May 2, 2015
Executives
Raimundo Monge - Corporate Director, Strategic Planning
Analysts
Guillermo Costa - NWB Fred de Mariz - UBS Tito Labarta - Deutsche Bank Saul Martinez - JPMorgan Alonso Correa - Credit Suisse
Operator
Good day, ladies and gentlemen and welcome to the Q1 2015 Banco Santander-Chile Earnings Conference call. My name is Tia and I will be your operator for today.
At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference.
[Operator Instructions] I would like to turn the call over to your host for today, Raimundo Monge, Corporate Director of Strategic Planning. Please proceed.
Raimundo Monge
Thank you very much. Good morning ladies and gentlemen, to all of you.
Welcome to Banco Santander-Chile’s conference call for the first quarter 2015 results. Thank you for attending today’s conference call in which we will discuss our performance in this quarter.
Following the webcast presentation we will answer your questions. Before we get into more details regarding our results, we would briefly give our latest update on the outlook for the Chilean economy in 2015 and 2016.
Regarding economy, despite existence of internal and external uncertainties the overall outlook for the Chilean economy is improving. We expect the economy to grow close to 3% in 2015 and 3.6% in 2016.
As a result of this moderate uptake in the economic growth expectations inflation expectations for the year has also gone up. The inflation rate measured by the variation of the U.S.
and inflation linked unit and the most relevant indicator for the Bank should increase around 3% in 2015. Given this inflation outlook we expect the Central Bank not to cut interest rate any further during the year.
The pickup in economic growth is being led by various factors first of all internal demand should expand 2.5% in 2015 and 3.5% in 2016. Secondly, the outlook of growth of Chile’s main trade partners especially the U.S.
continues to be healthy. Export growth as measured in GDP figures should expand at around 4.6% in 2015.
At the same time, the fall in international oil price is just another positive event for the Chilean economy as Chile imports most of its oil. Regarding investment in 2015 and ’16, we are expecting a slight recovery in investment levels following the contraction seen in 2014.
This should be driven by the greater investment expected in infrastructure and the energy sectors. Finally, total consumption including government expenditure should continue to grow at around 4% in both 2015 and 2016.
All-in this should represent a relatively supportive market environment for banks. For this reason loan growth should continue to grow close to 8%-9% in 2015.
We expect that ROE for the system to fall in 2015 compared to 2014 due to the lower inflation for the whole year and higher corporate taxes. But core operating and asset quality trends should remain relatively healthy throughout the period.
Now we will review how the Bank continues to move forward in its strategic objectives and the main commercial results achieved in the year. The Bank continues to experience robust core business strength in various business segments.
As we will see in the rest of the presentation we continue to see solid loan growth especially in those segments with the highest risk adjusted contribution. Our funding mix is also improving as growth has not only been focused on the lending side but our non-lending business has also been growing at a steady pace.
We have also seen a continued improvement in our client base cross-selling and customer satisfaction levels. At the same time, the evolution of our asset quality indicators also show that the different changes in our credit approach are starting to be positive contributors to the Bank’s profitability.
Our capital levels also remained robust allowing us to continue paying an attractive dividend. All the above should allow us to continue to achieve an optimal balance between return on equity and our cost of capital.
By maximizing this gap we should be able to expand shareholder value on a consistent way. In terms of our first strategic goal focused growth in the first Q of 2015 total loans increased 3% Q-on-Q and 9.9% year-on-year.
The Bank targets its loan growth in the higher income segments while remaining more selective in the lower income segment and SMEs. Lending to individuals increased 2.1% Q-on-Q and 12.9% year-on-year.
This growth was led by loans in the high income segment that increased 13.9% year-on-year. The other area of relevant growth in the loan book was in the middle market segment.
In the first quarter loans in this segment increased 3% Q-on-Q and 9.6% year-on-year. The Bank’s strategy of focusing equally on lending and non-lending businesses has also led to a strong deposit growth, total deposit increased 4.6% Q-on-Q and 15.9% year-on-year.
Non-interest bearing demand deposit increased 14.8% year-on-year and the time deposit rose 16.6% in the same period. Core deposits, that is total deposit minus short-term wholesale deposit increased 14.3% year-on-year.
The effectiveness in the execution of our loan and funding strategy has been based on the growth of our client base and the improvement of our commercial approach, our second strategic goal. The first quarter of ’15, the Bank achieved positive net client growth for the eighth consecutive quarter.
But with a greater focus on improving cross-selling, retail clients with check-in accounts rose 6.3% year-on-year, more importantly among our individual clients, those are cross-sold measured not only in terms of how many product they had, but whether they used intensively or not increased 16.2% year-on-year. A similar situation can be of serving the SME segment where cross-sold clients rose 13.8% year-on-year.
In terms of our third strategic goal, the transformation project is also resulting in a further evolution of our asset quality, which is the key element of our strategy to obtain higher margins net of provisions. The Bank’s total non-performing loans ratio, decreased to 2.7% in the first quarter.
Total coverage of non-performing loans in the first quarter reached 111.3%, compared to 107% in the first Q of ’14. In the quarter, the Bank saw stable or improving asset quality trends in the majority of the products and segments.
These reflect the changes in the loan mix, the focus on pre-approved loans granted through our CRM, the improvement in asset quality in SMEs and the strengthening of our collections area. The Bank also concluded the first quarter with a strong the capital ratios.
Our core capital ratio reached 10.6% this is a 100% tangible common equity, the highest among our main peers. The Bank’s shareholders approved on April 28, 2015, the Bank’s annual dividend equivalent to 60% of 2014 net income or CLP$1.75 per share.
This was achieved equivalent to our dividend yield of 5.1 based on the dividend record date in Chile. The dividend increased 24.5% compared to the dividend paid in 2014.
The prudent management of the Bank’s capital ratios and solid yearly profitability has allowed the Bank to continue paying attractive dividends without issuing new shares since 2002. Now we will explain the evolution of our quarterly results.
In the first Q of ’15, net interest income decreased 23.3% Q-on-Q and 12.8% year-on-year. As expected, the Bank’s profitability was lower mainly after result of the zero inflation seen in the quarter.
The net interest margin reached 4.4% in the first Q compared to 5.8% in the first Q of ’15 and 5.4% in the first Q of ’14. In order to improve the explanation of margins, we have divided the analysis of net interest income between client net interest income and non-client net interest income.
In the first quarter of ’15, the variation of the UF and inflation indexed unit was negative 0.2% compared to positive 1.88 in the fourth Q of ’14 and 1.28 in the first Q of ’14. The average gap between asset and liabilities index to the U.S.
was CLP$3,905 billion in the first Q of ’15. This imply that for every 100 basis point change in inflation, our net interest income increases this or decrease this by approximately CLP$40 billion, all other factors being equal.
The system of this gap is mainly due to the Bank’s lending and funding activities. We expect UF inflation to be approximately 1% per quarter for the remainder of the year and therefore non-client net interest income should rebound.
Client net interest income which excluding part of inflation increase 2% Q-on-Q and 9.1% year-on-year, driven mainly by loan growth and improved funding mix. Client NIMs defined as client net interest income divided by average loans, reached 5% in the first Q and was stable compared to both first Q of ’14 and fourth Q of ’14.
Client NIMs have remained stable despite a continued shift to less riskier segment and the first of all in interest caps due to regulations implemented in the early in just last year since early 2014. This stability in margins was mainly due to an improved funding mix the Bank’s strategy of focusing both on lending and non-lending businesses and a strict management of loan spread has driven this ability of servicing client spreads.
Net fees and commissions were flat year-on-year and decreased 7% Q-on-Q in first Q 2015. Fee income continued to rebound in retail banking but this was offset by lower fees in our corporate area.
Fees in this segment tend to be more volatile than other segments due to large transactions are not recurring between one quarter and the next especially during the summer period. Excluding the large corporate segments, fees grew 2.1% year-on-year led by the SME segment.
This evolution of retail fees which led the Bank’s efforts of expanding the client base and to increase cross-selling in the retail segment. Going forward, fees should continue to grow at a healthy pace in the retail banking with fees from corporate banking picking up from current levels.
As we saw in previous slides asset quality improved in the quarter as a result provision for loan losses decreased 27.8% Q-on-Q and 2.5% year-on-year despite the growth of lending volumes as we saw. The improvement in credit risk level has led to a rise in client net interest margin net of risks which reached 3.6% in the first quarter of this year compared to 3.5% in the first Q of last year and 3.1% in the last quarter of 2014 with improvements in most segments.
The improvement in asset quality should be a key element in sustained and steady levels of recurring profitability going forward. Operating expenses increased 9.9% year-on-year in the first Q of this year.
The efficiency ratio reached 42% in the first Q of ’15. This rise in cost was mainly due to; number one, the higher inflation rate in 2014 that has a lag effect over salaries and some administrative expenses which are indexed to inflation; and number two, the ongoing investment to continue optimizing the branch network.
In the quarter the Bank did not open new branches but is in the process of modernizing the existing network. The Bank has developed a new branch format that was successfully tested in 2013 in various locations.
These new formats have exceeded expectations in terms of efficiency and client satisfaction. The Bank will now expand these layouts to approximately 100 additional Santander branches.
The Bank also remains focused on growing through complementary channels such as Internet, phone and mobile-banking. This will allow the bank to maintain solid levels of efficiency going forward while improving productivity and customer satisfaction.
This increase in cost was partially offset by the 9.9 year-on-year decrease in depreciation and amortization expenses. As a reminder, in 2014, the Bank performed a one-time impairment of intangibles mainly of obsolete or unprofitable systems.
This explains the reduction in amortization and depreciation charges. These savings will be used to finance further investment in systems and the Bank’s network as mentioned above.
Our effective tax rate reached 24% in first Q up from 15.5% in the first Q of ’14. The reason for this higher tax rate were mainly two; the lower inflation rate in this quarter, which resulted in a non-adjustment of the Bank’s capital by the Consumer Price Index which translates into a higher taxable net income in the tax books; and number two the statutory corporate rate for 2015 that increased to 22.5%.
For the rest of 2015, our effective tax rate should be approximately 19% to 20% assuming a 1% quarterly CPI inflation rate. In summary, the first Q ’15 results showed positive recurring trends in our business segments clouded by the low inflation and higher tax rates.
The Bank’s pre-tax ROE reached 19.9% in the first quarter compared to 88.3% in the first quarter of ’14. Adjusted the pre-tax ROE for normalized inflation levels of 3% on an annualized basis that is 0.75% inflation per quarter as we have been doing in the previous quarter the Bank’s pre-tax ROE was 23.9% compared to 24.9% in the first Q14 reflecting the relative stability of the Bank’s core profitability trends.
These healthy normalized profitability levels reflect that the Bank is increasingly reaping the benefits of our comprehensive transformation project. This initiative is helping our client activity, business volumes, asset quality and profitability levels.
For the remaining of 2015, we expect that these trends will be more visible in the bottom-line as we expect inflation to increase and our effective tax rate to be slightly lower. At this time we will gladly answer any questions you might have.
Operator
[Operator Instructions] The first question comes from the line of Guillermo Costa. Please proceed.
Guillermo Costa
This is Guillermo Costa from NWB. So my first question is on asset quality, could you comment what is your expectation regarding the NPL ratio going forward?
I mean you have been presenting a higher growth in the high income segment. Do you expect this to improve even for NPL ratio going forward?
And my second question is about your competitors' perception of this segment. Have you been watching an increase in the competition in this segment?
Raimundo Monge
In which segment?
Guillermo Costa
In the high income individuals and also the mid-market companies.
Raimundo Monge
Well in terms of non-performing loans, we think that going forward there are two forces here; one is that the economy for the second year will be showing longer than its potential growth and that could have an impact in job creation and impact also in salary growth. So that is kind of negative element to take into consideration.
And the positive is that especially in retail, where we measure delinquency levels and by vintages, we have seen that our vintages the quality of the origination process has been steadily improving. So the two forces have been up to now more or less compensated and that’s why we have seen a stable or slightly lower levels.
Going forward we think that we should maintain that at least for the year assuming the central scenario of growth of 3% in our non-performing levels in close to 2.7 and 2.6, but we don’t foresee these changes another up or down. In terms of the competitive landscape, I would say that most banks have been moving to the safer segments impart because of their softer market environment but also because the regulations to some extent has made the process of going to the low-end of the consumer market and the mortgage market, increasingly more difficult.
There we are seeing some hints of banking penetration suffering in the market. So everybody is kind of moving to a segment that we have been targeting.
There I would say that our competitive advantage today is mostly in terms of speed being a little bit faster than the rest in addressing the needs of the client and that’s why we launched the selective format a couple of year ago and that’s what today the bulk of our lending origination is done through pre-approved deals. That is providing us what I would say a competitive advantage.
So being a little bit quicker than the rest in addressing the needs of the clients has been making in our case a big difference and that’s why we have been growing faster than the rest than our calculation is that we have been increasing our market-share and catching up actually market-share in the segment, because we were under represented historically and that has not been because of lower spreads or lower fees. And that’s why we think that again given that these CRM and this new platform that has been originated, still has room to improve and has been steadily improving, we see we can outpace the growth of the rest of the system.
The competition today we’re seeing generally speaking is probably softer than historically impart because the retailers are increasingly reducing their credit activity and because the other banks have their own destructions and are starting to do the, what we think is the homework that we have done a little bit ahead of the rest. So I would say that the competitive landscape is a little bit softer than before and that is allowing us to do the transformation and at same time delivering what we think are solid commercial results.
Operator
The next question comes from the line of Fred de Mariz with UBS. Please proceed.
Fred de Mariz
A few questions on my side, first on the tax rate, we saw that the taxes were a bit higher than usual in the quarter. Can you -- you mentioned your guidance for this year around 19%, 20% from the effective tax rate.
Can you just comment on why the taxes reached this level in the quarter? That's my first question.
Second question on the ROE, can you just remind us what's your guidance for sustainable ROE for this year and next year? And then a final question on the fee income, you gave some explanation in your press release on the fees.
They tend to be quite volatile on the corporate side. I just was curious about your guidance for this year.
I remember you were mentioning that fee income would grow together with the client base and just wanted to hear from you what the latest update is here? Thank you.
Raimundo Monge
In terms of the tax situation in our first release we published hopefully a clarifying table. There the explanation is the following that for tax purposes our equity is adjusted by CPI and that is considered as a tax expense.
Therefore, the higher the inflation levels, given that this is an expense, the lower the effective tax rate. And the opposite happens when you have zero inflation or negative inflation that the lower the inflation or the more negative inflation the higher is your effective rates that’s I would say one of the basic elements that they has resulted in an increase we are comparing a period of relatively high inflation last year with a period of zero slightly negative inflation this year.
And the second element is that the after the tax reform that was approved last year our corporate tax rate has increased from 21% to 22.5% so the two elements combined. But the volatile element is linked to inflation.
So as long as inflation goes by to sort 1% per quarter which we foresee to get a final inflation was 3% this year our effective rate will be lower than our statutory rate. But year-on-year we’ll be higher than last year it’s simply that it would be lower compared to what we have seen in the first Q.
So that’s why rates will be closer to like 10%-20% for the whole year probably lower in the second, third and fourth than in the first Q. In terms of the ROE, we have been mentioning that our medium term ROE before taxes to be around 23-24 now the taxes are a little bit higher that means our after tax ROE could be around 18.5%-19%.
But again as we always do the caveat a moving average of three-four quarters, because given the volatility that the inflation gives in our results every quarter it’s very difficult to have a specific comprehensive data year-on-year stable we think that they’re something around 18.5 or 19 as an average for four quarters is a good estimation. In terms of fees, as we have commented before fee tend to move very much in line with client activity and that’s why we don’t -- we maintain our basic guidance of fee growth of 6%-7% for this year as the first quarter is a little bit not a meaningful quarter because it’s holiday period it’s the summer vacations in the Southern Hemisphere and therefore especially in the corporate side it’s difficult to get fees on the corporate side.
On the retail it’s more linked to use the products and it’s linked therefore to the number of clients and the number of products that has been used. And there we’re seeing encouraging trends in our retail customer base.
So that’s why tend to be confident that the something close to 6%-7% for the year is achievable.
Fred de Mariz
That's right. That's very clear.
Thank you for this. Just a follow-up to clarify [Technical Difficult].
Operator
The next question comes from the line of Tito Labarta with Deutsche Bank. Please proceed.
Tito Labarta
A couple of questions first summing up on the asset quality one the provisioning side we saw the cost of credits this quarter fell to like 1.4% of loans, well below the levels we have been seeing. And you mentioned asset quality should be relatively stable going forward.
So do you think the cost of credit should remain around these levels or was it a bit lower than normal this quarter and should kind of normalize back up? Just want to get a sense of how you see the cost of credit going forward.
And my second question is on expenses, even though expenses fell in the quarter, it's still growing 10% year-over-year well above inflation. So I wanted to get a little bit more color on why growing so much year-over-year?
I think you did mention that it should kind of moderate going forward. So where do you see that for the full year as well.
Thank you.
Raimundo Monge
In terms of asset quality our cost of credit has been trending down for some time. We think there is room there as we commented last year we had no big concerns about asset quality except in the SME segments.
So we took a number of actions throughout the year especially in the second half we set the specific provisions for the segment and we moved from clients which were more transactionally rented one of the needs of the clients is to borrow but there are other needs that banks fulfill. And therefore today we are operating to a large extent with the SMEs that apart from borrowing need other services that provide lots of checking account and things like that.
And that’s why we have improved the profitability and at the same time reduced delinquency levels on that segment. And that’s why today again as general we don’t have the big concerns about asset quality again assuming an economy that grows faster this year than last and but we don’t see big external shocks.
In the central scenario, asset quality is stable or slightly improving and therefore the cost of credit that today is close to 1.5, probably moving that line for the rest of the year it could be marginally lower because we foresee growth a little bit higher than the figures for provisions. In terms of expenses, we think that again the first Q is not or the year-on-year growth as we saw in first Q is not a good indicator.
We still maintain our basic guidance of growth cost growth of 6%-7% for the year and there are many things in the first Q that probably won't be repeated and among them volumes sales and things like that that we don’t repeat them throughout the year. In terms of the investment and changes of models, et cetera, they are considered in this 6%-7% growth of cost for the year.
So, we foresee that -- we don’t see cost you can have control, actually we -- part of the tricks that have been delivered by the transformation project, but precise to make our people more productive and to make the job a little bit easier for them.
Operator
The next question comes from the line of Saul Martinez with JPMorgan. Please proceed.
Saul Martinez
Two questions, one a follow-up on the previous question on cost of risk. If I just look at this quarter, Raimundo, it was about 1.36%.
That's the lowest level it's been at since 2011. So I just want to clarify that you feel there is still some incremental room for improvement relative to the 1Q level.
And secondly, a related question, your risk adjusted debt interest margins from client activity stripping out obviously the inflationary impact have had a very nice bounce and you showed that on the slide if I look at -- in terms of adnominal growth rates was actually very strong this quarter. How do you see risk adjusted client net interest margins and net interest income evolving going forward?
Is there additional room for expansion there?
Raimundo Monge
Yes, in terms of cost of credit, we think that there is room because we have made big a shift in the profile of business and we have in our books. Remember that historically Santander was in the forefront of the process of increasing banking penetration et cetera and we to some extent didn’t put too much of attention in the high-end of the consumer market.
Today because of regulation et cetera we have been moved to the opposite direction, so we are going into first set of segments that have lower delinquency levels and provide extra compensation in terms of higher checking balances and more fees and things like that. And that’s why we are moving into a different profile and that necessarily has a change in our risk profile and accordingly to the requirements of provision.
Apart from that we have improved our tools for our ’15 and for originating away from loans where mostly granted one-by-one into pre-approved deals that we have a lot of information about clients and therefore we can produce -- increasingly narrower. And therefore we think we have an ability to price rate today is much more thinly than say three or four years ago.
And that’s the combination of the tool are lower risk segment by itself, plus better tools of a segment, make us believe that we still can reduce in time the cost of sales. For this year we think we can maintain or see some slightly reduction, we’re not seeing a big reduction anywhere there.
But this is a reflection of a relatively structural change that we have done in the segments we attend and in the way we’re reaching in our business. which is linked to the second part of your question, how high can we expect our client margins that operate to go and there is -- there are two forces; one is that that of course is our segments are lower risk and therefore that your gross margins they are under pressure, but stay free and therefore the provision expense is slower.
Today we are seeing, we think that this should increase in time, when we talk about time is not on a quarter-by-quarter basis, but on a year-on-year basis, today -- very short-term the next is two quarters or something like that we think that will be not likely because most of our business or our growth is centered in mortgages which tends to be the relatively low yield and very safe business, but very low yielding and that has to do with changes in the tax performance, et cetera. So it is something that is simply a short-term movement that we don’t control and that’s why there are pressures that this we will cannot drive faster, but if you're asking me about what to expect in 2015 definitely be higher because we are pressing the correct keys we think.
Saul Martinez
If structurally it does move higher, would that cause you to reassess your long-term ROE assessment and could there even be some upside to 18.5%, 19% after tax ROE?
Raimundo Monge
It could be, but remember that unfortunately factors will rise also to sales in the ’16 and ’17 as well. So that’s why we think that all these changes and the transformation project came in a period where we were facing headwinds and in terms of caps, of rates, in terms of limits to the fees, et cetera.
So we think that we have been diligent to a large extent compensate for those drives but today it’s too early to say that we will to outpace that we have.
Operator
The next question comes from the line of Alonso Correa with Credit Suisse. Please proceed.
Alonso Correa
My question is regarding -- and apology if you have already addressed this but my line got disconnected briefly -- is regarding any potential impact on provisions stemming from the new standard methodology to provision the mortgage portfolio that is going to be affective next year? Thank you.
Raimundo Monge
There are two things number one is that this provision guidance are still under discussions so they’re not a final say. And depending on how harsh or how soft is the final because remember that to go from the very basic to the more specific.
The provision in the or the loss, the actual losses that we have been seeing in the last -- historically on the mortgage market has been less than 0.5% of the loans so this is -- has never over the last 20 or so years has never been a concern on the provision level. So that the Superintendency is putting a more demanding especially in terms of the type of mortgage to go forward.
So if you don’t originate mortgages with a loan to value below 80% you would have to set increasingly the higher provisions. So the biggest changes in terms of signaling that this is the regulators doesn’t want the banks to move too much ahead of the loan to value of 80% at the region or more.
So that means that all the business that is done above that could have an effect in terms of provision. So, we don’t have a firm calculation of the impact, it is something that starts in 2016.
And the second element is that the banks are trying to or asking that this charge if at all should be done against reserves because it’s changing the rules. And historically that has been the case when you have a change in rules you don’t go through profit and loss you try to go through equity or capital base.
So, depending on that, the impact can be zero or it goes against the equity. But at the end given that we don’t lose too much money, it’s simply that we are over provision or you have a sort of a buffer of capital index unless but of course we see changes in the mortgage market which up to now we haven’t seen.
So, probably by the -- in the end -- rest of the year we will have a more precise calculation that we can share. But today it’s more of a discussion and will be applicable throughout the 2016.
Operator
There are no further questions in queue at this time.
Raimundo Monge
Thank you all very much for taking the time to participating in today’s call. We look forward to speaking with you again soon.
Have a good day.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. That concludes the presentation.
You may now disconnect. Have a great day.