Banco Santander-Chile (BSAC) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the Quarter Two 2015 Banco Santander-Chile Earnings Conference Call. My name is Ashley and I'll be your operator for today. [Operator Instructions]. I would now like to turn the call over to Raimundo Monge, Corporate Director of Strategic Planning.

Thank you very much and good morning, ladies and gentlemen. Thank you for attending today's conference call in which we will discuss our performance in the second quarter of 2015. Following the webcast presentation, we will answer your questions. Before we go into more detail regarding our results, we will briefly give you our latest update on the outlook of the Chilean economy in 2015 and 2016. Regarding the economy, the existence of internal and external uncertainties has led to a revision of the economic growth figures for this year and the next, but with growth still rebounding compared to 2014. We expect the economy to grow between 2.2% and 2.5% this year and between 2.6% and 2.9% next year. This performance should have a mild impact on the unemployment rate this year, stabilizing in 2016. In the quarter, the peso continued to depreciate which has led to further rises in inflation expectations for this year. As a result, the inflation rate measured by the variation of the UF and inflation linked unit and the most relevant indicator for the Bank should increase between 3.5% and 3.7% this year and close to 3.4% next year. Given this inflation outlook, we expect the central bank not to cut interest rate any further in 2015. This growth scenario continues to occur in a relatively low risk environment that the Chilean economy offers. Sovereign risks measured by the spread of -- the CDS spreads remains stable. Chile's fiscal situation is robust with net debt representing only 2% of GDP and our sovereign ratings continue to be among the strongest in the world. Even though the price of copper has fallen in 2015, the fall in international oil prices has been greater, leading to a positive evolution of Chilean terms of trade and Chile's current account deficit has gone from a deficit of 3% of GDP in 2014 to a balanced situation this year. All in, this should represent a relatively supportive macro environment for banks. For this reason, our expectations for loan growth have not changed at 8% to 9% both in 2015 and 2016. Loan growth in the banking system has low exposure to mining commodities and greater exposure to non-mining exports that are thriving. We expect ROE in the system to fall in 2015 compared to the previous year due to the lower inflation and higher corporate taxes, but core operating trends and asset quality are expected to remain healthy. Furthermore, this period of low economic growth occurs at a moment in which the Chilean households are in a relatively healthy financial situation as debt servicing ratios have not increased in the last six years. As a consequence, the non-performing loan ratio in the system had been trending down in the last five years. Now, we will review how the Bank continues to move forward in its strategic objectives and the main commercial result achieved in the year. In terms of our first strategic goal, focused growth, in the second quarter of 2015 total loans increased 2.7% Q on Q and 11.2% year on year. As in previous quarters, growth has been focused on segments with higher risk adjusted profitability; therefore, the Bank centered on expanding its loan portfolio in the middle to higher income segments, while remaining more selective in lower income segments and SMEs. Total loans to individuals increased 3.1% Q on Q and 14.1% year on year. Loans in the mid higher income segment increased 4.5% Q on Q and 17.3% year on year. The other area of relevant loan growth was in the middle-market segment. Loans to mid-sized companies increased 7.2% Q on Q and 16.3% year on year in the second quarter of 2015. Growth in this segment was focused on mid-sized exporters which are benefiting from the stronger external conditions and the weaker peso. These clients are also generating increasingly higher levels of business volumes in other areas such as cash management which has helped to drive the rise in client deposits. The Bank's strategy of focusing equally on lending and non-lending businesses has also led to strong deposit growth. Total deposit increased 3.8% Q on Q and 22.5% year on year. The Bank continued increasing its core deposit base which grew 15.8% year on year, led by a 17.6% rise in non-interest bearing demand deposits. Demand deposits have also grown at healthy rate in all segments; individuals, plus 21.9%; SMEs, plus 13.9%, middle-market, plus 19%; and corporate, plus 13.8% year on year. The high levels of liquidity in the local market led to an improvement in spreads earned over deposits from institutional sources. We also achieved a rise in various market share metrics. In the beginning of the year, our loan market share has increased 50 basis points, led by lending to companies and our deposit market share has increased by 80 basis points. We believe that this increase in market share has been achieved with relatively high quality clients. The effectiveness in the execution of our loan and funding strategy has been based on the growth of our client base and the improvement of our commercial approach, our second strategic goal. In the second quarter of 2015, the Bank achieved positive net client growth for the ninth consecutive quarter, but with a greater focus on improving cross-selling. Retail clients with checking accounts, a subset of clients that tend to be more profitable than the rest, increased 8% year on year. More importantly, among our individual clients those are cross-sold, measured not only in terms of how many products they have, but if they use them intensively, increased 15% year on year. A similar situation can be observed in the SME segment, where cross-sold clients rose 17% year on year. In terms of our third strategic goal, managing our risks and capital conservatively, our strategies resulted in a favorable evolution of asset quality which is a key element of our goal of obtaining higher client margins net of provisions. The Bank's total non-performing loans ratio remained stable at 2.7% in the second quarter, with a coverage ratio of 106%. The stability of the majority of the Bank asset quality metrics continued to reflect the change in the loan mix, the focus on pre-approved loans through our CRM, the improvements in asset quality in the SMEs segment and the strengthening of our recollections area. The Bank also concluded the second quarter with solid capital ratios. Our core capital Basel I ratio which is 100% tangible common equity, reached 10% and our Basel ratio -- complete Basel ratio was 13%. The prudent management of the Bank's capital ratio and solid yearly profitability has allowed the Bank to continue growing soundly and paying attractive dividends without issuing new shares since 2002. Now, we will explain the evolution of our quarterly results. In the second quarter of 2015, net interest income increased 21.3% Q on Q and decreased 4.7% year on year. The net interest margin, NIM, reached 5.1% in the second Q of 2015 compared to 4.4% in the first Q of 2015 and 6% in the second Q of 2014. In order to improve the explanation of margins, we have divided the analysis of our net interest income between client net interest income and non-client net interest income. In 2015, client net interest income increased 2.2% Q on Q and 7.2% year on year, driven mainly by loan growth and the improving funding mix. Client net interest margins, defined as client net interest income divided by average loans which exclude the impact of inflation, reached 4.9% in the second quarter of 2015 compared to 5% the previous quarter and 5.1% in the second quarter of 2014. Client NIMs declined due to the shift to less riskier segments, in line with the Bank's strategy of focusing on margins net of risk. This metric reached 3.6% in the second Q of 2015 compared to 3.5% in the second Q of 2014 and was stable compared to the first Q result. The Q on Q rise in non-client interest income was due to the higher quarterly inflation. As explained in other calls, the Bank has more assets than liability linked to inflation and as a result, margins have a positive sensitivity to variations in inflation. In the second quarter of 2015, the variation of the Unidades de Fomento, an inflation linked index currency unit, was 1.46% compared to negative 0.02% in the first quarter and 1.76% in the second Q of 2014. The average gap between assets and liabilities which are indexed to the UF, was CLP3,891 billion, roughly $6.5 billion gap in the second quarter of 2015. This implies that for every 100 basis point change in inflation, our net interest income increases or decreases by approximately CLP39 billion, all other factors being equal. The existence of this gap is mainly due that long-term assets are usually denominated in UFs while deposits tend to be either non-interest bearing or linked to nominal rate. We expect UF inflation to be approximately 1% per quarter for the remaining of this year. Fee income is gradually increasing, driven by our different client strategies. Fee income increased 5.1% Q on Q and 4.4% year on year in the second quarter of 2015. On a year on year basis, this individual segment grew 9% and in the SME segment they increased 7.1%. This rise in retail fees was mainly due to the greater product usage and cross-selling standards as seen before. In the quarter, loan growth in the individual segment also boosted brokerage of the insurance products associated to loans. At the same time, the Bank has expanded its co-branding program with LAN, Chile's main airline. A client can now obtain airline miles by using their credit card and through all debit ATM and Internet transactions. As we saw in the previous slide, asset quality has been a driver for our profitability. Provisions for loan losses increased 3% Q on Q and decreased 2.9% year on year in the second quarter of 2015. The Q on Q rise was mainly due to the loan growth that boosted gross provision and the depreciation of the peso in the quarter which resulted in greater -- in a translation increase of our provision expense over loans denominated in foreign currency. Charge offs remained stable in the quarter and loan loss recoveries increased 5.5% Q on Q and 18.2% year on year. The cost of credit reached 1.4% in the second quarter of 2015, a similar level compared to the first Q of 2015 and improving from 1.6% in the second Q of 2014. As a result, the year-to-date client net interest margin rose 10 basis points to 3.6% and the cost of credit improved from 1.54% in the first half of last year to 1.36% in the first half of this one. In the first half of 2015, net operating profit from the bank business segments increased 8.1%. As described throughout this presentation, our solid loan and deposit growth efforts, the renew free growth and the positive evolution of asset quality has bring in this positive business segment result. In-line with guidance given in our last earning calls, the growth rate of operating expenses has begun to decelerate to the 6% to 7% range we expect by the end of the year. In the second Q of 2015, operating expenses increased 7.8% year on year. This rise in cost was mainly due to, number one, the higher year on year inflation rate which affected salaries and certain administrative expense such as rental costs that are indexed to inflation; second, higher severance costs; and third, the ongoing investment to improve the productivity of our branch network. As a result, the efficiency ratio reached 41.1% in the first half of 2015. In the quarter, the Bank opened three branches and continued the process of modernizing the existing network. The Bank has developed a new branch format that was tested in 2014 in various locations. These new formats has exceeded expectation in terms of efficiency and client satisfaction. The Bank also remained focused on growing through complementary channels such as Internet, phone and mobile banking. This will allow the Bank to maintain solid level of efficiency going forward, while improving productivity and customer satisfaction. In summary, second-Q 2015 and first-half 2015 results show positive recurring trends in our business segments. Our reported ROE descended from 25.3% in the first half of 2014 to 18.2% to a large extent due to the lower year-to-date inflation rate and the higher tax rate. However, in line with our previous calls guidance, adjusting the Bank's reported ROE for a normalized inflation level of around 3% per year, our profitability has been approximately 18.6% in the first half, very similar to what we generated in the same period of 2014. This reflects the stability of the Bank's core profitability trend. At this time, we will gladly answer any questions you might have.

[Operator Instructions]. Your first question comes from the line of Carlos Macedo, Goldman Sachs. Please go ahead.

A couple of questions. First, the move to -- that you made the repositioning to upper income, we understand the challenges, upper income is a much easier -- much easier to get on the funding side commitments than on the asset side, the loan side. And loan growth on the consumer side has weakened and expenses are running a little bit stronger than they have in the past. Asset quality has weakened year over year though the quarter was okay in terms of consumer. When should we expect to see this move materialize? Is it something to do with the branches that you are now opening under this new format, they have to mature? I mean is that something that we should expect? We will see this -- let's say, the score or adjusted ROE that you are reporting here at 18.6%. Should we expect it to at some point increase to 20% as these things start to mature and what timing should we expect this to happen? Thanks.

Okay. There are two elements. One are the -- I would say the macro conditions that of course are less supportive than what we had in previous years and accordingly getting to 20% ROE were facilitated by the macro environment that was more supportive. So that is a sort of a headwind that we have to counterbalance with internal efforts. And in the previous two or three years where we have been working is to revamp our operations aimed at the middle to high end of the consumer market. We launched a new format of a pension model that was called under the branding -- general branding Select, yes which has been very successful with growth of 17% per year loan growth, deposit growth something in the same line, et cetera, et cetera. The process we're today concentrated -- and as we highlighted in the presentation -- is replicating some of the elements that were successful for the high-end of the consumer market in the more middle-market. Because the Bank has not changed the basic format of branches and the basic attention model for many years and we think that it's time in order to counterbalance these headwinds that we're seeing on the macro side with our new model approach. And that's what we have been testing last year and we're now in the process of moving to the branches. So the combination between our new format and a renew attention model at the branches combined with increased facilities on the complementary channel side, we think can make -- will make a difference in the next 2-3 years, increasing our productivity, client or service standard, etcetera. And that's why we still maintain our basic guidance of delivering ROEs on a moving average of three, four quarters of -- 18%, 18.5% ROE can be achieved. What we will basically be doing will be absorbing the higher corporate tax and at the same time absorbing these headwinds coming from the macro situation. If those elements are mitigated and the economy grows faster than we expect, confidence is regained faster than we assume, of course we can increase our ROE. But in the short term, most of the effort will be done internally as has been the case in the last at least two years. So we maintain our basic guidance. We maintain our approach of improving our attention models to counterbalance these more softer growth that we expect or what the general market expects for this and the next year.

So I mean from the data that you showed here in terms of high income individuals and all that, you would consider that on the select format that you deployed is already running at a rate that is a run rate and now you have to just migrate it downstream a little bit to the more of a middle income kind of segment. Would that be an accurate description?

Exactly, that is the case. Today we're putting our efforts to revamp the format for the middle mass market and hopefully we will have as good news as we have had in the upper end of the market in the more massive market. In the case of the high end, we're already at the running rate and it's very unlikely that we can outpace the growth of 15%, 17%.

Yes, that is a very solid rate of growth. So just to be sure, does this migration or this new effort into the middle end of the -- middle side of the market, is that something that will keep expenses running at the same rate that they have or was this something that was just as you finalize the upper side now you can move down as there's going to be some sort of synergy between the two and we could see expense growth rate decline a little bit?

Yes. What we're doing is getting increased productivity out of the different tools that we have launched, among them the CRM, the new credit models and the increased use of complementary channels -- they are producing slack in our cost structure to keep on investing in this new format and in this new model. That's why, as we mentioned in the call, we think that by the end of the year cost growth will be between 6% and 7%, a little bit lower than the 7.8% that we're seeing today on an annualized basis. So we think that cost will be trending down and most of the expenses that we're incurring to reformat our mid-sized oriented branches will be generated by the same synergies and the same savings that we produce in the upper end and on other investment we have done in CRM and things like that.

Your next question comes from the line of [indiscernible].

So first congratulations on the results and thank you for the opportunity. My question is regarding asset quality. I was wondering your expectation going forward. And we also saw in your press release that provisions in the corporate segment increased almost 30% quarter over quarter mainly as a consequence of some rating downgrades. Could you comment if this was to do to a specific factor or it was in general in the commercial segment?

No, what happened is that -- a large proportion of that is because you have to -- you take provisions over dollar denominated loans, mostly export and import loans. You have to adjust it by the exchange rate. So you are reflecting the depreciation of the currency over all the stock of loans that you have there and the provision you have to take over all the stock of loans. And that's why it's not recorded unless of course you assume that the peso will keep on depreciating in the coming quarters. In terms of impacting the bottom line, that translations effect is compensated by other lines because we have matched our peso/dollar gap. We don't have a meaningful gap. So it's simply that provisions are overstated because of the depreciation of the currency and at the same time other lines maybe in the financial transaction line are also compensating the effect. So it doesn't have an impact in terms of profitability because we have no relevant hedge or say unhedged portion in the dollar book. But of course it grows the provisions. We have had some downgraded, but nothing relevant and nothing concentrated. It's simply ongoing business. I would say that going back to the [indiscernible] point, we still have a positive view about the evolution of asset quality in the central macro scenario that we hinted. We think that we can maintain our cost of risk provisions over loans at around 1.4. It could be a little bit lower going forward, but probably close to what we're seeing today. And the mix effect combined with the change in models that we have done in the last two or three years are helping to stabilize that level of delinquencies. And again, as we don't foresee deterioration in the job market -- relevant deterioration in the job market going forward, we expect that the asset quality shouldn't be a major concern.

Your next question comes from the line of Fred de Mariz, UBS. Please proceed.

A couple of questions from me. You mentioned the UF for the year at 3.5% to 3.7%, if I heard you well. Can you give us a sense of the trend in the third quarter and fourth quarter, how will it be shaped by quarter? And then my second question is on the tax rate. We saw it was a bit lower in the quarter. There was a bit of tax credit. You had a bit of inflation accounting going on as well. What's your view for the next quarter in terms of tax rate? Thank you.

Okay. Two things. In terms of inflation, we don't have any particular view, but we think that we should -- given that today we have an accumulated UF inflation of 1.5% roughly and that we foresee that it will be closer to 3.5%, we have 1% per quarter on average for the remaining two quarters. That would be -- it could be a little bit faster in the third and a little bit lower in the fourth. But it will depend in the end to a large extent in the evolution of the exchange rate, because, as you know, in the Chilean CPI index tradable goods, the ones that have international prices or are linked to the dollar tend to be like 50% of the basket of goods and therefore the pass-through is relatively rapid. The fact that the peso has continuously depreciated in the last three or four weeks make us believe that we could have high inflation in the third Q compared to the fourth. But on average 1% each quarter would be sound. If that is the case, in terms of the effective tax rate -- whenever inflation is higher, the effective rate tends to be lower. We tried to explain that in the previous quarter press release. That's why although we still believe that with a 3.5% UF inflation, the average rate for the year will be around 19%. It could be a little bit lower in the remaining two quarters to know exactly about 17%-18%, so that the average for the year is around 19%. What happens is that the higher the inflation, the lower the effective rate. In the second Q, for example, with a 1.5% inflation we saw an effective rate of close to 14%. That's why if we expect 1%, the effective rate jumps to 17% or 18% or something like that.

Your next question comes from the line of Catalina Araya, JPMorgan.

I just wanted to get your thoughts on dividend policy and capital. This quarter we saw the Tier I ratio falling to 10% after paying 60% of 2014 earnings. So my question here is what level of Tier I capital are you comfortable and what would trigger a lower dividend payout ratio? Thanks.

Yes. In our case, our dividend policy is stated in terms of expected growth and secondly, maintaining a comfortable position in capital. Today the Chilean banks are moving -- starting to move into Basel III which we think today with the definitions that we have been hinted by the regulators shouldn't be a big concern for -- at least for us and probably the larger banks, the banks that tend to have more branches, et cetera, because on the funding side also they are changes. But we think that going forward our dividend policy that has been in the last five years or so repaying 60% will be moving to something closer to 50%. I'm not sure at this time whether that will happen in the next April when we have to pay the dividend of the 2015 profit or the following year. But we expect that we will eventually reduce our dividend simply because, well, we have to maintain more and more capital due to the change in Basel and given the fact that we still believe that medium-term growth on the lending side will be probably closer to 9%-10% than to the current 8% or 9% that we have been hinting. So it's nothing that will change dramatically, but is part of the smooth adjustment that we foresee for banks to adjust to Basel III definitions.

[Operator Instructions]. We have another question from the line of Fred de Mariz, UBS.

Just a follow-up on loan growth. You had a loan growth above 10% for the quarter. What are you seeing for the next quarter especially considering the softer economy?

Yes. In this quarter or in the last two or three quarters and as we stated in our press release, mortgages had been growing faster than in the medium-term as we foresee and basically it's because many people are rushing to buy flats and houses because of some increases in prices are expected due to the implementation of the tax bill last year. These are some benefits that will be eliminated starting 2016. And that's why we think that in the rest of the year and 2016, mortgage growth will come down to a more normal 12%-11% growth. That will affect our basic growth. However, we foresee that consumer lending which has been dragging to some extent and corporate lending for the large corporations will also pick up assuming that confidence is starting to be regained by the new authorities that are running especially in the ministry of finance that is starting to do a very good job in terms of cooling down a little bit uncertainty and giving a more -- a path of changes and reforms that is more predictable for the market. But there is still uncertainty on that side. So we think that we will see lower mortgage growth going forward and possibly higher consumer and especially corporate lending going forward. That's why the two effects will to some extent net between themselves.

So do you think we should work with something close to 10% in terms of loan growth or maybe a bit above this?

Yes, 9%, 10% is a good assumption.

There are no more questions waiting at this time. I would now like to turn the call over back over to your host, Raimundo Monge.

Okay. Well, thank you all very much for taking the time to participate in today's call. We look forward to speaking with you again soon. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you.