Banco Santander, S.A. Q2 FY2023 Earnings Call

Good morning, everyone, and welcome to Banco Santander's conference call to discuss our financial results for the first half of 2023. As a reminder, both the results report and presentation we will be following today are available on our website. I am joined by our CEO, Mr. Hector Grisi, and our CFO, Mr. Jose Garcia-Cantera. After their presentations, we will open the floor for any questions you may have in the Q&A session. Now, I will hand it over to Mr. Grisi. Hector, the floor is yours.

Thank you, Begona. Good morning everyone, and thank you for joining us. Let me just share with you what we will focus on today. First, I will talk about our half one results in the context of how we are progressing with the strategy we outlined at our Investor Day. Jose will then review our financial performance in greater detail. And then, I'll conclude with a few closing remarks. Despite the challenges the financial system experienced at the beginning of the year, Q2 was another strong quarter for Santander demonstrating the strength and resilience of our strategy and unique business model even in times of market volatility. We delivered record profit of €2.7 billion, an increase of 14% compared with Q2 in ‘22, thus plus 17% in constant euros. In the first half of ‘23, profit was €5.2 billion, up 7% supported by robust customer revenue growth. Revenue increased double-digits year-on-year, supported by all regions and global businesses. Global scale and network businesses are contributing around 40% of total Group revenue. Our number of customers grew by nine million year-on-year, taking the total to 164 million, and loans increased by 1% and deposits by 5%. The Group continues progressing towards a simpler and more integrated model through One Transformation. The program that is accelerating our structural model change to drive efficiency improvement, and growth in profitability. As a result, our efficiency ratio improved by 1.3 percentage points year-on-year to 44.2% and our net operating income grew double-digits. Our return on tangible equity (RoTE) rose 80 basis points year-on-year to 14.5%, while our earnings per share improved 13% year-on-year supported by greater profit and share buybacks. At the same time, our strong balance sheet with solid and sound capital ratios, liquidity at comfortable levels, and robust credit quality contributed to solid profitable growth, value creation, and shareholder remuneration. These results allow us to deliver value creation in terms of TNAV per share plus EPS year-on-year of 11%, which represents an increase of more than €6 billion in the first six months of the year. Moving on to the income statement. Firstly, remember that as we usually do, we are presenting growth rates, both in current euros and constant euros. This quarter, there was no material difference between them. As I have just mentioned, profit increase in the first half, supported by, first of all, a strong line performance with all the regions and global businesses growing; cost in line with our expectations growing 1% point below the rate of inflation; double-digit growth in net operating income to approximately €16 billion, which demonstrates the strength of our results; and low loss provisions normalizing land with our expectations. These trends resulted in our highest quarterly profit on record, 4% higher than in Q1, even after the following impacts, net of taxes recorded in Q2. The SRF contribution of more than €200 million and additional Swiss mortgage provisions in Poland of €140 million and one-offs in Brazil of €137 million. Jose will go into more detail on all of these points later on. This was a great first half, that makes us confident that we will deliver on our 2023 targets. Good business dynamics are translating into double-digit revenue growth; our efficiency ratio improved as a result of good cost control and revenue trends; our cost of risk remains contained in line with our target of keeping it below 1.2% at year end. CET1 was 12.2 after profitably growing our businesses organically, and at comfortable levels allowing us to accrue funds to meet our shareholders’ remuneration targets of a 50% payout. Our RoTE also grew year-on-year to 14.5, on track to reach our target, it would already be close to 15% if we don't analyze the extraordinary banking tax on revenue earned in Spain. As we announced at our Investor Day, we have entered into a new phase of value creation that will help us grow TNAV per share plus EPS at a double-digit rate during the year – or through the cycle. I like to spend a couple of minutes updating you on the progress of our transformation plan, now that we are six months down the road from our Investor Day. We are transforming the bank in the right way because we're structurally changing our model to improve both cost and revenue. We are making great progress in the implementation of One Transformation, creating a common operating model and technology for our retail business across our entire footprint. To better serve our customers and improve efficiency and increase the size and profitability of our customer base, we are delivering across the three pillars of One Transformation. In simplification, we have already reduced by 5% our number of products; nearly 400 fewer products in 2023. We are progressing in our digital self-service model, increasing the availability of products and services in our digital channels, and reducing the use of our contact center by 17% just alone in the first quarter of 2023 compared with the same period last year. We are digitalizing the onboarding process and to enter in Mexico. This initial pilot has resulted in a 36% growth in digital accounts per month, compared to those in 2022. And we have already captured around €70 million in savings so far in the U.S. from transformation and simplification initiatives. As you can see on this slide, the initial efficiencies for One Transformation, and the impact of our good sprint management in a context of higher interest rates which our CFO will cover later in depth, have already contributed 85 basis points in efficiency improvements. Our Global and network businesses keep contributing to the Group's profitability and have already delivered another 43 basis points. Multi Latinas and multi Europeans, our initiatives to better serve our Multinational corporates and SMEs through regional coverage model are growing at very high rates with revenue increasing by more than 70% year-to-date. In asset management, we have progressed to enter the alternative business, starting to serve open market and institutional segment and has reached more than €2 billion in commitments already. In payments, we have deployed in Portugal and Argentina in the first half and we expect to launch latest in Chile, in the second half. In Auto, we're increasing our management of OEMs and retail relationships globally, expanding our partnerships in Europe to LATAM and the U.S. We have recently onboarded new partners in the U.S., leveraging the existing agreements in Europe, which are expected to materialize in around €4 billion of new business per year. We have also deployed a new parent regional leasing platform in two markets and more countries will be added throughout 2023 and 2024. Finally, our global technology capabilities have already resulted in a 36 basis points improvement in the efficiency ratio. Our Global approach to technology has allowed us to capture €80 million in savings this year, mainly driven by One Transformation and efficiencies from the recent development and deployment of Gravity in two countries, which has contributed to €31 million in savings in the first half. A new global agreement with vendors, which represents around €40 million in cost reduction year-to-date. The actions that we are beginning to carry out as a part of One Transformation, which we are expanding across the Group, are starting to be reflected on cost and operational efficiencies. As you can see on this slide, simplification has already driven significant improvements in our cost and revenue per active customer ratios. The solid progress we are making with the process digitalization and automation to capture efficiencies enables us to spend less time on operations in branches, and turn the branch network into a powerful sales and advisory channel. Portugal has already taken out most of the operational activities from the branches freeing up branch employees so that they can spend more time supporting customers and commercial activities. We're extrapolating this to other of our banks. In only six months through One Transformation, we have already reduced the number of operational FTEs per million customers by 3%. We are already deploying global tech platforms to improve customer experience, leverage economies of scale and extend best practices. Open Digital Services, as we call it, ODS, our cutting-edge front-end platform allows us to deliver a best-in-class omni-channel experience to our customers. At the same time, Gravity, our award-winning core banking platform drives significant efficiencies versus mainframe technology. We have integrated both in the U.S., so we will operate on an end-to-end cloud-based retail technology stack core and omni-channel, which is already tested and will result in significant improvements in service quality and customer experience. Our global and network businesses continue to contribute to this new phase of value creation. In CIB, we continue growing strongly after record performance in 2022, beating the market. Our global presence has allowed us to grow at 24% year-on-year, well above the average annual growth target of 10% for the period ‘20 to ‘25. Because, first of all, we can provide a One-Stop shop service to our clients across all geographies, thereby capturing cross-border flows and because we bring CIB products and services to all wealth, retail and commercial clients across a group and vice-versa. As a result, revenue related to these two concepts, which we call network revenue, grew 27% year-on-year to €2 billion. Wealth management and insurance grew 25% year-on-year, well above our target, and this has been boosted by the finance benefits obtained from the Santander network effect. A fundamental part of our value proposition in private banking is how unique that combination of local presence and global reach is. Our customers can move and transact easily from one country to another, and that's the reason why customers have €50 billion in assets under management abroad, 10% higher than one year ago. Our payments business is also growing very strongly. Two years ago, we began to move our payments business onto scale global platforms. And, as of today, our payments platform already manages a significant part of all payments in the Eurozone, and we are progressing in other key countries such as Brazil, Mexico, and the UK. We are in the process of expanding our cards platform across the Group, delivering real-time digital processing capabilities to our banks, accelerating our business growth, as well as generating operational synergies of around €100 million per year during the next two years alone. The first delivery of the platform will be live in Brazil by the second half of 2023. In Auto, we continue to prioritize profitability and our market share growth in a context of rising interest rates. Our transformation plan, which is making us much more efficient and increasing the contribution of our global and network businesses, is helping us reach our 2025 profitability targets across all regions and businesses. As I mentioned earlier, the Group's RoTE rose 80 basis points year-on-year to 14.5% and would be around 15% if we didn't analyze the extraordinary banking tax in Spain, which is in line with the Group's targets for 2022 - sorry ‘23 and ‘25. Jose will now go into more detail through the Group’s first half performance. Please, Jose.

Thank you, Hector, and good morning, everyone. Our growth in volumes and fees in Europe and Latin America has been positive. The Digital Consumer Bank benefited from asset repricing actions and gains on financial transactions due to foreign exchange hedges. We also experienced strong performance across our businesses, with the exception of Auto, which faced challenges from lower leasing income in the U.S. due to an increase in end-of-lease vehicles repurchased at the dealership. Revenue at the corporate center improved by nearly €400 million, thanks to higher liquidity buffer remuneration and a reduced negative impact from foreign exchange hedging that affected revenue last year. The majority of our revenue growth was driven by net interest income, which saw a 6% increase in the quarter, particularly in Europe. We anticipate further growth in the upcoming quarters. The first half of 2023 showed a 15% year-on-year increase in constant euros, supported by positive sensitivity to rising rates, particularly in Europe and Mexico, along with volume growth in Auto, North America, and South America, which offset negative duration sensitivity in Brazil, Chile, and Auto. In terms of profitability, we have been improving our margins every quarter since the first quarter of 2021. We are actively managing our credit spreads to maximize the benefits from the higher interest rate environment. Gains from credit yields have outperformed higher funding costs, thanks to our disciplined deposit remuneration strategy tailored to each country's specific needs. In Europe, we are carefully managing deposit costs, especially in Spain and Portugal, where there is excess liquidity and lower credit amounts. The UK environment remains competitive as anticipated. In LATAM, deposit rates are closely linked to market interest rates, leading to negative sensitivity but promising margin benefits when rates begin to decline in the coming months. In the U.S., deposit betas have increased due to heightened competition following the collapse of Silicon Valley Bank. Overall, net interest income sensitivity to interest rates has resulted in €500 million above the projections we provided during our Investor Day. Therefore, we remain on track to achieve our double-digit net interest income growth guidance for 2023. Turning to fees, despite a generally low fee growth landscape due to weak loan demand, our net fee income rose by 4% in the quarter year-over-year and by 5% in the first half. CIB and PagoNxt are at the forefront of this growth, with CIB increasing its share of prominent roles and mandates, and PagoNxt expanding total payment volumes by 25% year-on-year, with transactions increasing by 32%. We also recorded strong performance in card activity, with turnover growing 9% year-on-year and fees increasing by 20%. Retail banking continued to grow, mainly due to an increase in customer numbers and transaction volume. Wealth management and insurance saw slower growth as customers shifted towards lower risk, fixed income products with reduced fees and margins. However, we observed improvements in private banking, with net new money of €6.5 billion and over €3 billion in net sales for Santander Asset Management. The Auto segment's year-on-year performance was impacted by new insurance regulations in Germany in the first quarter but made a significant recovery in the second quarter. Our transformation efforts, as mentioned by Hector earlier, are starting to yield results despite initial investments; real-term costs are growing at a slower rate than inflation across most of our footprint, reflecting the savings from our stringent cost controls. This is evident in the efficiency improvements in Europe, which saw a seven percentage point increase, driven by strong revenue gains alongside a 2% decrease in real-term costs. Consequently, our Group efficiencies have reached the lower end of our target range, where we expect to remain for the remainder of the year. Credit quality is robust across our footprint, with a stable non-performing loan ratio against a backdrop of expected soft lending and strong labor markets, as unemployment rates heavily influence credit quality. Notably, Brazil has demonstrated positive trends due to the more selective lending policies we implemented 18 months ago. We mentioned last year that we believed the Brazil NPL ratio had peaked, and current trends support that, with a nearly 60 basis point improvement year-to-date. Our cost of risk remains comfortably aligned with our 2023 target of staying below 1.2%. Spain continues to perform well, with a 12-month cost of risk down 16 basis points year-on-year, owing to the quality of the loan book and improving macroeconomic conditions. The normalization in the U.S. is proceeding but shows more resilience than expected. Brazil's cost of risk remains elevated due to the unsecured individual borrowers portfolio; however, we are observing signs of stabilization, with a 12-month cost of risk of 4.74%, which annualizes to 4.5% for the first half. Mexico is increasing from a low base, mainly due to a shift towards unsecured loans that necessitate higher upfront provisions but are also more profitable. Other regions like the UK, Portugal, and the digital consumer bank are rising but remain below cycle averages. Regarding our balance sheet structure, as discussed in earlier presentations, our credit portfolio is well diversified by segment, product, and country, resulting in a low-risk profile. The portfolio is highly secured with quality collateral and low average loan-to-value ratios. Year-on-year loan growth remained flat in constant euros, as gains in auto and consumer lending were offset by declines in CIB, particularly in Spain from high levels in 2022, as well as mortgage reductions due to early repayments in Europe and slowing corporate demand in Europe as well. We saw positive dynamics in North America, South America, and the Digital Consumer Bank. However, deposits have continued to show strong growth, up 4% year-on-year following a €3 billion increase in the second quarter in constant euros, reflecting successful customer acquisition that outweighed mortgage prepayments. Growth was primarily in time deposits as customers sought higher rates. Our deposit base is highly diversified and stable, with 75% of our deposits being transactional, which are generally stickier, and a substantial percentage of individual deposits being covered by deposit guarantee schemes. We have not witnessed any unusual deposit movements year-to-date amidst market turbulence, particularly in the U.S., where deposits have grown and remained stable year-to-date, indicating market share gains along with an average cost lower than that of our main competitors. Mutual funds have started to recover, rising 4% year-on-year following a year of instability in 2022. To conclude, our fully low-risk capital ratio is comfortably at 12.2%, supported by robust organic capital generation, which increased again by 10 basis points net of dividend accrual in the quarter. We accounted for the payout to minority shareholders in Mexico, which reduced capital by four basis points, alongside various minor positives and negatives that mostly offset each other this quarter. We are focused on profitable growth opportunities, reflected in a front book return on risk-weighted assets of 2.9%, up from 2.5% in the first half of 2022, corresponding to a return on tangible equity exceeding our current group return on tangible equity, which will bolster future profitability. Additionally, we are enhancing balance sheet mobilization and increasing the share of risk-weighted assets contributing positive economic value added, making good progress towards our Investor Day target of 85 by 2025. This boosted profitability will assist us in building capital over the next several years, and we are confident our capital ratio will remain above 12%, even after the final implementation of Basel III on January 1, 2025. Let me return it to Hector for his concluding remarks. Thank you.

Thank you, Jose. In summary, Q2 of ‘23 was another strong quarter supported by customer growth, double-digit revenue increases, and also backed by strong performance by all the regions and businesses. We are accelerating the structural change to a simpler and more integrated model through One Transformation spreading the initiative all across the Group, which is driving efficiency improvement, and also profitable growth. A rock-solid balance sheet and robust credit quality are contributing to growth, value creation, and shareholder remuneration. In summary, we have a very strong first half of the year, and we are confident that we will achieve our 2023 targets and remunerate our shareholders in line with our 50% payout policy supported by our global and network businesses while we continue with our structural model transformation. We see upside potential for further net interest income growth in the coming quarters, as tailwinds in Europe and Mexico are expected to remain, and inflation and interest rates in our largest Latin American countries seem to have picked or nearly picked resulting in a positive outlook for margins in the next 6 to 9 months. Cost of risk is normalizing in line with our expectations. In a context of an expected soft landing of the economy and a strong labor market, we continue to see resilient customer and corporate behavior in most of the geographies. Group RoTE has reached 14.5% in the first half, and we expect to close above 15% at the end of the year. All in all, our TNAV plus cash dividend is growing at a double-digit rate, well on track with our target of average growth through the cycle. And now, we will be happy to take any of your questions. Thank you.

We already have the first question from Carlos Peixoto from CaixaBank BPI. Please go ahead.

Hi, good morning. Thank you for taking my call - my question. The first question would actually be on Brazil. Margin stabilized quarter-on-quarter, it’s still a bit under pressure year-on-year. I was wondering what evolution you expect for the rest of the year? And also on cost of risk what's the outlook there? Then the second question would actually be on capital. So basically, the capital generation in this quarter was only three basis points, a bit below the run rate you have discussed in previous quarters. I reckon that this partially has to do with the Mexico minorities incorporation, but I was wondering how do you see this evolving throughout the rest of the year? And also, what is behind the increase in RWAs in this quarter? Thank you very much.

Thank you, Carlos. What I'll do is, I'll – last - the first question on. Brazil we will give you a comment on capital and then Jose will tell you a little bit about what's going on with increasing RWA, okay? In terms of the Brazil margin quarter-on-quarter, as we say, basically is explained by the following: our launch since 2021, we have become much more conservative and growth – grown volumes very selectively changing the loan mix to lower risk. Okay? So we mainly get out - we're out of credit cards. Went on to Consignado, auto loans, and mortgages. On deposits also, the fast increase in rates has meant a rapid rise in the cost of deposits, okay, as well as a change of the mix on the deposits. Rates staying higher for longer has prevented the cost of deposit from coming down impacting NII. Remember that in Brazil, we have negative sensitivity to rates, okay? So Brazilian NIIs in the second quarter of ‘23 is already flat. Okay? As we set and Jose was very precise on that the worst is behind us, and we are already seeing a reduction on the average cost of deposits, and we also see an improved customer spread. Okay? So we expect NII in the second half of ‘23 to be higher than the first half of the year leading to a flat NII in the year with a substantial improvement in ‘24, okay? In terms of the cost of risk, not only the macro outlook is improving, but since ‘21, I just – I explained, we've been very selective in the approach of the new lending extension and focusing on more secure and higher rate customers as I explained, okay? This is showing good results, and we believe the worst, as I said, is behind us now. Cost of risk in the second quarter is already improving versus the first quarter, and the vintages are showing really good performance as we have seen. So we don't expect cost of risk that will deteriorate in Brazil in ‘23 versus ‘22, excluding the one-off that which implies staying close to around 4.6%, okay? And then, to be on capital to be very precise, we expect to generate at least 10 basis points of organic capital on average per quarter with the current shareholder remuneration policy that we put in place. As a result, we will be on track to meet our target to be above 12% even when the final implementation of BASEL III comes into effect on January 1st ‘25, okay? And with that, I don't know, Jose, you can comment on RWAs please.

Yes. Thank you, Carlos. You are right. Loan growth was zero, but risk-weighted assets grew more or less than 2%. Half of that growth is due to FX as we consolidate the Latin America, basically, the peso and the Brazilian-based assets into the Group. Of the other half, half of the other half, so a substantial amount corresponds to stock finance. And this is due to the recovery of the new auto business in Europe. This will eventually translate into auto loans, so this is obviously short term that will eventually lead to higher profitability going forward. When we look at the outlook, as Hector said, we don't expect any significant regulatory or supervisory capital impacts in the second half of the year. We see no inorganic charges in the second half of the year. Obviously, it looks like the available-for-sale portfolio valuation also will stay relatively stable. We see improving profitability, as we have mentioned, particularly driven by higher NII in the second half. An increased weighted assets should be probably under control. So net-net, we see stronger organic capital generation in the next couple of quarters again, leading to a capital that will remain well above 12% every quarter and building up sufficient capital to be above 12%, post BASEL III.

Thank you Hector, and Jose can I have the next question, please?

Hi, good morning. Thanks for taking my questions. A couple of questions from my side, on the U.S. and Spain. U.S. has obviously done much better in provisions. I know you've touched on it a little bit, maybe you can give a bit more detail as to why the provision was so low in the quarter? Is it collateral? Is it default rates? And when you think about the rest of the year maybe you can update us about the guidance. Would you expect costs of risk for the full year? I think you gave us some color in Q1, maybe an updated view on the moving parts there. And the second question on Spain. Deposit is much more stable this quarter, previous quarter. I wonder if you can give - again a bit more color on the deposit migration and remuneration and when do you expect NII to peak in Spain, I am extrapolating, Spain, Portugal, which I assume have the same dynamics. Thank you.

Thank you, Alvaro. Okay, let me give you our outlook in the U.S., okay? And I explained it – it’s basically the same dynamic I explained in the first quarter, okay? Credit provision, as you know, decreased as credit quality is remaining robust, and credit net charge-offs actually, what we call realized losses show better than anticipated performance. And this is basically on the back of used prices continuing to be strong, okay, as I explained, and declining at a slower pace than we previously anticipated. The changing out to loan portfolio mix of our subprime, do you remember that I told you that before 2018, we had a lot more subprime than prime, and the change on the mix has helped. Also, we have a robust and better than expected labor market in the U.S., okay, which is sustaining that, okay? And out of customers that are delinquent exactly as I was explaining in the first quarter for more than 90 days are rolling into charge-off status at historical low levels, okay? Normally, they were above 90%, 95%. Last quarter they were around 59%, this quarter around 67%, okay? So it's still much better than we expect and much better than it was actually happening pre-COVID, okay? And in 2023, we expect cost of risk to continue on the normalization at around 2%. And after two years of artificially low figures given COVID, etc., as I was saying, normalized levels should be below pre-pandemic, costs of risk at around – you remember, pre-pandemic was around 285, it’s never going to get there, okay? Because of the change of mix and what I was explaining, okay? In terms of Spain, okay? In Spain, the deposits, I mean, continued to be stable, okay, at around €299 billion, okay? We have excess liquidity in Santander Spain, LTVs around 78%, as is the case for the whole Spanish system that is around 80%. Quarterly claims are most linked to CIB deposits, flat in retail in the quarter despite the early repayments of mortgages, okay. 60% compared to the same period of 2022 and increased volume of deposits moving off-balance sheet products. Also, what we see between the first half of ’23 versus the first half of ’22 is plus 0.9% okay? So we have a different change of the mix with time deposits going up at around 61% year-on-year, while demand deposits are going down around 5% on the back of the higher rates, driven by the growth of CIB, which allows us to maintain also - and maintain a stable net liquidity position, okay? In terms of - what I was saying NII, we don't expect to peak yet. I mean we have still revisions and I will have horses playing in detail exactly how we’ll see an evolution in Spain.

Good morning, Alvaro. Let me talk about all the Corporate Center, because Santander SA more than and Spain, because this is going to give you a better view of our Euro sensitivity to rates in Spain. So we have assets of €330 billion, with 60% floating and 40% fixed. This fixed includes the ALCO, which is €27 billion that we've been buying recently with an average duration of six years on an interest rate of over 3%. We also have intra-group transactions, etc., money markets that are fixed, but these are very short term. So they will reprice as short-term ULIBOR actually goes up. Of the floating €200 billion, €65 billion will reprice or reprices with 12-month ULIBOR. We expect that if we use today’s ULIBOR, compared with the average of the first half, so let’s assume that the ULIBOR remains flat in the first half of next year, we have at least a 50 basis point pickup in the repricing of this part of the portfolio next year. And then we have €30 billion that reprices with a six months, €40 billion with three months, and €65 billion with one month. So, we would still expect significant repricing upwards in the first half of next year, as interest rates in Europe may go up once or twice, but as they stabilize, we will still have significant repricing of a big chunk of the portfolio in the first half of next year. So obviously, the asset yields are expected still to expand well into 2024. Obviously, margins will depend on the cost of deposits but as Hector said, we are not seeing any pressures today to increase the remuneration of retail deposits. We are already paying almost ULIBOR for CIB deposits, institutional deposits, but we don't see any pressures on the retail side of deposits, which means that probably the peak in net interest margins will not happen until well into 2024 in the Eurozone.

Thank you, Alvaro, for the questions and Jose and Hector for the answers. Can we have the next question?

Wanted to ask about NII in the UK and in the U.S., if you can please update your guidance in the UK. I see lending is weak following a local mortgage market that is declining, asset spreads are low, and the deposit betas are still relatively low. How do you see all these dynamics going forward and the NII? And also in the U.S., you are gaining market share, but are you gaining new clients or do you paying out for deposits? How do you see the beta compared to the local peers and in absolute terms going forward and then NII there in the U.S.? Thank you.

Thank you, Francisco. Okay. Let me give you the details, okay? In the - let's talk about first about the UK. NII, it was up double digits in the first half of ‘23, okay? It was driven mainly by higher rates on the strong focus on managing the spreads and profitability. Although the UK tends to be more competitive than other European markets as you know, okay? So we're putting profitability ahead of market share, okay? And we have a lower risk appetite, but we're expecting good performance to continue leading to NIM expansion, okay? So, we expect it to stabilize towards the second half of 2023 with high-single-digit growth on higher rates. And despite the lower volumes that we have because of what I just explained about profitability, okay? In the second quarter, NII was flattish. Okay? Higher yields on loans did not offset the higher cost of retail funding and the slowdown in new originations, okay? In terms of the betas, Jose will tell you afterwards that I tell you about what's going on in the U.S. In terms of the U.S., overall, as you have seen, has performed better than expected given the change of mix towards prime, okay, as I explained in detail, lower yield, but also better risk profile and the lower grade provisioning is helping us, okay? NII is flattish in the quarter and year-on-year on funding pressures on the wholesale and retail as you know, a lot of this is funded by wholesale, as well and a common trend across the sector which has been partially offset by higher yields that we have. Santander's U.S. betas are above what we expected but lower than the average of our peers. Just to give you exactly what's going on. And we expect NII to be down mid-single-digit on lower originations and also the higher funding pressure again in line with the peers. However, given the strong behavior that we have on the labor market and seeing the performance in the first half, the U.S. NII could do better than we expect, okay? U.S. NII is not the only one that has a cost of risk, and profitability are also better than expected in the country, okay? So Jose, I don't know, if you can comment on the betas please.

Yes, betas in the UK, when we look at the cost of deposits today relative to the level of rates today, that's around slightly below 30% is increasing slightly in the quarter three percentage points. We still think that that will continue. So the UK is a market with less excess liquidity than Spain for instance. So we would expect as Hector said, margins probably - they were stable in the second quarter relative to the first and we would expect them to remain more or less flat in the third and probably slightly going down from there. In the U.S., as Hector said, we kept our deposits flat, paying less than our regional bank competitors. The beta in the U.S. is 36.8%, up two percentage points quarter-on-quarter. So after the spike that we saw in February and March, the betas in the U.S. have remained very stable. And we are actually increasing deposit market share at a lower cost than our competitors.

Thank you, Paco. Can we have the next question, please?

Thanks very much for taking my questions. I have two questions. One is on the Spanish loan book. You could update a bit on the trends that we have seen in the quarter. Year-on-year rate, you see an 8% decline. If you could elaborate a bit on what are the dynamics there and what we should expect going forward? And the second question is a bit at a Group level? If I just look to the first half cost of case, 100 around 106 basis points, you are speaking to the guidance below 120. And is there any region besides the US whether we could see some deterioration in the second half that makes you to keep that conservative guidance, which would imply around – a rate of around 135 basis points, 140 basis points in the second half to meet the 120? Thank you.

Thank you, Ignacio. Let me tell you a little bit about the dynamics on the Spanish loan book, and then Jose will talk about your second question, okay? In the Spanish loan book, the dynamic that we have seen is quite clear, okay? We have seen low demand for credit, okay, which is impacting us a little bit; mainly, we have seen an increase in the prepayment, mainly on the mortgages, okay? Because of the increased rates, remember that a big percentage of our portfolio is some variable rates and floating rates. So in that sense, that’s the dynamic that we have seen. And also we have seen due to the increased rates, the corporates and the SMEs are being more cautious in new credit demand, okay? And the dynamics we lived throughout the year continued that way; let's see what happens at the beginning of the year. And also, if we can see more confidence a little bit on investment, okay? But now we see the dynamics in that way. Please, Jose, on the second one.

Morning, Ignacio. Cost of risk, well, we see cost of risk normalizing in the U.S. as we discussed. Also in Mexico, where we are seeing the normalization of the cost of risk as we change the business mix. In Auto, it will very much depend on the amount of loans that we are able to sell, but it should remain stable in the second half of the year. So we feel very comfortable that we will beat our 1.2% guidance for the end of the year. We expect it to be better than the 1.2% that we gave as a guidance.

Thank you, Ignacio. Can we have the next question, please?

Yeah. This is Sofie from JPMorgan. Thanks for taking my question. So, could you just explain that the difference between your reported net interest income which was €10.5 billion on the underlying €10.7 billion? What explains the €200 million delta? And are there any more one-offs in interest income that we should be aware of in the short term? And then the second question would be on the capital headwinds you mentioned that you're expected to remain above 12%, but could you just outline what capital or core equity Tier 1 headwinds you're expecting in the coming quarters or at least on the year-end? And also, if you could remind us what the Basel IV impacts are? Thank you.

Okay. Thank you. So, Jose will explain the NII evolution. On capital, let me reiterate exactly what I said and then Jose can expand a little bit more. So, as I told you, we expect to generate at least 10 basis points of organic capital on average per quarter, okay? And that is included with the current remuneration policy that we have, okay? So, as a result, what I told you, we will be on track to meet our target to be above 12%. Also with the final implementation of Basel III comes into effect in 2025 to be precise on that point. Jose will comment a little bit more on that and explain the NII evolution.

Yeah. So, Sofie. Hi, good morning. As I said, we don't expect any headwinds significant from any of the three big components that could affect capital regulatory or supervisory charges, inorganic charges, or other charges basically market-related pensions, intangibles, we don't see significant headwinds in the second half of the year. In terms of BASEL III, we have seen the proposal. It’s still a proposal. So we need to wait to see exactly how it is approved. We still think we will have an impact of between 40 to 60 basis points, probably and again depending on how this is finally written, probably towards the lower end of that range, if things are confirmed when the final proposal is approved. In terms of the accounting, well, I think Investor Relations will give you more details about - this is pretty detailed. But in the first half, there is no impact or no adjustments between net interest income statutory and underlying zero. What happened in the first quarter is, we had a positive adjustment of €211 million and we have reversed exactly the same amount in the second quarter, which by the way, in terms of the €20 billion, it's a very small amount. So no adjustments to NII in the first half. What we added to underlying in the first quarter was reversed in the second quarter. There are other adjustments in the P&L, but basically netting out in most cases that will happen in the first quarter in the second quarter. But Investor Relations will give you all the details line-by-line of the differences between the first and the second quarter. Thanks Sofie.

Thank you, Sofie. Can we have the next question, please?

Thank you very much. My first question is on the digital bank. Could you please provide an update on your strategy for gathering deposits here? You've raised possibly €3.4 billion year-to-date, but seems a bit below what you had planned a few months ago. And also possibly, you are trying at 200%. So how much more deposit do you expect to get? And where do you feel like you need to put rates in order to be more successful in Northern Europe and Germany? The second question is a follow-up on mortgages in the UK? You are shrinking pretty fast for €1 billion per quarter. When do you expect to stabilize that book? Thank you.

Thank you, Marta. Okay, on the study the open bank is quite clear. Okay. And we just don't have open bank as the only vehicle to raise deposits. We have some other vehicles also. We are having some of the other different countries, okay? We believe that strategy is right? And the one that we manage at open bank is going along to our expectations, and we believe that we are going to continue to manage that accordingly. Okay? In the some other different initiatives that we have, for example in Germany and some other places, the study has been proving very successful and we don't believe we need to basically continue raising rates depending on what the market reacts to it. Okay? So we're going to be moving it according to the market. In terms of mortgages in the UK, I was very specific about what we're thinking in terms of profitability, okay? And the way we're managing the portfolio. First of all, we've been very cautious in the way we manage, and our risk appetite has been very prudent in the way we’re managing the UK, okay? If we see that there is a change of how we see the market, then we'll adjust at that point. But right now, we’re concentrated on the two things I told you: first of all, profitability and being cautious on the risk appetite there. If we see one of these changes, then we will adjust in any way. I don't know Jose, do you like to comment a little bit more?

In the digital consumer bank, now includes open bank. We have €60 billion in deposits, like you said. And I think we obviously manage that to maximize profitability. So it's not only a question of the amount of deposits, but the question is managing the margins in a business that has negative sensitivity to rates. And I think we've been very successful if you compare these figures to what it was a couple of years ago, and you look at margins and interest rate sensitivity management, I think you have to look at the whole picture, and I think we've been very successful in managing interest rate sensitivity in a business that is naturally – that has naturally negative sensitivity to raising rates. Thanks, Marta.

Thank you, Marta. Can we have the next question, please?

Yes. I wanted to get more clarity on basically in page, so to speak of going to the different geographies and particularly you've given a lot of detail on NII in a lot of countries. Can you do the same for Brazil please? And the second question is on Spain. And if you could split the drivers of NII there between the effect of increasing interest rates of deposit beta and the ALCO portfolio contribution? Thank you.

Okay. Thank you, Andrea. Let me explain a little bit, the NII in Brazil, and then Jose will give you the details of the drivers of NII and the betas in Spain, okay? Yeah, in Spain. So to start, I mean, Brazil NII, okay, performance in the recent quarter has explained first of all on loans in 2021, I have been very specific about that. We have become very much conservative and we have changed the mix, okay? And we have grown selectively, okay, changing the loan mix to lower risk on deposits, okay. The fast-increasing rates mean a rapid rise in the cost of deposits, okay. We expect NII in the second half of ‘23 to be higher than in the first half of the year leading to a flat NII in the year with a substantial improvement in ’24, okay? If we see that the rates basically start to come down because it's very important to understand that Brazil has negative sensitivity to the, we should gain traction. And we maintain, we're going to maintain our cautious stance, but we believe that we can go back to the market, okay? And we believe that the functional rates could fall in the second half, bringing the cost down in retail funding. Okay? And then in the drivers of NII in Spain and Jose will give you more details. Spain is one of the countries that has benefited most from the higher rates, okay? We will continue to see strong growth in clients. Just in the first half of the year, we have 300,000 more active clients, okay? NII in Spain is up around 57% in the first half of the year and 60% just alone this second quarter is mostly supported by the pricing of the loan portfolio. The height yields and remain contained on the cost of deposits. So, we have been managing very well in that sense. We expect double-digit growth for NII in 2023 and regarding the peak of NII in Spain, there are several things to consider that Jose will explain as this will continue to reprice at least during the first half of ’24, clients which we expect will continue to grow and betas, which will be key. We're still seeing rational competition with low betas for individuals in a system which remains highly liquid, okay? So as of today, we don't speak much higher remuneration on the foreseeable future.

So, hi Andrea. The ALCO in Spain we have €27 billion ALCO, €21 billion is a structural long-term held to collect with an average maturity of - duration of 7.7 years on a yield of 3.3%, 3.4%. And then we have €6 billion which is more associated with short-term liquidity management average duration of 1.2 years and yields slightly below at 3%. We expect to continue increasing the amount of the ALCO portfolio in Spain to gradually reposition the balance sheet towards a lower positive sensitivity because as interest rates start reaching a peak, we don't want to run a balance sheet with such huge positive sensitivity to rates. So one way of doing that is not the only we are also taking other measures, but one way is obviously increasing the ALCO portfolio. In terms of betas, the beta for deposits in Spain is 17.8%. If we exclude CIB, by the way, this is three percentage points higher than in the first quarter. If we exclude CIB, the beta is 9.5%. The beta in CIB is around 60%. So I think I've given you all the numbers to figure out exactly how we see the betas and the NII going forward. Thanks.

Thank you, Andrea. Can we have the next question, please?

Yeah, hi there. Thanks for taking my question. Could you give a bit more color on the NII increase, the absolute NII increase in Spain Q-on-Q? The customer spread was up less in the previous quarter, but NII was up a lot more? And then, secondly, you could also update us on the net interest income sensitivity in Brazil over one year and two years? And lastly, on the €500 million rate benefits that you see more so than previously. Can you give us an idea as to where you see them and how much of that has been recognized in the current run rate? Thank you.

Okay. So let me go backwards here. Yeah, in the first half, the sensitivity was more or less €500 million higher than what we - the guidance we gave at the Investor Day. We would expect more or less a similar amount in the second half in Euros. We - relative to the figures, we gave at Investor Day, the interest rate sensitivity in Euros due to the fact that obviously rates are higher, and we are seeing better betas remember that the betas we use to give that sensitivity at Investor Day in Euros were around 30%. We are below 20% right now, and it's already half of the year. So we would expect another €500 million more in the second half over €1 billion higher than what we mentioned at Investor Day. NII sensitivity in Brazil I'm going to give you the rest of the currencies as well. So if today, we had a 100 basis points parallel shift upwards, we would make €1.1 billion, €1.2 billion more in euros. €250 million more in the UK, flat, slightly negative in the U.S., and €100 million less in Brazil. I think we gave you all the details to understand the NII sensitivity in Spain, but we can take it offline and if you wanted more detailed analysis, but I think we gave you all the details. I give you the composition of the balance sheet by repricing on the asset side. So I think that's sufficient, I think, but we will take it, we will take it offline.

Thank you, Britta. Can we have the next question please?

Hi. Thank you very much for taking my questions. Just a quick follow up on NIM capital. You mentioned the finance impact, could you please quantify that in terms of stock and one single specific impact on risk-weighted assets just to clear that out from other impacts? Thank you.

Okay. So, the stock finance is seasonal. It tends to go up in December, which is the peak in the year, then it goes down in March, goes up a little bit in June, and then the same in September to peak again in the December. This year, the increase in June was higher than we expected. We are talking around €6 billion in total risk-weighted assets from stock financing in the first half.

Thank you, Carlos. Can we have the final question, please? Thank you.

All right, thank you for taking my question. Two questions please. One is on Poland. What we expect in terms of mortgage provisions related to these funds going forward? At least you can comment on the average and this was helping out. And a second one is on average rate growth. I am looking at your key figures and Poland figures I am looking at loans – loan growth and FX impacts, and it seems like part of the result increase in – and if you can comment on why it’s happening there and those would be changing? Thank you very much.

Okay, so Fernando, what you said at the beginning was mortgage provisions in Poland? Yeah. Okay. So, Fernando, let me tell you exactly how we are in Poland, okay, up to today, okay? And with the extra that we did, okay, we believe that is completely adequate. Okay, we're talking about that in the blended provisions that we have, we are provisioned up to 58%, okay, of the outstanding that we have, okay, and we believe that's enough to sustain exactly what needs to be done over there given the dynamics that we have seen in the market, and if you basically changing towards a lot these when these mortgages just started be about there, okay? So I believe that we're at the right point and we believe the provisions at this level is completely adequate, okay? On the second, I will have Jose give you the answer. Thank you.

No, as I explained, loan growth year-on-year was zero. Risk-weighted assets increased 2%, half of which is FX and I can’t take you through the composition of risk-weighted assets by country. But half of the risk-weighted asset inflation has to do with FX. Of the other half, we had some positives and negatives. As I said, we have contraction in the UK. We have contraction in terms of risk-weighted assets ex stock finance in auto, a slight contraction in Europe. And then we have the contraction in Europe and also risk-weighted asset growth both in ex FX in Mexico and in Brazil.

Thank you Fernando. I'm unclear if there are any further questions?

Yeah. Hi, good morning. Sorry, it’s just a quick follow-up on Brazil. If you can give us a little bit more color or at least a ballpark magnitude of the substantial growth of NII you are expecting in ‘24 and the sensitivity to rates, Jose was mentioning. So I guess, it’s probably around yeah 1% for 100 basis points decline. So, just trying to understand basically, I guess, what kind of magnitude in terms of acceleration of NII you are expecting next year in Brazil. Thank you.

Okay. Thank you, Ignacio. I will answer the first part of the question and then Jose you will help me out with the rest, okay? This is sensitivity. What I told you is that we believe that the worst is over in Brazil. Okay, and we're starting to see a little bit more growth in the portfolio. Okay. So we're changing that around. We're starting to basically go back to the open market, which, you know, in ‘21 we decided basically to come out of it, given the what we saw in the core environment, okay? So at this point, we believe that Brazil is going to be able to turn around and also we see that the rates are going to be helping us out because we believe that the rate in August should start coming down. So in that sense, we don't know exactly how the trends are going to work. But we see that is - this is coming much better than we expect, okay? And we see that we're going to end up the year basically flattish to where we started, okay. So, hi, Ignacio. We believe interest rates in Brazil will start coming down in August. They are at 13.75; our central scenario is for rates during the year at around 12 and twelve and a quarter and then probably below 10 by the end of next year. So NII, when you look at sequentially quarter-on-quarter, NII probably will be flattish in the third, but it should increase in the fourth and more so into next year and the exact sensitivity, I mentioned the sensitivity to higher rates, but the sensitivity in Brazil to a 100 basis points. But it is a parallel shift I insist the parallel shift, which is not what will probably happen because we are what we will see is lower rates in the short end of the curve, but flattish in the long end of the curve. But through a parallel shift, a drop in 100 basis points will generate €140 million higher revenue in Brazil. Thank you Ignacio.

Thank you, Ignacio. I believe there are no further questions. So thank you everybody, for your attendance and the Investor Relations team is at your disposal for any other questions that you may have. Thank you very much.