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, okay? So we expect NII In the second half of twenty twenty three to be higher than the first half of the year leading to a flat NII in the year with a substantial improvement in 2024, okay?

Speaker 1

In terms of the cost of risk, not only the macro outlook is improving, but Since 2021, as I explained, we've been very selective in the approach of the new lending extension and focusing to more secure and higher rate customers, As I explained, okay, this is showing good results and we believe the worst, as I said repeatedly, is worst sorry, the worst is behind now. Cost of risk in the Q2 is already improving versus the Q1 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 2023 versus 2022 excluding the one off that will be which implies staying close to around 4 0.6%, okay? 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 first on 2025, okay?

Speaker 1

And with that, I don't know, Jose, if you can comment on RWAs, please.

Speaker 2

Yes. Thank you. So Good morning, Carlos. You're right. Loan growth was 0, but risk weighted assets grew more or less 2%.

Speaker 2

Half of that growth is due to FX As we consolidate the Latin America, 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 higher profitability going forward.

Speaker 2

When we look at the Outlook, as Hector said, we don't expect any significant regulatory or supervisory capital impact the first 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

Operator

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

Speaker 3

Next question from Alvaro Serrano from Morgan Stanley.

Speaker 4

Please from my side on U. S. And Spain. U. S.

Speaker 4

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 And cost of risk for the full year.

Speaker 4

I think you gave us some color in Q1, maybe an update for you on what are the moving parts there? And 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 do you would you expect NII to peak in Spain. I'm extrapolating Spain, Portugal, which I assume is the same dynamics.

Speaker 4

Thank you.

Speaker 1

Thank you, Alvaro. Okay. Let me give you our outlook in the U. S, okay? And I It's basically the same dynamic I explained you on the Q1, okay?

Speaker 1

Credit provision, as you know, decreased as credit quality is remaining robust And credit in our charge offs actually what we call realized losses show better than anticipated performance. And this is basically on the back. Juice prices continue to be strong, okay, as I explained and declining at slower pace than we previously anticipated. The change in auto loans portfolio mix towards more prime. Remember that I told you that before 2018, we had a lot more so prime than prime and the change On the mix has helped.

Speaker 1

Also, we have robust and better than expected labor market in the U. S, okay, which is sustaining that, Okay. And auto customers that are delinquent, exactly as I was explaining in the Q1, for more than 90 days are rolling into charge off Status at historical low levels, okay? Normally, they were above 90%, 95%. Last quarter, they were around 59%, this quarter around 67%, okay.

Speaker 1

So it's still much better than we expect and much better than it was Actually happening pre COVID, okay? And in 2023, we expect cost of risk to continue the normalization at around 2%. And after 2 years of artificially low figures given COVID, etcetera, as I was saying, normalized levels should be below pre pandemic. Cost of risk at Around if you remember pre pandemic was around 285,000,000,000. It's never going to get there, okay, because of the change of mix and what I was explaining, Okay.

Speaker 1

In terms of the Spain, okay, in Spain, the deposits, I mean, continue to be stable, Okay. At around we have around €299,000,000,000 okay? We have excess liquidity in Santander, Spain. LTD is around 78%, as this is the case for the whole Spanish system that is around 80%. Quarterly decline is mostly 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.

Speaker 1

Also what we see between the first half of twenty twenty three versus the first half of twenty twenty two 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, driven by the growth of CIB, which allows us to maintain also our and maintain a stable net liquidity position, Okay. In terms of what I was saying, NII, we don't expect to peak Yes, I mean, we have still revisions and I will have Jose explain to you in detail exactly how we see NII evolution in Spain.

Speaker 2

Good morning, Alvaro. Let me talk about the Corporate Center because Santander is say more than Spain because this is going to give you the A better view of our euro sensitivity to rates in Spain. So we have assets of €330,000,000,000 60% floating, 40% fixed. This fixed includes the ALCO, Which is €27,000,000,000 that we've been buying recently with an average duration of 6 years and an interest rate of Over 3%. We also have intra group transactions, etcetera, money markets that are fixed, but these are very short term, So they will reprice as short term Euribor actually goes up.

Speaker 2

Of the floating, €200,000,000,000 65,000,000,000 We'll reprice or reprice with 12 month year LIBOR. We expect the If we use today's 12 month year LIBOR compared with the average of the first half, so let's assume that the LIBOR remains flat in the first half of next year, We have at least 50 basis points pickup in the repricing of this part of the portfolio next year. And then we have EUR 60 sorry, EUR 30,000,000,000 which reprices with the 6 months EUR 40,000,000,000 with the 3 months €65,000,000,000 with 1 month. So 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. So obviously, the asset yields are expected still to expand well into 2024.

Speaker 2

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 your arrival 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.

Operator

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

Speaker 5

Wanted to ask about NII in the U. K. And in the U. S. If you can please update your guidance in the U.

Speaker 5

K. I see Lending is weak, falling, local mortgage market is declining, asset spreads are low, the deposit EBITDA 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?

Speaker 5

Or are you paying up for deposits? How do you see the EBITDA compared to the local peers and

Speaker 1

Thank you, Francisco. Okay. Let me give you all the details, okay? Let's talk about first about the U. K.

Speaker 1

NII was up double digit in the first half of twenty twenty three, okay? It was driven mainly by higher rates and the strong focus on managing spreads And profitability, although the U. K. Tends to be more competitive than other European markets, as you know, okay? So we're putting profitability ahead of market share, okay?

Speaker 1

And we have a lower risk appetite, but we're expecting good performance to continue, leading to And NIM expansion, okay? So we expect it to stabilize Towards the second half, okay, to end 2023 with a high single digit growth on higher rates and despite the lower volumes that we have because of what you just explained about profitability, okay? In the Q2, NII was flattish, okay? Higher yields on loans did not offset the higher cost of retail funding and the slowdown in new originations, In terms of the betas, Jose will tell you afterwards that I tell you about what's going on in the U. S.

Speaker 1

In terms of the U. S, Overall, as you have seen, has done better than expected given the change in mix towards prime, okay, as I explained in detail, lower yield, but also better risk profile and the lower credit provisioning It's helping us, okay? NII is flattish in the quarter year on year on funding pressures on the wholesale retail. As you know, a lot of this is funded by wholesale 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.

Speaker 1

However, given the strong behavior that we have on the labor market and seeing the performance on the first half, U. S. NII could do better than we expect, okay? U. S.

Speaker 1

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 Jose, I don't know if you can comment on the betas, please.

Speaker 2

In the U. K, When we look at the cost of deposits today relative to the level of rates today, that's around slightly 30%, it's increasing slightly in the quarter 3 percentage points, we still think that, that will continue. So the U. K. Is a market with less excess liquidity than Spain, for instance.

Speaker 2

So we would expect, as Hector said, margins probably they were stable in the Q2 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.

Speaker 2

Is 36.8%, up 2 percentage points quarter on quarter. 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.

Operator

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

Speaker 3

Next question from Ignacio Largie from BNP Paribas Exane. Please go ahead.

Speaker 6

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?

Speaker 6

And the second question is a bit at a group level. If I just look to the first half course of this case, it's around 106 basis points. You are sticking to the guidance below 120. Is there any region besides the U. S.

Speaker 6

Where we could see some deterioration in the second half that makes you to 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 basis points? Thank you.

Speaker 1

Thank you, Ignacio. 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. Okay. In the Spanish loan book, the dynamic that we have seen is quite clear, okay? We have seen low demand of credit, okay, which is impacting us A little bit.

Speaker 1

Mainly also we have seen an increase on the prepayment mainly on the mortgages, Okay. Because of the increased rates, remember that a lot of big percentage of our portfolio is on variable 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, the corporates and the SMEs being more cautious In new credit demand, okay? And the dynamics we lived throughout the year continue in that way.

Speaker 1

Let's see what happens at the beginning of the year and also If we can see more confidence a little bit on investment, okay? But now we see the dynamics in that way. Please Fostio on the second one.

Speaker 2

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 the normalization of the cost of risk as we change the business mix.

Speaker 2

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.

Operator

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

Speaker 3

Next question from Sophie Petersons from JPMorgan. Please go ahead.

Speaker 7

Yes. This is Sophie from JPMorgan. Thanks for taking my question. So could you just explain the difference between your reported net interest income, which was €10,500,000,000 and the underlying €10,700,000,000, what explains the EUR 7,000,000,000. What explains the EUR 200,000,000 delta?

Speaker 7

And are there any more one offs Would be on the capital headwinds. You mentioned that you expect it to remain above 12%. But could you just outline what capital or core Equity Tier 1 headwinds you are expecting In the coming quarters or at least on the year end? And also if you could remind us what the Basel IV impacts are? Thank you.

Speaker 1

Okay. Thank you, Francois. So Jose will explain you the NII evolution. On capital, let me reiterate exactly what I said and then Jose I can expand a little bit. So as I told you, we expect to generate at least 10 basis points of organic capital on average per quarter, okay?

Speaker 1

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 you the NII evolution.

Speaker 2

So Sophie, hi, good morning. As I said, we don't expect any headwinds, significant headwinds from any of the 3 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 in the second half 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 is 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.

Speaker 2

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, 0. What happened in the Q1 is we had a positive adjustment of EUR 211,000,000 And we have reversed exactly the same amount in the second quarter, which by the way in terms of the €20,000,000,000 it's a very small amount. So No adjustment to NII in the first half. What we added to underlying in the Q1 was reversed in the second quarter.

Speaker 2

There are other adjustments In the P and L, but basically netting out in most cases what happened in the Q1 in the second quarter. But Investor Relations will give you all the details line by line of the differences between the 1st and the second quarter. Thanks, Sophie.

Operator

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

Speaker 3

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

Speaker 8

Thank you very much. My first question is on the digital bank. Could you please provide an update on your strategy for gathering deposits here? You've raised roughly EUR 3,400,000,000 year to date. That seems to be below what you had planned a few months ago.

Speaker 8

Your loan to 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 more successful in Northern Europe and Germany. The second question is a follow-up on mortgages in the UK. You are shrinking pretty fast, €4,000,000,000 per quarter.

Speaker 8

When do you expect to stabilize that book? Thank you.

Speaker 1

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 story 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?

Speaker 1

And in some other different initiatives that we have. For example, in Germany and some other places, the strategy has been proven 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 U.

Speaker 1

K, 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 U. K, okay? If we see that there is a change 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.

Speaker 1

1st of all, profitability and being cautious on the risk appetite there. If we see all 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.

Speaker 2

In the Digital Consumer Bank that now includes OpenBank, we have EUR 60,000,000,000 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.

Speaker 2

And I think we've been very successful in managing interest rate sensitivity in a business that is naturally that has naturally negative sensitivity to raising rates. Thanks, Marta.

Operator

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

Speaker 3

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

Speaker 6

Yes.

Speaker 5

Juan, can you go into the different geographies? And particularly, you've given a lot of detail on NII 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 the rate of increases in interest rates Of the positive beta and the ALCO portfolio contribution.

Speaker 5

Thank you.

Speaker 1

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? Sure, yes, in Spain. So to start, I mean, Brazil NII, okay?

Speaker 1

Performance in risk of quarter is explained. 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, Okay, changing the low mix to lower risk. On deposits, okay, the fast increasing rates Main, the rapid rise in the cost of deposits, okay? We expect NII in the second half 23 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, okay?

Speaker 1

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, Okay. And we believe that the financial rates could fall in the second half, bringing the cost down in retail funding, okay? And then in the drivers of NII in Spain, And Jose will give you more details. Spain is one of the countries that has benefited most from the higher rates, okay? We continue to see strong growth in clients.

Speaker 1

Just in the first half of the year, we have 300,000 more active clients, Okay. 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 and remain contained on the cost of deposits. So we have We've been managing very well in that sense. We expect double digit growth for NII in 2023.

Speaker 1

And regarding the peak of NII in Spain, there are several things To consider that Jose already explained you, assets will continue to reprice at least during the first half of twenty twenty four, 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.

Speaker 2

So, hi, Andrea. The ALCO, in Spain, we have EUR 27,000,000,000 ALCO, EUR 21,000,000,000 is a structural long term held to collect with an average Maturity of duration of 7.7 years and a yield of 3.3%, 3.4 percent. And then we have €6,000,000,000 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 only we are also taking other measures, but one way is obviously increasing the ALCO portfolio.

Speaker 2

In terms of betas, The beta for deposits in Spain is 17.8%. If we exclude CIB by the way, this is 3 percentage points higher than in the Q1. 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 details and the NII going forward.

Speaker 2

Thanks.

Operator

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

Speaker 3

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

Speaker 9

Yes. Hi there. Thanks for taking my question. Could you give a bit more color on the NII increase, the absolute NII increase Income sensitivity in Brazil over 1 year 2 years. And lastly, on the €500,000,000 rate benefits that you see More so than previously.

Speaker 9

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.

Speaker 2

Okay. So let me go backwards here. Yes, in the first half, the sensitivity was more or less €500,000,000 Higher than what we the guidance we gave in at Investor Day, we would expect more or less a similar amount in the second half in euros. So we 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 use to give that sensitivity at the Investor Day in euros were around 30%.

Speaker 2

We are below 20% right now and it's already half of the year. So we would expect another €500,000,000 more in the second half over €1,000,000,000 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 €1,100,000,000 1,200,000,000 more in euros, €2 €50,000,000 more in the U. K, flat, slightly negative in the U.

Speaker 2

S. And €100,000,000 less in Brazil. I think we gave you all the details to understand the NII sensitivity in Spain, But we can take it offline and if you wanted more detailed analysis, but I think we gave you all the details. I gave you the composition of the balance sheet by repricing on the asset side. So I think that's sufficient, I think.

Speaker 2

But we will take it offline.

Operator

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

Speaker 10

Hi. Thank you very much for taking my questions. Just a quick follow-up from NIM 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.

Speaker 10

Thank you.

Speaker 2

Okay. So the stock finance is seasonal. It tends to go up And then say in September to pick again in December. This year, the increase in June was higher than we expected. We are talking around 6,000,000,000 in total risk weighted assets from stock finance in the first half.

Operator

Thank you, Carlos. Can we have what I believe is the last question,

Speaker 3

Next question from Fernando Hilde Santibanez from Westenberg. Please go ahead.

Speaker 11

All right. Thank you for taking my question. Two questions, please. One is in Poland. What do you expect in terms of Mortgage provisions related to Swiss francs going forward.

Speaker 11

If you can comment on other things, what you're talking about? And second one is on RWA growth. I'm looking at U. K. Figures and foreign figures and looking at loans, Loan growth and FX impact.

Speaker 11

And it seems like other UAs are increasing faster than that. And if you can comment on why it's happening there in those particular regions, it will help a lot. Thank you very much.

Speaker 1

Okay. Sorry, Fernando, what you said at the beginning was mortgage provisions in Poland? Yes. Okay. So Fernando, let me tell you exactly how we are in Poland, okay?

Speaker 1

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%, okay, of the outstanding that we have, okay? 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 Changing to a slothis 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?

Speaker 1

On the second, I will have Jose

Speaker 2

to give you

Speaker 1

the answer. Thank you.

Speaker 2

As I explained, loan growth year on year was 0, 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 U. K, we have contraction in terms of risk weighted assets ex stock financing auto, A slight contraction in Europe and then we had the stock finance expansion in Europe and also risk weighted asset growth both

Operator

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

Speaker 3

We have a question from the line of Inacio Ferreza from UBS. Please go ahead.

Speaker 12

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 2024, the sensitivity to rates Jose was mentioning suggests probably around 1% for 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.

Speaker 1

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?

Speaker 1

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 as you know in 2021, we decided basically to come out of it given what we saw in the current environment, Okay. 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 already 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, okay?

Speaker 1

And we see that we're going to end up the year basically flattish To where we started, okay?

Speaker 2

So, hi, Nacho. We believe interest rates in Brazil will start coming down in August. They are at 13.75%. Our central is for rates to end the year at around 12%, 12.25% 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 3rd, but it should increase in the 4th And more so into next year.

Speaker 2

And the exact sensitivity, I mentioned the sensitivity to higher rates, but the sensitivity in Brazil To 100 basis points, but this is a parallel shift. I insist a parallel shift, which is not what will happen probably Because we are 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 €140,000,000 higher revenue in Brazil. Thank you, Nacho.

Operator

Thank you, Nacho. I believe there are no the 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.

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Earnings Conference Call
Banco Santander Q2 2023
00:00 / 00:00