Banco Santander-Chile (BSAC) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2015 Banco Santander-Chile earnings conference call. My name is Mark and I'll be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question and answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Raimundo Monge, Corporate Director of Strategic Planning. Please proceed sir.

Thank you very much, and good morning, ladies and gentlemen. And once again, welcome to Banco Santander-Chile third quarter 2015 conference call. Thank you for attending today's conference call in which we will discuss our performance in the third Q of '15. Following the webcast presentation, we will answer your questions. We will begin this presentation by giving a brief update on the outlook for the Chilean economy in 2016. Regarding the economy, there is a growing consensus that the growth figures have stabilized and for the first time this year we have not modified our outlook for GDP growth in 2015 and 2016. We do not expect a strong pickup in economic activity next year, but growth should stabilize at levels between 2% and 2.5%. [Indiscernible] should slowly begin to rebound, but average employment, which usually lags the rest of the economic indicators should pick up upwards but still remain at manageable levels. Even though the price of copper has fallen in 2015, the full international oil prices, Chile imports a 100% of its oil needs, and the depreciation of the peso has led to a reversal in Chile's trade balance and clearing account deficits, which has gone from a deficit close to 4% of GDP to an expected surplus of around 1% of GDP this year. Segment [ph] in the corporate sectors continue to contract, but given the diversity of Chile's economy and the fact that the average GDP growth of Chile's main trading partners is relatively high, the economy has done better than other regional peers. This is also reflected in Chile's sovereign risk measured according to CBS's spread, which are still the lowest in the region. Chile's fiscal situation remains robust with net fiscal debt at only 2% of GDP. All in, this is translated into a relatively supported macro environment for banks. For this reason, our expectations for loan growth have not changed at 8% to 9% growth in 2015 and 2016. Loan growth in the banking system has low exposure to the mining commodities and greater exposure to non-mining exports that are doing relatively well. The stability of employment has also led to positive momentum in recent banking activity. Now we will give further details into the encouraging achievements we have obtained in our core client business this year. The bank remains currently committed to its current strategic objectives that we have been pushing since mid-2012. As we will see in the rest of this presentation, the bank's business momentum has been solid. We continue to see sound loan growth, especially in those segments with the highest risk adjusted contributions. Our funding mix is also improving, as growth has not only been focused on the lending side, and our loan lending business has also been growing at a rapid pace. We have seen a continued improvement in our client base, on our cross selling and customer satisfaction levels. At the same time, the evolution of our asset quality indicators also shows that the change in our period approach has been positive contributors to the bank's profitability. Our capital levels also remain robust, allowing us to continue paying an attractive dividend. All of the above should allow us to continue to achieve an optimal balance between our recurrent equity and our cost of capital. By maximizing this gap, we should be able to expand shareholder value in a consistent way. In terms of our first strategic goals, loan growth has evolved quite heavily, focused on high income individuals and the middle market of corporate segments that tend to have a higher risk adjusted profitability. As a side note, loan growth was also affected this quarter by this inflation gain resulting from the depreciation of the peso and the higher variation of the inflation rate. Loan growth adjusted by these two elements was approximately 2.3% Q-on-Q and 9.2% year-on-year, in line with our guidance in previous earning calls. Retail banking loans increased 3.3% Q-on-Q and 12.2% year-on-year. The bank focuses on expanding its loan portfolio in mid to high income segment individuals and large sized SMEs, which obtained the highest loan spread net of risks, attractive funding and generates higher fees. Loans to individuals increased 3.3% Q-on-Q and 14.8% year-on-year, led by growth of loans to the mid to high income that increased 4.5% Q-on-Q and 17.3% year-on-year. With the initial mortgage loans expanded 4.3% Q-on-Q and 18.3% year-on-year; the growth of residential mortgage loans was partially explained due to the high demand for purchasing new homes before implementation next year of an increased value added tax over the price of new homes. For this reason, the growth rate of these products should decelerate by year-end and throughout 2016. Loans to SMEs increased 3.2% Q-on-Q and 3.4% year-on-year with loan growth focused on larger SMEs that also generate non-lending income. Loans in the middle market segment increased 3.5% Q-on-Q and 15.5% year-on-year. Loan growth in this segment was focused on mid-sized exposures, which are benefiting from stronger external conditions and the weaker peso. The bank's strategy of focusing equally on lending and non-lending businesses has also led to strong deposit growth. Deposits increased 2.2% Q-on-Q and 15.3% year-on-year. The bank continued to focus on increasing its core deposit base. Total core deposit increased 2.3% Q-on-Q and 11.3% year-on-year, led by a 16.1% year-on-year rise in non-interest bearing demand deposits. Demand deposits, as seen in the chart, have grown at double digit rates in all segments. We also have seen a rise in various market share metrics. Since 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 120 basis points. We believe that these market share gains have been achieved with higher quality clients, as we have been steadily improving customer loyalty and customer service. This is our second strategic objective. In the third Q of '15, the bank achieved positive net client growth for the tenth consecutive quarter. Only 15% of our customer base, meet our new loyalty standard, reflecting the large potential for further growth. Among our individuals, clients that are cross sold, measured not only in terms of how many products they have, but if they them used it intensively, increased 9% year-on-year. A similar situation can be observed in the SME segment, where cross sold clients rose 16% year-on-year and 10% among our middle market customers. This has been achieved with the bank's leading CRM systems and improvement in client service levels. In terms of our third strategic growth, our strategies resulted in a stable evolution advance of quality, a key element to obtain higher margins net off provisions and we continue to have robust core capital ratios, as already explained. The bank's total non-performing loans ratio improved to 2.5% in 3Q '15, compared to 2.7% in 2Q '15 and 2.9% in 3Q '14. Total coverage of non-performing loans in 3Q '15 reached 114%, compared to 104% 12 months ago. Improvement of most of the bank's asset quality metrics, continue to reflect the change in the loan mix. The focus on pre-approved loans or repaid to our CRM and the improvement in asset quality in SMEs and the strengthening of our collections area. On Slide 15, we have included an evolution of consumer loans and total loans to individual deemed eligible. These graphs reflect the non-performing loan ratio 12 months after our loan has been dispersed. So for example, a consumer loan dispersed in March 2011, 12 months later has a non-performing loans ratio of around 11%, compared to a consumer loan dispersed in June 2013, which 12 months later has an NPL ratio of 5.4%, reflecting the improvement in our origination process. This also shows that the incoming client continues to be of a much higher quality than the outgoing one, especially since the different changes in our risk models and policies implemented in mid-2012. Despite the sustained improvement of asset quality in consumer lending, the bank's Board and Management have proactively decided to further report consumer loan refinancing policies due to expected rise in unemployment in 2016. This should increase charge-offs in the short-term and reduce our exposure to the lowest-end of the consumer loan segment, which we have been gradually exiting in the past three years. These, in time, will allow the Bank to further increase the profitability of its retail banking unit, reduce non-performing consumer loans, boost coverage and maintain a positive outlook for the asset quality in 2016. We're aiming to achieving a cost of credit provisions over average loans of between 1.2% to 1.3% by 2017. Concerning risk models, in January 2015 Chilean banks, in accordance with rules adapted by the Superintendency of Banks, must implement a new standard credit provision model to calculate loan losses allowance for consumer, commercial and residential mortgage loans. These new models will mainly affect mortgage loans, but will also have some impacts on loan losses allowances levels for consumer and commercial loans analyzed on a group basis. The main modification is the inclusion of a greater provision requirement for mortgage loans with a loan to value of greater than 80%. Santander Chile is currently adjusting its models to this new requirement and expects to recognize the yearly impact of this new regulation in the fourth quarter '15, subject to regulatory approval. We estimate that the measure will signify a net pre-tax cost of up to CLP50,000 million in the period. Following this charge, the coverage ratio of non-performing loans should rise to levels greater than 125%. The bank also concluded 3Q 2015 with strong capital ratios. Our core capital ratio reached 9.9% and our total Basel I ratio was 12.8%. Chilean banks are gradually moving towards Basel III. We expect by year-end that the government will send to congress a new banking law with clearer signals regarding the full implementation of these new capital requirements. In any case, Santander Chile, as part of Group Santander, already reports Basel III capital ratios under the European Central Bank model, which although could be different from the standards adopted in Chile, leave us with a core capital ratio closer to 12%, reflecting the conservative levels that Chilean banks maintain. Now I will explain the evolution of our quarterly results. Banco Santander-Chile's net income attributable to shareholders in 3Q '15 totaled CLP129,254 million, decreasing 7.9% Q-on-Q and increasing 17.4% year-on-year. The Bank's ROAE reached 19.8% in the quarter and the efficiency ratio stood at 39.6% in the quarter. In 3Q '15, net income was stable compared to second quarter '15 and increased 10.8% year-on-year. The net interest margin reached 4.9% in 3Q '15, compared to 5.1% in 2Q '15 and 5% in 3Q '14. In the third quarter, client liens, which exclude the impact of inflation on margins, was stable at 4.9% compared to 2Q '15 and 5.1% in 3Q '14. The bank has been able to maintain relatively stable client margins Q-on-Q, despite stable loan yields by improving the funding mix. In the quarter, the bank also counterbalanced the relatively lower yielding asset mix in retail banking and middle market with a rebound in fees. Net fees increased 11.1% Q-on-Q and 15.5% year-on-year in the third quarter. This rise in fees was due to greater product usage and customer loyalty. As a result, retail fees increased 8.2% Q-on-Q and 16.9% year-on-year and fees from the middle market grew 17.8% Q-on-Q and 18.3% year-on-year. Corporate fees also rebounded in the quarter, in line with greater advisory activity in that segment. Provisions for loan losses increased 25.8% Q-on-Q and 3.3% year-on-year in 3Q '15. The cost of credit reached 1.7% in 3Q compared to 1.4% in 2Q '15 and 1.8% in 12 months ago. Charge-offs remained stable in the quarter and loans loss recoveries increased 2.4% Q-on-Q and 21.3% year-on-year. The Q-on-Q rise in provision expense was mainly due to the depreciation of the peso in the quarter and the downgrade of two clients in the corporate segment. The rest of the Bank's segments continued to show steady improvement in asset quality as previously mentioned. All of the above is resulting solid core trends in our business segment. Net operating profits from business segments rose 8.6% year-on-year in the first nine months of '15 versus compared to the same period of 2014. Net operating profit from retail banking increased 10.3% year-on-year and 15.7% in the middle-market. This has been achieved through positive loan growth, an improved funding mix, a rebound in net fees and lower provision expense. These positive results were partially offset by lower results from global corporate banking, which although has seen a solid rise in margins because of the strong demand deposit growth, this has been more than offset by higher provisions. This performance reflects the consistent execution of our business strategy of focusing on those business segments with the highest risk adjusted returns and is notable, considering Chile's relatively low economic growth environment seen during the period. Operating expenses decreased 0.6% Q-on-Q and increased 14.5% year-on-year. The efficiency ratio reached 40.6% in the first nine months of this year and 39.6% in the third quarter. The year-on-year increase in costs was mainly attributable to higher amortization and depreciation expenses, the impact of inflation and taxation and the depreciation of the peso in various cost items, with separate funding counterbalancing hedging financial transactions mix, higher severance payments and greater business activity. As mentioned in previous earnings reports, the growth rate of expenses should begin to stabilize, given the stability in headcount, lower severance payments, greater productivity in the branch network and higher use of the digital banking services. The bank continues to optimize its branch network by closing branches that service at the lower end of the market and opening branches for other segments. The total number of branches in the last four years has fallen by 5% and the loan and deposit volumes per branch have increased by 40%. This increase in commercial [indiscernible] will allow the bank to maintain solid levels of efficiency going forward. In summary, results show positive recurring trends in our business segment. We expect fourth quarter operating trends to be similar with the strong performance of our business segment. Considering the implementation of the new provision standard model defined [indiscernible] bank, we should conclude the year with an all-in ROE's of between 17% to 18%, excluding in the quarter. Excluding this one-time item, the bank ROE 2015 will be in the range of 18% to 19%, in line with previous guidance and well prepared for another sound year in 2016. At this time, we will gladly answer any questions you might have.

[Operator Instructions] Your first question comes from Guillermo Costa. Please proceed.

My question is about the asset quality evolution. We observed that your NPR ratio showed a decent evolution and I would like to ask if you're expecting a deterioration going forward due to the economic slowdown and what sectors, if any, concerns you the most? And my second question is about the standard generic provisions you need to do in the 4Q. What's the average loan to value of your mortgage portfolio? And how much of your mortgage portfolio has a loan to value higher than 80%?

In terms of evolution of asset quality, we think that the aligned trends are generally positive, especially in the consumer side, in the mortgage side and in the mid-size market. We haven't seen any deterioration. That, as we mentioned in the call, is a combination of a mix which we have been for the last two or three years moving to the upper end of the consumer market and to the relatively larger companies. And therefore, the mix effect is helping to maintain asset quality metrics that are stable or slightly improving as we mentioned in the call. And going forward, we don't have basically big clouds of concerns of course, as we saw this quarter. We sometimes, especially in the large corporate segment you have an asset quality progress and the impact is relatively large. But there at the end of the day, it's easier to work with those clients to solve their problems because they are clients with viable business models, [indiscernible] that eventually sometimes we have short-term difficulties. So we don't expect many of those large client provisions to be effective losses at the end of the day. They might be delayed in terms of how soon you recover the money, but we don't have big clouds there. So, the fact that the central economic scenarios that we have seen that -- is sound. The fact that our models have been delivering on the promises, as we saw in the slide we included in this conference call. And the fact that the mix is included, allow us to be relatively comfortable. And that's why we have expectation that asset quality metrics should be stable going forward or with some marginal improvement by the end of next year's dividends. In terms of the mortgage portfolio -- Robert Moreno is also with me and he will give some --

Regarding the loan to value, the average for the full loan book is around 70% to 71%. And I would say we are no longer, or very rarely, giving loans now above a loan to value over 85%. To give you an example, less than 1% of the loan book now of the new sale is over 90%. And I would say more than 50% to 60% is being sold at loan to values, or even greater percentage, lower than 80%. So there is a one-time impact because there are still some loans with loan to values over 80% and that's what the charge will be more or less. This change in provision requirement also has some effects on the margin and consumer and commercial loans, but the big effect is on mortgage and that's what the CLP50 billion charge will cover. And with that, we should be up to date with this new provisioning guideline.

If you [indiscernible] model Superintendency apart from taking or forcing banks to set better provisions for operations with a loan to value higher than 80%, also is very strict in terms of clients with delays in the payments. So what happened is that in a mortgage that lasts 20 years on average, you have many advancing with clients' is basically delays in the payment of this total debt. Now you are forced to radically increase the level of provision to that client, although you know that at the end of the day you won't be losing money because the client has a lot of time to be back in normality, et cetera. And then eventually you have the property to foreclose. So that's why we think it's a very conservative model that is in many cases you also have a client that from a commercial standpoint you go to more than 80% because he has a lot of kinds of [indiscernible] or shares of things that can be used as proof that the guy is wealthy. So we think it's a very conservative positioning model that we have of course to comply. And but at the end of the day, you take a long time [indiscernible], even in the financial crisis of 2007 and 2008 and the previous Asian crisis in the mortgage book, the actual losses has never been higher than 0.3% to 0.4% of the outstanding. So if I think that it simply proves that our regulator is very prudent, which we share that view. But of course, in our case we think this makes basically a provision that is basically ahead. We don't foresee that our relevant share of that will be an actual loss, but we have to comply of course and we prefer to anticipate the recognition of that fees than to wait until 2016 as we could.

Your next question comes from line of Catalina Araya from JPMorgan. Please proceed.

I just wanted to follow-up on asset quality. I see headline NPLs and coverage posted improvements. However, the provision charges rose significantly because of the two specific cases, so my question is do you expect these two companies to become non-performing? And if they do, what would be the impact of the NPL ratio? And then also following up on the credit provisioning, this 50 billion increase is a one-time off, but do you -- what normalized level of cost of risk are you seeing into 2016?

In terms of this corporate client, we cannot speak about specific cases or specific names, but in both cases, are companies with viable models and that there's old incentives to give them breathing space. They're facing short-term difficulties related to very specific issues and of course all the lenders have incentives to give them breathing space, because they have a viable business model. So again, only in extreme cases where somebody really gets too nervous or tries to rush things, we could foresee losses. And that's why we set these provisions against those worst case scenarios but the central scenario is that we should manage to, under [indiscernible], to manage, to do relatively well with delays in terms of how soon we will be paid back, but we don't foresee a loss. This is something that happens every [indiscernible]. It's simply that in the case of large corporate borrowers the receipt [ph] is more difficult. But in the mid-size and the large company segment, this is relatively common. It's difficult to model because they are -- events that happen and you cannot have an operating model for anticipating. What you see is here for more diversified or a smaller client where you have a large sample of clients to anticipate. In terms of the ongoing cost of credit paper, as we point to the aim for the year, we will finish closer to 1.5 or something like that, yes. And we think that as we put in our call, or as we mentioned in our call, that in 2017 we could be around 1.2, 1.3. So in 2016 especially by the end of the year probably approaching 1.4 or something like that, in a gradual slowdown of that figure. And as I mentioned before, the key elements there are our more robust for origination process and the fact that our mix, although it's lower yielding, which could use some spread, is basically better quality and the [indiscernible] are good enough that the claim has foundation. With our origination process is smoother and that the mix we have -- should be lower risk and therefore it's reasonable to approach levels similar to other larger banks in Chile.

Your next question comes from Philip Finch from UBS. Please proceed.

Really just one question from my side, and that's regarding your net interest margins. In the past week we saw a positive correlation between inflation and margins. In the third quarter, as you pointed out, inflation was stable and yet we saw a 20 basis point decline in net interest margins. So can you explain first of all why this relationship broke down in the third quarter, what were the drivers? And going forward, what can we expect in terms of the outlook from the interest margins? Will we see further compression?

In terms of net interest margin and the stated inflation, as you correctly point, the correlation is positive. Banks by the natural commercial growth tend to create a gap. They have [indiscernible], it's linked to inflation and liability. And what we do every once in a while is manage the gap so to anticipate what will happen with inflation going forward. In our case, our view is that the Central Bank has already started taking actions to reduce the headline inflation to something closer to a 3% level in the next -- they have a horizon of around 24 months. So what you do is you start taking actions to reduce a little bit that gap in anticipation to lower inflation rate. And that's why the correlation being positive is not one-to-one, especially on a quarter-by-quarter basis. This correlation is clearly, when you smooth out and take three, four quarters moving average but with the ratio it's much more [indiscernible]. So it's simply a reflection that we said we are sharing the view that the Central Bank will have a [indiscernible] space in terms of controlling inflation, which has been running on a little bit ahead of the essential target that has been set by themselves. And as a consequence you tend to adjust your structural balance to face that reality. So the market and we share that, we expect next year inflation to be lower than this year and simply you're moving the structural balance to face that reality. In terms of client margins, we think that we are very much finishing this process of a change in the mix that started three or four years ago. We still have a long priority originated before 2012 [indiscernible]. We think that the conversion of the client mix is to the large extent happening. And next year we should see relatively stable net interest -- decline in net interest margin. Because as we try to put in the conference call, this year the drag on the client net interest margin has been because we have been growing abnormally fast in mortgages, which is by far the assets have yields with lower spreads.

Your next question comes from Alonso Garcia from Credit Suisse. Please proceed.

Regarding the 50 billion provisions charge, I would like to clarify if it's going to float with the P&L or if it will go directly to shareholders equity.

No, the superintendency has not yet fully stated, the course is very likely that will go to P&L and that's why in principle, of course we will follow whatever the superintendency decides, but it's very likely that will be against P&L.

Your next question comes from Peggy Koury of Hartford Investment Management.

I want to talk about asset quality too. You mentioned the reasons for why the provisioning rate went up third quarter and one of the reasons you gave was because of the currency depreciation. Could you elaborate on that a little bit? And specifically, are you making foreign currency loans? And secondly, can you tell us what sectors, what industrial sectors those corporate clients are in that are having a little bit of difficulty? Thank you.

What happened is the following that our foreign trade loans that represent like 14% of the loan book are denominated mostly in U.S. dollars. And as a consequence, the provisions you have to set aside also is expressed in terms of U.S. dollars. Your provisions say 1%, meaning that you have a dollar equivalence of provisions that are earmarked for these loans. So when the depreciation of the currency is like in the previous quarter, like 9%, you have that amount of provision has to be adjusted by the translation effect. So what is beneficial from loan growth and that's why we try to eliminate that in our report, it's also equivalent in the provision side that we have gross up your provisions simply to keep up with a new exchange rate. However, as we explained in our press release, we have very little [indiscernible] position all our book. What we do is we close that gap, but from an accounting standpoint, the bad news is that provisions are grossed up, but the good news is that you have an equivalent profit on the financial transaction line reflecting that we have covered that translation gain or loss, because sometimes it can be a loss. So at the end of the day, has no impact from a bottom line perspective, the different changes of translation in different lines of the profit and loss statement because it's already hedged. But of course it can gross up line specific. Because in the same case with the emulous [ph] cost, we have, for example, [indiscernible] denominated in U.S. dollars, they are grossed up in the cost line, but you have an equivalent profit on the financial transaction side that counterbalance they do. So that's why from a profit and loss statement or from a net income basis, the changes in exchange rate, that can have a relevant impact, but of course you have impact in other lines, especially cost provision, et cetera. The reverse is also true, that when, for example, the peso strengthens, you see the opposite effect. You have lower provisions, you have lower costs, but of course you have a loss on the financial transaction, and that's why it's relatively neutral from a net income standpoint, but has impact in -- simply where we highlighted this quarter because depreciation of 9% on a quarter is something completely unusual. In terms of sectors, we don't have any concern about specific sectors. The two clients that we mentioned are completely unrelated, they affect us. And the rest of the players in their own sector are also sound. So that's why it's very [comprehensive] specific issues and not necessarily sectors specific issues.

Thank you, I can follow up with one question. These foreign currency denominated loans you're making, are they strictly to companies?

Yes, they are companies. Mostly foreign trade loans for import and export.

Great.

And very short term.

[Operator instruction]. Your next question comes from Juan Dominguez. Please proceed.

I have a couple of questions regarding net interest margins. The first one is I wonder if you can provide us some color on the margin of maneuver the bank has to keep its structural balance in [foreign language]. And the second one is related to the client margin. You already said that you'd expect this have in client margin. But under a scenario of a still a mild demand of credit, and considering a less expansive monetary policy, I wonder if you can elaborate on what are your expected trends, especially on the cost of funding side. You already said that due to a change or a relatively stable mix in terms of mortgages, consumer and commercial lending you don't expect major changes in your deal and loans. But I wonder if you can provide some guidance on cost of funding. Thanks.

Okay, sorry, didn't understand the first part of the question. In terms of means and how they are impacted, the impact of writing short-term interest rates is [indiscernible] at the beginning, because basically you are repricing your liabilities at a faster pace than your assets. And that's why interest rates tend to compress shortly our net interest margin. However, very rapidly, the once you have repriced most of your liability, you have two counterbalancing effect. Number one is that -- well, actually this is very-very fact as well. That you start making more money on your demand deposits, which are 99% are non-interest bearing. So that tends to counter a little bit the effect, the negative effect of the repricing. You tend to compensate by giving a high return on your demand deposit. And the second element that is positive is that you start doing the repricing on your assets as well after a time. And that's why typically when you see interest rates increasing, you see a short-term margin compression followed by a margin expansion. And that process tends to last three, four quarters, more or less. In terms of cost of funds, it's basically the same, that at the end the time deposits are more expensive, but at the same time, the profitability of your demand deposit is wider because of the fact that most of them are non-interest bearing and you can reinvest those funds at the higher marginal rate.

Just a follow-up on that answer, I mean to what extent you could translate increasing cost of fund into your clients in that scenario, which seems pretty completed right now.

It's a challenge, but it can be done because at the end all the market will be facing more or less the same -- in the same incremental costs. So again, on this there is something really trying to reduce the stated profitability, which I guess nobody wants. At the end you try to pass prior incremental costs and given that everybody has the same expenses, it's meant to happen. Not instantaneously, but very rapidly you pass it to your customers. Because, it's something that is completely coming from the outside, it's an external condition that is common for all the players.

There are no further questions in queue at this time.

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.