Banco Santander Mexico SA Institucion de Banca Multiple Grupo Financiero Santand (BSMX) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Grupo Financiero Santander Mexico Fourth Quarter 2017 Earnings Conference Call. Today's call is being recorded. (Operator Instructions)

For opening remarks and introductions, I'd like to turn the call over to Mr. Héctor Chávez, Managing Director, Head of Investor Relations. Please go ahead, sir.

Thank you. Good morning, and welcome to our Fourth Quarter 2017 Earnings Conference Call. We appreciate everyone's participation. By now, everyone should have access to our earnings release and the company's presentations which were released yesterday after market closed.

Speaking during today's call will be: Hector Grisi, Executive President and CEO; Didier Mena, CFO; and also talking is Rodrigo Brand, Executive General Director of Public Affairs, all of whom will be available to answer questions during the Q&A session.

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 that could cause actual results to materially differ, including factors that would 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.

Now let me turn the call to Hector Grisi. Please go ahead.

Thank you, Hector. Good morning, everyone, good afternoon of the lots of you in Europe. After the first year of our 3-year investment plan, we are proud, too, of the steps we have taken to become a more customer-centric bank, focus on a streaming -- lean process and enhancing our digital capabilities. In the short term, however, these initiatives will temporarily impact efficiency and profitability. While our focus on profitability over volume impact loan growth in lower-margin segments this year, we are confident of our strategy to build a stronger and more profitable franchise for the longer term.

We also have finalized the corporate reorganization of Santander México announced last October. As a result Banco Santander México is now (inaudible) and listed entity. The ticker in México was changed from BSMX, from SANMEX.

Now turning to the Mexican banking system on Slide 4. Total industry loan growth continued to decelerate as of November. The most recent publicly available data published by the CNBV, expanding 8.9% year-on-year, down from (inaudible) on the year-ago quarter. Consumer loans posted a similar trend, with growth slowing to 8.5% in November. While system deposits remained stable at around 11.9%.

During the second half of the year, the macro environment began to experience a deterioration, which worsened in the fourth quarter. Inflation rebounded, reaching 6.8% by year end, negatively affecting purchasing power and causing Banco de Mexico to raise interest rates in December, closing the year at 7.25%. Similarly, the weaknesses in GDP observed in the third (technical difficulty) sales. For example, contracted around 17% in December, while retail sales fell by 1.5% year-over-year in November.

We also observed a moderate systemwide deterioration in asset quality for credit cards and personal (technical difficulty) wages with the consequent deterioration (technical difficulty) and uncertainty over the (technical difficulty) particularly affecting corporate and market activity (technical difficulty)

5. We continue to see good traction in high-margin loans. Actually, consumer loans, credit cards, middle market and SME loans represented 55% of total loans and contributed with almost 70% of net interest income in the quarter. Lower-margin loans, however were practically flat, impacted by specific factors, which I will discuss shortly. As a result, we closed the year with a total loan growth of around 4.5%, below our annual target of a range of 7% to 9% without significantly impacting profitability.

Turning to Slide 6. Consumer loans rose 8% year-on-year, in line with the market. Growth in personal loans remained healthy. Our strategy to leverage our strong position in corporate and middle market to attract new payroll accounts, reinforced by the Santander Plus Loyalty program, has supported growth of 10% in payroll loans above market levels.

Credit card loans were up 6% year-on-year and 2% sequentially. Credit card usage was up 17% year-on-year, with growth also supported by the success of El Buel Fin campaign. These, however, was not fully reflected in credit card loan growth as many customers paid their balances in full during the quarter. Santander Plus reached 3 million affiliated customers at year end, up 21% sequentially, of which, 52% are new clients to the bank.

By contrast, growth in mortgages remained soft, slightly over 1% year-on-year, mainly reflecting the run-off of acquired portfolios which will still represent around 9% of total mortgages. Mortgage loans, excluding the impact of this run-off, expanded by 5% year-on-year. This affect will continue to impact growth in mortgages during this year as well.

We continue addressing our strategic weaknesses of a lower retail business posture than our peers. In this regard, we are making headway by even reducing attrition and attracting new customers, mindful that loyal customers are key to our profitability. We are making strides in operational innovation and business transformation. As our digitalization and mobile banking offerings continue to evolve, these initiatives have helped us achieve a more than 25% growth in loyal customers over -- to over 2 million clients, almost doubling net new customers in the year. Similarly, digital customers grew by 45% and mobile customers by 67% year-on-year in the quarter.

Turning to Slide 8. Market loans rose 10% year-on-year, with loans to SMEs also 6%, both in line with market growth. We continue to boost our offering for SMEs and recently launched further enhancements to the digital onboarding processes and extended our successful loyalty programs to SMEs. At the same time, we continue to grow selectively in corporate and government loans, which represent 25% of our loan book, prioritizing margins over market share gains. As a result, these loans contracted by 4% and 6%, respectively. This was the main reason for not meeting our loan growth guidance for the year.

Turning to Slide 9. Our deposit base rose 9% year-on-year, in the low end of our 9% to 10% guidance range, reflecting a couple of specific withdrawals by large corporates at year end.

Our client-centric focus for individuals and SMEs, along with good dynamics for Santander Plus, continue to support deposit growth. Individual deposits remained strong, up 19%; with SME deposits of 13% year-on-year. Driven by higher interest rates, term deposits increased 14%, adding some pressure to funding cost.

Looking ahead and with the goal of supporting margin, we will remain focused on implementing initiatives that will enable us to bring retail demand deposits up to 45% of total deposits, in line with market average, from the current level of around 30%. This is one of the key goals of our operational transformation plan, along with our objective of becoming a client-centric bank and a leader in profitability in Mexico.

Now let me turn the call to the Didier Mena, who will go over our capital position, P&L and guidance. Afterwards, we will be happy to respond all -- to all your questions. Thank you.

Thank you, Hector. Good morning, everybody. Please turn to Slide 10. We maintained a strong funding position, with net loans to deposit slightly over 92%. Our liquidity coverage ratio stood at 176%, exceeding regulatory requirements. Our capitalization ratio for the quarter fell 46 basis points to 15.73%, mainly reflecting the MXN 4.8 billion cash dividend paid in December and the payment of the AT1 coupons in October. Our core Tier 1 capital increased 50 basis points year-on-year to 10.84%, while the Tier 1 ratio rose 39 basis points to 12.18%.

Turning to the P&L on Slide 11. Net interest income growth decelerated to 7% year-on-year. Interest income from the loan portfolio was up 16% year-on-year, while our securities portfolio contributed with growth of around 32% in interest income. Net interest margin stood at 5.34% in the quarter, up 22 basis points year-on-year, mainly driven by higher interest rates and growth of high-margin loans more than offsetting higher interest rates on term deposits and repurchase agreements.

Sequentially, higher interest expense associated with term deposits, along with funding of investment strategies by our treasury, specifically in FX, resulted in a 47 basis point decline in net interest margin. However, this high interest expense was more than offset by increased market-related income.

For the full year, net interest income rose 13%, with a NIM expansion of 46 basis points, reaching 5.43%.

Moving down to P&L, as you can see on Slide 12. Net commissions and fee growth slowed down to 5%. This mainly reflects lower financial advisory fees, down 45% year-on-year, as investment banking activity declined due to overall macro uncertainty. By contrast, this was a very good quarter for credit card fees, which continued to accelerate in the quarter, up 38% year-on-year and were the main contributor for fee growth.

Credit card fee income for the year was up 19%, supported by strong card usage and stable origination and reward costs. Net cash management fees were up 5%, driven by higher fees from collection and payment, along with account management, driven by higher transactional activity and client retention from our Santander Plus program. Finally, investment fund and insurance fees maintained a similar soft trend as observed in the previous quarter.

Summing up, gross operating income increased 4% year-on-year, as higher interest income and commission and fees was partially offset by a 45% decline in trading gains. Our trading gains returned to our estimated quarterly average of around MXN 600 million to MXN 800 million. Comparisons were impacted by significantly higher than average trading gains in the year-ago quarter.

Moving on to asset quality. Loan loss reserves for the quarter declined 3%, benefiting from payments by credit card customers who took advantage of the seasonal increase in liquidity. For the full year, loan loss provisions were up 13%, above loan portfolio growth, mainly reflecting the specific provisions, particularly in a couple of corporates and home builders, together with the shift up to higher-margin segments. This year, we completed the cleanup of our home builder portfolio.

Cost of risk for the quarter declined 13 basis points, contributing to cost of risk of 3.54% of the year, in line with our guidance. NPLs increased by 6 basis points year-on-year to 2.54%, mainly reflecting the deterioration in credit cards and SMEs, NPLs, following the trend started in June with the deterioration in purchasing power.

Commercial NPLs in turn fell 6 basis points year-on-year, as the year-ago quarter was still impacted by pass-through homebuilder loans. Sequentially, commercial NPLs increased 29 basis points, reflecting the pass-through corporate loans we have provision earlier in the year. SMEs, consumer, mortgage NPLs also showed moderate deterioration quarter-on-quarter.

Turning to costs on Slide 15. We remain on track executing our investment plan designed to drive digitalization and strengthen our business to better serve clients, which along with our focus on margins, will enable us to drive higher profitability in coming years. In the meantime, this has resulted in higher expenses, which, this quarter, were up 15% year-on-year, mainly related to personnel along with higher depreciation and amortization charges. This brought our efficiency ratio to 44.1% in the quarter, up 369 basis points compared to the same quarter last year.

For the full year, costs were -- costs rose 13%, slightly above our 10% to 12% guidance range for the year and reached an efficiency ratio of 42.3%.

We're making headway in the implementation of our investment plan, and this is reflected in the higher costs in the short term. As part of our commercial transformation to establish a client-centric culture and improve the customer journey, we are introducing greeters in our branches as well as hiring sales employees to attract SMEs and develop additional payroll clients. Higher expenses also reflect the implementation of our IT and digitalization initiatives as we seek to enhance our operational processes.

Turning to Slide 16. Net income for the quarter was relatively stable year-on-year and increased almost 13%, reaching MXN 17.7 billion for the full year, benefiting from a lower effective tax rate. Net income growth of 13% for the year was below our 17% to 20% revised target range but exceeded our original guidance range of 8% to 11%. In fact, the effective tax rate for 2017 reached 20%, below our guidance range of 21% to 22%, reflecting an inflation rate of close to 7%, while our guidance was based on an inflation rate of 6%.

ROAE for the quarter and the full year reached almost 16%, contributing to the ROAE expansion of 156 basis points.

Turning to Slide 17. Recapping on our results for the year, we've missed some of our revived targets, as we discussed -- we have discussed throughout the call. We experienced strong operating conditions during the first half of 2017. The combination of higher inflation in the second half, along with our commitment to execute investment plan as expedite as possible contributed to our miss in net income growth. If expenses had grown at 10%, at the lower end of our range, we will have reached our net income revised targets.

Now moving on to 2018 guidance on Slide 18. Given the current macro environment, we're anticipating GDP growth to remain unchanged from last year's levels at 2.1%. We also anticipate our average exchange rate of 18.7 pesos per dollar, similar to that of 2017. Inflation already declined to 5.5% in the first 2 weeks of January, as one-off effects from fuel prices started to fade away and is anticipated to converge to 4% by year end. Despite expectations of lower inflation and FX appreciation for the year, we remain cautious as current internal and international macro uncertainty could extend to economic weakness observed in the second half of last year into 2018.

Based on this economic framework, along with our continued focus on profitable growth amidst this competition, we expect to accelerate the growth rate of our loan book in the range of between 7% to 9% from loan growth of 4.5% achieved in 2017. Deposits are anticipated to expand between 9% to 11% during the year as we continue to target individuals and SMEs while increasing the share of retail deposits.

In terms of asset quality, we're keeping our product risk appetite and anticipate cost of risk to remain in the 3.4% to 3.6% range, reflecting a healthy portfolio. Operating expenses are expected to increase between 12% to 14% as we move ahead with implementation of investment plan, as we pursue our operational transformation.

Given our expectation of lower inflation by year end, we forecast our effective tax rate to range between 24% to 25% in the year as we continue to approach a normalized effective tax rate of 27% to 28%.

Finally, despite anticipating increased operating costs and a new effective tax rate, net income is expected to expand between 4% to 6% as we remain focused on executing our investment plan.

We're pleased with the progress of our strategic initiatives over the past year as we seek to strengthen our position in retail banking, consolidate leadership and key products and markets while realizing the full potential of our corporate and investment banking franchise.

We're making solid progress on operating technology infrastructure, talent, quality, processes and branding across the organization. We still have significant work ahead of us, but the progress already achieved on these fronts give us the confidence that we are on the right track to meet our goals for the benefit of our customers and all stakeholders. We're now ready to take questions, operator, please go ahead.

(Operator Instructions) Our first question comes from the line of Tito Labarta with Deutsche Bank.

A couple of questions. First, on margin. And then, I understand your funding cost went up a bit in the quarter, which led to the margin pressure we saw. How do you think that should evolve in 2018? Because -- do you expect any more rate hikes this year? Also if you can give the guidance on the interest rate that you expect and how that will expect your -- impact your margins? Second, on asset quality, also maybe get a little bit more color. I know there's some corporates impacting asset quality in the quarter, but I think consumer NPLs also went up. So any other risk there that you see for this year in terms of asset quality? Because you did keep the cost of risk guidance pretty stable. So just want to understand the differences between the 2.

Tito, this is Didier. Regarding our expectations on interest rates this year, we think that there's a high chance that there will be an increase of 25 basis points during the first half of the year. And then depending on the results of the presidential elections, it might be the case that interest rates will come down 25 to 50 basis points. So on average, we are expecting the reference rate to remain relatively stable, okay? So relative to last year, that means an increase to the average reference rate that we saw during 2017. So we are expecting a margin expansion, not as -- the 46 basis points that we saw last year, but we still think that there's a potential for an expansion, I would say 10 to 15 basis points, of net interest margin.

Thank you, Tito, this is Héctor Grisi. Look, in terms of asset quality, first of all, let me tell you that in the end, we decided to clean up a little bit the portfolio of builders of housing that we still have pending. So we decided, basically, to completely finish that off. So we're completely clean of that thing after around 3 years of suffering. So that was one of the reasons that you see that we increased our provisions a little bit, and took note, our portfolio. Then we decided to be a little bit more aggressive in some, particularly, a couple of situations that we didn't like. And we took preemptive approach to that. With that, I really feel that our portfolio is in very good shape. In the corporate side, I don't think we should have any problems in middle-size companies, I'm quite comfortable of where the portfolio is. And if you take a look of what is happening to the SME portfolio, it's also quite stable. So we actually went a little bit ahead in terms of in the last quarter to basically to clean up as much as we could. So we had a more clean balance sheet for this year. And that exactly was the reason. And I don't expect anything. I mean, unless there is a huge turbulence with any of the situations in Mexico with NAFTA and with some more things, I don't expect that the portfolio will have any hiccups for the year. I'm quite comfortable with it, with the way the portfolio is in.

All right, that's very helpful. So just understand the decrease in margin this quarter from the higher funding cost. Could you just clarify a little bit what exactly happened there? And why you don't expect that to continue to happen?

Yes, it was mainly related to some investment strategies in our treasury. You've reach -- we've matched those strategies with repos and that's what -- we mentioned that, that impacts our NIM but benefits our trading income. And we don't think that, that will continue. It's more like a one-off.

Our next question comes from the line of Carlos Rivera with Citi.

My first question is related also to the net interest margin. I understand part of the decline was due to these higher funding costs. But also on the interest income side, I saw decline on the yield on loans. And here, I want to ask a little bit more, why? I mean, the high-yielding segments, which is your strategy, were the ones that grew faster. In middle market, 3%; SMEs, 2%; credit card, 2%. So just a little bit more color there. And my second question is related to operating expenses. I mean, we understand the strategy in investing in the franchise. For when do you think we should expect to see a little more of a relief there in OpEx? Is this something for 2019? Is it something for 2020? Any color there would be appreciated.

Yes, Carlos. We are seeing some pressure in terms of spreads in some of the segments which were expanding. So mainly, I would say that it's for competitive reasons, the ones that -- this yield on loans decreased just slightly. This quarter, we see it's relatively flat, okay? That's -- I would say that that's the key reason behind it, okay? Regarding OpEx, I think that when we announce the 3-year investment plan, what we mentioned is that during 3 years, expenses will grow at least 10% to 12%. And then we announced that the inflation was not as high as we have seen over the last year. So I think that's quite important to bear in mind, okay? So we don't think that next year, operating expenses will decrease its expansion. We think that it will continue at a similar pace to what we saw last year, that what -- to what we are expecting this year. However, on 2020, the level of operating expense increase should be trending down to what we historically have been achieving, of expansion close to an inflation rate. That will not happen -- that will not decrease immediately in 2020, but the convergence to those levels will start happening. I think this operating expense increase is probably the single largest contributor to the impact that we're seeing in our short-term profitability. Just to mention one thing. If for this year's guidance, for 2018, if our operating expenses grew by what we're expecting inflation, our net income growth would be 15% to 16%, okay? So we understand there are short-term pains in order for us to have a more strengthened competitive position. We are making all these investment plan to have a more sustainable ROAE with a higher net income growth, not only for 1 year or 2 years, but in medium to long term. So I think that we shouldn't be expecting a decrease in the rate of expansion of operating expenses in the short term.

Okay. Just a quick follow-up on the first question. What are the segments that you're seeing more pressure on the spreads?

Credit cards is one that it's been quite stiff, and mortgages. I think it's quite impressive the fact that despite the more than 400 basis points increase in the reference rate, interest rates in mortgages in Mexico have not moved that much in this 3-year horizon.

Our next question comes from the line of Jason Mollin with Scotiabank.

Jason Mollin. I'm with Scotia. Just another follow-up on the net interest margin. You mentioned these treasury operations in the funding side related to FX and investment strategy. Can you quantify the effect this somewhat onetime on the margin and net interest income and on the trading side? So maybe that you did have a pretty good trading quarter. And secondly, I wanted to ask, I mean, we're seeing competition, but you've done a really good job. I mean, impressive increase in net new clients. They almost doubled to 1.9 million. I mean, where does this go from here? And I guess the idea is to keep them and make them profitable over time, as you've been talking about. But are these -- I guess, these are coming from your largest competitors. And how far can you go?

Regarding NIM, probably a good reference is to highlight the fact that (technical difficulty) treasury activities. Margins associate with, let's say, our retail banking franchise would have expanded close to 4.5%. So you can maybe do reverse engineering associated with this investment strategy.

Yes, sorry (inaudible). I didn't quite hear the -- actually, the line went dead for a second. So the NIM with clients increased to 4.5%. What did you say before that?

Yes, net interest income associated with clients taking away this effect of the financing activities of the treasury, it would have increased 4.5%.

Okay.

Jason, in terms of our net new clients, the strategy is basically to continue towards getting more, much more, clients. I mean, Santander Plus has been a very good success. We are now at 3.2 million clients, 52% of those are new clients to the bank. And those clients, basically, now that we have them, come with mobile capabilities and different things. And it's basically helping us to turn ourselves into #1 client for our banks. Remember that in the past when we were product-oriented, we would have basically just the mortgage, and we probably would be the second or third bank to that customer. And we wouldn't basically loyal-ize this client as the way we're doing it now. Our strategy, as being a new -- I mean, now a client-centric bank, is basically continue towards that. And we want to continue pressing on that. We are fighting head-to-head with our competitors, basically, to win favorable accounts, that's exactly what we've been doing, and to continue getting as much new clients as needed. As you remember, already our client base was really penetrated, and the only way to go is basically to get more clients, and that's exactly what we're doing. And that's a model that we're taking to. So as Didier was telling you, if you guys basically have patience on the long term, you're going to see the results. I mean, even though we have some situations in the short term due to the amount of expenses that we are currently going into, on the long term, you're going to see the that strategy is going to pay off. Because at the end, we're going to have much more clients, much more demand deposits and much more loyal clients, which are the ones that are basically to give us -- that's -- we have numbers, that between 3 to 4x more revenue than from a normal client. So that's exactly the strategy, and it's going to continue to be. What we're doing is also, as you can see, our portfolio in middle market companies and SMEs is going quite well. We are probably the #1 and #2 bank for those companies, and we are leveraging on that to get favorable customers from that companies. And that's going to be -- to continue to be the strategy. Also on our retail, we are basically focusing on attracting new clients with new products and different things. And you going to see us running out some new different things. I mean, for example, we just came out with SuperDigital. SuperDigital is the first fully digital account in the Mexican market. This is a level 2 account. We just launched it formally, and we already have 20,000 accounts opened. And we're just starting.

And to add to what is the explanation, Jason, I would just say highlights the fact that there's a lag effect between the clients that we're attracting and retaining and the benefit that we'll get out of this attraction and retention. According to [CRN] data, the clients that have been 5 or more years with us are 3x to 4x more profitable to clients -- than clients that have been less than a year with us. The pickup in profitability, we see it between years 3 and 4. So just taking into account those clients that we have attracted during the second half of 2016, that, that's when basically Santander Plus program was launched. So the -- let's say, the full benefit of those customers coming in, we'll get to see it basically during the second half of 2019, okay? So there is -- it's very important to understand that lag. So that also impacts our short-term profitability. But at the end of the day, we will not improve our strategic position and improve our performing cost if we were not able to continue attracting these retail customers as we are doing.

Our next question comes from the line of Philip Finch with UBS.

Two questions for me as well, please. First is ROEs. Clearly, you would appear to be a bank in transition. You've invested -- or you're investing in your digital platform. The focus is moving away from volume towards profitability. And clearly, this is going to probably take another year or 2. But once you're out of it, what sort of ROEs can we assume is achievable for you? So what is your ROE target? And what sort of time line are we should we expect before you achieve that? Second question is regarding your capital. Obviously, we saw a small reduction in your core Tier 1 in the quarter, down to 10.8%. But going forward, what is the optimal level of capital that you would like to run that in terms of common equity Tier 1 ratio?

Thanks you. Thanks for your questions. Regarding ROEs, we think that this and next year will still be affected because of what we have discussed during the call. However, let me say that during all this investment and transformation plan, starting with an ROE close to 16%, is a very good position to be in, okay? So what we are aiming at is there are couple of peers in the market that either have (technical difficulty) that have been achieving (technical difficulty) 20%. And in the case (technical difficulty) when you look at these 2 players and see the CapEx (technical difficulty) in their operations, and that's why we think that they are benefiting from solid trends (technical difficulty) key strategic weakness in the (technical difficulty). I think that there's no reason why we shouldn't be getting ROEs similar to those 2 (technical difficulty). I would say that probably 2020, 2021, we'll start seeing that (technical difficulty)

(technical difficulty)

Hi everybody. Are we on the call?

Yes, you're back in the call.

Okay, thank you.

Philip, I don't know exactly where got disconnected. I will start back again with the answers of the questions that you made. You asked about our ROEs expectation and targets and timing.

What I was mentioning is that once we address our key strategic weakness of not having the exposure that we would like to have in terms of business with individuals in the Mexican market, I think that we will be able to have a much stronger deposit franchise that will, by -- in that regard, will reduce our cost of funds, and that will represent a significant boost in our profitability, along with a higher exposure of retail loans in our loan portfolio. Those 2 things, in my opinion, are the ones, the single 2 largest, more contributors to our potential ROE expansion. Now this is not going to happen this year, and this will not happen next year. I think that we will start seeing an ROE expansion probably 2020 onwards. What is our goal? I think that Banorte, that has a scale similar to us, has been achieving ROEs higher than ours, and getting closer to 18%, 19%; while Bancomer is actually achieving ROEs of close to 22%, 23%. So once we address this strategic weaknesses that we have, that, that's one of the key goals of investment plan is actually do that. Once we execute on that, I think that there's not a single reason why we shouldn't be achieving those levels of ROEs. So I would say that 2020 onwards, probably a couple of years 100 to 200 basis points expansion, and then gradually reducing the gap to our comparable peers. Now regarding capital, we think we feel comfortable with the capital core Tier 1 ratio of 11%. We think that that's strong enough to benefit from the growth opportunities that we see in the Mexican market. And probably one way to look at it, in my opinion, is that rather than fixing payout ratio that we've been doing since we are a listed company, we probably think of it as paying out excess capital just to prepare ourselves to a much stronger asset growth in the medium to long term. So whatever excess capital we have on top of, let's say, that 11% core Tier 1 ratio, that's what would be the source of dividends, okay? So that's the response to your questions. And I'm really sorry that we got disconnected.

(Operator Instructions) Our next question comes from the line of Eduardo Nishio with Plural.

One question just regarding your strategy. Very good results in client acquisition, loyal customers growing at 25%, and digital customers, which is supposed to be more profitable as well, 45%. My question is, why we don't see, at least on the revenue line, some of this strong growth flowing through? Because revenue, I think it's something that you supposed to see right now. Or correct me if I'm wrong here. We seeing that happening in other Santanders in Latin America. So my feeling is that, at some point in time, we might see that flowing, like for instance, on your net commission fees that are growing in a mid-single digit. So how you see that? And when we're going to see this convergence of growth happening? Hopefully, faster than 2022, right?

Yes, I would say that, Eduardo, that there's -- what we see in our current customers, those customers that have stayed longer with us are much more profitable than the ones that just started the relationship with us. And the expansion, let's say, the full benefit of new customers, we'll get to see it between years 3 and 4. Okay? That's a consequence of an increased relationship with our customers. So I would say that we have the -- probably the most of the cost upfront while the benefits are more back-loaded, okay? So we agree with you, and we're optimistic in the sense of having the capacity to attract and retain customers. That's going to be the source of our net income growth in the years to come.

Also Eduardo, what is important to point, I mean, part of our growth is payrolls. And those, basically, have an acquisition cost upfront that we have to basically absorb at the beginning. And that's where you'll see that it's costing us a little bit. This always -- it is a tough market. As you have seen, is very, very competitive. And you have seen it in what's happening in the mortgage business also. So that's why, basically, you don't see that ramp up right away. But you're going to see it in the future. And I believe that the strategy is one of where we'll self-correct because when you're operating a bank, the more customers you have and the more deposits you have, there is no way to go wrong there. So if you guys a little patient, you're going to like the strategy and you're going to start looking at the profits in the short -- in middle term, I would say. This is also, as someone greatly have pointed, a transitional year for us. In my opinion, 2018 is then a decisive year in terms of our strategy and what we're doing, and also because this is the year that we're going to spend the most. So we basically are going to have to execute on a really rigorous way in order to be able to have a good year in combination with the amount that we have to spend in order to put the bank where it needs to be in the future.

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

Sorry about this, but I follow-up in your NII growth and NIM. When we compared your NII growth performance to your peers, it seems that they have benefited much more from a higher interest rate environment. So I just want to understand what's the reason behind? Is it the higher cost of funding? Or as you mentioned it before, it could be related to a tougher competition and create spreads, as you mentioned, in credit cards and mortgages? The second question is in terms of your loan growth. Can you provide the breakdown of the loan growth per segment? And how are you seeing competition? How do you -- who do you see as the most aggressive competitors?

Regarding -- you're completely right by stating that we have benefited not as much from interest rate increases in our net income and net interest income growth or NIM expansion. And that's precisely why we're making this investment plan. We have higher cost of funds, and that's because we rely more on corporate deposits than retail deposits, okay? If you look at our market share on demand deposits coming from individuals, it's less than 10%, while our natural market share is much higher than that. So the corporate deposits are -- have a higher sensitivity to interest rates, okay? So that's on the liability side, okay? We are making progress, I would say, in the terms of retail deposits growth at a faster pace than our overall growth in total deposits. So I think that we are confident that this last year was a good year in showing some progress in that regards. So that's on the liability side. On the asset side, we are less exposed to retail loans than our peers. And that also makes our yield on assets lower than our peers. So that's why the combination of these 2 factors makes us look not that great in terms of the benefit of interest rate increases as we've seen in our competitors. But bear in mind that these initiatives, the ones that we're putting in place, are precisely to have a more stronger NIM as a consequence of having a higher exposure to retail business in Mexico. Now regarding loan growth, I think that when we look at mid-market and SMEs, those 2 segments are strategic to us. We will continue investing in increasing our footprint this year to service more clients in these segments. So we expect that the recent trends that we're seeing in these 2 segments to continue, okay? Now on consumer loans, payroll loans is the one that is driving growth in this segment. And given the -- our focus on payrolls and how the Santander Plus program is working, we think that payroll loans will continue growing at a similar pace and what we've seen recently. On credit cards, we're growing slightly below the market. I think that the Aeroméxico credit card now represents more than 20% of our -- no, yes. 20% of our loan portfolio in credit cards. So I think we should continue expecting a relatively strong growth in those segments or products. Now turning to those segments that have not been performing as strong. On the individual side, it's mortgages. And the key impact there is the run-off of the acquired portfolio of the ING business back in 2012, 2013. So that is dragging our loan growth in this important segment. And we don't expect a significant expansion in mortgages, even though our origination is growing at a similar pace on what the market is growing. We don't see that this trend will revert this year. I think that we will continue showing modest growth in mortgages, I would say stronger than the ones that we are currently experiencing, but I don't think that we will get higher than 3% during this year. We'll continue at the pace that we are originating. Then the last 2 segments are more unpredictable, in the sense of large corporates and government loans. Government loans, from a sector perspective, have been decreasing. And we also are experiencing that. And I would say that both on large corporates and government loans, it's been more an issue of focusing on profitability, okay? In those -- for those clients that we don't think that there's enough business on the table and there's a competitor willing to enter into certain terms and conditions that are not enough for us, then we'll let go those transactions. So in that regard, we'll obviously continue being an active player in these segments, but we will rather have -- stay focused on profitability than on scale. I would say that there's not an aggressive dynamic in the market during this year, we should be able to meet our loan growth guides of 7% to 9%. But I would say that it will depend heavily on what happens with large corporates and government loans.

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

Three brief questions. One is if you could comment on SME spreads and how they have been evolving. That's one area where you are strong. Second, in terms of matching your peers in terms of profitability, one area where, historically, you have been smaller has been actually government loans, on 11% of your portfolios there. Would you think of increasing your presence in that area?

Thanks, Carlos. Regarding SME spreads, I would say they are relatively flat over the last few quarters. We haven't seen any -- not a significant expansion, but not a contraction there. They're relatively stable. Regarding our exposure to our government loans, I'll turn it to Hector.

Thank you, Didier. I mean, Carlos, look. I mean, I have been very outspoken in terms of focus on profitability. And that basically has been the fact in terms of what's been happening with government loans. The spreads have been compressing over the past couple of years quite a lot, I mean as you know, there is a lot of competition in this sector, first of all because of payrolls. And we have basically taking very conservative approach towards government loans, and we are basically just participating in those when we have an opportunity of getting more transactional business, first of all, and when we have to defend our positions in payrolls. And that's basically been the strategy. We've been very cautious in the way we manage these because we basically want to focus, as I told you since the beginning, on profitability and on opportunities. And what's been happening is, in this market, it's basically the tenor is being -- going longer. I mean, you have now -- you now see the, basically, that state's going towards 10 or so -- more than 10 to 20 years, which basically, we don't like as much due to the fact of RWA. Even though they don't impact as much as corporate loans. But at the end, it's 20 years in your balance sheet at some very low margin levels. So we're going to continue doing that, and we're not going to grow the portfolio just because we're going to grow the portfolio. This basically has to have sense. And we have just be smart about it. Capital, in my opinion, is not infinite, and we need to deploy it in an intelligent way, and we want to continue to do that. Sometimes, the market doesn't like that, but at the end, I mean, I think reason will prevail. And the most capital we have and the way deployed, we have it, I mean, the market is going to give us a premium then on the future. Maybe at this time, people basically are concentrated much more on volumes than growth. We believe that we need to be intelligent about it, and we're going to continue that way. There are some sectors that you need to basically increase because you cannot allow your competitors to grow much more than you or basically lose contact. And we're not going to do that either. So it's a very difficult balance where we're not -- but we're going to maintain it, okay? And we're going to maintain our discipline.

And just sort of to clarify then, in the government lending sector, you have the federal entity, the large companies and then you have the states and municipalities. The competition that you referred to, and in the increased tenors, that will be more in the states and municipality side?

That's correct, that's exactly what the tenor extending and the rates are getting lower. So it's seems very hard. I mean, if you see the levels, you get completely, I mean, impressed by what's happening, even in 20-year loans. The spread, you see them compressed, I mean, more than 100 basis points.

Very clear. And my last question, I forgot earlier. Can you tell us how you account for the upfront expenses of your payroll loans? So as you said, they are expensive. How do you account those expenses, at upfront? Or you do that over the life of the...

Okay, first of all, I mean, it's an expense, but you have an acquisition cost in terms of basically getting those payrolls. What is important to a point is that we are very disciplined in the ROE we are doing with these payrolls that we negotiate. And all of them, I can tell you are net present value positive. And also, they have a positive ROE. We have a very disciplined approach towards it, but I want to ask Didier exactly to tell you exactly how we account that.

I think that it's basically the acquisition cost, we go upfront. And in some cases, it involves setting up a specific branch for our customers or adding ATMs. So in some cases, I would say that with infrastructure, that it's -- it could be depreciated over time. So it various, depending on the specific payroll business that we are attracting. Okay?

(Operator Instructions) We did get another question from Alain Nicolau with Bradesco.

Let me just go back to your guidance for loan growth. You are guiding for the same range that you guide, June 2017. And my question is, how comfortable are you that you are able to reach this same guidance this year, considering all the uncertainties in Mexico this year? And more than that, what can we expect from the platform in 2019 onwards? Do you think it's reasonable to assume that since you are getting all these new clients, that you can accelerate your credit growth going forward?

Alain, I think that we are comfortable in the guidance that we're providing. That's what -- that's why we are actually giving it out. We think that what -- we acknowledge the fact that there are some segments in which there is a higher uncertainty in terms of us achieving those growth rates, as I -- this cost in the question Ernesto Gabilondo asked us. So I would say that we are relatively -- or very confident, extremely confident of achieving very strong growth rates in mid-market, SMEs, consumer loans and I would even say credit cards. In those segments which, I would say, depends more on whether the transactions are profitable enough for us to participate. And those transactions are more related to corporate loans and government loans, however, these 2 segments represent a significant part of our loan portfolio, close to 25%. So it's not that we're losing, that these 2 segments are not important to us. It's just that they're important as long as the profitability makes sense to us. Thinking about 2019 and 2020, I think a player as relevant as Santander in the Mexican markets, you should expect us to grow at similar levels to what the market is going. If we are successful in our investment plan, we should see that the loans associated to individuals should be growing at a faster pace than the market, but that's in the medium to long term. And that's not going to happen in the short term, okay? But I would say that we should expect us to grow either slightly faster or at what the market is growing, I would say, on a medium- to long-term basis. Okay?

Our next question comes from the line of [Manuel Gonzales] with Interacciones.

I just want to ask a quick question. I was wondering if you could, like, give us some insight in the sensitivity of your margins to the interest rates. Because I see the interest rates, push forward the -- kind of hard to tell, I don't know what the effect on the margins might that be. Can you give us some color?

Sure, if you look at what happened last year, we saw the NIM expansion of 46 basis points, while the reference interest rate increased to 253 basis points. So that's basically the impact that we saw, okay? Close to 20% of what the reference rate increase. Now let me say that, that dynamic has to do more with a significant increase, with a fast increase, in the interest rates in Mexico. Just bring in mind the following relation. Go back in 2015 the reference rate, 3%. And our NIM was 1.89%. So that's 1.62x our NIM relative to the existing reference rate. In 2016, our NIM was 4.97%, while the reference rate was 4.15%, the average, okay? So that's 1.2x the reference rate. Now in 2017, our NIM was 5.43%, while the average of the reference rate was 6.68%. So that's 0.81x the reference rate. So what we should expect -- or given the fact that there was a very fast pace of interest rates increasing in Mexico, banks either have not a path ultimately that leads just to customers just because there's a higher margin, there's a higher cushion. Now when interest rates start coming down, we should probably see the reverse effect, okay?

Mr. Chávez, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Well, thank you very much for everyone for joining Santander México on this call. We look forward to maintaining an open dialogue with you, and you are welcome to visit us in Mexico. So if you have any further questions, please don't hesitate to call or e-mail us. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.