Banco Santander Mexico SA Institucion de Banca Multiple Grupo Financiero Santand (BSMX) 2020 Q4 法說會逐字稿

Good day, everyone, and welcome to Banco Santander México's Fourth Quarter 2020 Earnings Conference Call. Today's call is being recorded. (Operator Instructions)

I'd like to turn this conference over to Mr. Héctor Chávez, Managing Director and Head of Investor Relations, who will make some opening remarks and introduce today's other speakers. Please go ahead, sir.

Thank you, operator. Good day, and welcome to our fourth quarter 2020 earnings conference call. We appreciate everyone's participation today. By now, everyone should have access to our earnings press release and the presentation for today's call, both of which were distributed yesterday after the close of the market and can be found on our Investor Relations website.

In response to your current feedback, this quarter, we have reduced our prepared remarks in order to allow for more time for Q&A. And also, we have included in the appendix of this earnings presentation a slide with information on our responsible banking standards for your reference.

Presenting on our call today will be Héctor Grisi, Executive President and CEO; Didier Mena, our CFO; and Rodrigo Brand, Executive General Director of Public Affairs.

Before we begin our formal remarks, allow me to remind you that certain statements made during the course of this discussion may constitute forward-looking statements, which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties, including COVID-19, that could cause actual results to materially differ, including factors that could be beyond the company's control. For an explanation of these risks, please refer to our filings with the SEC and the Mexican Stock Exchange.

Héctor, please go ahead.

Thank you, Héctor. Good morning to everyone, and good afternoon to those of you participating from Europe. I hope that you and your families are managing to stay healthy and safe in this particular situation that we're going through.

Following a big difficult year during which our markets and our operations were disrupted by the pandemic, our top priority remains safeguarding employees and customers. Our prudent approach to safety and our balance sheet have enabled us to withstand the aftershocks of the pandemic to date. This quarter, we delivered some financial operating results in still a very weak operating environment. Despite a small year-over-year contraction on our loan book, we maintained solid performance levels in loans to individuals, particularly mortgage and auto loans, while commercial loans remained weak in line with market trends and soft demand conditions.

By contrast, deposits have proven very resilient. In fact, individual demand deposits increased more than 20%, thanks to our loyalty and customer acquisition strategy, while corporate demand deposits also grew double digit with companies favoring liquidity.

Importantly, our prudent balance sheet strategy has allowed us to maintain ample levels of liquidity and capital, while our ROE for the year surpassed that of the system for the first time in the past 5 years, a result in which we are very well satisfied.

In terms of asset quality, we are pleased to report that 75% of the loan portfolio under the payment holiday program in support of retail and SME customers remains current. Only 9% have missed payments, and of that, 16% has been restructured already. Given this better-than-expected performance, we estimate that the preemptive loan provisions for MXN 2.9 billion that we made in the second quarter of last year are sufficient at this time.

We will discuss our business environment shortly. But first, let me emphasize our conviction that Santander México remains very well positioned against the still adverse economic effects of the pandemic.

Slide #4, please. The chart on Slide 4 shows the full year impact of the pandemic on economic activity and employment. While it seems the worst is behind us, this year, recovery is likely to be very gradual, and business activity is expected to remain well below pandemic -- pre-pandemic levels for some time. Although there has been a gradual turnaround in formal job creation, the annual trend remains negative. January normally shows a seasonal rebound in job creation, while the recent spike in COVID cases has resulted in renewed restrictions on economic activities that have reduced population mobility following an asset recovery in prior months. These restrictions will likely impact the pace of the recovery in the first quarter of '21.

It is important to note that most job losses have been concentrated among individuals who earn less than 2 minimum salaries, while approximately 80% -- 86% of our customers earn more than 2 minimum salaries, meaning that the rise in unemployment has a limited impact on asset quality within our consumer loan portfolio thus far.

Given current economic conditions, inflation should remain within Banco de México target range. We forecast inflation of 3.5% for '21, giving the Central Bank room for 2 more interest rate cuts of about 25 basis points each. We estimate that the reference rate could fall to 3.75% by year-end. The combination of modest economic growth, lower employment and low interest rates present a challenging outlook for Mexico commercial and consumer environment and therefore our business in 2021.

On Slide 5, you can see that system loan volume contracted nearly 2% year-over-year, the weakest performance since 2002. The decline was mainly driven by consumer loans, which had not contracted this much since the 2009 crisis. We coincided with the gradual reduction in corporate loan demand following high volumes in the first quarter of last year. By contrast, system deposits remained strong, expanding 11% year-over-year, with demand deposits up 17% year-on-year, likely reflecting a greater need for liquidity among households and companies as well as lower rate environment.

Moving to Slide 6, a brief update on our strategy. Our strategic priorities remain focused on building a stronger bank for the future. As we shift the business mix toward higher share of retail loans and deposits, those attracting more retail customers and increasing loyalty remain the cornerstones of our strategy.

Digitalization also remains a priority, and we continue investing in technology. This part of our strategy includes collaborating with fintechs and other tech companies to introduce faster and more convenient digital tools and functionalities that increase customer engagement and drive more transactions.

For example, this year, we plan to release a new integrated app that is simple, intuitive and offers enhanced functionality. We expect the app to become a market benchmark and will be exported to other markets where Santander operates. Cloud technologies embedded in our everyday operations as well as reinforced cybersecurity are key to our delivering higher value to our customers as well as increased operating efficiencies.

Continually improving our customer journeys and service excellence are also our aim. Being a top 3 player in terms of NPS is one of our strategic targets, and this indicator is already a relevant KPI in the variable compensation for all the employees at the bank.

Digital conversion is crucial to our goal of serving customers anytime, anywhere and anyhow. Progress on this front includes expanding the number of digital customers by 20% to 5 million by year-end. A critical part of our strategy has been driving digital adoption levels as well as expanding our base of loyal customers who now account for almost 40% of the total active customers. Helping drive digital adoption is our network of smart and agile branches as well as new functionalities that we're introducing across our digital banking platforms in addition to new digital products and services.

One example is our new digital onboarding platforms that are boosting our auto and mortgage loans, which represents 62% of our retail loan portfolio, and continue performing extremely well even under these conditions. Importantly, we are growing our auto loan business organically and rapidly, achieving a 5.4% market share as of December. Our alliances with Mazda, Tesla, Suzuki and Peugeot helped us gain nearly 400 basis points in market share during the last 12 months. We plan to at least double our market share over the next couple of years with the goal of reaching our natural market share of 13.5% in the medium term.

Our mortgage business broke our own production record again for this product in December as well as the banking system, originating MXN 5.6 billion of home loans, driving growth for our innovative Hipoteca Plus and Hipoteca Free products boosted by our newest digital product, Hipoteca Online, the only mortgage platform in Mexico that contacts -- connects to all end-to-end processes.

Our customer acquisition and loyalty initiatives have been paying off over the past 2 years, with our mix of retail deposits improving 373 points to 35% of total demand deposits, which will contribute to lowering our cost of funding over time. Attracting retail customers under low-cost deposits is core to our strategy. Our goal is to reach the average mix of 42% retail and 58% commercial demand deposits over time.

Turning to Slide 7. Total loans contracted 1.5% year-on-year and 4.4% sequentially in line with the market trends and mainly due to lower balances of corporate and consumer loans. Given the constraints of the current economic environment and with an eye on maintaining asset quality, we continue focusing on more defensive segments, such as mortgages, payroll and auto loans, where we have been gaining a lot of market share, and we have been a leader in the market.

On Slide 8, you can see that individual loans are growing above 7% year-on-year on the back of mortgages and auto loans, while credit cards and personal loans remained weak. Mortgages have proven defensive despite current conditions. In fact, we grew mortgage loans over 18% year-on-year, again, organically. Also by focusing on the middle- and upper-income segments, we have been able to increase our average ticket, which is 35% higher than the market compared with 5% only 4 years ago. This approach has also allowed us to attract more high-quality customers that we then convert into loyal customers with Hipoteca Plus offer that has been a huge success.

In December, when we set our mortgage origination records, around 70% of originations came from our Hipoteca Plus, which helps drive cross-selling in other products as well as build customer loyalty. Our digital onboarding platform for mortgages, Hipoteca Online, has been critical during the pandemic and also helped drive originations during 2020. 70% of mortgages were processed through this digital process. Like mortgages, our auto loan origination reached a historically high level in December, nearly doubling auto loan production sequentially in the fourth quarter.

Turning to Slide 9. Growth in loyal and digital customers continue demonstrating solid progress in this key area of our strategy, with year-on-year increases of 14% and 20%, respectively. As you can see on the slide, loyalty penetration continued to increase significantly. We have also focused on digital conversion while increasing digital transactions and sales. This quarter, product sales via digital channels accounted for almost 50% of total sales, a significant increase from a year ago level.

Digital monetary transactions also spiked, reaching almost 1/3 of our total, with mobile transactions accounting for 94% of total digital transactions versus 87% in 2019. Mobile customers also kept growing at a solid 23% annual rate, reaching 4.7 million at the end of the quarter.

As shown on Slide 10, commercial loans decreased approximately 7% year-on-year and 9%, respectively. And some corporates and the middle-market firms continue to prepay some lines they tapped in the first quarter of 2020. Loans to government and financial entities also contracted, mostly driven by prepayments from PEMEX and CFE. Middle-market companies continue showing a year-on-year expansion, although the segment declined sequentially.

SME loans registered a sixth sequential quarterly contraction as this segment has -- was weakening even before the pandemic. Putting this in perspective, our outstanding loans to SMEs is similar to our third quarter in 2016. The downward trend in these and other segments is also related to our reduced risk appetite in the current economic environment, particularly on SMEs, which are higher risk when the economies are weak. Comps will be difficult in the first quarter of '21 given the precautionary lines of credit that companies drew at the start of the pandemic.

Moving on to total deposits on Slide 11. This increased 10% year-on-year, while we saw a slight contraction sequentially. As in previous quarter, there was a shift between demand and time deposits due to lower interest rates that favor the former. Deposit growth from individuals stands out at 24% year-on-year, supported by our promotion campaigns to attract these types of deposits. Although this effort, we have been able to reduce the cost of our demand deposits by 110 basis points year-on-year on -- better than the market has decreased. Although we are satisfied with this result, we continue working to reduce our cost level further as we make additional headway improving our deposit mix while lowering the cost of our commercial deposits. With term deposits, there is also some room to improve our funding cost under the same strategy.

I would like to conclude by highlighting that we finished the year better than we have expected due to our swift response to the negative market conditions. And although many challenges remain, we are well positioned with very strong capital and liquidity levels.

Now let me pass the call over to Didier who will review the quarter, most important trends and metrics. Thank you.

Thank you very much, Héctor. Good day, everybody. Turning to Slide 12. We continue maintaining very strong capital and liquidity positions, as Héctor just noted. Our liquidity coverage ratio stands above 300%, a substantial buffer and well above the regulatory threshold. We also remain very comfortable with our debt profile given manageable debt maturities.

Our capitalization ratio increased to 19.01%, while our core equity Tier 1 ratio increased 209 basis points to 14.35%, reflecting the recommendation made by the banking commission in March 2020 of not paying out dividends.

As you can see on Slide 13, our net interest margin contracted 89 basis points to 4.5% for the quarter. This was a result of lower interest rates, along with lower balance sheet within high-yielding segments, partially offset by a significant increase in our securities portfolio during the second quarter.

Please move to Slide 14. In the fourth quarter of last year, net commissions and fees increased 9% year-on-year supported by solid performance in insurance, credit cards and cash management. For the full year, net commissions and fees increased approximately 4% driven by the same items.

Turning to Slide 15. Gross operating income declined 3.6% year-on-year due to a 50% decline in market-related income as we return to our quarterly average range of MXN 600 million to MXN 800 million per quarter, partially offset by a solid 9% increase in fee income.

Moving on to asset quality on Slide 16, you will find an update on the evolution of our payment holiday program for customers. As of June of last year, 25% of our total portfolio was under payment holidays and, by December, already had [made] payments, showing a better-than-expected performance. 75% of the loans under the program remain current by year-end, 16% have already been restructured, while only 9% missed the payments.

As expected, mortgages had the best performance with 91% being current. Our proactive and early strategy for recoveries and restructuring proved effective as we have already restructured around 30% of the mid-market and SME portfolios under holiday payments and 13% of our consumer loans.

On the next slide, you can see that our NPL ratio show a 80 basis point year-over-year increase to 3.08%, reflecting the effect of the loans that had missed payments as they become past due. The largest impact has been in credit cards and SMEs, with increases of around 300 basis points year-on-year. We expect our NPL ratio to remain above 3% in the next couple of quarters as most of these customers will likely become passive.

Given that we had anticipated this increase in NPLs, we have been able to implement strategies to mitigate and manage its impact on our results. Provisions in the quarter fell more than 30% year-on-year and sequentially, supported by recoveries and the usage of a fraction of the anticipated provisions made in the second quarter. Our cost of risk for the quarter and full year stood at 2.89%, a 29 basis point year-on-year increase or 24 basis points lower on a sequential basis.

Considering the behavior of our holiday payments portfolio to date and its expected evolution, we estimate that the level of additional reserves that we made in June of last year remains adequate and gives us a comfortable buffer for future losses. In any case, rest assured that we will continue focusing on mitigating the risk of credit losses through 2021.

Turning to costs on Slide 18. Administrative and promotional expenses rose slightly over 7% year-on-year mainly driven by higher IT-related expenses as we continue migrating our operations to the cloud, enhancing our ATM software and reinforcing our cybersecurity tools among other technology investments. To a lesser extent, IPAB and personnel costs also contributed to the increase. This was partially offset by lower administrative expenses as we maintained cost controls.

While the efficiency ratio has been increasing since the second quarter of this year, impacted by weaker income in light of a more challenging environment, we remain to focus on controlling expenses. Moreover, as we continue investing in digitalizing the bank and as digital adoption rises, this should make us more efficient through time.

Turning to profitability on Slide 19. Net income increased 11.5% year-on-year to MXN 5.5 billion mainly due to lower provisions and resilient fee income. For the full year, net income declined nearly 6% year-on-year to MXN 20.1 billion, a very positive result considering the challenges we faced in an unprecedented year.

Return on average equity was 14.7%, 15 basis points below year ago level and up 86 basis points sequentially. Year-to-date, ROE contracted 259 basis points to 13.55%. Note, however, that if we had been able to make a dividend payment in line with our usual distribution practice, which was pay in the excess of core Tier 1 ratio above 11%, ROE for the year would have increased by 70 basis points.

Let me turn the call back to Héctor Grisi for some final remarks. Héctor, please go ahead.

Thank you, Didier. Before going into the Q&A session, let me share with you some final thoughts presented in the Slide 20. Even though visibility has improved from a year ago, we continue to suspend our guidance given the strong uncertainty regarding loan demands and other business indicators.

On this slide, we share our current expectations for our market and business this year. Considering the current state of the pandemic and our assessment on the evolution of the vaccine program in Mexico, we anticipate a very gradual recovery of economic activity this year mainly driven by the external sector, while private consumption and investment as well as the government spending will likely remain weak. With this in mind, we anticipate anemic loan demand through the year, likely accelerating through the second half as the effects of the vaccination program start having a positive impact in consumer and business confidence.

Given the uneven pace at which households and companies will likely recover, we expect the various segments of our portfolio to show different dynamics. As we remain focused on favoring low-risk segments such as mortgages and auto loans, we expect that our attractive product offering will allow us to keep gaining market share driven by double-digit growth in these key products. Given the slow pace of job creation and marginal upturn in consumer confidence, we expect demand for payroll and personal loans to remain weak.

On SMEs, highly impacted by the pandemic, we expect the portfolio to continue shrinking along the year. Given that 50% of our loan book are medium-sized companies, large corporates and government loans and their performance has been volatile since the onset of the pandemic, while clearly losing steam recently, we remain cautious. Even though it is hard to predict the performance of this part of our total portfolio, we anticipate our total loan portfolio to show marginal growth in this year.

While loan demand might take some time to recover, we remain focused on our strategy of attracting retail customers and further enhance loyalty. This focus is anticipated to contribute to high single-digit growth in total deposits, while we will continue with our efforts to improve the mix, mainly growing retail demand deposits faster than commercial ones.

In terms of asset quality, the better-than-expected performance of our portfolio following the expiration of the payment holiday period is quite encouraging. As I said earlier, considering the level of anticipated provisions we made in June of last year, its allocation so far and expected trend in the asset quality of the year, we anticipate our annual level of provisions to decline slightly, allowing for a stabilization of cost of credit risk at the current levels, with room to improve by year-end.

In terms of cost, although we intend to make additional investments in the bank transformation mainly in IT and digitalization, we will continue to keep in a tight control of other expenses and to seek overall efficiencies in support of our bottom line. We estimate that costs should grow around inflation this year.

With that said, we look forward to our questions. Operator, please open the call for Q&A session. Thank you very much.

(Operator Instructions) Our first question comes from the line of Jason Mollin with Scotiabank.

I have 2 questions. First, on the dividend outlook, if you can give us an update on the expectations, I guess, given the operations and the muted growth that you're looking for, but also on the regulatory -- the regulators' outlook for or views on whether banks should be paying dividends in the current environment.

And my second question is on the announcement that was made, I guess it's almost a year ago that Santander Group was going to acquire Elavon México, with Santander México owning in the end, I guess, 49% and the Santander Group company owning the other 51%. If you can tell us what's going on there and what's going on in that business and the prospects there, especially given what we're seeing Santander's subsidiaries announce in terms of payments elsewhere in the region.

Regarding dividends, there's -- as you can imagine, there is an ongoing discussion with the regulators. And I think that from a banking association standpoint, we have made clear what's our recommendation, how we think regulators should look at this topic. Basically, what we have recommended is that rather than looking at potential payout ratios as other regulators have done in other countries, I think it's more applicable in the Mexican market to look at capital ratios, okay?

There are, in my opinion, 2 things that merit this approach. First, the Mexican banking system has a very healthy capital ratio, north of what we can see in other geographies. That's one point. The other thing is that profitability, even with the impact of the pandemic, the ROE of the entire Mexican banking system is around 9%. So even in challenging environments, we have as a banking sector the capacity to continue building up capital. And that's what most of the banks and clearly the largest players have been doing over the last year.

So that's why we are recommending the banking commission to look at capital levels. What is the capital ratio that they will feel comfortable with? One of the exercises that it was looking at, in the most recent financial stability report published by the Central Bank in a couple of weeks ago, they run 3 scenarios -- well, actually 6 scenarios. And under all of them -- and obviously, there are stressed -- highly stressed scenarios. Mexican banking system continues to be above the minimum levels and I would say that, in some cases, within 14% to 16%. So in my opinion, that is a lot of capital tied up in the banks.

Now having said this, that this is our recommendation, I'm concerned that what Mexican regulators will do is just follow what others are doing and that they might end up recommending the Mexican banks not to pay more than 15%, 20% of last year's service. That definitely is something good, but I think that that's not the right approach. Let's see if we can be able -- if we were successful in trying to convince them that it's more applicable having or setting a certain level of capital ratio and then allowing banks to pay out what it's in excess of that, okay?

On -- and well, and finally, regulators have mentioned us that they expect to have a view and share that view with us during the first quarter of this year. So we expect that those conversations will continue happening and that we will have a final view coming from them relatively soon within the next couple of weeks.

Now on your second question, I will turn the microphone to Héctor. I think that he has a more comprehensive view of what's going on with Elavon México.

Thank you, Didier. Let me tell you, we concluded the acquisition of Elavon last year. Actually, we finished that off around midyear. And actually, group took over the 51%, and the bank in México ended up with 49%. And now basically, we are changing the system, and we're changing the name from Elavon México to GetNet México, okay? As you know, GetNet is our name in Brazil, which has been very successful, and now GetNet México is a new reality. We are growing the business in a very healthy way. We have -- now we are the second-largest acquirer in the country. We're growing very well in that business, and we will continue to do so, okay? This is one of the most important things that we're going to be concentrated on.

As you know, Santander Group has announced the formation of a new subsidiary called PagoNxt, which is basically our payment subsidiary. And PagoNxt is the one that owns the 51% of -- and now GetNet México, okay? And this is a business that is going to be very important that we will continue to grow. We hope that we will be rolling out the new system and the new software for the system in the -- probably the next couple of months, which, by the way, would be one of the most advanced in the Mexican market. And we hope to continue growing that business very fast also with the huge SME penetration that we have.

So are you waiting to grow that business? Are you waiting for the new software, like standing by, you're just kind of treading water with the market share you have at this point, and you're waiting for this launch?

No, no, no. We're not waiting for anything. We're growing very much. As I told you, now we overpassed Banamex as the second-largest acquirer in the country. And I mean BBVA is the largest one. We're the second one. And we will continue to grow that business.

The rollout of the new software will be in the next couple of months. Right now, we're still operating through Elavon, and this -- the new software will be ready. We already have -- we're already on friends and family. We have a group of clients already working out with the new software. We're just checking the last points. And this would -- the rollout would be completed, I mean, in the first quarter.

Our next question comes from the line of Ernesto Gabilondo with Bank of America.

My first question is on provision charges. We noticed that you used around MXN 1.5 billion out of the MXN 3.9 billion of the preventive provisions built in June. And on the other hand, the research coverage declined to levels below pre-COVID. On the other hand, you mentioned that the behavior of the deferred portfolio has been better than expected and that there is 9% of your deferred portfolio that is delayed. So this represents around MXN 15.7 billion.

So considering that you still have preventive provisions of around MXN 2.4 billion, how should we think about this MXN 15.7 billion that are delayed? And how much do you think you can restructure, considering you have probably collaterals in mortgages and SMEs? And what could be the worst-case scenario for this delayed portfolio?

And then my second question is related to your net income for the year. When incorporating your expectations for 2021, we are getting to a flat net income for 2021. So just want to know if that sounds reasonable on what you're expecting.

Regarding provisions, something that it's important to have in mind is how the different loan portfolios are performing in terms of 1 late payment, 2 late payments, 3 late payments and comparing that to prior years, okay? And what we're seeing is that in some portfolios, customers that are at 3 payments late are slightly above but just for very, very selected portfolios. But most importantly, when you analyze or when you compare 1 or 2 payments late for the vast majority of our loan portfolio, what we are seeing recently are levels below pre-COVID. When you compare December 2020 to December 2019, we are -- the performance is better than what the loan portfolios were performing back in 2019.

So all this to say that there was clearly an increase in NPLs associated with the impact of the pandemic, but that the level of provisions that we made in the second quarter of last year, we consider that are still sufficient for the deterioration that we've seen already and that we don't have evidence regarding a potential further deterioration of the loan portfolio that is not taken into account. Obviously, if there's any deterioration that is not well incorporated into our provisions, we'll definitely make those.

I think that what we have shared with you over the last few quarters in the strategy that we laid out in terms of classifying customers depending on their -- on the risk, on the performance, on how linked they are to the bank, what type of product that they have, all those strategies, I think, that have worked pretty well so that we have a good understanding of what the current standing, current exposure and potential risks that we have with clients, particularly in SMEs. I think that -- those SMEs that have been restructured, we were able to increase the guarantees that we have with them, not only -- not the guarantees that come from Nafinsa, from the government development banks but guarantees that come from the clients. So probably around 75% of those SMEs that have been restructured have an additional guarantee to the one that we had prior to doing the restructuring.

So we think that we enhanced the collateral that we have relative to SMEs. So I would say, Ernesto, that we feel proud to be comfortable. You rightly point out that there's a decrease in the coverage ratio, and I think that this is a temporary decrease. With the increase in NPLs, then you -- coming to a write-off policy, we have to try to recover those loans. When we have a reasonable expectation that those will not be recovered, then we have to write those loans off. So an increase in NPLs recently implies that during the following quarters, there will be an increase in loans that are written off. And when that happens, the coverage ratio will increase.

So I think that most importantly, what is very important for us is to stress the fact that when we make provisions, we take into account expected losses, probability of default, the severity of the loss. And according to that information and with the different scenarios that we are analyzing, we don't see a compelling reason of why to increase or provide or make additional provisions, okay? So that's on provisions.

Now turning to your question on net income, I think that you're right in the sense of, with the soft guidance that we are providing, with the key trends that we are seeing, gets -- in the combination of the different assumptions that we are sharing with you, it could get you to flat income or slight contraction in net income. Those are the things that we're seeing. There are clearly some potential downside, and that has to do obviously with -- mainly with the continuous impact of the pandemic.

Also, there's clearly an upside, and that has to do, in my opinion, with -- there's an accelerated rollout of the vaccination program from the government. Even the governor of the Central Bank, in their assumptions, they state that a successful and efficient implementation of the vaccination plan could imply a 200 basis points difference in terms of GDP growth for the Mexican economy this year, going from 3.3% to 5.3%. We think that most likely, if that happens, it's going to be more concentrated over the second half of the year.

There has been a relatively slow implementation of the vaccination plans in Mexico. So the upside is that, in my opinion. And if that happens, definitely, we are very well positioned. We have the capital and the liquidity to continue providing support for our customers.

Just a follow-up in terms of the provisions. So at the end, in considering the potential expected losses, the restructures and the collaterals, do you think that the delayed portfolio of around MXN 15.7 billion could be reduced to around MXN 2.4 billion?

I think that the provisions that we have, they are sufficient for the deterioration that we're seeing. And it's not only about the portfolio that is in the payment holidays but also the entire loan portfolio.

Our next question comes from the line of Jorge Kuri with Morgan Stanley.

Two questions if I may. The first one is on trading market-related income, it's evidently been quite volatile in 2019 and 2020. Could you remind us what you think the per quarter normal level for trading should be? And if -- and I know it's very difficult to answer this second part. But do you think 2021 would look more normal and hence delivering on that normalized level?

And my second question is on NII. Your comment about marginal growth in the loan book and falling interest rates in Mexico, does that mean that we'll probably see another year with NII contraction similar to 2020, 1%, 2% contraction? Or is there anything that you see this year that would help you not deliver NII contraction?

(foreign language) Let me tell you, on trading, what I believe is basically -- I mean as you have seen, we had a tremendous year this year. I think it's going to be highly difficult that we're going to be able to repeat this kind of year. We were very well positioned to the situation, and fortunately, we came out really well.

The normal number should be between MXN 3.3 billion and MXN 3.7 billion per year, okay? That's the normal thing that we should make. And I believe this year should be around between MXN 3 billion and MXN 4 billion. I don't think it's going to go beyond that given the size of the book that we have and the size of the positions that we have at this point unless there is an unexpected move or there is much more volatility. But otherwise, I don't think that it's going to be beyond that.

And then second question, I would please ask Didier to follow on that.

Yes. I think that net interest income, in my opinion, should be relatively stable to what we are delivering this -- in 2020. And there are -- there's obviously headwinds in terms of the expected growth in our loan portfolio. However, let me share with you some of the dynamics that we are seeing.

If you look at how interest income and the interest expense are performing, what we've seen in the last quarter is that interest expense decreased almost 31% year-on-year while interest income decreased only 15%. Given that we -- when you compare what we've done relative to our most relevant peers, we started -- we were very cautious in terms of the potential impact of the pandemic in terms of deposits. Prior crisis had that deposits typically contracted as a consequence of the crisis. And we were somehow expecting that, and that hasn't happened. So for the first half of the year, we were monitoring closely the dynamic of the deposits and being not as aggressive as other peers in terms of the reduction of interest rates.

And now at the end of August, when we had -- we ran some stressed scenarios in -- taking into account recent information of the performance on deposits, we realized that we had a very, very significant cushion in terms of liquidity even under very, very stressed scenarios. So we started a more aggressive campaign to reduce our cost of deposits. So that's why when you compare the reduction in interest expense relative to the third quarter of 2020, in the fourth quarter, we were able to reduce it twice as much as what we reduced in the third quarter of last year.

So all this to say that you should probably look at what happened in the fourth quarter as some guidance, some guide to what could happen in the following year. And we still have some potential in terms of the benefit of what we have reduced recently in terms of deposit rates and having the impact for the full year in 2021, okay? So I think that, that should be one of the most relevant factors that will make NII be relatively flat this year.

Our next question comes from the line of Tito Labarta with Goldman Sachs.

My question is following up on the cost of risk, just want to understand a little bit the cost of risk this quarter. And given the rough guidance you mentioned for remaining more or less around current levels, around 2.93%, but in the quarter, it did fall a lot to like below 2%. So just to understand why the big decline this quarter given that you expected it to go back to the roughly 3% level.

And we saw a big spike in NPLs this quarter, and you expect that to continue to deteriorate. I mean you mentioned you benefited from recoveries. Maybe if you can give some color on what those level of recoveries were this quarter relative to other quarters, how that could evolve this year, I mean, just to get a sense of how we should think, at least like on a quarterly basis, that -- how that cost of risk should evolve from here because it looks like we should expect a big jump from what we saw just in the fourth quarter.

Regarding cost of risk, you have to take into account that the spike that we saw in the second quarter was mainly to make additional provisions. So when you compare the fourth quarter relative to the prior quarters, then that's why you see that decrease.

But at the end of the day, in my opinion, the way we have to look at it is to analyze whether the provisions that we're making are enough cover for the potential losses that we expect in our loan portfolio. And what we have analyzed is that we expect the level of cost of risk being around 3%. So it is clearly higher than what we had in pre-pandemic, and it's not as high, but it's like 15, 20 basis points lower than the numbers that we were getting in the second and the third quarter of last year.

In terms of recoveries, Héctor, would you like to -- Héctor Chávez, would you like to expand on that?

Yes. I mean first off...

Sure.

Yes. First of all, let me tell you, I mean what we did on the last quarter is we sold a lot of the Fed portfolio, okay? We sold a big piece of it, around MXN 1.2 billion, okay? So that was a big part of the portfolio that we sold. That's why the numbers basically came down. What we have seen also is that the deterioration on the portfolio, mainly in credit cards and in SMEs, is not growing, okay? It grew into the fourth quarter. But basically, the deterioration has stopped over the past, I would say, 45 to 60 days, okay? So with that, we feel confident that at this point, it's not going to get worse.

Now I mean we are being a little cautious in the sense with this second block of what's going to happen, okay? What we have seen is that our portfolio is resilient. And if you see -- I mean if you take a deep look at what we've been doing, is we were cautious not since the pandemic started but a long time before then, since the new government came in because we were a little bit concerned about the investment and a little bit concerned about what's going on. So we were already cautious. So our portfolio in that sense was already not growing as much as it was growing before the new government came in.

So on that regard, I feel very confident that the portfolio that we have left is very resilient at this point, okay? But I mean nevertheless, it's very difficult to -- I mean to see if -- I mean if the vaccines come in before then, then the situation could be better. But at this point, I could tell you that I'm not extremely comfortable enough with the portfolio and the levels we have on past dues, okay?

Okay. And can you give some color on the recoveries?

Yes. The -- first of all...

Yes...

Well, I mean as you have seen the numbers, I mean they are actually much better than expected. What we did -- and I'm going to give you a little detail. We divided our clients into clusters, okay? And we defined the clusters that were a little bit more dangerous in the sense that we believe that had a little bit more probability of not getting paid. So we actually went a little ahead of the market, and we were negotiating with those clients since the beginning. And we reviewed the portfolio. And also, we were very aggressive in -- basically in SMEs, in buying guarantees from Nafinsa.

So our portfolio is one of the best, I mean, secured portfolios in the market. I mean, best guaranteed, sorry, one, portfolios in the market. We were very, very aggressive on that even before the crisis started. So I believe that we're going to come in a very good position in that way.

Yes. Tito, this is Héctor Chávez. And just in addition to what Héctor Grisi just mentioned on the strategy of recoveries, the actual number on the fourth quarter of reserves of MXN 3.1 billion, there, we did sell a portfolio of bad loans for MXN 1.2 billion. Without that sale, the level of provisions would have been MXN 4.3 billion, which is very much in line with the average normal level of provisions that we put every quarter. That's part of the -- or another reason why you saw a sequential -- an important sequential reduction of provisions quarter-over-quarter.

Our next question comes from the line of Carlos Gomez with HSBC.

My first question is about interest rates and sensitivity of margin. I noticed that everybody's expectations is changing, and yours has changed to 3.75% for the year. Can you remind us about your sensitivity in terms of basis points for the margin for every 100 or every 50 basis points change in the interest rate?

And second, in terms of risks, we have seen the proposed energy reform that is now being discussed in Congress. Could this have any impact on private producers? And would that have any effect on your portfolio?

Regarding interest rates, I think that given how inflation has come over the last few weeks in terms of being closer to the midpoint of the range that the Central Bank has, I think that, that provide us with certain confidence that there's still some room to reduce the interest rate by 50 basis points. We expect that to happen within the next 2 meetings of the Board of Directors of the Central Bank.

We have reduced the sensitivity in our net interest margin associated with a parallel reduction in interest rates. 100 basis points contraction implies close to MXN 300 million of impact, okay? That's the most recent sensitivity that we have.

Then on the -- or turning on the energy reform, I will let Héctor Grisi to comment on that. Héctor, would you like to comment on the energy? How's the outlook that you see?

Sure, sure, sure, Didier. Okay. On that look, I mean we have taken a close look at the portfolio. Even though we have risk to the sector, we are one of the most important -- most of the risk basically has been put it into bonds and to some other securities. We will have probably an impact, but it would not be material to the portfolio, okay? So we're not worried in that sense.

If you let me add -- this is Rodrigo Brand. If you let me add to the [electric] reform, I think what -- it's very important what happened yesterday with the Supreme Court, which will, I think -- what I mean is it's very uncertain what would happen with this reform given that the Supreme Court has ruled against normative changes that were in the same sense. So I think it is going to be a very long run for this reform in order for all the amparos and rulings from the Supreme Court in the long term.

Our next question comes from the line of Gilberto Garcia with Barclays.

A couple of questions. First, just to clarify, the loans coming out of the holiday programs that you disclosed had to be restructured, are those restructured loans making payments regularly? Or did some of them enter a sort of second holiday program?

And secondly, one of your competitors have stated that they intend to be rather aggressive in the mortgage sector. Do you intend to -- do you believe there's room given that rates continue to go down to be even more aggressive there?

Thank you, Gilberto. Let me tell you, I mean in terms of loans on holiday, the set of loans we basically did were giving grace on capital, not on interest. And the majority of the portfolio is performing well, as Didier explained.

So in that regard, I mean -- and some of the portfolio, as I discussed, we have not seen that the portfolio past due is increasing beyond 3 months and is behaving properly -- in a proper way, okay? So in that sense, we're not worried about that. And the holiday payment basically is just, as I said, on capital.

In terms of the mortgage, we'll see. I think that, I mean, that at the levels we have at this point in the market, we're very comfortable. The portfolio and the trend has continued to grow, and the demand has continued to grow. So I don't see at this point that we will be lowering rates still. But I mean still -- I mean we need to see and see how the market evolves. But at this point, I wouldn't be seeing that we will be lowering the rates at this point.

One thing to have in mind, Gilberto, is the fact that relative to our peers, we are positioned in a higher-income segment. As we noted in our comments, in our remarks, when you compare the average ticket that we have in our loan portfolio, that's close to 35% higher than the average of the loan ticket, the mortgage ticket that we see in our peers. So I think that we need less number of customers or loans to have to reach to a similar balance that our competitors.

And probably most importantly, what we also comment on in our remarks is that unfortunately, the pandemic has impacted more low-income individuals. We're not that exposed to low-income individuals. And within our customer base, the vast majority made more than 2 minimum wages that are the ones that -- individuals that made less than 2 minimum wages are the ones that have suffered more -- losing their jobs.

So we think that the way that we are positioning the product and the strategy is relatively safe, aiming at higher-income individuals that are less vulnerable to the impact of the pandemic.

Our next question comes from the line of Brian Flores with Citibank.

Just a couple of questions. The first one is, would you be comfortable going below the level of coverage of 100%? And the second one is if you see the regulator approving the potential for booking write-offs of the pandemic directly against capital as this happened some time ago with some specific real estate portfolios.

Sorry, can you repeat the last part of the question because you broke up a little bit?

Sure. The second question was if you see the regulator approving the potential for booking write-offs directly from -- against capital as it has happened before with some specific real estate portfolios.

Okay. I mean to your first question, I mean I don't feel comfortable, I mean, going below 100% coverage. I mean what we will see is we will see how the portfolio evolves, and depending upon that, we will create more reserves if needed, okay? So we'll be taking a really close look at the portfolio. At this point, I think we're in a comfortable way the way we are, given the portfolio that we sold and also the size of the portfolio that we have at this point, I mean, under observation, okay? But no, I won't feel comfortable below 100%.

And in terms of the regulator, we have not discussed that particularly with the regulator to go in against capital. I don't think that's going to be the case. That will depend on how -- I mean as Didier basically exposed to you, the amount of capital that we have is big, and also, the return on equity on the different banks is also important. I mean we're still generating a huge amount of money. So I don't believe that at this point would be needed. I don't know about the smaller banks. But the big 7, I don't think that will be -- we will have to be in that situation. I don't think it's a time for that.

And I believe -- and also, I don't think it would be a healthy thing because it would create a difference to the market, and I think that wouldn't be the right thing to do. I mean when I'm talking about the market, the international market, okay?

Okay. And just a quick follow-up. You mentioned to my colleague, Carlos, the sensitivity to a decrease in 100 bps in the interest rate. Could you please repeat that figure?

Yes. Didier, could you, please?

Absolutely, it's around MXN 300 million. That's a 100 basis point decrease.

There are no further questions at this time. I'd like to turn the floor back over to Mr. Héctor Chávez for closing comments.

Thank you, operator. And thanks, everyone, once again for joining Santander México on this call. As always, we wish to maintain an open dialogue with all of you. If you have any additional questions, please don't hesitate to call or e-mail us directly. Until next earnings call, please stay safe.

This concludes today's conference call. You may disconnect your lines at this time, and thank you for your participation.