Banco Santander Mexico SA Institucion de Banca Multiple Grupo Financiero Santand (BSMX) 2020 Q3 法說會逐字稿

Welcome to the Banco Santander Mexico Third Quarter 2020 Earnings Conference. (Operator Instructions) Please also note the event is being recorded.

I would now like to turn the conference over to Héctor Chávez, Head of Investor Relations. Please go ahead, sir.

Thank you, operator. Thank you. Good day, and welcome to our third 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. Presenting on our call today will be Didier Mena, our CFO; and Rodrigo Brand, Executive General Director of Public Affairs. We will review our third quarter results as well as provide you an update on the status of our operations, in what remains a complex and challenging economic environment. We will also discuss the evolution of the loan portfolio of those customers that enrolled in the debtors' relief program, which is under temporary CNBV accounting principles. Then we will be happy to answer your questions during the Q&A session.

But before entering our formal remarks, allow me to remind you that certain statements during the course of the 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 those risks, please refer to our filings with the SEC and the Mexican Stock Exchange. Didier, please go ahead.

Thank you, Héctor. Good morning, everyone, and good afternoon to those of you participating from Europe. Thank you for joining our earnings call. I hope you and your families are healthy and safe.

After 2 challenging quarters, during which the bank's operations were disrupted by the pandemic, we have started moving forward toward normalizing our operations. The steps we're taking in this regard are being done, of course, without compromising the health and well-being of our employees and customers.

This quarter, we delivered robust financial and operating results that were achieved in a still very weak operating environment. To start, our loan book grew mid-single digits year-over-year. While demand for mortgages, auto and commercial loans was healthy, consumer and SME loans continue contracting in line with market trends and weak demand conditions. Deposits have proven resilient and registered double-digit growth, which, together with our prudent balance sheet strategy have allowed us to maintain ample levels of liquidity and capital.

In terms of asset quality, we're pleased to report that 85% of the loan portfolio under the payment holiday program supporting our retail and SMEs customers remains current. Only 8% have missed 1 or 2 payments and 7% has been restructured. Thus, the program has had no negative impact on our P&L ratio to date. Nevertheless, we are actively executing a recovery, a restructuring strategy to mitigate the impact of the pandemic on our asset quality. Due to this better-than-expected performance in NPLs, we estimate that the preemptive loan loss provisions of MXN 3.9 billion that we made in the previous quarter are adequate at this time.

As we normally do, we will provide an overview of our business environment, but let me emphasize here our conviction that Santander México is very well-positioned against the current and still growing economic effects of the pandemic.

In Slide 4, we present selected economic indicators that show an inflection point in economic activity and employment. A recovery is underway in Mexico, but it's very gradual, and business activity remains well below pre-pandemic levels. Recent high-frequency indicators support market consensus expectations of a near 10% annual contraction in GDP for 2020. These include August industrial production, which fell 8.5% year-on-year and September, and that's retail sales declining 4.1% in real terms. Although more than 200,000 formal employees were created during August and September, this pace of recovery is unfortunately slow, as over 1.2 million jobs were lost during the previous 5 months, according to social security data. Most job losses are concentrated among individuals, who earn less than 2 minimum salaries, which is around $177 per month. Approximately 91% of our customers, on the other hand, make about 2 or 3 minimum salaries a month, meaning that unemployment is expected to have so far, limited impact on asset quality within our customer loan portfolio.

Given current economic conditions, inflation should remain within Banxico's target range. We forecast 3.8% for 2020, given the Central Bank room to cut interest rates further. We expect another cut of 25 basis points in November, which would take the reference rate to 4% by year-end. This scenario of modest economic growth, a contraction in employment and low interest rates represents a challenging outlook for Mexico's commercial and consumer environments and therefore, for our business.

If you turn to Slide 5, you see a significant slowdown in system loan volumes, which expanded only 2% year-over-year, the lowest since late 2009. Behind this trend are contracting consumer loans and companies gradually borrowing less following a period of strong loan demand to boost their financial liquidity that began at the end of the first quarter of this year. This is the first time in over 10 years that consumer loans fell as much as 6.7% annually. By contrast, system deposits remain dynamic, expanding almost 11% despite the slowdown in economic activity. As was the case in the previous quarter, system-wide demand deposits remained strong, up 16% year-on-year, likely reflecting heightened needs for liquidity among households and companies, as well as the benefit of the payment holiday program.

Please turn to Slide 6. Before walking through our performance this quarter, I would like to share with you some thoughts on the topics that we do not normally touch upon in our quarterly calls, but that is increasingly relevant for us and many investors, which is responsible banking. Santander was one of the founding members of the Principles of Responsible Banking, contributing to their creation in alliance with the United Nations Environment Program Finance Initiative. We're fully convinced that a responsible bank guarantees good corporate governance, fair and transparent relationships with employees and customers, positive contributions to communities and environmentally friendly business practices, without losing sight of financial stability and health as well as responsible investments.

We have a number of initiatives underway across all of our stakeholders. Though I won't go over all of them, I would like to mention a few. For employees, we aspire to be the employer of first choice in our industry and have established clear commitments to foster and support women in their career to occupy senior leadership positions and to reduce the gender pay gap.

We're supporting the ongoing development of renewable energy sources, and we help our customers in their transition towards a green economy. We recently advised on clients on the issuance of a green and sustainable bond. This is a clear example of this commitment.

We promote social development to leave a positive mark on each of the communities in which we are present. We're convinced that the location is a cornerstone of all efforts to drive the progress of current and future generations. This is why your social investment strategy focuses on education, mainly higher education, and encourages young entrepreneurs to help them transform their ideas into reality.

Our scholarship programs and entrepreneur competitions are also part of these efforts. We are promoting financial inclusion in 3 key areas: guaranteeing access to quality financial services and products; offering products and services that have been adapted to the needs of each community and each group; and promoting financial education to ensure that people make better use of their financial resources. Our ongoing initiative, TUIIO, is designed around such principles. These are only a few examples of what we're doing, and I would like to invite you to learn more about responsible banking initiatives by visiting our web page, where you can find all relevant information about our efforts. About once or twice a year, we will be reporting through our earnings calls any important developments related to our responsible banking initiatives.

Please turn to Slide 7, where we would like to give you a brief update on the evolution of the bank's operations and strategy. Our health and business continuity protocols remain in place, with 90% of our corporate center's workforce still working from home and 75% of our branch staff working on site, up from 62% at the end of the second quarter.

Our digital channels and ATMs are fully operational, while 94% of our branch network is open and still equipped to provide safe services to our customers. At the same time, we continue to invest in enhancing our multichannel infrastructure with a particular emphasis on mobile and remote services and our digital platform capabilities. On this front, the number of digital customers expanded 25% year-on-year to 4.8 million. A critical part of our strategy has been driving digital adoption within our customer base and expanding our base of loyal customers, as these will be relevant drivers of profitability, both in terms of higher net interest income and fee income.

We know that as our digital offering improves, our efficiency levels as well as customer service and quality will improve. Two of our individual loan products, mortgages and other loans are performing quite well. They represent 60% of our individual loan portfolio. Our auto loan origination is growing fast and has allowed us to achieve 2.9% market share within the last 2 years, having started from scratch. Currently, we're one of the banks in Mexico with the highest loan growth in absolute terms on an annual basis. Our strategic partners, Mazda, Suzuki and Peugeot have gained jointly 53 basis points of market share in the past 12 months, allowing us to further penetrate the auto loan market. Given current trends, we plan to at least double our market share in the next couple of years with the aim of reaching our natural market share in the medium term.

With regard to our mortgage business, September was our strongest month on record for originations. Not only did we break our own record, but we led the banking system with the highest ever loan originations, (inaudible) in a month. These achievements are thanks to our innovative products, such as Hipoteca Plus and Hipoteca Free as well as our commercial efforts.

In TUIIO, our financial inclusion initiative, growth has resumed after an abrupt stall in the second quarter when the pandemic struck. The program enables us to continue supporting customers, who traditionally have very limited access to financial services and is consistent with advancing the principles of responsible banking.

On Slide 8, you will find a more detailed update on the evolution of our payment holidays program for customers. Asset quality has been a key concern for us since the beginning of the pandemic. Through the regulatory facility established by the CNBV, we have helped customers with liquidity problems by allowing them to skip loan payments, both interest and principal, for 4 months without any penalty or cost to them. By the end of June, 25% of our loan portfolio, close to MXN 191 billion, was under this payment holiday program with more than 600,000 customers benefiting from it. Of that amount, 71% was due between August and September. We registered a better-than-expected performance with almost 85% of that portfolio remaining current, only 8% registering 1 or 2 missed payments, while the remaining 7% has been restructured. As expected, mortgages had the best performance during the quarter with 93% of this loan portfolio being current, while cost consumer and SME loans were 83% and 74%, respectively.

Our proactive and early strategy for recoveries and restructuring proved effective and we are encouraged by these results. During the fourth quarter, MXN 55 billion in commercial loans that have been in payment holidays will be due, and we expect the payment trend to be similar. This remaining portfolio in payment holidays represents 7.5% of our total loan portfolio. We will continue focusing on mitigating the risk of impairments with our recovery strategy as well as through the restructuring of loans, but it will not be until the next 2 quarters that the real impact of the pandemic would be reflected in our asset quality metrics. With regard to the loan portfolio not registered under payment holidays, we have observed a good performance in asset quality.

Please turn to Slide 9 for an overview of our recent loan performance. Total loans expanded 5.4% year-on-year, but contracted 2.1% sequentially, with corporate loans normalizing after the strong demand that we experienced at the end of the first quarter. Given the conditions and constraints of the current economic environment and with an eye on maintaining asset quality, we have been focused on more defensive segments such as mortgages, government and auto loans, which have smaller margins but lower risk profiles. Consequently, our low-margin segments are growing almost 5x faster than high-margin ones, leading the latter to contribute 300 basis points less of net interest income from loans in comparison with a year ago. It will therefore, take longer to achieve one of our main strategic goals, which is to establish a greater mix of high-margin retail products. In the meantime, we're growing faster than the market without compromising asset quality. For example, in August, we gained market share in some segments, such as consumer loans, where we grew 3% compared with a 5% market contraction. Mortgages, of course, remain a key segment for us, as the product help us attract very profitable customers who become loyal in a very short period of time as well.

More about retail loans on the next slide. Individual loans show a slight pickup, growing almost 5% year-on-year, mainly supported by mortgages, auto and payroll loans. In Mexico, mortgages are a defensive segment, as I said. The country demographics, low home ownership levels and access to long-term fixed products continue to fuel loan demand. In September, our mortgage originations reached a record level, around 95% higher when compared with September 2019, expanding our mortgage portfolio 11% year-on-year and 15% when excluding the runoff effects of the ING and GE portfolios. During September, around 66% of our mortgage origination came from Hipoteca Plus, which also helped us drive cross-selling of other products, mainly insurance and credit cards, supporting fee income growth. In addition, we also launched our Hipoteca Free product, which has 0 commissions and 0 appraisal costs.

Credit card loans contracted 10% during the quarter but only decreased 2% sequentially after falling 6% in the second quarter. This lower sequential decline stemmed from a sustained recovery in credit card usage [since] its minimum level back in April. Usage increased 24% [sequentially, although it] remained 18% [below third] quarter 2019. [Although low usage levels] continue effecting balances, these have been showing a gradual improvement that could continue, as it normally shows positive seasonal effects of [El Buen Fin, the holiday season].

Growth in our [consumer loans] has been constantly in the payroll [loans category, 2.5%] year-on-year and still above the market, per latest CNBV data. Our (technical difficulty) loans continued to contract, consistent with our strategy to focus on more defensive segments of the market. [Finally, our auto-loan origination this quarter more than] doubled sequentially, (technical difficulty), which is producing excellent results. Based on current trends, we could reach our (technical difficulty) market share of between (technical difficulty) in the auto loan market within the next 5 years.

Turning to Slide 11. Loyal and digital customers continue demonstrating solid (technical difficulty) in this key area of our strategy, with year-on-year increases of over 14% and 25%, respectively. Loyalty penetration, that is loyal to active customers, stands at 37%, 500 basis points higher than a year ago. We have also seen continuous adoption of our digital channels, aided by (technical difficulty) who have stayed home during the pandemic. (technical difficulty) quarter, product sales via the digital channels accounted for [44%] in total, a significant (technical difficulty) from year ago levels. Digital (technical difficulty) also spiked, reaching almost (technical difficulty) our total, with mobile transactions accounting for 93% (technical difficulty) versus 86% in 2019. Mobile customers also kept growing at a solid 30% year-on-year rate, reaching 4.4 million at the end of the quarter.

As you can see on Slide 12, (technical difficulty) year-on-year (technical difficulty) corporates and mid-market companies [started prepaying] some lines they withdrew in the first quarter. Mid-market and government segments continued to register double-digit year-on-year expansion, although their sequential evolution showed lower and relatively stable volumes, respectively. SME loans registered a fifth sequential quarterly contraction (technical difficulty) a weakening trend even before the pandemic. Putting this in perspective, our outstanding loans in SMEs is similar to what we had in the first quarter of (technical difficulty), 13 quarters ago. The downward trend is also related to a reduced risk appetite in the current economic environment, particularly SME loans, which are for higher risk when economies are weak.

[Moving now] to total deposits on the Slide 13. This increased 13% year-on-year, while (technical difficulty) happened in the previous quarter, there was a continued shift between demand and time deposits due to lower interest rates that favor (technical difficulty). Deposit growth from individuals stands at 27% year-on-year, supported by our promotion campaigns to attract these types of deposits. Through this effort, we have been able to reduce the cost of our bank deposits [80 bps] year-on-year, twice as much as the market. With term deposits, there's still room (technical difficulty) our cost of funds.

Turning to Slide 14. We continue to maintain [strong] capital and liquidity positions at 91.78%, [the net loans to deposits ratio] remains [at one of its strongest] levels since becoming a listed company. Our liquidity coverage increased 64 percentage points relative to the second quarter of this year and now stands at 275% far above the differential of 100%. (technical difficulty) maturities. Capitalization ratio increased [47 basis points] sequentially to [17.16%, reflecting the performance of the dividend payment] as recommended by the CNBV in market, while our core equity Tier 1 ratio increased 62 basis points to 12.26%, a level [significantly] in excess of the 8.2% minimum established for banks or for size and significance. Lastly, our Tier 1 ratio stood at 13.6% at the end of the quarter. Our total capital ratio is [the highest] we have since we become a listed company.

As you can see on Slide 15, our net income decreased [3%] year-on-year, while increasing 1% sequentially. As a result...

Pardon the interruption, Didier, I apologize, sir, your line is breaking up. We are going to put on some hold music here for just a moment, while we dial out to you via audio. If you can just standby one moment, everyone. We apologize for the inconvenience. Please stand by.

(technical difficulty)

Thank you everyone. We have reconnected the speaker location. And once again, apologies for the interruption. Please proceed, sir.

(technical difficulty) I'm told that my [initial] remarks regarding capitalization were not (technical difficulty) clear. I'll just (technical difficulty) repeat that regarding capitalization, our ratio increased 47 basis points sequentially to 17.16%, reflecting the performance of the dividend payment, as recommended by [CNBV in market], while our core equity Tier 1 ratio [increased 62 basis points to 12.26%], a level significantly in [excess of the] 8.2% minimum requirement established for banks of our size. Lastly, our Tier 1 ratio stood at 13.6% at the end of the quarter. Our total capital ratio is the highest we've had since becoming listed.

As you can see on Slide 15, our net interest income decreased 3% year-on-year, while increasing 1% sequentially. As a result, the NIM contracted 124 basis points to 4.50% for the quarter. Our margin decline was a result of (technical difficulty) rates along with low forward balances within [Audio Gap], partially offset by a [significant increase] in our securities portfolio during the second quarter.

We're expecting net interest income to (technical difficulty) during the remainder of the year. On one hand, we (technical difficulty) interest rates to stabilize on our portfolio to continue to shift, with growth likely coming from low-yielding segments for these risky segments. While on the other hand, loans in high-yielding higher risks segment (technical difficulty) However, this downward pressure (technical difficulty) mitigate (technical difficulty) securities portfolio.

Please move to Slide 16. Net commissions and fees increased 2% year-on-year, supported by a robust increase in credit card fees stemming from a commercial agreement with one of our credit card partners (technical difficulty) extraordinary income in September as well as sequential pickup in credit card (technical difficulty). Insurance fees registered an important recovery, supported by strong origination in cards and mortgage loans. By contrast, market activity in overall investment banking (technical difficulty) causing financial and advisory service fees to contract 70% year-over-year. For the first 9 months, financial advisory fees, they are down 8.6%.

(technical difficulty) Slide 17, gross operating income declined 1% year-on-year, driven by the 3% decline in net interest income, partially compensated by a solid 17% (technical difficulty) in market-related income, which was supported by decline in interest rates and (technical difficulty).

Moving on to provisions on Slide 18. This increased by only 2.6% year-over-year on the back of the better-than-expected performance of our loan portfolio, as (technical difficulty) customers remain current with their payments after the grace period ended. And given the solid performance of the portfolio, noting holiday payments, our provisions level normalized in the third quarter. The special charge of [MXN 3.9 billion] in loan loss provisions that we made last quarter, remains adequate and give us comfortable buffer for future losses. However, this amount could be revised in the future, depending [on the performance] of the portfolio that joined the payment holiday program and which was paid -- which has payments due in the fourth quarter and on the speed of the recovery in (technical difficulty) activity and employment levels.

Our cost of risk for the (technical difficulty) [3.13%] at 51 basis points year-on-year increased substantially, as it reflects the special loan loss provisions made last quarter.

Our total NPL ratio showed that 24 basis points year-over-year decrease to [2.09%], mainly due to the fact that those clients who enter the payment holiday program and have 1 or 2 payments due are still not accounted for as NPLs. We expect our NPL ratio to [increase] in a couple of quarters, as some of these customers would likely become past due. (technical difficulty) we acted preemptively and diligently (technical difficulty) the pandemic, with our recovery and restructuring strategy that is producing good results. However, it would not be until this fourth quarter and the first quarter of 2021, when our NPL ratios will reflect the true magnitude of the pandemic's (technical difficulty) impact.

(technical difficulty) [to Slide 19]. Administrative and promotional expenses 6.6% year-on-year, reflecting higher (technical difficulty) amortization and depreciation charges related to the (technical difficulty) that we have made over the past 3 years, and IPAB costs. Administrative expenses increased only 6.4%, while the personnel expenses decreased 6.2% during the quarter, a result of our efforts to control personnel finances, including [reserves for variable compensation].

We (technical difficulty) bank and in technology upgrades as part of our strategy, is providing a better customer journey and overall service quality for our clients. As digital adoption rises, this should enable us to continue operating more efficiently as well.

Turning to profitability on Slide 20. Net income decreased 9% year-on-year to MXN 5 billion, mainly due to lower net interest income, but supported by the normalized provisions and resilient fee and (technical difficulty) income. The [profit] before taxes was down 10% for the quarter and nearly 11% for the first [9 months] of the year. Our effective tax rate in the third quarter decreased 83 basis points to 24.9%. On a 9-month basis, our net income was MXN 14 billion, a year-over-year decrease of almost 11%. Return on average equity was (technical difficulty) 276 basis points below the year ago (technical difficulty) and up 201 basis points (technical difficulty) contracted 300 basis points to [13.5%]. Note that we have been (technical difficulty) level compared with the industry average. Our year-to-date ROAE is up 200 basis points (technical difficulty) difference not seen since 2014.

Please turn to Slide 21. Before going into Q&A session, let me share some final thoughts regarding our outlook for the next few months. Even though visibility is better than the previous quarter, uncertainty about the duration and impact of the health crisis still makes it difficult to (technical difficulty) forecast our performance. [Current] economic indicators, such as those that (technical difficulty) earlier in the presentation, suggest (technical difficulty) gradual recovery of Mexico's economy and (technical difficulty) 2019 levels for at least several quarters. This has obvious implications with regard to health (technical difficulty) environment and ability to grow.

(technical difficulty) our strategy to prudently favor low-risk segments and protect asset quality. We expect our loan portfolio to be driven by costs, mainly with medium and [large companies] and by consumer (technical difficulty) mortgages, auto and payroll loans. The consumer (technical difficulty) very gradually, and this will depend on the speed of job creation, of (technical difficulty) as well as business and consumer (technical difficulty) portfolio -- the total portfolio that will grow in the low single-digit range (technical difficulty). In terms of asset quality, the better-than-expected performance (technical difficulty) portfolio following the (technical difficulty) individuals and (technical difficulty) as I said earlier. We will be executing the recoveries and the restructuring plan that has enabled us to act swiftly and preemptively to effectively respond to the challenging operating environment as well as customers overcome temporary financial difficulties. And although we might need to increase provisions further, the current level is sufficient based on what we know today. At the same time, we continue executing well against our core strategy, such as growing (technical difficulty) and cross-selling noncredit products to support noninterest income. We also continue making new investments in the bank's transformation, mainly in IT and digitalization, (technical difficulty) lines and maintaining tight control of costs (technical difficulty). The level of execution that we are maintaining, in addition to our bank's strong liquidity and capital position, make us confident, not only well-positioned to continue effectively well during the crisis, but to capitalize on growth opportunities that will invariably arise as it subsides and eventually ends.

With that said, we look forward to your questions. Operator, please open the call for the Q&A [session], please.

(Operator Instructions) And the first question today is from Jason Mollin with Scotiabank.

I'm very interested in the focus on the lower risk segments, in particular, on mortgages, which you showed some pretty impressive numbers beating what you show is the record of mortgage origination in Mexico, MXN 4.4 billion in the month of September. That would be around, according to my calculation, about $200-plus million in the month. I just wanted to see if you can give us some more color on the dynamics there. I've been working with something like the average loan amount is $100,000, or whatever, MXN 2 million plus. So that's like 2,000 mortgages per month. How do you feel about the risks in that segment, the pricing of real estate and the outlook for unemployment, if that is a concern, given how aggressively you're growing there?

Hi, Jason. I think that we feel quite comfortable with the exposure that we have in mortgages. Let me share with you some facts. As mentioned (technical difficulty) to middle class or high-income individuals in Mexico. (technical difficulty) in individuals that make less than (technical difficulty) and 91% of our clients (technical difficulty) minimum wages. So (technical difficulty) comfortable that we are (technical difficulty) clients that they have not been impacted so far (technical difficulty) you know how the performance of the clients that have joined (technical difficulty) quite well. So that tell us about its -- the good dynamics that we're seeing in that segment. Also very, very important. The average ticket that we have in mortgages continues (technical difficulty) and also, it's the difference, the gap that we have relative to the average (technical difficulty). It's also increasing. (technical difficulty) average mortgage ticket was 5% higher than the average of our peers. And now it's (technical difficulty) percent. So it's even more (technical difficulty). So an important fact, a significant part of our (technical difficulty) what we call jumbo mortgages, the 15% of our mortgage. And I would say that those are mainly aimed at private banking clients, I would say, [high-income individuals] they feel comfortable in the risk that we have here. In terms of the rate that we are offering to our clients, now bear in mind that in order for the clients to get Hipoteca Plus that is [7.75%] lower than average rates than we have in our loan portfolio that is close to 10%. They need to bring with us their payroll account, have insurance products with us, and also credit cards. So when you look at profitability per customer, and compare what we have with a client that has a 7.75% mortgaged rate, but has all the other products with us and you compare that to a client that only has one mortgage at 10%, it's much more profitable, the first client. The one that is the loyal client that has the Hipoteca Plus with us. We think it's the right strategy to continue increasing our loyal customer base. And with that, having a higher share of the business that customers have (technical difficulty) the risks as well, have not only in one particular product, but in the overall exposure that we have with clients.

That's helpful. Maybe 1 follow-up. As of the end of September, I believe the mortgages -- the mortgage portfolio represented 22% of the total loan book. How do you see that composition of loan book? Should that be much larger in the future? The only larger portion is middle market, I guess, according to the way I'm looking at it, the way you broke that down on Page 9 of your presentation.

Yes. We -- one of the (technical difficulty) goals that we have, Jason, is increase our exposure to individuals. And we started our strategic program or plan of having close to (technical difficulty) loan portfolio (technical difficulty) in loans to (technical difficulty). So we haven't made much progress, and we will not make significant progress over the next few quarters, because there are the different trends that offset each other within the individual loan portfolio. Even though we saw -- we're seeing a very strong demand for mortgages. And for auto loans, credit cards also represented a relevant part of our portfolio, are contracting and (technical difficulty). So when you compare that to demand from both mid-market companies, large corporates and government loans, most likely, given the current circumstances, corporates will outpace the growth that we'll see individuals, taking into account the strong demand that we have in mortgages and other loans. Therefore, we think that the mortgages will continue growing. They're contributing to our total loan portfolio. (technical difficulty) would stay stable or relatively contract to, let's say, 37%. Okay? So I think it will remain within 37%. We were aiming at having that contribution (technical difficulty) individual being more close to 42%, 43%. That's going to take longer.

And maybe if you can just talk about the risks you see for the whole business. And just for -- obviously, you have different segments, and the economic outlook is complicated. But we -- it seems like we were looking for quite a -- for recovery coming and COVID potentially being better controlled, but what are you seeing now? Like what is -- is that the biggest risk for you guys? And how are you preparing for it? Is it that the economic recovery doesn't come through, COVID is still a problem and what does that mean? Could that -- with unemployment and the impact on SMEs, et cetera, how are you gauging that risk?

Okay. (technical difficulty) of the critical risks that we have, Jason, associated with how quickly would be the recovery. And the (technical difficulty) that we have, as we've shared, points to a slow recovery. When you take into account also the fiscal package, we have relative to other geography (technical difficulty) take longer for (technical difficulty) to reach 2019 level. So the pandemic is impacting businesses and [returns] in Mexico in a very big heterogenous way. So the best thing that we can do is to stay close to our customers and understanding the business dynamics for those that have (technical difficulty) in their businesses, offer them an appropriate restructuring program, or if there's nothing else to do, well we just proceed with the foreclosure and (technical difficulty) of the loan exposure that we have. What is probably more complicated, in my opinion, it's dynamics that we're seeing on SMEs. SMEs, as you know, represent a significant percentage of (technical difficulty) and even though the guarantees that Nafinsa provides are still in place that they -- it's a problem that has not grown. And we have been debating and trying to persuade regulators and the development banks to increase that exposure, to increase that program and the benefit of SMEs, not in the benefit of banks. But we haven't been able to convince them so far. So we're being very cautious on SMEs. A significant part of our portfolio has a guarantee from Nafinsa, from the Mexican development bank. So even though we're comfortable with that exposure, and with the potential losses that we have there, it's not only about the stock that we have. It's about, really -- it has been (technical difficulty) and under current circumstances, it's still banks to really offer loans to this segment, if they are not credit guarantees associated with these loans.

Thank you. Mr. Mena, this is the operator. We do ask you to please pick up the audio line that we got out for you, so we can get a little better audio quality. (Operator Instructions) Today's next question comes from Ernesto Gabilondo with Bank of America.

My first question is on preventive revisions. As you mentioned in your presentation, you can increase the preventive provision depending on the economic conditions. So what would be the scenario in terms of GDP and unemployment to consider higher preventive provisions?

And just very quickly, a second question on your capital ratio and dividends. We have seen you have been improving your balance sheet and your reserve coverage ratio. And you have now a common equity Tier 1 of 12.3%. So do you expect to resume ordinary dividends next year? And do you think that the postponed dividend could be staged during the second half of next year, depending on the economic conditions and midterm elections? Does that make sense?

Hi, Ernesto, thanks for your questions. Regarding the preventive provisions, I think that is difficult for us to correlate what we're seeing in terms of the provisions that we're making, relative to unemployment and GDP. I think that it's a good approach, the one that you suggest, and I think it's a good way understand what could be the potential implications. However, there is a significant caveat, in my opinion. Just look at unemployment, the data that we were sharing. The contraction that we've seen, a significant part of jobs that have been lost are concentrated in low-income individuals. So those are the ones that are suffering more in terms of formal employment, okay? So I think that you need to look into exposure that different businesses, not only banks have to those individuals, because definitely, the business associated with those individuals that have lost those jobs are going to be more impacted. So far, that's not our case. Given the fact that we are not that exposed to low-income individuals, except for the financial inclusion initiatives that we launched a few years ago. So I think we need to remain vigilant, very close to the needs that our clients have. I still consider that the exercise that was done by the Central Bank in terms of providing an external shock with current economic data, and looking at how much can NPLs could deteriorate into the banking system is a good reference. So I will look into that, and be looking closely if there's any update provided by the Central Bank. Rest assured that if we have evidence that will require additional provisions, we will do that. As we preemptively did them in the second quarter of this year. So I think that we -- this is going to be entirely data dependent. And we are looking very closely into this.

Okay, Ernesto, then on your second question regarding our strong capital ratio and potential dividends. Before I share with you some numbers. Let me comment on the discussions that we're having with regulators. I'm part of one of the commissions that the banking association has, the Finance commission, I co-chair with my colleague from BBVA, so we have very close dialogues with the banking regulators. So let me comment on what has been the most recent ones. As you probably are aware, in the facilities and the clarifications that the regulators made a few weeks ago, they suggested that if banks joined these facilities, they will be allowed to pay dividends if they have certain -- that they are above certain level and comply with certain conditions. I think it's good for the banking regulator to start discussing certain levels. We -- and by the way, we're not going to appear -- we're not going to join those facilities. So that's another topic. But what is not, in my opinion, is that rather than just sticking with our recommendation of not paying any dividends, I think that the banking regulator is starting to entertain certain levels of total capital that would be, that it would feel comfortable with. It's also important to recognize the fact that we are very prudent. So we will, in no way, we would recommend to the shareholders' meeting, paying a dividend that will compromise the capital position of the bank. In the past, what we have -- the dividend policy that we established, that we changed, was to pay what we have in excess of 11% core Tier 1 ratio. So as of the third quarter of this year, the excess capital that we have is slightly north of MXN 10 billion. If we try to estimate what we could have as potential excess capital for the end of the year, that should be close to MXN 15 million. That's close to 70%, 75% of net income, potential net income for the year, okay? So the -- we will definitely be suggesting for the shareholders' meeting, a dividend payment of that size when regulators feel comfortable that the concentration is under control and that the bank and that the capital that the banks have are sufficiently to address it. They told us that they would be reviewing their position by the end of this year. And I think that they will consider what other regulators do in other places in the world. So I'm starting to see certain openness of regulators to -- for banks to start paying out dividends next year in Europe, for instance. So that could give the Mexican regulator some comfort that what they're doing here is in line with what other regulators are doing in other places.

So I think that we will hear in the next couple of months, what's the banking regulator position. I would be surprised if they say that they're fine with banks going back and paying out dividends this year. I think that most likely, in my opinion, with the information that I have right now, it's going to be more towards the second half of next year. But if we have the opportunity to pay it earlier we're definitely going to pay. I think that the bank has very strong capital position, even if it's not the MXN 15 billion that I'm telling you, I think that there should be a possibility to pay out some dividends without compromising the strong capital position that the bank has.

Our next question today comes from Rodrigo Ortega with BBVA.

Firstly, you mentioned in your press release that you're about to launch a new app? Can you elaborate on what are the new functions being added to the app? And how will this app help you improve the share of sales in transactions carried via digital channels, so to close the gap with other competitors?

And second, NIM seems to have stabilized after the initial shock. Beyond the relative drops in the yields of the different productive assets, the recovery in net interest margin seems that we all reside more on the management of the balance sheet. Right now, loans represent close to 40% of total assets, down from 50% on the average of 2019. So help us to see a normalization of balance sheet composition happen in a way that NIM starts to recover going forward.

Regarding the app, what I would say, it's in a friends and family stage right now. What we are aiming is to make the experience most simple for the clients. So we've done several pilot steps even before launching these for, to friends and families -- we've had several focus groups to understand what are the critical needs and functions that our clients demand. So to give a very simple answer to your question, it's just trying to make most of the transactions that our clients demand on one click, okay? This will -- and I think that we have, when you compare our app relative to others in the market, and one of the -- the one that BBVA has is clearly best in market. I think that we will close the gap definitely. And in some cases, we think that it's going to be -- it's going to provide a better experience relative to other apps in the market.

Regarding your question on net interest income and the composition of the different assets that we have and how we see that evolving. No, I think that one of the responsibilities that we have as management, is to try to reduce the impact that the interest rates have on the reduction in interest rates have had in our net income. So that's why you've seen a significant increase in investment in securities and just to share with you some numbers. In terms of the asset and liability committee position that we have, the ALCO, that position has almost doubled in a year. And what we were aiming at is with the reduction in interest rates that we were ambitioning, we bought fixed income securities, that has mitigated the impact of reducing the interest rates. So we -- I cannot tell you exactly how it's going to be composition going forward, because it depends on the different, the evolution of the financial market conditions and exactly how we decide as a bank, as a committee to position ourselves just to mitigate the impact in terms of interest rates contracting. Or in some cases, if for any reason, we -- there's an increase in interest rates in the secondary market, you would try to benefit from that. So it kind of depends on how market conditions, financial market conditions, evolve. So at the end of the day, in my opinion, one of the significant benefits that we are achieving is that we have reduced significantly the reduction or the impact in the net interest income of 100 basis points contraction in interest rates.

And our next question today comes from Brian Flores with Citibank.

I wanted to ask a quick follow-up. You mentioned that excess capital should be close to MXN 15 billion by the end of the year. I wanted to ask you what level of delinquency would make you comfortable to achieve this, based on the comparison towards this quarter's NPL, which was very low.

In terms of delinquencies, as we said, Brian, we -- the impact of the pandemic is still not reflected in our third quarter numbers. And that's because those clients that joined the relief programs still have the most payments, too. So it's still not considered NPL. We're going to get to see that in the fourth quarter of this year and in the first quarter of next year. Some ballpark numbers, in terms of how we could see NPLs going forward. I think that less than 3% should be something that we could feel comfortable with and more -- probably closely 2.75% to 3%, I would say.

Perfect. That is very clear. And just following up on the last question, too. You mentioned a reduction in sensitivity to interest rates. Do you have a measure on how this sensitivity is in terms of bps?

In terms for 100 basis points reduction -- in parallel reduction in interest rates, the impact in our net interest income is close to MXN 200 million right now.

Our next question from comes from Tito Labarta with Goldman Sachs.

My question, just going back over your provisions, you highlighted here in the chart, the cost of risk for the year is running around 3.1%, 3.13%. Although that's kind of year-to-date, right? If you look at the quarter, it is around 2.5%, 2.6% kind of back to pre-COVID levels? And I understand you mentioned if things change, you can do some additional provisions. But how do we think about this, barring additional provisions going forward? Is that 2.5%, 2.6%, sort of the right cost of risk? Should it be closer to 3.1% that you're showing on a year-to-date basis? Just kind of how you're thinking about it? I mean, because you have the risk from COVID, but asset quality is obviously doing pretty well. So how do we think about a recurring level of cost of risk, excluding any additional provisions?

I think it should be close to 2.80%, 2.90%, excluding a significant increase from the pandemic. If not, the levels that we have for the first 9 months, because obviously, those include the excess provisions that we did in the second quarter. But I think that it will be slightly higher than the ones that we have presented. I don't know, probably 20, 30 basis points higher than that.

Okay. And then so just to understand, this quarter was a bit lower than that. Is that just because of the asset quality improvement? Anything specific about this quarter? Are you running below that? Just to understand.

Yes. I think that the performance this quarter, not only in those clients that pays well, their -- recover the payments program, but also the part of the portfolio that has -- that didn't join these relief programs is performing well. So I said, we probably think that it's more recurring in levels close to 2.80%, 2.90%.

Next question today comes from Thiago Batista with UBS.

One very simple question about the profitability post COVID. So prior of COVID, the bank ROE was ranging between 15% and 16%. Do you believe it's feasible to achieve this level again, let's say, in the coming years?

I think that it's probably good to have as a reference. What happened in the financial crisis, back in 2008 and 2009, so we -- back then, the contraction in GDP in 2009 was close to 6%. The ROE of the banking system was close to 21%, and for the following 8 to 9 years post the financial crisis, ROEs in the Mexican banking system were between 13% to 15%. That represents, on average, a GDP contraction -- sorry, ROE contraction of close to 30%. I think that in current circumstances, that potential contraction in ROE for the banking system, could be around the -- those numbers, It should probably be slightly higher than that when you take into account the level of contraction that we are seeing in 2020. But relative to what we had back then, I think that the bank is starting to achieve higher than average ROE for the system. With most recent data, we have close to 200 basis point gap relative to the average of the banking system. I think that the banking system, for the next few years, the ROE will be something around 9% to 11%. And if we continue maintaining this execution of our strategic plan, the results that we're seeing, I think that we should be above the average of the system. But we were also closing the gap to the peers that have higher profitability than also a significant reduction in to what BBVA and Banorte have, And we think that, that will converge full time. I don't think that given both the economic activity and the interest rates where we expect them to be in the foreseeable future, I don't think that it's achievable, 15% to 16% ROE within this -- the following years. However, I think that we will continue working to have a more sustainable and higher profitability level as a consequence of the investment and the strategic plan that we are executing.

(Operator Instructions) Today's next question comes from Alonso Garcia with Crédit Suisse.

My question is regarding asset quality. I mean what kind of performance you expect from the reprofile portfolio that at the end of September was still under the payment holiday. I mean, this 29% of the total reprofile portfolio, I mean would you expect a similar overdue ratio at around 15% as well, considering that this is made up only basically of SMEs. And based on that, I mean, what level of overdue loans, you will need to see in order to consider that you need additional provisions on top of what you did already in the second quarter?

No. I think that we will remain very, very -- watching very close what happened in -- not only in is SMEs, but on consumer loans. I think it's difficult to say on a specific number or what the outlook that we foresee, given that in my opinion, there is still ongoing uncertainty around those numbers. So I think we will have more visibility in the fourth quarter of this year, once 100% of the individuals and SMEs that join the program have had their payments due and also trying to see what's the performance in terms of corporates. Sorry for not providing you a specific number for what you're asking, but I think it will not be prudent, in my opinion, to just tell you a number per se. I think that it's -- we're looking into it. We are proactively managing recoveries. And we have, as mentioned in the prior quarter, divided the -- our customer base into 35 clusters and depending on loyalty, brief exposure factors and so on, we have different strategies for tackling the NPLs or the potential deterioration of the loan portfolio in our customers. So I think that the strategy is working well so far, but still provides with a significant level of uncertainty in terms of what's the magnitude, in terms of potential additional NPL, as I mentioned. I think that having NPLs close to 2.75%, 3%. That should be close to what the Central Bank sensitivity provided. Looking at what the level of NPL we had 2019, obviously, pre-pandemic, okay.

And our next question today comes from Yuri Fernandes with JPMorgan.

Actually, I have a follow-up on Alonso's question regarding the restructuring loans. I understand you have a lot of collaterals on those on those loans, right? And 80% of (technical difficulty) loans we are seeing today, maybe that number -- it may decrease over time, right, because that's the very early delinquency, but still when you look through these numbers, it seems like more prudence would be required, right? Like based on the 3 -- MXN 3.9 billion provisions that you did. Like if you just put 8% in the MXN 131 billion you had in that portfolio, that should be a number higher than that, right? So my question is, how is the curve of provisions for that? Do you net the collateral you have in that portfolio? So let's say, 70% of the portfolio has collateral, so you don't need to give provisions for that. Or no, you give the provisions for 100%. And in the future, if we are able to execute the collateral, you will have like a gain in other operating income, like how does it work? Like should we think on provision in this line, it will be -- like in the full portfolio? Or is the net portfolio of the collaterals?

No. Definitely the collateral is taken into account. The models that we have taken into account expected losses and loss given defaults. And in that regard, collateral is a significant part of this equation. And you're right. Of those loans that have been restructured, close to 90% of the loans that have been restructured are SMEs, loans to SMEs. And they -- as mentioned, close to 68% of the loan portfolio has a guarantee by Nafinsa. So we have been executing those guarantees in time. The process is working well, as always. So definitely, it's a mitigator in terms of the potential losses that we have, and we definitely take that into account when making provisions.

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Héctor Chávez for any final remarks.

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 you, and all the financial community. So if you have any questions, please don't hesitate to call or e-mail us directly. Until next quarter, please stay safe.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.