Banco Bilbao Vizcaya Argentaria SA (BBVA) 2016 Q2 法說會逐字稿

Good morning everyone and welcome to the second-quarter 2016 results presentation of BBVA. I am Luisa Gomez Bravo, Global Head of Investor Relations. And here with me today are Carlos Torres, Chief Executive Officer of the Group and Jaime Saenz de Tejada, our Chief Financial Officer.

As usual, Carlos will begin with the presentation of results and perhaps a few words on the recent reorganization. And we will move straight to the Q&A after that. We will try to answer as many questions as possible during this presentation as always. But needless to say, the IR team will remain available throughout the day to answer any pending questions.

And before handing the call over to Carlos, I would like to wish all of you who may be taking some time off in the next few weeks to have a happy summer holidays.

So good morning Carlos and over to you.

Thank you. Thank you, Luisa. Good morning everyone and welcome to our audio webcast. In fact, before starting with the quarterly results, I'd like to briefly comment on the organizational changes that we announced yesterday that are trying to simplify the organization and help us gain efficiency, accelerate also our transformation. On the one hand, the countries will now be reporting directly to me, which I think is a great thing. We are eliminating one layer and will help me have a direct dialogue with the CEOs of the geographies.

On the other hand, we are integrating under one responsibility that of customer solutions all areas that shape our value proposition and deploy locally. And in addition, we have made other changes, shifting responsibilities among some of the areas to further simplify and help us gain efficiency.

As you have seen in your organizational charts, now country networks has disappeared and [Bizento Rozero] who is in charge of that unit up to now will be leaving the Bank although he will be still very much related to it. After a very long and very successful career, he has really helped me in particular over the past year-and-a-half focusing a lot of efforts in the regional and the commercial businesses driving performance. And he will be continuing to be associated with us through Broad memberships.

But now, as you can see on the chart, Spain, Mexico, US and Turkey will be reporting to me with the same CEOs as in the past. A new position of country monitoring led by Jorge Saenz-Azcunaga will help me, will support me in overseeing the countries and will also channel the reporting of the smaller countries, the South American countries.

And then the customer solutions area that I mentioned is led by Derek White and he takes that responsibility of continuing to develop our core capabilities that are critical for better customer experience and then deploying the solutions locally through the business development areas. Derek has an impressive background both in the financial industry as well as in the traditional and in the FinTech as well. And in the few months with us he has left his mark as a great leader with significant contributions already.

There is also a change in person in the Talent and Culture responsibility, Ricardo Forcano, who has been until now head of business development for the growth markets for Mexico, Turkey, South America, he will lead this area of talent and culture which includes all of the HR, continuing the work of Donna DeAngeli who has set the foundations of our cultural transformation.

Now, moving on to the results of the second quarter themselves, I can say that we have had a very solid quarter with EUR1,123 million of attributable profit, growing sensibly, as I already anticipated when I presented the first quarter results which, if you recall, were seasonally low. So despite the complex environment, the uncertainties, the volatilities, the political situations in the various markets, Brexit, et cetera, low rates, we have had positive trends in revenue, recurring revenues growing at 5.4% versus last year in constant euros. Gross income growing at 7.1%, supported in this case by strong net trading income, also dividends. We have seen improvement in the risk indicators. NPLs, for example, are down 18 basis points versus last quarter and almost 100 basis points versus last year.

Solid capital ratios with the fully loaded capital ratio, 10.71%, up 17 basis points versus last quarter. And finally we have had specific positive and negative items in the quarter, in particular the highlights would be here the Visa European deal that has added EUR128 million to our bottom line. And on the negative, the contribution to the single resolution fund, EUR85 million that last year was recorded in the fourth quarter.

Overall, we have had EUR1,123 million which is growing -- a growth rate of 14.1% versus a year ago on a like-for-like basis. This 14.1% in constant euros versus a year ago is a significant 59% rise versus last quarter. And as you can see is the highest in the series that you can see here versus prior quarters. Now, as we have had quite a strong negative impact from FX in current euros we have a similar quarter than one year ago. In fact, there is a slight drop of 0.8%. I believe this will be the quarter when we see the peak negative comparison in -- because of the FX, because of the currency devaluations that took place right after the summer of last year. So we should see the negative impact of the FX tempered in coming quarters in the inter-year comparison.

On the right you can see that we have had again a softer quarter in the developed markets with Spain growing 4.2%, United States coming down 10% even though it's a rise versus last quarter, the EUR129 million. And very impressive Turkey, very impressive Mexico once again. And also South America, the 3.2% growth in South America is affected by abnormally low taxes last year which affect the comparison.

Looking now at the P&L lines, positive trends in recurring revenue, NII growing at 6.4%, fees and commissions at 2%. Both of these are core. Of course to support our earnings, strong quarter in net trading income EUR819 million. This includes the capital gains of Visa and also good results from the market, especially versus last quarter. Other income includes the negative contribution of the resolution fund. But it also includes dividends this quarter from Telefonica, EUR106 million, and CNCB EUR44 million.

Total revenue growing at 7.1%. While costs are under control it was a good quarter in costs growing at 6%. So we have positive jaws. Now, this is really very important. It's -- efficiency and cost control in the environment we're in, it's one of our strategic priorities. I'm personally very committed to pushing the organization to high levels of efficiency and in fact I believe the new organization structure responds to this in part.

I believe it will help us drive efficiency further. Also as we will be implementing new cost initiatives in the months to come.

Impairments, impairments are flat, behaving well, provisions are lower due to restructuring charges that were lower than last year. So overall, as I say, solid, very solid good second quarter results.

For the accumulated results in the first half, EUR1,832 million, similar to one year ago in constant terms but of course affected by the negative FX. But we see consolidating good trends in both revenue and costs. And overall that leaves us with nearly EUR6 billion operating incomes. So on net, pre-provision profit is strong at those levels also because we have had lower provisions and impairments that support the bottom line.

Moving on to the details. We have had the highest net interest income of the series, EUR4.2 billion, growing 6.4% versus a year ago. If we include fees and commissions, growth is slower, it's 5.4%. We have pressure in Spain, also in the US. Lot of it has to do with softer wholesale markets, CIB activity. But versus the first quarter we do see a good trend in both net interest income and the recurring revenues growing at 3%.

So despite the challenging environment, particularly in Spain, we are seeing that, we are seeing that growth.

Net trading income was high in the quarter, EUR834 million. This includes EUR225 million associated with the disposal of the Visa Europe participation and it also includes improvement in market-related results and it's particularly high versus last quarter which was particularly low.

Total revenues growing at 7.1%, 12.7% quarter on quarter. And this compares with 6.1% growth in costs, but costs are flat in the quarter, so good cost control, as I was saying, and this is even ahead of the Catalunya Caixa integration, which is to happen in September, our plan here is to close the 400 branches and have the -- an accelerated capture really of the synergies by one year. So 2017 versus the 2018 year to gain the EUR200 million of synergies. Again, as I already mentioned, within the current environment with high pressures on the top line in developed markets in particular costs are clearly our priority.

Operating income reaches a record of EUR3.3 billion, growing 8.1% versus a year ago, 27% versus last quarter supported by the emerging markets as you can see in the right, impressive in Turkey, Mexico, South America but drops in the US and more acute in Spain.

Risk indicators continue to improve, cost of risk flat at 0.9%, impairments down 1.7% versus one year ago, although they are growing at 6% or they have grown 6% versus last quarter due to some one-offs in Turkey. NPLs are also down to 5 -- the NPL ratio, sorry, down to 5.1% and coverage -- and cost of risk are flat versus the last quarter.

Moving on to capital, capital generation in the quarter was very strong, 17 basis points to 10.71%. We've seen contribution of net earnings and dividends in line with the prior quarter, plus 15 basis points, and then you see there the others. The others actually include various effects. It does include a negative market related impact of various sorts of approximately 10 basis points, which has been offset by measures of capital management which is clearly a strategic priority for us.

I am happy to see that the continued focus on returns on capital is bearing fruit on the capital management side and we've been able to more than offset the negative effect of the market through capital management.

Overall, we are on the capital side on track to achieve our 11% fully loaded target some time in 2017.

In terms of other key metrics, we continue to grow our digital customer base and the penetration to 35% versus growing, 21% versus a year ago, and then in mobile even more so, penetration there stands at 22% and the growth is 45% versus a year ago. Digital sales also continued to trend up significantly in all markets. As you can see here in the charts, I think it's very telling how now we are in all franchises with percentages of digital sales between 15% and 25% of total sales while one year ago we were below 10% in this same ratio.

We continue to work in improving the experience of our customers which is, as you know, another strategic priority, one of the key ones. And this quarter we have continued to launch and develop and put in the hands of our clients new developments and new amazing experiences. I would highlight a few. For example, in Spain we have improved the relationship through the remote managers of our customers with remote managers which is more or like continues to grow very significantly by having now MyChat functionality, a secure easy to use Whatsapp-like chat that serves as a secure communication and even has the legal implications of signature that the customers can use.

We are in fact expanding the remote manager model to other markets and we have already implemented in Spain and the US and Chile and we are launching now pilots in Argentina, in Turkey and in Peru. Other interesting developments, for example in products the Smart auto-insurance in Turkey which makes it quite easy through a direct channel for customers to buying a car insurance and select the various terms of the insurance product.

Commerce 360 in Spain which is a business intelligence tool for SMEs that we just launched. We also have new functionalities. One which we are just launching in Spain is a new free solution to help our customers find a house and it's pretty easy to see different areas of the market and get real-time data on the prices of various properties and then it's very easy to link that with the financial product. And then beyond this we have had our venture capital fund Propel Venture Partners, has continued to invest in start-ups of several types, Guideline, Drive Motors, Hippo and others. We have also had good development in Simple. We have concluded the integration with Compass and we are now on-boarding 100% of Simple's customers on the Compass platform and soon we will be migrating the past base of customers from Bancorp to Compass, so good developments in all of those fronts.

All of that has an implication or an impact in net promoter scores which you know is the key metric we used to see how we are making progress towards being a better bank for our customers.

Our NPS scores continue to show improvement. I'm particularly satisfied with the development in Spain. The NPS has grown from the 3% that we had at the end of last year to 12% in the reading now in June. So it's a significant improvement. We continue to work hard and happy to see that it shows. And as you can see, we continue to have leading positions in almost all of the markets in which we operate.

Now, moving onto the details of the various business areas. In Spain, despite growth in NII in the quarter at 3.4%, it has declined 1.9% in the first half and really I continue to see a very challenging environment. We have in Spain very little visibility in terms of volumes. I'm most disappointed by the evolution of fees and commissions where we expected growth and we have seen a drop of 3.4% quarter on quarter impacted by the market situation. But with this it is, to be honest, hard to see growth this year and as the market conditions change significantly.

On the cost side where given the environment I just described, cost control is going to be the critical lever. Costs are down 0.5 percentage point quarter on quarter. Even though they show a growth of 11% versus last year that's due to the changing perimeter of Catalunya Caixa to a large extent and also the restructuring costs of that integration. But, as I mentioned earlier, we are bringing, now we are going to execute the integration in September closing 400 branches in Catalunya and with some exits of nearly 1,700 people. So the synergies will start to materialize by the end of the year. And as I already mentioned as well we will bring forward the cost synergies, the full cost synergies by one year so the EUR200 million should be showing in 2017 instead of 2018.

And beyond that, we continue to work on the additional cost measures in Spain and in other markets. On the lower part we have positive trend in provisions and impairments.

Overall, the net profit in Spain for the quarter is EUR385 million, that's down 9.4% versus a year ago. And in the half it's EUR618 million, which is down 15.3%.

Activity levels in Spain are low, flattish, actually negative 0.2% excluding EUR1.1 billion of loans that were transferred from the real estate portfolio. And as I said, we have no clear visibility on the future trends. Customer deposits also flat and spreads coming down slightly, 1.75, we expect to continue to improve our cost of deposits going forward.

Risk indicators maintain good trends, NPLs decreased EUR700 million in the quarter, which is a sound number, and the ratios drops to 6%, cost of risk also declining trend, 0.4%, quite satisfied with the performance in risk and the perspectives for the second half that I believe will be better than what we have seen in the first half.

In real estate activity, the real estate activity in Spain, we are seeing in the market positive developments with increasing volumes of mortgages and prices as well of homes. In terms of our own portfolio, we continue to reduce our exposure and also and its negative impact to the P&L which has been reduced by 30% versus a year ago, the losses have, and the exposure is down 13% to EUR11.4 billion. And we will continue working on this now with a new responsibility of the real estate unit that has moved from finance to the strategy and M&A.

The total in Spain adding both banking activity and real estate, net income in the second quarter was EUR289 million, growing 4.2%, and in the half it's EUR410 million, which is down 4.6%.

In the US, we had a good quarter driven by good cost control, also by low impairments, net attributable profit of EUR129 million, that's up very significantly from a very low EUR49 million we had in the first quarter. We have growth in that bottom-line which is very significant. Trends are, however, very similar to last quarter in terms of revenue. Net interest income is up 5%, gross income is flat, but costs are under control, flat quarter on quarter and growing 1.3% versus a year ago. And then we had the positive news of successful passing the CCAR for the third consecutive year.

Lending activity continues to decelerate, this has been a trend for quite some quarters now, decelerates to a growth of 4.4%, in part as we focus on profitability over volumes. Really profitability -- profitable growth is the key priority here. We want to make sure we invest our capital in assets that have the adequate return on capital. And in terms of customer deposits, we are also seeing lower volume growth because of pricing strategy which shows in customer spreads that trend slightly up.

In risk, NPL ratio in the quarter rose to 1.6% as some of the names we had in the watch list moved on to non-performing but this has not had much impact on cost of risk because we had mostly provisioned these names already in the first quarter. If you recall, the first quarter had quite high provisioning levels because of the oil and gas. It was the quarter in which had the SNC review. And now we are back to more normal levels. And so far we have not seen any of the potential second round effects of the oil and gas situation.

Turkey, well, Turkey first before commenting on the results I like to really point out that despite everything that's happening in the country and the increasing uncertainty associated with that, Turkey is really an important part of the Group, it's quite strategic. Garanti is not only a great bank but it's an important part of the Group, as I say, and we are fully committed to Turkey. It's a commitment for the long-term. Nothing of what's happening changes that.

Having said that, the results in the quarter and in the half could not have been better, really a very, very strong performance. Net attributable profit in the quarter of EUR192 million, that's up 48.8%, EUR324 million in the first six months, that's up 31.8%. Outstanding growth in revenue, more than 20%. Here I remind you all that we have had a change in classification of the cost of the swaps that were before in net trading income last year. And now they are in net interest income.

So if we do a like-for-like comparison really, net interest income growth is -- it's around 20% levels on the quarter and even on the half. In terms of commissions, we had also positive performance. That was supported by a one-off effect of around EUR24 million. And then net trading income very strong but supported by the Visa Europe that Garanti was also a stakeholder there and that has contributed EUR87 million to Garanti net trading income in the quarter.

Cost control efforts, Garanti remain a key goal, and as you can see costs are down quarter on quarter 2.2% despite the inflationary environment in Turkey. Impairments and provisions are up, but that's as expected due to some client-specific names and some regulatory developments in the Romanian subsidiary of Garanti, but that's in line with guidance. And the bottom-line, as I said already, outstanding.

Activity levels converging to more sustainable but still very strong, 12.9% growth in lending, 14.2% in customer funds. And with excellent price management, as you can see, cost of deposits is down while yield of loans is up, so the spreads have really improved.

Risk indicators are stable, although the cost of risk, as I already mentioned, is up to 1.2% because of the names and the Romania effect. This was already incorporated in what we expected and in the guidance as well the end-of-year expectations.

Okay. And then Mexico, Mexico excellent results, double-digit growth throughout the P&L, similar to prior quarters, preserving all the good trends, attributable profit of EUR486 million, 11.2% growth. And in the half, it's almost EUR1 billion operation, EUR968 million, again double-digit growth, more than double digit growth -- more than 10%, sorry. Income steadily growing at 10%. We're maintaining positive jaws. Impairments are growing also but substantially below the growth in activity levels, so that's why have this bottom-line growing at more than 10%.

Now, on the other hand though the Mexican peso has depreciated quite significantly in the year, 20% or so, and that is generating this very negative FX impact which, as I already mentioned, we expect will be tempered in the following quarters as the depreciation was very significant in the summer of last year or right after the summer of last year.

Activity growth in Mexico still at high levels 14.2% in loans, 12% in customer funds, supported by all segments. We are seeing convergence of growth within the retail and the commercial segments. And in terms of the pricing, interest rate hikes have not yet quite translated into the asset deals due to competition dynamics in the Mexican market.

On the risk side, asset quality and risk indicators continue with a positive trend and healthy asset quality levels, as you can see, with the NPL ratios 2.5%, good coverage levels, cost of risk is up to 3.4% but quite as expect. And in fact, as I said, impairments growing less than activity.

And finally, the -- finally South America. Well, in South America we are also repeating the good trends we had in prior quarters, the profit -- the bottom-line in the quarter to EUR106 million, that's up 3.2%, EUR394 million in the year, that's up 7.1%, in the first half I mean. Net interest income growing very healthy, 13%, both because of activity growth and good pricing levels. Fees are up 12%. Gross income total revenue at 14%, while costs are flat in the quarter although they are impacted by the exposure to high-inflation economies but that's a very good development.

Impairments, positively impacted by provisions that were released in Columbia. This is accounting effects of IAS 39 adoption. And as I commented, the tax line is effected by abnormally low taxes in 2015 in Columbia and as well in Venezuela. So very good dynamics although here the same effect we have in terms of the depreciating currencies as I mentioned in Mexico which again should be tempered as we move on to the second half.

Business activities and spreads in South America remain strong, continue to grow at more than 10%, 12.5% lending, 17% customer funds with loan yields trending up with reprising, that's supporting customer spreads despite rising the cost of deposits as well. Risk indicators in South America are good as well, affected by deterioration in Argentina and in Columbia but still below our internal expectations and the effect I mentioned already in Columbia due to the IAS 39 adoption which brings the cost of risk down at a very low 1% level in the quarter, 1.1% year-to-date better than expected and in line with last year.

So concluding, we have what I think it has been a very solid quarter with solid revenue trends, maintaining our cost control efforts which will continue going forward very strongly, strong risk indicators, earnings growing as expected with a clear trend versus the first quarter and capital on track to achieve our target of 11% in 2017.

Looking ahead, however, we are cautious in the months ahead, particularly in Spain. I mentioned already we don't have much visibility on top-line growth. And really our cruising speed for NII growth is likely to be similar to what we have seen so far in the year. And as I mentioned also, it's going to be difficult to see growth in fees and commissions in Spain this year.

Now, on the cost side, apart from Catalunya Caixa we will continue to work on additional initiatives in Spain and in the rest of the country. In the US, we will continue to monitor our oil and gas portfolio and also potential second round effects which we haven't seen yet or we haven't seen so far. And then in the emerging markets, while performance looks quite sound not only in recent months but in the months ahead, our franchise are delivering very good performance, very good profitability although we do have the negative effects of the FX depreciations.

And then finally, as I said at the beginning, to conclude, I do believe that the new organization simpler, agile, more efficient, will be a great platform to drive not only a performance profitability but really to achieve our transformation and all of our strategic objectives.

So I thank you for your attention, I turn it over to Luisa for the Q&A. Luisa?

Thank you, Carlos. We'll start with a few overall questions. The first one is regarding the management changes. Carlos Cobo from Haitong and Daragh Quinn from KBW ask if you could please elaborate on the recent changes to the management structure of the Bank and why do you need to keep changing the management structure?

I already mentioned just now that we are making this changes to gain agility an efficiency, so its really a very natural evolution of the structure we had a year ago, bringing to the businesses closer to me and while at the same time unifying all of the areas that are really shaping the value proposition to our customers, the products and services, and the shaping of those, the creation of the new solutions, leveraging, digital leveraging, technology leveraging data and design under Derek White.

In terms of people, however, and despite the ample press speculations given the nature of the topic, in terms of people if you look at the chart out of the approximately 20 names that you can see there at the top line reporting to either the Chairman or myself, I would say all of those names were there a year ago with the additions only of two names, Jorge Saenz-Azcunaga who will be supporting me in that oversight role of the countries. And Derek White who, as I mentioned, came into the Bank a few months ago and has already shown he is a great leader who is, also because of his track record before BBVA, the right person to lead that wider customer solutions function.

Thank you. With regards to strategy, Stefan Nadialkov from Citigroup and Sofie Peterzens from JP Morgan ask if you are interested in growing outside or inside Spain via acquisitions and which countries are attractive?

Yes. This is a recurring question and the recurring answer we have, full focus on the geographies where we're present today. We do believe that local market share is a good driver of return and in that sense we always aspire to have consolidation moves when they make strategic sense in the sense -- in the markets where we're present when they make financial sense.

So if there are opportunities in Spain or in other countries where we have presence, we will surely continue to look at them as we have done in the past. But beyond that, we don't have any other plans.

Thank you. Also with regards to the Group, Adrian Cighi from RBC asks about the FX impact, he says that the FX impact was quite negative as you mentioned this quarter. Can you please remind us of your policy of hedging for P&L and why you might believe that we are coming to an end of the headwinds from FX as you noted in your opening remarks?

The hedging policy that we have established that we will be hedging on the 12-month forward looking view between 30% and 50% of the FX impact. Currently we are at the higher end of that band. The reason why we expect a smaller year-on-year impact in the second half is because of base effect. Remember that we already experienced a significant depreciation of some currencies in the second half of last year.

Moving on to capital, Fabio Mostacci from Mirabaud and Carlos Cobo from Haitong ask if we can please elaborate on the capital generation in the quarter and any new guidance?

Capital generation was strong during the quarter on a fully-loaded basis, our capital increased by 17 basis point from 10.54% to 10.71%. We had a strong earnings performance that explains the majority of that generation. But we also had someone one-offs that had to do with our strategic priority of improving our capital allocation and measures to improve that capital allocation and generated synergies were implemented during the third quarter -- the second quarter, sorry, in many geographies. That was case in Peru, in Argentina, in Turkey, in Spain, that allow us to compensate some negative impacts that had to do with the market, especially the stake in Telefonica.

The guidance hasn't changed, and our target ratio for the Bank remains intact, and we expect to reach that 11% in 2017.

Thank you. Sofie Peterzens from JP Morgan asks if you could please remind us how much AFS gains you have included in your Basel III fully loaded CET1 and what was the quarter-on-quarter change in your available-for-sale gains?

We have included EUR1.2 billion, and it was slightly negative, the quarter-on-quarter evolution, around EUR150 million.

Thank you. Jemej Omahen from Goldman Sachs asks, have you marked to market your stake in Telefonica? What's the impact?

As you know, the stake in Telefonica is accounted for, as available for sale. So it is mark to market daily, and its impact is recognized in the capital number every single quarter. We have a mistake of 5.35% in Telefonica and I think it's easy to calculate the impact.

Mario Ropero from Fidentiis asks, you're almost at 11% fully loaded now, please update your targets and the timing of them, also does this make it easier for you to move to full cash dividends in 2017?

Well, as Jaime just mentioned, we are keeping our target of trying to achieve, and I already said in the presentation as well of achieving an 11% fully loaded target some time in 2017. So there's no change there. And also there's no update on our cash dividend policy to the one that we already communicated in past quarters. So no changes, Mario.

Santi Lopez from Exane BNP Paribas asks, what would happen the year-to-date evolution of your fully loaded Basel 3 CET1 ratio if you hadn't moved a material part of the AFS portfolio into held to maturity?

Santi, as you can imagine, we do not speculate with this type of information, but I could tell you that the impact would have been positive, as you know the risk premia for the Spanish sovereign debt that has improved greatly during this year, and that would have had a positive impact in our capital ratio. Precisely that is why we moved part of the portfolio to held to maturity so as to avoid this type of volatility in the capital ratio.

With regards to the EBA stress test, Sofie Peterzens from JP Morgan asks, the press has speculated that BBVA will have an 8% to 9% CET1 under the stress scenario. Any comment on this?

We will actually see tonight. We are confident that we will have a good result judging from past exercises also. We really had a good result in 2014. It's true that the stress test this time is more stringent but we're confident that we will see tonight a good result for BBVA.

Okay. Continuing on capital, Stefan Nedialkov from Citi asks, the risk density was 53%, 53.0% in the quarter versus 53.9% in the first quarter 2016, what drove the decline?

As I mentioned before we've had different efficiencies being implemented in the second quarter. The upgrade in the Argentina sovereign rating had a positive impact, the way we account for repo transactions in Peru also had a positive impact. Different ratings of local public entities in Spain also had a positive impact on RWA's evolutions.

Also Turkey implemented additional savvy measures during the quarter. And last but not least, the CIB business especially related to the way that CBA is calculated also allow us to improve our RWAs in the quarter. They went down by 1% and that's the reason why -- and this -- the asset density improved slightly.

On capital, Ignacio Ulargui from Deutsche Bank asks what should we expect going forward in terms of RWA optimization?

Capital allocation, as Carlos always says, is one of our top priorities in our strategic plan. Every single business unit is extremely conscious about return on regulatory capital as well as return on economic capital. Of course, second quarter impacts were very positive and we cannot expect a similar impact going forward but we do believe that additional saving measures will be implemented in the following quarters.

Thank you. With regards to liquidity Andrea Unzueta from Credit Suisse asks if we could update the market on the more recent developments of the MREL requirements, what are you expecting and how are you preparing for it?

There is still a lot of question marks open regarding MREL especially type of instruments that we will eventually issue. But what I think is important is that it will not change the funding structure of the Bank. As we said before, we have in the next two-and-a-half years wholesale maturities with an original maturity of above one year of EUR20 billion.

And according to our numbers that the roll over of those maturities in MREL-eligible debt will be enough to comply with our MREL requirement. We will have more information in the latter part of this year on both the actual requirement and on the type of instruments. And hopefully we will be able to provide further clarity by the end of the year.

Okay. We're going to move to the questions regarding our footprint. We're going to start with Mexico first because I believe there are still questions coming in other parts of the group. So with regards to Mexico, Carlos Cobo from Haitong, Jose Abad from Goldman Sachs, Adrian Cighi from RBC, Alfredo Alonso from Kepler Cheuvreux and Alvaro Serrano from Morgan Stanley asks, how do you see the competitive environment and therefore margins evolving, also a view on customer spread outlook and the expected impact on NII from [Bancsikko], new reference rate hikes, and what is the sensitivity to the higher rates? And the slowdown that we've seen in NII growth is punctual or we could expect us to continue?

Thank you, Luisa. The environment in Mexico is of a very strong competition as in every single market in which we are operating. Customer spread is one down slightly in the second quarter although they remain very robust, around 10.8%. Bancsikko interest hikes do have a positive impact on our NII, and our expectation is that this will be reflected specially in the second half of the year.

Our sensitivity to a 100 basis points parallel increase in the curve it's around 2.4% positive. I think that will more or less answer the questions.

Okay. Carlos Cobo from Haitong, Sofie Peterzens from JP Morgan and Daragh Quinn from KBW ask if we can please update the guidance on Bancomer, still expecting double-digit growth in earnings on the back of similar growth in volumes in 3.5% cost of risk.

Substantially yes, our guidance for Bancomer remains the same even though we are seeing signs of potential slowdown in the economy because of on one had the US deceleration with some numbers that came in in April that were softer and the fiscal cuts and the monetary policy rate increases in Mexico.

So that plus the uncertainty around the US elections that might impact Mexico give some signs of a potential slowdown in the economy. Even though that is the case, we maintain activity growth at high levels and we are seeing still ahead for the year double digit growth.

NII growing in line, I think Jaime commented already on the sensitivity of that to the policy increases. Commissions maybe slightly lower growth, above inflation however, and even though first half growth was 10% in commissions, so might be lower for the second half. Expense is growing because of the investments we have made and (inaudible) project and the new headquarters, but below the growth in revenue so maintaining positive jaws for the rest of the year.

And asset quality, we reiterate the 350 basis point cost of risk. So that -- all of that would leave us with a bottom line growing above 10% in constant euros, and of course we will suffer the negative effect of the peso devaluation that has already happened.

Thank you. Stefan Nedialkov from Citigroup asks if we can give some color on the loan growth by segment and the outlook for 2016.

Loan growth in the quarter was fairly strong, around 3%. It is true that it's slightly lower than what we saw in the first quarter, which was at 3.7%. It's taking place what we were expecting at the beginning of the year. Retail performance is converging towards the ratios, that increases, that commercial used to have last year especially driven by the consumer portfolio, the payroll loans is growing at a very healthy rate in the quarter, 3.4%. And the SME portfolio still shows a very positive growth rate around 4%.

The only portfolio that is not growing at these levels is the mortgage book, which is growing at around 1.7% in the quarter. And as you all know, we continue to experience the leveraging of the former Wal-Mart portfolio in (inaudible) but now it's a very small part of the book.

Going forward, although we are expecting some downside risk on GDP, as Carlos mentioned we remain committed to growing our volumes at double digits.

Thank you. Mario Ropero from Fidentiis asks about the evolution of costs in Mexico.

As Carlos has just said, we will continue to show positive jaws. During 2016 we are almost done with refurnishing the branches, 90% of the branches have already been refurnished, only EUR200 million to go. The same is true with the building where we still have more investments expected using the technological transformation, and that should continue to move through the P&L.

But what we are also seeing is a significant increase in productivity due to these investments, so we are very happy on the way that Bancomer is behaving in the cost side.

As you all know, around 10% of our cost in Bancomer are foreign currency denominated and although we might have some hedging in place it does affect our cost performance.

Okay. Alfredo Alonso from Kepler Cheuvreux and Mario Ropero from Fidentiis and Ignacio Cerezo from UBS asks what are the main reasons for cost of risk increase in Mexico.

As I just explained, we have a slight change in mix in the loan production, retail production is converging to the growth rates that we are seeing in the commercial book, and those do have a higher margin but also a higher cost of risk. That was expected at the beginning of the year and that explains why our cost of risk guidance for the end of the year is around 350 basis points.

The second quarter year-to-date number is around 328, 329 which is exactly the same cost of risk as we had during 2015. So nothing out of what we were expecting.

Okay, moving to Turkey, Carlos Cobo from Haitong, Stefan Nadialkov from Citi, Andrea Unzueta from Credit Suisse, Daragh Quinn from KBW and Sofie Peterzens from JP Morgan, Juan Tuesta from JB Capital Markets, Mario Lodos from Banco Sabadell, Fabio Mostacci from Mirabaud and Adrain Cighi from RBC ask the following questions. How do you view your investment in Turkey given recent political turmoil? What are the potential implications from the recent coup attempt in terms of economic activity in the country and financial impact for Garanti funding costs, volume growth et cetera? How have loan volumes and asset quality behaved in June and July and what would be the outlook under these circumstances for 2016? And do you reiterate the cost of risk guidance for Turkey at 1.1% in 2016?

Okay, it's too early to really figure out the potential impact this all will have in the economy. We still have to see how the events develop going forward. So far we have not seen relevant effects on our activity in June and July and neither on activity growth, new originations, nothing beyond the ordinary changes nor on the asset quality beyond the rise that we had in the second quarter that is more associated with other things and not the coup as I already explained in the presentation. But going forward, it's really depending on how events unfold and how that will affect -- the uncertainty will effect expectations of the market agents and therefore the economic activity and depending on the political scenarios that we might draw going forward and how fast the country returns to normality.

It's true that also, and I think it's an important point that Turkey has a very solid financial system and it has a central bank that has responded with measures, announcement of measures that further reinforce financial stability and provide sustainable liquidity at the markets. So we are not overly concerned right now on that front. But, as I say, it's too early to know how events will unfold and what impact they might have going forward.

In terms of guidance, we do reiterate the cost of risk that we indicated at 1.1% for the year. And in how we view the investment, well, we continue to view it as a quite strategic investment and a very important part of BBVA. We are here for the long term. We do believe Turkey is a great market for the long term and that Garanti, as we always say is the best bank in the market, the best management team and they continue to deliver quarter on quarter with, as you have seen, quite impressive results in the first half.

Thank you. Franco Insausti from Autonomous Research asks what is the sensitivity to a downgrade in Turkey AFS Capital, so available for sale capital, and what is the sensitivity to a 10% depreciation in the Turkish lira, I understand in capital as well.

Okay, the 10% depreciation in the Turkish lira will have a 1 basis point negative impact on our core capital ratio. As you can see, the hedging is pretty significant. We reduced the sensitivity as soon as we increase the stake. On the downgrade side lower rating by Moody's will have an impact of 15, around 15 basis points in our core capital. I do want to say that in the case of Turkey, our P&L coverage, our FX P&L coverage for the year is 100%, so we are fully hedged for 2016.

Oh, yes, one more thing. If we receive the regulatory equivalent as we expect at the end of the year, this negative impact will be more than recover.

Thank you. Andrea Unzueta from Credit Suisse asks about net interest income in Turkey, NII was strong, what explains evolution in NII in Garanti?

Everything behaved very well in Turkey. In Garanti in the second quarter of the year we had very strong loan growth but also a very good, especially in liras because the foreign currency exposure went down by 2%. Customer spreads improved significantly, both by increases in the loan yield and reduction in the cost of deposits, the reduction in the upper band of the interest rate CAGR had significant impact on reducing our funding cost in Turkey, and that's the reason why we had a quarter-on-quarter NII growth rate of 8%.

Okay with regard to trading income in Turkey, Fabio Mostacci from Mirabaud asks if you could please clarify the strong trading performance this quarter and provide any guidance for coming quarters?

On the trading income line we had the one-off positive effect coming from Visa, that's an EUR85 million positive impact that we had in the second quarter, that is clearly non-recurrent. And then I must remind everybody that this year we do not include in the net trading income line the cost associated with the swap funding which is now included in the NII line. And this distorts year-on-year comparison. Yes, beside that we did have a positive quarter but more or less average.

Thank you. With regards to expenses in Turkey Fabio Mostacci from Mirabaud asks do you think the quarter-on-quarter decline in expenses is a sustainable trend?

No, there are some one-offs in the quarter that had to do with negative impacts that were accounted in the first quarter of the year some taxes on branch openings were front loaded in the first quarter of the year, and that partially explains the improvement. Garanti is committed to grow at console level its expenses at around double digits and we are clearly on track to delivering those.

Okay we are now moving on to Spain banking business and we'll start with the NII evolution, plenty of questions there, Francisco Riquel from Nmas1 Equities, Mario Ropero from Fidentiis, Fabio Mostacci from Mirabaud, Stefan Nedialkov from Citi, Andrea Unzueta from Credit Suisse, Jose Abad from Goldman Sachs, Arturo de Frias from Santander Investment Bolsa, Derek Quinn from KBW, Juan Tuesta from JB Capital Markets, Alvaro Serrano from Morgan Stanley, Sofie Peterzens, JP Morgan, Franco Insausti from Autonomous -- I don't want to leave anybody out, Alfredo Alonso from Kepler, Ignacio Ulargui from Deutsche, Carlos Peixoto from BPI, Ignacio Cerezo from UBS, Martha Sanchez from BofA Merrill Lynch and Nuria Garcia from Ahorro Corporacion -- I don't think I have left anybody out -- asks the following questions. First of all let's start with the update on our full year guidance in NII.

Okay, well, thank you. Thank you all for the question, which itself indicates that we have to have a cautious view of how our business in Spain is evolving as I already mentioned in the presentation. So we don't have much visibility of loan growth in the book and we are seeing it now flattish towards the end of the year, specially we lack visibility in the corporate sector, and maybe the uncertainties on the political side have some weighing on that as things get delayed.

With that NII will likely continue to trend with the same rate of decrease that we have seen in the first half, so that was a negative 2% year-on-year drop, and that could be a good proxy of the rate of growth of NII going forward. Commissions, I mentioned, quite a disappointment. If market remains the way it is it's going to be hard for us to meet our objective of having growth this year in fees and commissions.

And in terms of expenses, this is where I already mentioned we are working hard and will continue to work hard. We have -- even though you might see growth in 2016, that's mainly due to the inclusion of four additional months of Catalunya Caixa and also the restructuring costs associated with that which are higher in 2016 than they were in 2015. But now we will start to see the synergies materialize in this last part of the year. And also as I indicated we'll bring forward the full cost synergies of EUR200 million one year forward to 2017. In addition to that we will continue to have addition efficiency measures. And I think the new organization will help us drive that further, as well as the full focus of our management team in Spain in driving efficiency given the environment.

In terms of cost of risk, no change in guidance. We are seeing good evolution there, so we will surely be below the 60 basis points we indicated with provisions likely to be lower in the second half than what they have been in the first half. I think that's an overview of the main elements of guidance for Spain.

Okay. Thank you. Specifically with regards to the net interest income can you explain the dynamics behind the quarter-on-quarter increase in NII, has the NII bottomed? And with regards to loan growth, can you explain loan evolution in the quarter? Are you seeing a slowdown in corporate loan volumes in Spain? Update loan growth guidance for this year and next. Which I think Carlos just did. Please give us some color on new loan production in Spain by category as well as loan yields on back book versus front book. Where do you see the bottom?

And with regards to deposit pricing, (inaudible) deposit pricing, what is realistic for to assume? And last but not least the NIM NII over average total assets in Spain is up quarter on quarter for the first time in several quarters, what is your for NIM going forward?

Okay, I will try to be as short and to the point as possible. Loan volumes were up by 2.1% in the quarter, so clearly a positive performance, although we do have to take into account that we had an internal transfer of EUR1.1 billion from the real estate portfolio to Spain banking activities that we thought that the loan book would have grown slightly above 1%.

The growth has been particularly positive in the consumer portfolio, that grew quarter-on-quarter by 5%. It was also positive on the large corporate and the CIB business, in the case CIB it went down by over 7%, we did have some one-offs in the quarter, and we also experience some one-off which we do not expect to be recurrent in the public sector book.

As Carlos mentioned, there is not sufficient clarity on volume evolution as of yet so we want to be fairly conservative here. And our guidance remains flattish for the year.

On the question regarding front book evolution and loan production mix, let's start with spreads. The mortgage portfolio clearly had a very positive performance in the quarter, not only in terms of volumes that grew around 25% loan production but also in terms of spreads. The proportion of fixed income mortgages keep rising. We are talking now that we are reducing 32% of our mortgages at fixed rates. And that brought the spread around, the front book spread at over 210 basis points, clearly much higher than the average margin, the average spread of the back book which remains around 105 basis points.

The consumer portfolio spreads went down slightly in the quarter after the very significant success of the one click loan that justify the very good behavior in volumes the back book spread it's around 730 basis points. The SME portfolio remain more or less stable at around 230 basis points front book, again here above the back book which is around 215 basis points.

And, of course, thanks to some one-offs the corporate front book was -- had a spread above 200 basis points, and again above the back book which is around a little bit above 180 basis points.

On the deposit side we continue to see significant reduction in the time deposit front book. It went down in the quarter from 26 basis points at the end of March to only 14 basis points at the end of June. The back book went down again by 10 basis points from 61 basis points to 51 basis points, so continue to benefited from the reduction in the front book. And the good change in mix that we continue to experience in the customer fund side and current and saving accounts increased again in the quarter by over 5% allows for a much better funding mix.

So, overall, the spread, the customer spread in the quarter went down only by 2 basis points and what I think it is the most important news in the quarter is that no impact whatsoever due to spread compression. As I mentioned, the front book is behaving in general very well and the deal compression only had to do with the lower Euribor rate.

In order to explain the NII evolution in the quarter is also important to take into account the fact that in the ALCO portfolio more or less contributed the same amount as in the first quarter, and we had a significant reduction in wholesale funding cost, both in terms of prices and also due to much lower volumes on that side.

Going forward, I think Carlos has already answered.

Okay, yes. And with that regard, Alvaro Serrano from Morgan Stanley asks NII down 2% second half -- first half for 2016, 2015, and I would say, yes, the first half evolution of NII looks like a good proxy of what the full year growth rate of NII will be for 2016 with the current visibility we have today especially in regards to volumes.

So continuing with Spain and picking up a little bit on speed, TLTRO, Carlos Cobo from Haitong, Franco Insausti from Autonomous Research, Alfredo Alonso from Kepler, Martha Sanchez from BofA Merrill Lynch. Could you please explain your policy towards TLTRO II usage, total take up versus TLTRO I? Do you plan to accrue already in 2016-2017 any interest from conditional negative rates? And what would be the expected impact on NII?

Our current TLTRO take up is almost EUR24 billion after amortizing the EUR14 billion that we drew from the previous TLTRO. We've been able to lengthen the maturities of this money from 2018 to 2020. As we said already many times we do not really expect this to have a significant impact on loan demand, but we do believe that will continue to help us reduce our funding cost.

I think that's something that we are already delivering. It is helping us to reduce both the funding and the cost of our wholesale funding. In retail maturities are also being re-priced down in significant fashion and this increase on draw down will allow us to reduce our wholesale market access in the following quarters.

Regarding the cost, we are not yet accounting the minus 40 basis points, and that's a decision that has not been taken yet and we will be able to answer in following calls.

Okay. With regards to ALCO in Spain, Vanessa Guy from JP Morgan and Ignacio Cerezo from UBS ask what is the size of your current ALCO portfolio in Spain yield and duration and the amount of unrealized available for sale sovereign gain, losses?

Losses?

Gains or losses.

Okay. The current size of our euro ALCO portfolio is EUR33 billion, is down slightly from the first quarter, and is down by almost EUR3 billion on a year-on-year basis. The average yield is 2.5%. And the average maturity has increased slightly from the first quarter to 3.3 years. And we do have capital gains in the euro portfolio above a billion.

Okay. On fees, Mario Ropero from Fidentiis and Alvaro Serrano from Morgan Stanley ask if we can please explain the quarterly decrease of fees in Spain and please update your guidance.

Okay. Fees were, as Carlos said, clearly the negative of the P&L of the Group in the quarter. Market related fees did not behave well. This is the case of the CIB business, fees went down by 44% and they do represent around 10%, 15% of the overall fee structure. We also had a significant decrease in the mutual funds and pension business after an accounting change that took place at the beginning of the year. But more important than that is that the average commission that we're charging on our mutual funds is down by 9 basis points this year to around 104 basis points. We are being a lot more conservative in the type of products that we are selling to our clients, and that is explaining the decrease in the average commission charge.

On banking services, commissions grew in the quarter and that's clearly the positive of the quarter.

Okay, thank you. On expenses, Francisco Raquel from Nmas1 Equities, Mario Ropero Fidentiis, Carlos Cobo from Haitong, Arturo de Frias from Santander Investment Bolsa, Sofie Peterzens from JP Morgan, Andrea Unzueta from Credit Suisse, Daragh Quinn from KBW, Ignacio Ulargui from Deutsche, Juan Tuesta from JB Capital Markets, Ignacio Cerezo from UBS, and Jose Abad from Goldman Sachs ask the following questions.

Could you please comment on the reports of 2,000 reduction in Spanish employees and the outlook for Spanish costs? Also can you comment on cost restructuring initiatives at the group level beyond the Catalunya Banc integration? Can you update on the Catalunya Banc integration pending restructuring measures and update on your target for synergies? Can you give us guidance for the cost base in 2017 in absolute terms in both the Spanish division and the corporate center?

So a lot of interest as well in, as it's natural, in our cost reduction efforts in Spain. In Spain and elsewhere this is one of our critical strategic priorities, improving customer experience while at the same time driving further levels of efficiency. And we are focused on several initiatives to do that. In terms of Catalunya Caixa, I already commented, but very briefly we are bringing forward the total cost synergies that amount to EUR200 million per year by one year so it will be achieved in 2017 reducing starting -- in September we're going to be closing down 400 branches. There will be the employee exits. And this is well beyond the plans we had originally with the requirements from Brussels.

Beyond that, we are working in Spain and elsewhere in adopting our operating model. I would not pay much attention to the press numbers that are frequently misquoting things that are running around, so the 2000 could refer to anything.

What we're doing is working on one hand the distribution model that I just mentioned with the first 400 closures in September. But we have many projects in engineering with the new paradigms around the infrastructure as a service, platform as a service, data as a service. All of that will allow us to cope with growing numbers of transactions and customer interactions, which are big part of the improving experience at costs that are coming down very significantly on a per transaction basis.

We have also lots of efforts ongoing in terms of streamlining our operations, leveraging automation, and there is big potential there in Spain and elsewhere to do that. And we're working as well in the intermediate structures.

There was also an announcement yesterday or the day before on simplify structures in Spain in the regions and intermediate structures that are being reduced. Similarly, the holding level and with the organization we will have further synergies that will have effect in Spain among others. For example, in the US we have our real state, even here at the headquarters where we have. Now, this summer, we're going to use the month of August to bringing more people to the headquarters, that can hold up to 8,000 people and we had a 6,000 now. So with the open space we now have that flexibility to cram in more people and still maintain a good working environment. That will allow us to close a couple of buildings.

So there's lots of things we're working on. Rather than come up with a flashier announcement of a grand plan, we would rather show results as we progress. So will be informing you of our delivery quarter on quarter on all of these plans.

But I just would highlight once again that cost control, cost reduction is one of our key strategic priorities and it's going to be one of the drivers of management going forward, in particular in Spain because of the environment.

Okay. Thank you. Going pretty quickly now. With regards to asset quality, Carlos Cobo from Haitong, Mario Ropero from Fidentiis, Juan Tuesta from JB Capital Markets, and Carlos Peixoto from BPI ask if we reiterate our cost of risk guidance to 60 basis points for the Spanish banking and real estate activity does your 60 basis points guidance cover any potential top-up of provision reserves resulting from the new Bank of Spain circular? And what is the bottom level of costs of risk you expect for Spain in the future?

Okay. Yes, we do reiterate our cost of risk guidance. Although we did already say in the first quarter call that it is clearly conservative. As we've mentioned before, we do not expect significant impacts on because of the new circular.

And we do not speculate with the bottom level of cost of risk. Clearly, the second quarter number was very good, below 50 basis points. We could experience certain write-backs in the future, but I don't think that we should speculate on that.

Okay. Moving to the US, mainly the questions are with regards to the evolution of cost of risk, NPLs, and everything that's related to our oil exposure there. Carlos Peixoto from BPI asks if the increase in NPLs is related to the oil exposures and if we should expect further increases?

Martha Sanchez from BofA Merrill Lynch asks on update on oil exposure, total and also undrawn coverage, what can we expect from the October reviews? Are you comfortable with the level of current coverage?

Fabio Mostacci from Mirabaud, Ignacio Cerezo from UBS, Andrea Filtri from Mediobanca, and Martha Sanchez from BofA Merrill Lynch also ask, this quarter you experience a significant decline in cost of risk versus first quarter. Do you stick to the guidance of the full-year or is there any chance to review it downwards? What is your expectation in the US Bank for 2017 from oil and gas going forward and loan growth and cost of risk?

And last but not least, Carlos Peixoto from BPI asks or mentions that the loan loss coverage in the US was down 13 points quarter on quarter, falling below a 100%. To what levels would you be willing to allow NPL coverage in the US to drop? So basically, NPL evolution, cost of risk evolution, coverage evolution, and guidance for this year and next?

Okay. I'll try to be short and to the point. Regarding NPLs, it's true that we had a 20 basis points, almost 20 points increase from 143% to 162%. That had to do with some internal rating downgrades that we did during the second quarter of the year on our oil and gas exposure. These downgrades did not have any impact on the provision line as part of them were already provisioned and another portion of that had every good collateral.

We stick with the guidance of cost of risk below 55 basis points, even if the cost of risk in the quarter was around 35 basis points only.

As you know, we have the Shares National Credit coming again in the third quarter of the year. And there is always a certain level of certainty around them.

It is true that our coverage ratio is, precisely because the increasing in NPLs, were down in the quarter. But we feel comfortable with the 30%, almost 30% coverage that we have on our oil and gas NPL portfolio.

The actual oil and gas exposure went down by EUR300 million in Compass to EUR3.6 billion. Taking into account the oil price evolution and -- we feel confident that current levels are sufficient.

And finally moving to South America. Arturo de Frias from Santander asks, Latam provisions are much lower than previous quarters. Why is this happening? And do you think this is a sustainable level?

And Ignacio Ulargui from Deutsche Bank asks, given the impact of [IIS 39] in Colombia, what should we expect in terms of cost of risk in 2017?

Okay, I'm going to answer Ignacio first. Ignacio, you more than anybody else should know that we do not give guidance beyond the current year. So nothing can be shared about 2017.

On the cost of risk in Latin America, it has been going down for quite long time already. First quarter numbers were already very strong, and that's why we are ready to improve on the guidance. And we are not expecting now any deterioration whatsoever from last year levels.

Clearly countries are proving very resilient. And portfolio is clearly very well-constructed.

Okay. Thank you very much everybody for the call and your questions. As mentioned previously, we remain available from now on from Investor Relations to take any further calls or questions. Thank you very much all. And happy summer holidays.