Grupo Financiero Banorte SAB de CV

BMV:GFNORTEO

Earnings Call Transcript 2023-Q1

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Welcome to Grupo Financiero Banorte's First Quarter Earnings Call. On behalf of Banorte's management team, I want to thank you attending our Banorte Day in New York a few weeks ago. We hope we have met your expectations and answered your most pressing questions regarding the Group's strategy and the long-term profitability.

Many of you received an email request participating in a short survey over the phone regarding the clarity and content of the event. We really appreciate if you could accept the interview as it would provide us valuable feedback to improve our communication with all of you.

In today's call, our CEO, Marcos Ramirez, will provide a quick microeconomic overview, including the positive impact of nearshoring for Mexico and Banorte, followed by a review of the main results of the quarter. On our ESG slides, you will find highlights of our 2022 Integrated Annual Report, as well as our TCFD Report, which we were launched at the end of March. After our CEO's presentation, Rafael Arana, our COO and CFO, will walk you through our main financial results, including our NIM evolution, strong asset quality and capital levels.

Please note that today's presentation may include forward-looking statements that are subject to risks and uncertainties, which may cause actual results to differ materially. On Page 2 of our conference call deck, you will find our full disclaimer regarding forward-looking statements. Thank you.

Marcos, please go ahead.

[Marcos Ramirez, CEO]

Thank you, Tomás. Good morning, everyone. Thank you for joining us today.

First, I would like to take a moment to thank you for the interest and participation in our recent Banorte Day. Your presence and engagement were key in making it a success. As discussed during the event, we are committed to become the best financial group operating in a digital world. And in order to achieve that, we are optimizing our technological capabilities along with hyper-personalization business model to drive our competitive edge in the marketplace. We know how importance it’s for you to have visibility in our strategy. Therefore, we have set an ambitious set of financial targets that we aim to accomplish in the next five years. At the same time, that we create value for our investors, customers and employees. We will work prominently to achieve them and will keep you informed in our progress.

Moving on to the macroeconomic environment. We expect the Mexican economy to extend the positive performance observed in 2022 throughout most of 2023, despite the risk of a global economic slowdown and a likely recession in several regions; Mexico could remain resilient given the two important drivers: private consumption and external demand. In this regard, we revised our 2023 GDP estimate from 1.5% towards 2%. Inflationary pressures in Mexico are starting to fade away. Although we still see some indicators of tight monetary conditions for the remainder of the year, we expect annual inflation to gradually normalize down, reaching around 5% at the end of the year. Therefore, we anticipate an additional interest rate hike from Banxico in May, taking the reference rate in a terminal level of 11.5% which should remain stable until the start of the important cycle in early 2024.

Mexico will continue on the spotlight, driven by positive tailwinds. We expect a continuous strength of the Mexican peso with a year-end estimate of 11.7 pesos per dollar, supported by high interest rates and strong macroeconomic fundamentals. Nearshoring activity will continue its momentum, as we expect more companies to announce further investment projects in our country. We are convinced that the nearshoring is a reality, as evidenced by incremental investments in the industrial and commercial real estate along the border with the U.S. and in the center of the country. Currently, established manufacturing operations in different sectors have the most to gain in the short-term. However, we also foresee top opportunities in warehouse construction, as well as investment in logistics and transportation, and so on. Not to mention the transactional banking opportunities that may come once the companies are fully operational in Mexico.

We estimate nearshoring to generate an additional spillover of 168 billion over the next five years in non-oil exports, which will come on top of the inertial trend that has been well established by the trade agreement with the U.S. and Canada.

Moving now to the business operation on Slide #3. We highlight the solid performance of the Group supported by improving margins, our well prepared asset and liability management strategy that should help us to take advantage of the rate cycle and anticipate a timely change. It's not the knockoff of gears to face the imminent easing cycle.

Moreover, during the quarter we saw a dynamic fee activity, an expanding loan portfolio, both underpinned by strong internal demand. Our stable asset quality has been supported by structural changes at the bank, including internal risk models and improved recoveries. Last but not least, we strive to optimize our capital and liquidity levels, which have been a paramount importance, particularly in recent turbulent times. Rafael will provide more details on this intermediate.

Starting off with profitability Slide #4, net income had a 12% increase quarter-over-quarter. ROE improved more than 200 basis points in the quarter, driven by an expanding performance across most businesses, which is also reflected in a solid return on assets. Our non-banking subsidiaries continued to recover their contribution to these indicators, as we will see in a moment.

Moving on to the top-line results of the group on Slide #5, NII from the loan portfolio increased 4% on a quarterly basis on volume origination across all product lines and the positive effect of the rates hikes that have been gradually incorporated into our portfolio. Our sound deposit mix continues to strengthen our net interest income performance. Non-interest income in the quarter was supported by a seasonal effect of insurance premiums renewals during the first quarter of the year, along with a better performance from other operating income. On a yearly basis, the result was impacted by lower trading results despite the strong fee income from banking operations. Altogether, total revenues showed solid quarterly and annual increases.

Turning to fees, Slide #6. They remained flat sequentially despite the high seasonal activity during the fourth quarter. On an annual basis, fees had double-digit growth led by strong core banking fees, higher advisory and restructuring fees in commercial and government portfolios and higher domestic demand for consumer products. Digital transactions continue to evolve driven by the ongoing adoption of digital channels and stronger digital product offerings.

Loan growth on Slide #7 continues to exceed our initial expectations even in the positive macroeconomic impact. Loan expansion reached double-digit annual growth across most of our portfolio. During the quarter, the commercial portfolio continued to expand and further growth is expected as nearshoring operations materialize in the country. Corporate loans had relevant performance in the quarter, but we were affected by the prepayments. While the dollar loan market continues to add to this book performance, it currently represents close to 12% of our loan book. The government book had a strong quarter as well with solid demand from federal, state and municipal governments.

The consumer portfolio on Slide #8 displays a solid quarter of a record annual increase, reflecting the internal demand dynamism in all consumer lending activity. The evolution of payroll loans and credit cards has been driven by good consumption dynamics, as well as by the adoption of our digital banking offerings. Auto loans had a strong recovery as the industry normalized the supply shortages and also thanks to new commercial partnerships with strategic initiatives. The mortgage group got on the positive trend, reflecting the results of our strategic approach to optimize the customer lifetime value of high value customers.

On the Slide #9, asset quality continues to perform better than expected. The quarterly decline in NPLs was supported by higher loan origination, along with gradual changes in our existing risk models, adapting those to behavioral changes in our customers' approach to credit, particularly when using the convenience of digital channels to higher riskier products such as digital payroll loans. The annual increase in cost of risk is well aligned with growth in the loan book and include some isolated non-performing bases, which do not represent any industry wide or geographical trend and are expected to normalize in the upcoming months.

Analyzing the quarterly results by subsidiaries, Slide #10. The bank results displayed are some core banking operations, boosted by a more dynamic lending activity and higher rate environment, together with a strong fee income. On that regard, it is worth mentioning that as of this quarter, the intercompany fees scheme within the insurance company and the bank had an upward adjustment for insurance products, higher to bancassurance. Altogether, these results sustain a solid return on equity of 27.5% for the bank. The insurance business is already operating at pre-pandemic levels in terms of claims, with good premium expansion. These should normalize this business contribution to the Group's overall performance. The broker sector reduction was mainly driven by the inflation premiums in assets valuation during 2022. The annuities business was impacted in the quarter by higher technical reserves related to premium sales and inflation adjustments. As for the pension funds, the quarterly evolution was affected by the valuation effect of higher rates in its long-term investments. Nevertheless, the unit comparison displays a solid evolution with higher from financial products.

On Slide #11, we provide greater detail into the insurance business performance showing the seasonal effect in premium origination during the first quarter, together with the normalization of plans to pre-pandemic levels. On an annual basis, there’s reduction in premiums in response to temporarily delay of the annual premium renewals. Moreover, the acquisition cost line is affected by the bancassurance fee increase mentioned earlier.

Moving now to Slide#12. Rappi's operation continued to perform as expected. During the Banorte Day, we committed to achieve ideal targets for the business, as well as for our digital bank. We will keep you posted on this progress.

Shifting gears to ESG, Slide #13. We have just completed the initial steps for our decarbonization strategy, which we started in October of last year. We now have fully quantified carbon emissions for the most intensive sectors in our portfolio and we have also set government reduction targets for all of them, which you may find on our sustainability webpage.

On Slide #14. I am happy to communicate that in late March, we released our most recent integrated annual report, which underscores the importance of ESG as a fundamental part of our growth study. I want to thank you for your constant feedback regarding ESG matters. We have incorporated many of your recommendations into the design and content of the report, including greater disclosure of our executive compensation structure, our gender equality agenda, and greater detail in our Board position and its alignment with our corporate strategy. In addition to this, we also published our second TCFD report, which provides a deeper insight into our climate-related risks and opportunities.

Now, I will leave you with Rafael Arana who will walk you through the positive results of the first quarter of the year. Rafael, please go ahead.

[Rafael Arana, COO and CFO]

Thank you very much and thank you for your interest in Banorte. I will move to the next slide of deck. Basically what we're going to cover in the next minutes about the balance sheet and return on equity, the transformation process and capital expenses, and the net interest margin. There has been some concerns about the evolution of the margin. So we will touch on that in a bit. Also, there were some concerns related to what's the operational effect that had on the capital because of the change in the regulation, we also will touch on that. And so I would move to the next slide please.

You see that at the bank level -- we will look at the numbers of the bank level. The ROA of the bank, as you can see is moving to 2.6%, I think a strong 65 basis points from a year early. So we continue to see a very good trend on the ROA because as you have seen the consumer book is really moving forward on that point. The net income of the bank jumped to 35% on a year-to-year basis. So that's a continuous positive trend on the net income of the bank. The return on equity of the bank is a very strong 665 basis points on a year-to-year basis, reaching that 27.5%. And I would like to also to remember that we are the least leveraged bank in the market. So this has an additional benefit for the strength of the bank. So very positive results at the bank level.

On the next slide, as you can see -- we will start to touch some of the concerns that you have. The net interest margin of the bank, you'll see that it was a reduction from 6.7% to 6.5%. There's a very clear explanation about this. Assets grew at a very fast pace in the last part of the month and during the end of the quarter. So you can see that the revenue grew 0.5%, but the assets grew 3%. So those assets will mature in the next quarters and will benefit against the expansion of the margin. We are very confident to see a continuous evolution on a very positive trend for the margin. What is very positive is that this loan growth will benefit in the coming months for the bank.

And I also would like to add here another thing. On the net interest margin of the bank, especially on the loan book, you have seen a continuous evolution on the fixed rate part of the book. That fixed part of the book is the one that is now 42% fixed rate loan book, around 58% variable rate book. So the more we push the fixed rate part of the book, it will be a natural hedge against the reduction on the rates when the rate starts to come down.

So very -- I think it was extraordinary what happened at the NIM because of the very, very strong growth on the loan book. And another issue that is important to highlight is that, in the month of February -- and this is not usually the case, the liability side, the set aside, creep above the tier that is the asset side. So that will reverse in the -- it will immediately reverse on much, but that effect also is putting some pressure on the NIM. But it's nothing structural about the NIM. We are very positive about the NIM function.

If you return to that. Sorry. No, in the next. What also is quite very important to notice is that, the net interest margin of the loan of the loan portfolio is exactly the same case. The net interest margin or the NI from the loan portfolio is growing 2.5% and the assets, the loans are growing [2.7%]. So it's exactly the same pace that I just mentioned before. It will eventually be coming back to offset that benefit of the margin. So we see very, very strong NIM coming from the loan portfolio.

The net fees of the Bank, also something very, very relevant, grew 24.2% on a year-to-year basis. That reflects all the activity that is happening at the bank in every single of the channels of the Bank and every one of the products of the bank. So we are very positive about this net fee growth.

Again, if you move to the next one, please. And the NIM expansion that I just mentioned to you is, nothing is structural. It will be basically coming back to us in the next quarter. But we are very positive is that the quality of the book that we have, so the loans that we put on the book are very, very positive loans with regard to risk credit part. So we are very positive about the NIM expansion in the coming quarters. Thank you.

As you can see, and Gerardo explained that very well on the Banorte Day. We continue to have pretty strong numbers on credit. We don't like to compare ourselves anymore to the pandemic or pre-pandemic. But the numbers continue to be quite strong. And you have to take into effect that we have been having a very strong growth on -- especially on the consumer book. The consumer book growing 17.5% is really, really something that the Bank has not experienced in the past. So the run of rates continue to be very steady, cost of risk at 1.6 and as you can see NPLs barely above 1%. So the credit quality continues to be a strong hold for Banorte.

There was also a question and thank you for that question because I think allow us to clarify, and we were very, very clear about this at the Investor Day. Last year, we had an extraordinary mix based upon very strong growth of close to 14% on the demand deposit side. And only 3% growth on the time deposit side. So we were able to really manage the cost on a very efficient way. But remember that we experienced a very high loan growth, especially in the third -- in the fourth quarter last year on that part. So, we also advised at the Investor Day that our cost of funds will reach close to the 40%, 41% based upon, they need to balance out the very high growth on the balance sheet that we have on the loan book. And remember that basically, the first three months, it usually goes to May, you have a dry season on the funding side, okay? So that will start to recover. But what was completely abnormal during this year is that usually that the deposits on the loans are basically at the same pace. But this year, the pace of the growth of the loan book was completely aggressive against the funding side. So we will manage that to balance out during the year, but this has put pressure on the funding costs. Basically, because we have to start moving -- as you know, we are the leaders in the time deposit side. So we are now pushing more the time deposits also along with the demand deposits. So that's the explanation of the expansion of the funding costs.

There was well, but the competition is not following exactly that. They will eventually do this. The sensitivity on the book and we also touched this on the Banorte Day. We are around 1 billion per 100 basis points on the peso book and 977 on the dollar book. As we advise also, we think that these numbers will reach around 800 million, when we start see the downward trend on the funding side -- on the interest rates.

So that's basically what we're referring to what Marcos was mentioning, that's why we are very preparing the balance sheet to support this. Furthermore, we grow on the front on the fixed rate part of the book, the better we will be also in this.

There's also -- as you know, we advanced some important expenses last year and we are now starting to normalize them the expense growth. Remember that if you split the expense growth, close to 6% goes to the personnel expenses and 3.2% of those -- and this will be also a once event for the expense growth. We are building two data centers in order to be able to run almost as on line real time all the time. So, we will have really best-in-class for our data centers and that has put in around 3.2% cost for the expansion on the expense side. So, basically, we see expenses under control. We are investing where we need to invest and the other thing that is quite important is that the cost to income ratio now is reaching the 34.2% that is a record for Banorte. So, we are investing where we need to invest and building out some of the high part of the expense line, but it will be really for support and continuous evolution of the transformation process of Banorte.

The capital ratio as you can see continues to be very strong. Now you're looking at the change that happened in the TLAC. Now the minimum TLAC is 13.025%, Banorte is well above that in that part. So liquidity also very on line where we want to be around 150, 156. So the liquidity in the right place, the capital really in the right place and the leverage ratio as I mentioned before, the risk diversity in the market.

I will refer to this slide, because there were some concerns that we had raised on the -- at the Banorte Day. And Gerardo was very clear about our capacity and stability on the funding side. So, I will ask, Gerardo if you can really go through the slide, please.

[Gerardo Salazar, Chief Risk Officer]

Sure, Rafael. Thank you. As Rafael was telling you in Banorte Day we stressed that the maturity transformation game is nonexistent in the fixed interest rate part of the book and very modest in the variable interest rate part of the book. I will explain myself with some arguments here. The first one being that if we play a maturity transformation game, that means that we borrow short-term to lend long-term. That doesn't happen in the fixed interest rate part of the book. As you can see, asset duration is 4 years and liabilities duration is 5.5 years. So liabilities duration exceeds asset duration if you measured that by outstanding balances by 103%. But if you measured that by duration, it is 138%. That's very important. If you did by 5.5 years by 4 years, that is liability duration divided by asset duration, you will get to 137.5%. That's in rounded numbers 138%. So, you can see that in that part of the book, we are depending on the positive stickiness, which it is happening because 62% of that deposits are of -- the fixed rate deposits are retail deposits and 34% are nonretail, but transaction banking related deposits, which is very, very important for us. 59% of those deposits are insured by IPAB. So, we can be very comfortable in that part of the book.

Although this slide doesn't depict what we told you at the Banorte Day, regarding the variable interest rate. I will remind you by March with some latest figures that liability duration in our variable interest rate part of the book is 2.8 years, it was 2.4 by December of last year, but asset duration remains at 3.2 years. So, we play a maturity transformation game which is very modest in the variable interest rate part of the book. So, I will tell you that by now, the difference between liabilities and assets duration in this part of the book is just 0.4 years which is less than the 0.8 years that we have by the end of 2022. So, we remain very conservative and prudent managing the balance sheet risk.

Regarding point C, AT1's hedge to call, you'll remember that Rafael stressed the fact that held to maturity government USD fixed rate bonds are budgeted inflow that the Treasury just made in order to hedge against the outgrowth of the AT1's U.S. dollars fixed rate. So, we have 100% economy hedged by outstanding balances. So AT1s are just budgeted to be paid. And 102% economic hedge by duration to call. So we remain very prudent on that regard. So everything is automated within our balance sheet regarding that AT1s within our capital structure.

And mentioning point D, the Basel III leverage. Marcos and Rafael work towards it, he knows that we are the least leveraged bank with comparable banks and you can see by Basel III. I just remind you that what you do trying to make this calculation possible is to have our capital measure divided by risk weighted assets. The less it is, the less leveraged we are. So we have more capital in proportion to risk weighted assets. So Banorte is the less leveraged bank among peers.

And at the right hand side of this is like we will remind you that theoretically what we have -- if we were to mark-to-market held to maturity on realized losses, we will have an impact of just 47 basis points on capital. That remains a very low probability event, regarding the Bank. So we remain very, very prudent and conservative in that regard. But we already have accounted for realized losses in the available-for-sale part of our bond book. We have 23 percent basis points impact on our capital. So liquidity remains very, very good. But if you were to realize those losses, we can withstand that.

You will recall that when this market volatility started with these bankruptcy events on some U.S. banks, we told you that the impact that we were expecting was 70 basis points. After that, we just make a calculation of 59 percent basis points against capital which was delivered to you as our metric in the Investor Day. But by the end of March, due to market volatility being lower, that same impact accounted for just 47 basis points against our capital. So those are the metrics, and we are just very, very satisfied with the way that we have been managing the balance sheet risk in our books.

[Marcos Ramirez, CEO]

Thank you, Gerardo. And along with that, there was some concerns about the annuities. What would be the case for the annuities in case that, we do some of the calculation that Gerardo mentioned. Remember that the annuities by law, the money of the person has to stay there. There cannot be alone rate of risk on the annuity side. By law, by contract, that's the way it goes. So there is no case to even measure those.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Thank you, Marcos, Rafael and Gerardo. Now we will continue with our Q&A session. As always, we kindly ask you to present only your most relevant questions, and we will be happy to take any other questions any time after the call. Questions will be ordered on a first-come first-serve basis. Please raise your hand on the platform and we will unmute you when your turn comes. José Luis and myself be calling the name of the person that is next on the line. If there any technical difficulty, please let us know by using the chat. Thank you. We are now ready to start the Q&A session.

We will start with Tito Labarta from Goldman. Tito, please go ahead.

[Tito Labarta, Goldman Sachs]

Hi. Thanks so much. Good morning, everyone. Thank you for the call and taking my question. My question, I guess is on the margin. Just to understand a little bit. As you reduce your sensitivity to interest rates, what does that mean? I guess both on a short term and longer term basis, I kind of understand. But you mentioned, Marcos you expect another increase in rates in May. So -- but as you are reducing sort of some of that exposure, is there any more upside to your margin from here? Do you think that's now capped? And then thinking longer-term at the Investor Day, I think you gave guidance for your long-term margins between 6 to 6.3. Is that -- will that primarily be a function of you reducing that sensitivity? And how long will it take so that when rates start to come down, your margin doesn't come down immediately? Just to understand a little bit that sensitivity and the movement in rates over the next year or so?

[Marcos Ramirez, CEO]

I think Tito, that’s a lot of questions. I will ask Rafael to answer it.

[Rafael Arana, COO and CFO]

Yes, Tito. This is -- remember, we preferred -- Banorte has always been very -- I would say, very efficient in running the bank on the upward trend and on the downward trend. If you see the stability that we have on the yields of the balance sheet, you will see that it ranges from 10.2 to 11.2, that's the whole piece. What we are talking about this now is that, we have to start preparing the balance sheet in order to be prepared for the downward trend of the rates. Obviously, that will put some, I would say, pressure on the sensitivity part, that will reduce to 1 billion, that is currently the 1 billion to 800 million. So 200 million would be on that part. But remember that we are building also the fixed rate portfolio. So the fixed rate portfolio, we also balance that out in a continuous way, going forward.

The NIM compression that eventually will happen on the variable rate part of the group, will be not fully but in a very important way compensated by a fixed rate part of the group. Also remember that the liabilities immediately get updated. On the asset side, it usually takes around six months to fully reprice the effect on the upward trend of the rates.

So, you see that there's a buffer on this timeframe about going down on the rates, and how the balance sheet is positioned. So when we say that 6 to 6.3 is the running rate of the normal stage of the margin, we are looking at rates around 5.5% interest rates. So that can give you a very good understanding of how we are building up more and more -- a much more profitable portfolio and not to be fully dependent on the upward trend of the rates or the downward trend of the rates. We have very balanced portfolio, a very balanced portfolio.

Obviously, when you see the potential downward trend, you start releasing some of the hedges that you put in place, and that is the one that is reducing the sensitivity. But you will see that the fixed rate part of the group will start balancing that out in a very important way in the coming months. So I would say that we are confident we can manage the downward trend in the same way that we manage the upward trend. A very important thing that you have to -- and you can check that out on based upon the data that you have is that the spread that you have on the liability side and on the asset side continues to expand for Banorte.

That is giving you this for about six months that I'm taking once the interest rates start to go in down. So that will allow you to have also some time -- additional time to balance out exactly how you want to position the balance sheet.

[Tito Labarta, Goldman Sachs]

So just maybe to simplify a little bit from my perspective. Does that mean that your margin probably in the short-term, you're kind of at these peak levels, but -- and you're now beginning to focus on making sure it doesn't go down much more as -- I mean, rates, I think you said 2024 is when you expect rates to come down? Just to get that shorter term sort of evolution. Any color that you can give there will be helpful.

[Rafael Arana, COO and CFO]

Yes. You will continue to see expansion on the margin through the year. The margin will continue to expand and even when the interest rates start to go in down, you will see an increase on the margin and momentum will continue on that part of the margin, Tito. So we are very positive about how we are managing the balance sheet and how are we managing the margin. We will have the exact date of the interest rates. But we position ourselves from that. I think the Treasury -- those are extremely good work on that.

[Marcos Ramirez, CEO]

Tito, we can still get to the guidance on the NIM, that mentioned change. And just to complement with everything that Rafael mentioned, that the full movement of the changing sensitivity can take up to nine months, between six and nine months.

[Tito Labarta, Goldman Sachs]

And sorry, just one last point on the margin. So I think this quarter, as you mentioned, it was down a little bit, particularly for the bank. But those seem to be more like one time things that as you kind of get through that. That's probably where their upside would come from in the short-term?

[Rafael Arana, COO and CFO]

Yes. Because as we mentioned, there’s very, very strong growth on the asset side. The NII grew the revenue 0.5%. But the asset side grew 3%. So it's 1 to 6, so you can see that really we have an extraordinary month on the loan growth. And that obviously will benefit us through time in a very short time.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

We will now take the next question from Ernesto Gabilondo from Bank of America.

[Ernesto Gabilondo, Bank of America]

Thanks for the opportunity to ask questions. My question will be on your net income guidance. We were positively surprised by the double-digit loan growth, which is above your 6%, 8% guidance, and also about the solid asset quality with cost of risk rolling at the low end of your guidance. So, how should we think about your net income guidance for the year? Again, given the solid loan growth, good asset quality, subsidiaries, earnings bouncing back? So can we expect now the high end of the range? And if we can expect some upside risks?

And then my second question is on your dividend payment and the buyback program. We have been hearing most of the Mexican banks are evaluating to pay the dividend in two exhibitions this year. So is this something that you're also considering, given the higher than expected credit demand, and also to be cautious, given the global volatility on banks? And on the other hand, how much of your buyback announced last year has been used? And what are your expectations to use it this year? Thank you.

[Marcos Ramirez, CEO]

I'll start from the end. We are not using the buyback so far. Yes, you're right, Ernesto, thank you for your question. Maybe we will move to the high end of the guidance, but we're not moving it now. That means that maybe in the future we can change it but not now. But just we are moving to the high-end. And talking about the dividend, Rafael?

[Rafael Arana, COO and CFO]

It will be the 50%, we will be paying the dividend either May or June. We will be paying the 50% of the net income of '22 to balance that out in one exhibition.

[Ernesto Gabilondo, Bank of America]

And just a follow-up on the first question about the guidance. So again, in terms of loan growth, you're guided 6%, 8% given from what you're seeing, and then nearshoring. Should we be thinking that the double-digit lone growth is sustainable? Or do you still need another quarter to think about, it could be at those levels?

[Rafael Arana, COO and CFO]

In order to say we want to wait another quarter officially, let's say, but it seems that is going to happen.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Now we will go with Geoffrey Elliott from Autonomous.

[Geoffrey Elliott, Autonomous Research]

Wanted to drill down a bit more into the deposit side. Got a 5% decline in noninterest bearing deposits this quarter. How much of that is seasonal? I know you do get a bit of a seasonal impact in Q1, and how much of that is simply clients looking at the opportunity cost of leaving noninterest bearing money and moving it into somewhere they can earn some interest? And then how should we think about share of noninterest bearing deposits evolving as it goes forward? Thank you.

[Marcos Ramirez, CEO]

Yes, we have a seasonal effect, because -- and I don’t know these. It's fair to say that each year it picked up a little -- we don’t know. Rafael, do you know how to distinguish one or the other? I don't know.

[Rafael Arana, COO and CFO]

I think this year -- last year happened something that was not usual on that part. We have the normal inflow of very high number of demand deposits coming to the bank in November of December. But usually those deposits stay up to the end of January. This year because of inflation and people were more and more active on home buying and the economy recovering, that number really stayed for a few weeks, less than a week in January. So that is also the case on the demand deposit side.

What we have seen now is that what you mentioned about people moving more to the interest bearing deposit is happening. We are the leaders in that part of the market and we were able to because of market power to really control that. But now we see that we need to pay a little bit more on the interest bearing side. But we are very confident because of what we do in the transactional banking, payroll, the opening of accounts at the branches and on digital is really, really active. So we think that we will start to balance it out by the month of May. We will start to balance this out and start to trending down the cost of funds again or leveling out the cost of funds again. So it's a combination of what you mentioned. People looking for more returns. Inflation obviously accelerates the speed of the money in the market, so that's also an issue. But now we see a much more stable. The month of March was starting to be on the positive side on the demand deposits growth and also on the time deposits growth. And the transactional banking piece also is becoming extremely active also in the managing of funds.

And remember that, we are growing very nicely in acquiring business, on the merchant business. And the merchant business is also very strong source of funds for us on the funding side. And the 300 more bankers that we put on SMEs at the end of last year is also basically devoted to bring more funding onto the Bank. So we experienced an extraordinary event last year. I think we are balancing that out, not as fast as we like, but we are balancing that out.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

We will now take the question from Rafael Frade from Citi. Please go ahead Rafael.

[Rafael Frade, Citigroup]

Hi, guys. Good morning. Thank you for taking my question. I have two questions here. The first one is related to, you mentioned that there were some delay in the renewal of premiums. Just to understand what was that and how we should expect the impact for the -- maybe for the coming quarters? And the second question relate to fees, very strong fees, growth in fees. If you could elaborate a little bit on the breakdown here, is mostly across the board or is there any particularly line that is helping the strong performance in fees? That would be helpful.

[Marcos Ramirez, CEO]

Thank you, Rafael. First one, please, Tomás?

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Yes. Rafael, it was a premium that, as you know, seasonally typically happens most of them in the first quarter, and it was a large premium government related that will be happening in the second quarter. So that was the effect.

[Gerardo Salazar, Chief Risk Officer]

And actually, we have already closed the business with them. We obtained the policy again. We have been having this policy for the last almost six years. And it is the largest life insurance policy in the Mexican market. It is for the federal employees. And yes, we already closed with them, and it’s going to be paid this month. So that was explanation. Although, of course, in terms of what we expected in the budget and the guidance, for instance, we didn't even plan it to have it because it's very difficult and very competitive process. Fortunately, we will have it again.

[Rafael Arana, COO and CFO]

Yes, Rafael. So with this, you will see it in the second quarter, so that's the effect. Thank you, Gerardo.

[Marcos Ramirez, CEO]

And the second one? The breakdown. Rafael please?

[Rafael Arana, COO and CFO]

Yes. On the breakdown of fees, that explains. I think you will have a combination that is explained. I think the electronic banking business growing extremely strong. Everything related to merchant business is also pretty strong. All the loan growth that we have during this quarter also adds to this. But I will say that is all over the place. I think it's not just one specific part. Another thing that you see is that on the insurance side, since we have an arm’s length negotiation with our company, because that's the way it has to happen, that's we benchmark against the market, the fees that we paid to the bank from insurance company, that also is adding a bit on that part. But I will say it's all over. It's not just one. The activity that we have seen on the transactional banking piece, on the branches, on the digital world, I think everything is adding up to that. We have seen a lot of activity at the Bank. I can give you some three events that happened during the month of February and March. The number of transactions that we usually run at the Bank, they pick usually around December. Well, in March, we have more transactions than what happened in December. So the bank is extremely active in every single part of the business.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Thank you. Now we'll continue with Thiago Batista from UBS.

[Thiago Batista, UBS]

I have a question on the bank's capital position. Banorte's return on capital and this combination of ROE over 10% plus a loan growth of high single if it was the guidance, or even in the first Q with low things, clearly the bank is raising lot of capital. I remember in the past that you had a target of cap of 12.5. And now we have around 50% of capital. When I look to the long-term, how can we think about the capital, the bank will deploy this capital only with a traditional payout ratio? Or we can see other ways to really try to improve, not referring to the whiteboard, but to reduce your excess capital?

[Marcos Ramirez, CEO]

Thank you for the question, Thiago. Rafael please go ahead.

[Rafael Arana, COO and CFO]

Thiago, I think, as we mentioned before, we will start to converge to the numbers that we -- I think it's more prudent now to move to the 12% to 12.5% to 13%, but we have to converge to that number. And it's not going to be up dividends. We are always looking for opportunities in the market. If we say an opportunity in the market that we can present to the shareholders and the shareholders say, yes, we will start using some of that capital also to specific I would say acquisitions or specific way to increase the profitability of the bank.

But I think, I agree with you. Sometimes we see that we have more capital than we need. But remember, as we said at the Investor Day, the world is not quiet at all. So at this point in time, I think it's prudent to have capital in the way we have been managing the capital, stay with a dividend policy. And if we see an opportunity in the market, believe me, we will take.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

And now we'll go with Nicolas Riva from Bank of America.

[Nicolas Riva, Bank of America]

I also have a question on capital. So if I think about your capital structure, capital stack, I'm going back to Thiago’s point just now that you are guiding for that 12.5% to 13% CET1, it's going to take some time to get there. But when you think of that kind of terminal or target CET1, if I look at the rest of the capital structure, at this point, you essentially have no Tier 2 capital and the strategy has been taking out some of that old Tier 2, replacing that with the additional Tier 1. And right now you have about 630 basis points of AT1s. The number does fluctuate every quarter also because of FX volatility.

So if I look into the minimum capital requirements you're going to have with TLAC fully loaded by 2025, the minimum total capital requirement is going to be for you I believe 17.9%. So if I take your target of let's say 12.5% CET1 and then a year of what you currently have of AT1, which is 630 basis points, then I get to a number of about 19% total capital assuming no Tier 2, which would be about 100 basis points above your minimum requirement by 2025.

So which means that in this case you would be looking to replace the AT1s that you have outstanding. If you call them you will replace them with new AT1s. Is that kind of how you think about that target or terminal capital structure?

[Marcos Ramirez, CEO]

They are for you. And everything you are okay. So, yes, Rafael please go ahead.

[Rafael Arana, COO and CFO]

Nicolas, as always, you did the math perfectly. I think the AT1s -- as you mentioned, we will be replacing those AT1s. By the way yesterday we went to the Board and we asked the Board to -- that allow us to start building up what we call a continuous emission program for the market. And we also asked for the Board that allow us to replace the next AT1s that are coming to the market. I think this time also, we'll be looking also potential Tier 2 to be on the balance sheet. But the number that you reach the 19.9 is exactly the number that we see. And we will be going in a merry-go-round with the AT1s on a replacement basis, maybe less amount or a little more in some cases. But I think we are very comfortable with the way we manage the AT1s. But maybe this time, also Tier 2 will be present on the balance sheet.

[Nicolas Riva, Bank of America]

Just a follow-up. I think in the past, the strategy was to replace the old style Tier 2s from past acquisitions with a new AT1s? Going forward, you're saying is that there is an option to issue some of the Basel III Tier 2s as well, you wouldn't have a necessary preference for AT1 versus Basel III Tier 2s or would you?

[Rafael Arana, COO and CFO]

We would love to have the current structure big. Maybe we lose a bit on the AT1s and start building up some of the -- on the Tier 2 because of efficiency. But I think the main contributors will still be the 81s.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Now we'll continue with Carlos Gomez from HSBC.

[Carlos Gomez-Lopez, HSBC]

The first one is going back to the beginning to the loan growth, which has been very strong in the first quarter. How do you see that continuing again, now that we are willing to the second quarter. And as you mentioned that like you may eventually exceed the 6% to 8% guidance that you have given by how much? I mean how far do you think you can actually go? The second is if you could comment on your asset quality. I remember in the previous cycle, you mentioned that if rates went above 8%, we could see as a quality trouble, but we are now at 11 and we don't see to see any. When should we expect to start to see NPLs?

And the last one just to verify, you have given us new economic assumptions. But your guidance is not based on these new economic assumptions. I look at the table that you have at the end, you are still using the previous set of assumptions. Is that correct?

[Marcos Ramirez, CEO]

Yes, you are correct. The first one we don't know. That's why we're not changing the guidance. So we ask you to wait. We can discuss that in the next quarter. And the second one [cost incurred]. I don't know, do you have something….?

[Gerardo Salazar, Chief Risk Officer]

Yes, core growth. Yes, what we have seen -- thank you Marcos. It's an expected cost of risk, which is for the time being lowered, that we provided as an assumption to run some of our internal models. So we keep -- we still think that NPLs and cost of risk, although they're improving in some market segments and some loan types up to now, it’s too early to tell if we will see this megatrend for the rest of the year. So it is almost impossible to lower our sense of prudence regarding this issue. So it is too early in the year to go to a more optimistic mode.

[Rafael Arana, COO and CFO]

And remember that we still have 560 million of extraordinary provisions we have not used. But I agree with Gerardo, it will be not true and it will not be wise to start moving numbers right now.

[Carlos Gomez-Lopez, HSBC]

We understand that. But on the provisions, where is the surprise, is it mostly in the SMEs or in the consumer or everything together? And going back once more for the loan growth, I mean as we enter the second quarter, have you seen any type of a slowdown so far or we are still maintaining this entrance you had as of the end of March?

[Marcos Ramirez, CEO]

Nothing new so far either way. So there is nothing new so far. And the other one is loan growth.

[Gerardo Salazar, Chief Risk Officer]

Yes. Well, the positive surprises, we can locate them in mortgages and our commercial portfolio, the corporate portfolio, governments. So that -- SMEs, which have been performing extremely well. Mortgage SME and auto are very positive surprises. The other ones are not bad either, but they are not as good as them.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Thank you. We'll now go with Federico Galassi from Rohatyn Group. Federico go ahead. I think if not, we can continue with Gilberto Garcia from Barclays. Gil, please go ahead.

[Gilberto Garcia, Barclays]

Hi. Good morning. Thank you for the call. I had a question on your very strong growth in the auto segment. You mentioned that, that was partly driven by new partnerships. Can you give us some color on what the breakdown of the growth was between those new partnerships and the overall recovery of the industry? And whether that -- those new partnerships are for new cars or concentrated in new -- I'm sorry, used cars? Thank you.

[Marcos Ramirez, CEO]

You are right. We have some partnership with Honda and Hyundai…

[Rafael Arana, COO and CFO]

Yes, I know it's a mix of the two factors. Gil, I think it's a combination of the two of these new alliances that Marcos just mentioned. And also, the recovery of Mexico is receiving more cars available for sale.

[Gerardo Salazar, Chief Risk Officer]

And if you let me add, I mean, we also closed a new deal with KIA, and that's bringing also a lot of business. And that's mainly for the new cars. But we are also -- we were not very strong competitors in the used car market. And now we are also being more active in that market, for instance, I will not mention this market is the leader, but we're closing there also the gaps. So I think I'm optimistic about the growth in the future because of these and some other things that we are working on.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Now we will go with Andres Soto from Santander. Go ahead, Andres.

[Andres Soto, Santander Investment Securities]

Good morning, Marco, Rafael and team. Thank you for your presentation. I have two questions. The first one is regarding the cost of risk but this more looking into the medium-term. In your Investor Day, you mentioned you are now targeting a higher level of ROE between 19.5% and 21.5%. I would like to understand what is the implicit cost of risk that is on this assumption?

[Marcos Ramirez, CEO]

Gerardo?

[Gerardo Salazar, Chief Risk Officer]

Thank you, Marcos. What we are considering overall is 1.7%. That's the short answer. Because we have seen that mortgages, commercial, corporate payments or SMEs keep improving. So the last time that we reviewed this same number, it was 1.8%. Now we are moving to 1.7%.

[Andres Soto, Santander Investment Securities]

Perfect. That's very clear. And my second question is regarding the Citibanamex deal. We were expecting to get news about this. And I guess in this case, new news is not good news for Citi at least. I would like to understand from your perspective that the reason why you drop off from the deal, you adjust a matter of pricing expectations, or there is something more fundamental that make you decide that, this was not the right asset for Banorte?

[Marcos Ramirez, CEO]

Andres, believe us, we cannot say anything by contracted. Sorry, I'm really sorry. We cannot say anything.

[Andres Soto, Santander Investment Securities]

Got it. Fair enough. And thank you, Marcos.

[Tomás Lozano, Head of Corporate Development, IR and ESG]

Thank you. This was the last question. With this, we conclude our presentation. Thank you very much for the interest in Banorte. Thank you.

[Marcos Ramirez, CEO]

Thank you.