Banco Bilbao Vizcaya Argentaria SA

MAD:BBVA

Earnings Call Transcript 2018-Q1

[Gloria Couceiro]

Good morning, everyone, and welcome to the first quarter 2018 results presentation of BBVA. I am Gloria Couceiro, Head of Investor Relations. And here with me today is Carlos Torres Vila, Chief Executive Officer of the group; and Jaime Sáenz de Tejada, BBVA Group CFO. As usual, Carlos will begin with a presentation of group's results and then Jaime will review the business areas. After the closing remarks, we will move straight to the Q&A. As always, we would appreciate all the participants to try to make their calls from their land lines and avoid using the speaker phone. And now I'll hand over the call to Carlos.

[Carlos Torres Vila, CEO & Executive Director]

Thank you, Gloria. Good morning, everyone, and welcome to BBVA's First Quarter 2018 Results Audio Webcast. We have really started the year with an impressive quarter with a net attributable profit of EUR 1,340 million, which is the highest quarterly number in the last 3 years with growth of 12% versus the same quarter of last year and also growth of 12% versus the prior quarter. It has also been a strong quarter in terms of capital generation with 13 basis points, resulting in a yearly increase since March of '17 of 46 basis points and reaching a fully loaded core equity Tier 1 ratio of 11.47%. Pro forma, including here, of course, the full impact of IFRS 9 and also the impact of selling Chile and the real estate sale to Cerberus yet to come later this year. The key highlights for the quarter are the strong core revenue growth, NII plus fees growing above 9%. One more quarter with an excellent evolution of costs, which has significantly improved our efficiency ratio by more than a full percentage point in just 3 months to 48.9% with positive jaws in all of our businesses. Outstanding trend also in digital sales and customer digital sales were 36% -- 37% of the total units we sold in the first quarter versus 20% that we had a year ago. And the number of mobile active customers exceeded 19 million, up by 43% versus March of '17. Risk indicators continue to be very sound and improving with the drop of 50 basis points in the NPL ratio to 4.4% and an increase of 214 basis points in the coverage ratio as a result of IFRS 9 implementation. Cost of risks, stable at 0.85%. Capital, I already mentioned 11.47% with an increase of 13 bps. And finally, we remain focused on creating value for the shareholder. Our ROE in the quarter was 11.9%. Return on tangible equity, 14.6%, and the evolution of tangible book value per share plus dividends was a slight increase of 0.7% quarter-on-quarter as it was impacted by the first time implementation of IFRS 9. Now the increase in the quarter after that implementation was quite significant, 3.2% quarter-on-quarter growth of the tangible book value per share plus dividends. Incidentally, please note that the EUR 0.15 dividend that we paid in April has been deducted from our reported tangible book value at the end of March.In a flash, results were strong in the quarter with both net interest income and fees and commission growing above 9% in constant euro terms. Net trading income compares to a high first quarter last year where we recorded EUR 204 million gain that we had on the disposal of CNCB if you recall. So gross income grows at 4.2% rate, and that would have been 7.9% ex CNCB last year. Cost. One of the highlights here, once again very well contained. They increased 3.2% in the quarter, well below the growth of revenues, core revenues as well as total revenues and well below the inflation rate in all of our footprint. As a result, preprovision profits, EUR 3.2 billion growing 5.1%. That would have been 12.8% ex CNCB last year. And versus that, good growth of preprovision profit, impairments were quite low growing -- I mean, dropping by 5.2% versus last year. And provisions came down very, very significantly, both because of lower restructuring costs in Spain as well as lower provisions on foreclosed assets. Net attributable profit, as I mentioned, before grew 12% versus the first quarter in euros or 22% in constant euro terms. Going a bit more in details. Net income interest growth accelerated up 9.3% versus a year ago to EUR 4.3 billion. You see a slight decrease year-to-date. That's because of the high contribution that the linkers had in Turkey, the CPI linkers in the fourth quarter of last year when we -- if you recall, we updated the inflation rate that we use to calculate the CPI linkers. Net fees and commissions also grew fast in the quarter, 9.8% versus the same quarter last year, mainly driven here by Turkey and Spain. Net trading income, I mentioned in the first quarter, was EUR 410 million. That compares to a first quarter last year in which we have the gains on CNCB, and also in fourth quarter in '17, in which we had significant results from our FX hedges. In total, revenues are up 4.2% versus last year and that would have been, as I said, 7.9% ex CNCB. They're down 1% versus the fourth quarter for the reasons I just mentioned. In summary, strong core revenues in the quarter. On the expense side. We sustained the good performance. Expenses continue to grow well below core revenues quarter-on-quarter. This has been the case for many, many quarters now. This quarter, the cost growth 3.2% versus last year, well below the 9.6% growth in our revenues ex NTI. And also, the growth rate of expenses is well below the inflation rate in our footprint. That was 4.4% in the last 12 months excluding Venezuela. Efficiency ratio improved significantly, 106 bps improvement in the quarter to 48.9%. And then, we have looked -- if we look at cost to income ex NTI, the improvement is almost 200 basis points in just 3 months. And looking with -- since the end of '16, 600 basis points improvement. Quarter-after-quarter, I have reiterate our commitment here to this efficiency, and I believe the track record shows how high it stands as a management priority. The improvement in efficiency is common to all of our businesses. Costs are growing below revenues ex NTI in all of the geographies, also below the inflation except in the U.S.A. and in South America. In the U.S., it compares to an exceptionally low level in the first quarter of '17 where we had low personnel costs. And in South America, we have high inflation in Argentina. Now I would particularly highlight the case of Spain where costs continue to go down 4.7%. And Turkey with costs growing well below inflation, 8.6% versus 11.2% inflation. In summary, we have maintained our focus here on being more efficient. We're seeing the impact, the positive impact of our transformation efforts. We had really an excellent quarter in this respect and I'm very happy with the effort and with the commitment across the group. A large part of it has to do with our push to digitize the business, not only to drive efficiency but also to increase sales. Our digital sales keep growing at a fast pace in all of the countries to a very significant level. Almost 37% of our units sold in the quarter were sold digitally, and that is up from 21.5% a year ago. The strong growth trend is consistent across markets. As you can see, digital sales represented 42% of all units sold in Spain, 39% in Turkey. They more than doubled from 14% to 31% in Mexico. In South America, the percentage has also more than doubled with a high 46% of, in this case, the figure is less representative and very influenced by the high growth in the units sold of very small ticket items, micro-insurance products in Colombia and in Peru. In the U.S., the progression is also good, but here, we had significant growth of branch sales as well, thanks to our focus on increased productivity.Digital sales are growing strongly as we make more and more products available for purchase to the digital channels. We have increased our DIY availability from 83% last year to 92% now. And one recent example of this is that redesign of the pension plan digital purchase in Turkey in January of this year, where we made it fully digital, much simpler, faster, friendlier than the paper-based traditional sales process. As a result, pension plan sold digitally have multiplied tenfold in just the last 2 months. This is, I think, a good recent illustration of what I'm talking about. Quarter-after-quarter, we also continue to add tools and solutions to better support our customers in their life, in their business to make better decisions of their money. Developments like BBVA baby planner to help families understand the impact of their household finances or BBVA Valora, which has been extended to Mexico and Colombia after the continued success in Spain. It's a good feeder for our mortgage business. Our BBVA Invest, a platform for funds recently launched in Spain. Bconomy, the set of tools that we update every quarter that include things like the accurate prediction of future transactions and future balances and many more. We, for example, just completed the first global corporate loan transaction using Blockchain technology. The entire process from negotiation of the deal to signing the deal that was announced yesterday with Indra. The increased availability, DIY availability and the improved experience and drive the growth of digital sales. And as digital sales grow strongly, so do total sales. A couple of illustrations of that. In the U.S., for example, the production of our express personal loans, the personal loan -- consumer loan. For example, as you can see has seen growth of 47% since last year, while traditional channels had a growth of 16%. The booster was clearly on the digital side with sales multiplying by more than 4 and representing almost 1/3 of all of the volume. Another good example is the Click&Pay product for small businesses in Spain, which is a line of credit for regular payments. By improving the DIY, we have multiplied the sales through digital by 15x since a year ago. Not only the digital drive total sales as you can see, in this case, plus 33%, but it also helps to migrate transactions to channels that are much more efficient, improving our efficiency in selling and servicing. As you can see, digital sales were just 5% of this product a year ago, and they're now 59%. So it's a clear win for our clients. You get better service, better experience and it is more business for us and more efficient business. Underpinning the growth in digital business is the continuing digitization of our customer base with digital customers up 25% versus 1 year ago to 24 million clients. That represents a 45% penetration rate of our total target customers, and we expect to exceed the 50% tipping point over the course of the next few months, so we have already crossed that tipping point in 6 countries, including Spain, Turkey and the U.S.A. Our mobile active customers grew almost by 6 million, up 43%, 1 more quarter. And with a 36% penetration. We will also reached the tipping point sometime next year. We also find that digital customers have higher satisfaction levels and that they have lower churn. As you can see, attrition rates of the customers that are digitally active are less than half than that of nondigital customers. Engagement levels are much higher as well and they are growing as the functionality grows. In Spain, where our app is the best in the world as per the latest Forrester ranking. Monthly interactions of our customers through the app have doubled since May of 2016. While in the other channels, you can see it remain flattish. While the average number of visits to the branch is less than once per month, interactions through the app is almost a daily occurrence. The increased interactions logically drives engagement, drive satisfaction, reduces churn and increases sales.Moving on to the balance sheet to our risk indicators. We have seen lower impairments, down 13.6% versus last year with sustained low cost of risk of 0.8%. Also lower NPLs by EUR 3.7 billion. A very significant drop in the quarter, another EUR 1 billion just in this quarter in drop of NPLs. And the ratio NPL ratio decreasing to 4.4%. Coverage is up 73%, thanks to the increasing provisions as a consequence of the first-time IFRS 9 implementation. Overall, we maintain an excellent and an improving risk profile. Our capital position is also strong with core equity Tier 1 fully-loaded ratio pro forma reaching 11.47% in March, including here the full impact of IFRS 9. That was 31 basis points. The positives that will be coming from the sales of Chile and the real estate, 57 basis points on aggregate. Those will be close, as I say, this year, in the third quarter. Very good evolution of the core equity Tier 1 ratio in the quarter with the generation of 13 basis points, 37 coming from our results. Then we deduct the accrual of dividends of 15 basis points at a 40% payout. Another impact that deduct an additional 9 basis points. Once again, I would like to highlight the high quality of our capital, which is differentiated versus peers. We remain as a bank with the highest risk-weighted asset density, 52% and the highest fully loaded leverage ratio the best number here, 6.4% versus 4.9% in our European peer group. We're also one of the few banks with the AT1 and AT2 buckets already covered both on phased-in basis and also on a fully-loaded basis. So very strong position, overall, in solvency. I turn it now to Jaime, who is going to give you an overview of the business areas. Jaime?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Thank you, Carlos, and good morning, everybody. We've made a small change in the business area presentation, and now each one takes up only one slide but with the same information as the former 3. I hope you like it. But as always, feedback is welcome. Let's start with Spain. In Spain, macro continues to improve. BBVA Research revised upwards GDP growth estimates for 2018. From 2.5% to 2.9%, and also for 2019 from 2.3% to 2.5%. Core revenue growth, cost reductions and lower impairments boosted the profitability of the Spanish business. Net profit increased by over 17% year-on-year, and that's despite a decrease in net trading income. There are 3 main drivers that, I think, explained the good performance of Spain. First of all, fee and income growing over 7% year-on-year, higher than the mid-single-digit growth guidance. And that has been supported by both Asset Management and higher banking fees. That allow core revenue to grow 1 more quarter by 1.1% year-on-year, consolidating the positive growth trends initiated last quarter. And that is despite the decrease in NII. Also, costs are down by over 4%, improving the efficiency ratio that now stands at 51.5%. Now we also had lower impairments are down by over 55% year-on-year. Cost of risk in the quarter went down to 17 basis points, 1-7, explained by some large ticket provision recoveries, including the sale of a large NPL. We expect to comfortably achieve our cost of risk guidance of around 30 basis points by year end. On top of these, the NPL reduction trend continues down EUR 450 million in the quarter and coverage goes up by a full 7% points to 57%, mainly explained by the increase in provisions as a consequence of IFRS 9 implementation.NII decreased by 1.6% year-on-year. Loan growth was concentrated on the most profitable segments, mainly consumer, growing above double-digits year-on-year on SMEs. However, this was more than offset by the deleveraging of the mortgage and public sector book and also the reduction of the large corporates portfolio. We expect the second half to be stronger than the first half in terms of loan growth. Customer spread behaved well, increased by 1 basis points in the quarter, thanks to the increase in the loan deals, mainly explained by the mix change towards a more profitable segment and a successful price management. All in all, we remain confident that our 2018 guidance of a flattish NII will be achieved. Q1 NII is completely in line with our first quarter budget, and we expected to grow from current levels, thanks to a slight growth in loans and some recovery in the EURIBOR rates in the second half of the year. Moving now to real estate. As you already know, the agreement with Cerberus signed last November will allow us to reduce almost entirely our exposure to a real estate owned assets. We continue to expect the closing of this transaction to take place in Q3, probably in September. Regarding the P&L, net losses in Q1 were contained at EUR 27 million, more than EUR 1,100 million versus last year. And so we are well on track to meet the year-end guidance on the bottom line of around EUR 100 million loss. That compares with net losses of EUR 0.5 billion in 2017, helping to boost profitability in Spain.Now to the U.S., GDP growth expectations for the Sunbelt have also been revised upwards as a consequence of stronger global growth, solid domestic momentum as well as the recent tax reform. GDP in 2018 in our footprint is expected to grow by 3.8% in 2018 and 3.7% in 2019, 1 full percentage point above the U.S. as a whole. In the first quarter of the year, the upward trend in profitability continues with net profit growing by 74% year-on-year in constant terms. NII is growing at 15% year-on-year, being one of the main profitability drivers, mainly supported by improvement in customer spreads at 11 basis points quarter-on-quarter, benefiting from the higher rates and are focused on deposit cost. NII will continue to benefit from further rate increases as the balance sheet is asset sensitive. NII goes up by over 6% for every parallel increase in the curve of 100 basis points. Regarding loans, our main focus continues to be on the consumer book where growth accelerated to 13.5% year-on-year. This solid growth in the consumer portfolio is fully offset by the decrease in the mortgage and the CIB business as a result of our focus on profitable growth. Operating jaws continues to be positive with revenue growing by 12% year-on-year, significantly above expenses. Loan loss provisions are down, minus 68% versus Q1 of last year, and the cost of risk reached 16 basis points due to the recovery of provisions related to hurricanes Irma and Harvey and some commercial loans. Although Q1 cost of risk should not be extrapolated to the following quarters, taking into account the provision releases, 2018 estimates for cost of risk could be better than our initial guidance of 50 basis points. Finally, the new tax rates have declined to 22% after the negative one-off registered in the fourth quarter of last year due to the write-down of some DTAs. In Mexico, BBVA Research maintains the GDP growth forecast for the country, both for 2018 and '19 around 2%, driven by both domestic demands and exports. Once again, and despite the uncertainties related to NAFTA and general elections in July, Bancomer results continue to show sustained growth in all NPL lines with bottom line growing 12% in constant terms while maintaining its leadership in efficiency and profitability. NII growth over 8%, in line with our year-end guidance of above loan growth. Thanks to the improvement in customer spreads, up by 6 basis points and the higher contribution of the securities portfolio. The loans are up by 5% year-on-year with a similar trend as in the second half of last year. While the retail portfolios are growing well around 6%, the slowdown is concentrated in the commercial and public sector books. We expect loan growth to be stronger in the second half of the year due to diminishing uncertainties and seasonality especially in Q4, thus we maintain our 2018 guidance of high single-digit growth. Fees are growing above 6% year-on-year, also in line with our full year guidance of mid-single digit growth, driven by mutual funds, investment banking and credit card fees. Operating jaws remain positive and cost continue to grow well below inflation. The cost-to-income ratio continues to improve, it reached 33.1% in the quarter despite being already best-in-class in the industry. Impairments on financial assets decreased year-on-year. The NPL ratio is down and cost of risks stands at 318 basis points, well below our guidance for the year. We expect the cost of risk to be below 350 at the end of the year, but above Q1 levels, giving our expectations of higher activity growth. Finally, coverage goes up to 153% in the quarter as a consequences of higher profession due to IFRS line.Let's move on to Turkey now. BBVA Research expects growth to moderate this year from a GDP growing 3-point -- 7.4% in 2017. We now expect a 2018 that will grow around 4% on the back of tighter monetary policy and lower fiscal stimulus. Garanti continues to show outstanding results, net attributable growing by over 27%, excluding the change in perimeter, thanks to core revenue growth and its focus on cost control. Core revenues are growing by 16% year-on-year, thanks to both NII and fees. NII is up by 10%, mainly explained by loan growth and a successful customer spread management, more than offsetting the increase in swap cost. As Carlos said, the conversion versus Q4 was impacted by the inflation rate accrual of the CPI linkers that generated an extra EUR 124 million in the quarter. Excluding this, NII would have been flat quarter-on-quarter. Lending growth in Q1 is up by 11% year-on-year in line with our full year guidance of double-digit growth, thanks to the TL portfolio and despite the limited use of the credit guarantee fund this quarter. We're gaining market share in the most profitable segments as consumer and business banking. Costumer spreads are up by 25 basis points versus Q1 of last year due to our successful price management and the better mix. Net fees and commissions grow by over 40% year-on-year. The main drivers are credit card fees and project finance commissions. Operating expenses show an impressive performance once again with cost growing just 8.6%, significantly below average inflation, and positive jaws widened even further. It's worth mentioning that Garanti is implementing its new service model that continues to bear fruit, improving efficiency, customer experience and employee satisfaction. Finally, on asset quality. Cost of risk increase in the quarter to 170 basis points, explained mainly by large ticket provision and negative IFRS micro adjustments. Excluding these 2 effects, cost of risk would have been around 100 basis points in the quarter. So we maintain our guidance, cost of risk of around 100 basis points for year end. Although as we mentioned in January, it will continue to be very dependent on the economic environment. Let's wrap it up with South America. BBVA Research expects GDP and BBVA footprint to grow at 2.7%, above the 2.3% achieved in 2017. Convergence to levels above 3% in 2019 in pretty much all countries. Q1 results reflect a sound growth in all P&L lines with core revenues up by 14% versus Q1 of 2017. NII increases over 15% year-on-year with 2 main drivers, lending growth above 11% mainly explained by Argentina and Colombia and higher customer spreads in Colombia and Chile. A good performance in fee and commissions that grow over 10% year-on-year and an excellent cost management in the region also with positive operating jaws in every country but Chile where they are flat. Impairments on financial assets increased by only 2.2% year-on-year, significantly below activity growth. But remember that last year, we had large ticket to be in provision in Colombia. Cost of risk stands at 137 basis points, and we maintain our year-end guidance of around 160 basis, that's 30 basis points increase versus 2017. All in all, bottom line is growing by 33%. And now back to Carlos for some final remarks.

[Carlos Torres Vila, CEO & Executive Director]

Thank you, Jaime. My final remarks are only reiterate the high quality of our results this quarter supported by core revenues which grew 9.6%. We are seeing a clear impact of digital on our revenue growth and also on efficiency improvements with many quarters now increased efficiency as a consequence. We are achieving double-digit returns in developed markets, both in Spain, even including the real estate business as well as in the U.S.A. It has been a long journey after the crisis and it is good to see that returns in these 2 countries are now above the cost of capital even in the current low rate environment. Finally, we're sustaining growth and sustaining good returns in the emerging markets with strong performance in Mexico and Turkey and in South America. All in all, we continue to focus on shareholder value. Thank you very much for listening. Now, I give the floor to Gloria for the Q&A.

[Gloria Couceiro]

Thank you, Carlos. We are ready to move into the Q&A. As always, I would like to ask you to limit yourself to 2 questions per caller so that we can attend as many participants as possible. So first question, please?

[Operator]

The first question today comes from José Abad from Goldman Sachs.

[José Maria Abad Hernandez, Executive Director]

Do you hear me? I'm disconnected, I think.

[Gloria Couceiro]

No, no, no. We can hear you, José.

[José Maria Abad Hernandez, Executive Director]

Okay, okay. I have 2 questions. And the first question is, obviously, you make a very clear point this time on the causality coming from your digital strategy and lower cost at the group level. So I think my question here is could you please quantify what is the contribution? We've seen this improvement about 3 percentage points in the cost to income over the last year. So what would be the contribution of your digital strategy to that 3-percentage-point improvement in your cost to income? And a follow-up to this is, where do you expect actually the cost to income to get following your strategy? The second question is on capital. So you are reporting the pro forma core equity Tier 1 ratio, the 11.5%, including these 2 transactions. So do you consider that as excess capital? And if so, what plans do you have to deploy? Any potential excess capital going forward?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Thank you, José. On the impact of digital, it is very hard to attribute directly, impacts and quantify it in the way you request, José. But it is very clear now after so many quarters of growing not only the customer base exponentially, particularly in the mobile side with sustained growth rates of 50% now for many months. So as I was saying, it's not only the growth of the mobile customer base, not only the growth of our digital sales, but it is that then we are seeing that the total sales growth, that our revenues grow and they grow well above the rate of increase of cost. So certainly, there is a high element of the impact of digital on this. I think we have many -- much, much, much more room to go in this avenue. Still, we have not reached the tipping point. We will reach this year on digital customers, next year on mobile customers and then soon also on digital sales, so the digital sales will be more than 50% of our business within 2 or 3 years. And that opens the door to, we think, of the cost base on the fixed cost element, which represents really the traditional channels. Also on the back end below the glass, so to speak, the process improvements that I'm working on in the transformation of what we call the production model, the TMP, transactional production model in Mexico, in the U.S., in Peru and other countries we're working in many initiatives that should yield additional improvement in efficiency. So our view is that we will continue to see many quarters ahead with revenues growing ahead of costs. And thereby, continuing to improve the cost to income. I would not dare to give you what ultimately that might be, but it could significantly be lower than today. On the capital, this is a recurring question. I don't think we have much change from a quarter ago. Yes, we generated 13 basis points. That's really good. We still have to close the transactions, so the 11.5%, certainly, is 50 bps ahead of our target. So once we close those transactions and depending how then the business has evolved, how much growth we have seen in our loan book, in our risk-weighted assets, we will see where we stand and we'll make decisions on whether there is excess capital then. So I think it is a bit premature to consider what to do with that excess capital.

[Operator]

Your next question comes from Sofie Peterzens from JPMorgan.

[Sofie Caroline Elisabet Peterzens, Analyst]

Here is Sofie Peterzens from JPMorgan. Given that we have the elections upcoming in Mexico, I was wondering if you could just share your view on kind of what do you think will happen after the elections, especially if AMLO wins. Do you think loan growth could accelerate? And do you think asset quality will continue to improve further? What's your scenario once we have the presidential elections behind us? And my second question is around your hedging policy. Could you remind us on your hedging policy, especially for the Turkish lira given that we have seen -- or the currency has been reasonably weak year-to-date?

[Carlos Torres Vila, CEO & Executive Director]

Sofie, on Mexico, again, it's been now many months with the speculations as to what might happen in the election. So the good thing about election happening in July is that it will be over. So the uncertainty will be reduced and that has been weighing together with the NAFTA uncertainty for many months as I say. No matter what happens, Mexico is one of the most attractive regions in the world regardless of who wins. Competitive industry, great business community, promising growth ahead with a very young population with a history also of sustained growth for 2 decades. Strong, very well-regulated financial system. So none of that will change. And what we see is really -- we're looking ahead to the election independently of who wins, we believe Mexico will have a bright future. Also we have seen uncertainties around NAFTA decreasing significantly, and that I believe is much more relevant to Mexico's future than the election. On the hedging policy, I turn it over to you, Jaime.

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Yes. We currently have hedged around 50% of the P&L contribution coming from Turkey and around 70% in the case of Mexico. Regarding the CET1, sensitivities remain as in the previous quarter very, very low. For every 10% depreciation, CET1 will go down by around 2 basis points, and that is showing in Mexico, Turkey and Latin America. We currently have hedged 85% of what is not naturally covered by the ratio in the case of Mexico, 70% in the case of Turkey, and the FX impact in the quarter on the CET1 was 0.

[Operator]

The next question comes from Alvaro Serrano from Morgan Stanley.

[Alvaro Serrano Saenz de Tejada, Lead Analyst]

Two questions, please. First of all on Spain and the loan book growth. It continues negative. You've pointed out public lending, but I'm just curious if you can give us an update because the latest comments from yourselves, in general, in the industry would be that this is the year where we would see the end of the deleveraging. Can you give us an update of how you're seeing that process, and if you're still optimistic about seeing loan growth this year? And then the second question is related to some of the questions asked before around your footprint. There's -- obviously, you've talked about the elections in Mexico, these elections in Turkey. Ultimately, that's a reminder. I think political uncertainty is an issue in emerging markets. And I completely agree with you that the franchises in the countries have a lot of potential. But in the past, you've talked about bigger footprint in the developed world. If you could choose, would you choose to have a better -- a bigger footprint in developed world ideally? I'm just looking few years out how you see the bank and ideally, is there too much emerging market at this point?

[Carlos Torres Vila, CEO & Executive Director]

Thank you, Alvaro. On the same loan growth, I think Jaime summarized it really very well. We still see a slight loan growth ahead, and we believe the second half will be stronger than the first half, also the first quarter's typically seasonally low, more so this year, where we had the Easter holiday. So good trends we've seen and we'll continue to see in the consumer and SME portfolio. Mortgages still will deleverage. And then we have more uncertainty around the corporate world in CIB and the public sector. But we're still, as I say, think that the second half will be stronger. On the uncertainties on your question on developed on emerging. Uncertainties on elections happen in every country, in Italy, in Spain, in the Netherlands, in Germany. So I don't think it's fair to say that because we have elections in Mexico and in Turkey, then we have a footprint that has uncertainties. That happens everywhere, anywhere in the U.S., everywhere. So yes, there are particularities around the candidates here or there or around their personalities. But again, those 2 countries are large, populations are very, very young with bright futures ahead is how we look at it. And then we look at it as the drivers of our portfolio. In each one of the markets, we strive to have returns above the cost of capital. The issue, even adjusting for depreciation was not in the emerging countries, was in Spain and in the U.S. And for the first time in many, many years, we have the quarter in which in Spain and in the U.S., our return is above the cost of capital clearly. So that will continue. We have in the U.S. the headwind -- I mean, the tailwinds of the rate increases plus the huge potential of our franchise there, great performance with the management we have in the U.S. And in Spain, the weight has already increased to 25% of the total net profit of all our businesses and will continue to increase. So we see the increase in developed markets more by the financial return of Spain and the U.S. to profitability more than anything else.

[Operator]

The next question comes from Marta Romero of Bank of America Merrill Lynch.

[Marta Luisa Sánchez Romero, Director and Analyst]

I've got 2 questions. The first one is on the competitive landscape in Spain and the second one on cost in Spain as well. So the first one, how do you think BBVA is playing its card there? Are you being more aggressive on pricing? Because we think some of your peers are starting to complain about your pricing policy. And here, what are your -- the areas where you're more interesting in growing in mortgages consumer? What's your pricing strategy and loan growth targets for large corporates? And the second one is on costs. Your performance is pretty good. You're outperforming your peers. How sustainable this is? In particular, I was curious to see what would the outlook is for the depreciation line, given that you keep investing in digital. I would have assumed that, that line would be growing or at least not coming down. So it will be great to have a little bit of a view on your digital budget on the P&L.

[Carlos Torres Vila, CEO & Executive Director]

Thank you, Marta. So our competitive positioning in Spain. We clearly have a high -- a much higher market share in mortgages than what we're producing today. So in that segment, we're still well below what our financial market share would be. We're putting a lot of focus on growing in the consumer loan, small business segments, and we're having great results there. We have improved significantly our tools to discriminate price based on risk. That's true also for the mortgage business. So one might see aggressive numbers in terms of pricing. That's not the general pricing available to everyone. It's prices that are adjusted to the risk profile of the customers. So we're very confident that in each and every one of our originations, in any one of the segments, we are earning our cost of capital, both on an economic capital basis as well as on a regulatory capital basis and we have, as I say, improved tools to make sure that's the case. But we do want to grow in Spain. We want to grow in the consumer book. We want to grow in small business. Also, commercial has been one of our strongholds and will continue to be as well as mortgages. On costs, we will continue to see slight decreases as we said 3 months ago. We had a good performance this quarter, and that will continue. Of course, the effect of CatalunyaCaixa last year was still significant, so we won't see numbers coming down as much. But the fact that we are, as you say, investing in digital, it doesn't mean that we are increasing our total investment. Now we have put a lot of focus into dynamic allocation of resources. So that every 3 months, we're applying our general methodologies. We have reassigned resources both people and money to the projects that have most impact. So it's not I am doing a total of more things. We're just doing the right things. The things that have impact. And I think that goes a long way to improve the experience of our customers, to improve our sales, at the same time, without increasing the total bill.

[Operator]

The next question comes from Benjamin Toms from RBC.

[Benjamin Toms, Analyst]

Two questions from me, please. Firstly, are there any headwinds to capital that you foresee for the end of the year other than RWA inflation? And secondly, are your assumptions for loan growth in Mexico in corporate and positive outcome from NAFTA negotiations, would they be revised if a deal is not reached?

[Carlos Torres Vila, CEO & Executive Director]

So I don't quite understand the second question. What was it?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

[Foreign Language]

[Gloria Couceiro]

[Foreign Language]

[Carlos Torres Vila, CEO & Executive Director]

Okay. So there are no headwinds to our capital position, so that one's easy. And on Mexico. Again, as I said, the uncertainty has been lingering for long. We have seen already the fourth quarter last year slowdown in investments in the corporate sector that has translated into lower growth in the loan book, and we continue to see a bit of that in the next quarter. We don't believe that will continue given -- I mean, we are very confident that NAFTA will reach an agreement because it's -- everything has been going to the positive over the last 3 or 4 months and every successive round of negotiation, the 6, the 7, the 8, I don't know where they are now, shows that NAFTA will be concluding with something that is a win-win for Canada, for the U.S., for Mexico.

[Operator]

Your next question comes from Rohith Chandra-Rajan from Barclays.

[Rohith Chandra-Rajan]

I've got 2 as well, please. And the first one was on fees, where you've again showed strong growth and you highlighted Spain and Turkey as the key drivers there. So Spain up 8% year-on-year and actually up 6% quarter-on-quarter. And then, Turkey, 18% year-on-year, 21% quarter-on-quarter. I was wondering if you could just talk about the drivers there and also I guess the sustainability, because those I guess are particularly strong trends. So that was the first one. And then secondly just on the U.S. You've done a good job of keeping the deposit cost low. We are seeing, I guess, some increases in deposit fees across other U.S. banks. Just wondering if there's any more that you can do on deposit cost or if you expect them to stop rising from here?

[Carlos Torres Vila, CEO & Executive Director]

Jaime, do you want to answer these -- the 2 questions?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Yes, sure. Okay, on fees. There's nothing special really in Spain, both mutual funds and pension plans and banking fees support the good trends. this has been a trend that's already started last year, and we remain very confident that we're going to meet our mid-single-digit growth guidance for the full year. In the case of Turkey, the same is true, rates are even more impressive. But in this case, it's true that we have a project finance commission that we got in the quarter. But even with that, the performance will continue to be very strong, very diversified. Merchant fees are behaving very well and credit card fees in general, and I think that trend will remain true in the rest of the year. Regarding deposit cost in the U.S. I think it's a good question. It's true that we've had a very good cost control in our retail funding in the U.S. This has been going on now for over a year. And this has allowed us to improve significantly our customer spread over the last 4 quarters. As we continue to expect good behavior in rates in the U.S., we have no reason to believe that this trend won't continue. So we remain very positive, not only on beating our guidance in the U.S. but -- on reaching, but probably beating the NII guidance.

[Operator]

Your next question comes from Carlos Cobo from Societe Generale.

[Carlos Cobo Catena, Equity Analyst]

Two questions for me. One on Turkey, your [ NTI ] has showed the application IFRS 9, like the geographies and there's a big increase in the Stage 2, let's say, loans of -- top full loans, so to speak. Could you elaborate a little bit more on this if this includes restructured credit on how that compared with the ECB standards where those loans would have been included in NPL ratios under the ECB standards or not? And how do you expect those restructured credit performing, whether they'll be normalized impact to performing or there's a chance of increasing NPL stocks? And second, I know you're maybe tired of this question. But just quickly, if you could discuss your thoughts around capital in regard with European peers, let's say your 11% target could be comparing for an average CET1 ratio of 13% in Europe. Would there be a chance for you to increase your target ratio higher from 11%? Let's say, that will give you a better solvency position when you do business with large corporates and that could help. Is that an option at all or not?

[Carlos Torres Vila, CEO & Executive Director]

Starting with that one. This is -- again, we've talked about it before. We are very stable here. We've had this target of 11% now for years, and we continue to have that target. And there's nothing, in our business that would signal that we would need a different one, because we have very diversified business, very high risk-weighted asset density, good leverage ratio, very resilient recurring earnings, very low volatility in those earnings. All the good things. And if you look at other banks, yes, they might have higher ratios, but they are much worse in all of those elements or many of those elements. And then, you see quarter-on-quarter that they're losing 60 bps here, 80 bps there, like some announcements just this last quarter. So we consistently generate capital quarter-on-quarter. And with those characteristics, the 11% is what we're happy with. On Turkey, this has to do with what Jaime mentioned, the big names that have been restructuring, mostly it has to do with that. We are well provisioned for the names that we know very, very well. And again, the guidance continues to be the one we had, meeting it will depend on what happens on the macro side. But we are, as I said, there's no further than -- I don't know, Jaime if you want to add anything?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

No, that's perfect. Just clarifying, of course our consolidated numbers comply with all international standards, so you just look at our numbers, and they are perfectly correct.

[Operator]

The next question comes from Andrea Filtri from Mediobanca.

[Andrea Filtri, Research Analyst]

Two questions. With IFRS 9 implementation, would you expect lower like-for-like SREP in December? And if so, what would you need to see to change your payout policy? And secondly, what is the cost of the hedging strategy you have in place currently, and when does it roll off?

[Carlos Torres Vila, CEO & Executive Director]

Well we have to see what's SREP. It's really very premature to know what SREP will be like even with stress test is also going on. So I don't think we have a view that anything might change because of IFRS 9. No, I don't think so. But what the SREP will come up with, we will see. It's very, very early in the supervisory evaluation process. But if we look at the bank, everything has gone to the good side in terms of every metric. So things should look better than it ever looked. In terms of constant hedging, Jaime?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Yes. Well, what I said is all the data on a 12-month forward-looking basis. So the average -- it's an average, so we have 50% P&L hedged in Turkey and 70% in Mexico. And that's always on a 12-months forward-looking basis. Regarding cost, the cost of coverage of the P&L goes in the NTI line and the cost of hedging, the CET1 ratio goes in reserves.

[Operator]

Your next question comes from Ignacio Ulargui from Deutsche Bank.

[Ignacio Ulargui, Research Analyst]

Yes, just one question on my side. Could you update us on the interest rates sensitivity in the Spain and in the U.S.?

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Ignacio, it remains exactly the same as it was last quarter. In the U.S., for every 100 basis points increase in the curve, our NII will go up 6.3%. And in the case of the euro balance sheet, it will go up by around 15%.

[Operator]

The next question comes from Carlos Peixoto from CaixaBank BPI.

[Carlos Peixoto, Analyst]

Just have one question from my end as well. If I recall correctly, Jaime mentioned a cost of risk of 30 basis points for Spain.[Audio Gap]My question here was basically, do you see this as a level of -- for that coming quarters or should we expect that coming quarters to be above 30 basis points so that the full year is at. So this is basically whether we should expect a stronger duration in upcoming quarters or just a normalization after that write-back seen in the first Q?:p id="54717999" name="Carlos Vila" type="E" />Okay. Thank you, Carlos, for your question. What we said is that we will comfortably achieve our guidance of cost of risk of around 30 basis points and that remains true now. I'd rather leave it there.

[Operator]

Your next question comes from Andrea Unzueta from Credit Suisse.

[Andrea Unzueta, Vice President]

I have a couple of questions and apologies if you've addressed some of this during the call. I joined a bit later. Did I understand correctly that your flat NII guidance for Spain assumes EURIBOR increases in the second half of the year? And then, the second one is on Mexico. Your loan growth is at 5% year-on-year levels and there has been NIM compression in the quarter. Can you tell us if you reiterate the double-digit growth target in terms of loans, and can you comment a bit on margins, please? And finally, if you could quantify the one-off fees on Turkey.

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Okay. The answer to the first question is yes. We are expecting slight increase in EURIBOR rates in the second half of the year. In the case of Mexico, we are expecting a high single-digit loan growth in 2018. NII will grow in line with activity, and we remain very confident that NIM will behave well as we've been able to manage customer spreads very well during the last few quarters. And also the higher contribution of the securities portfolio.

[Operator]

Your next question is from Javier Echanove from Santander.

[Javier Echanove, Analyst]

I just have 2, very quickly. In Spain on the NII, could you give us an idea of how the ALCO book has moved or changed between the fourth quarter and the first quarter 2018 in terms of its highest yield and level of maturity or duration? And the second thing is, on the net interest income in Spain, it looks like the reduction in funding cost in Spain is logically bottoming. At the moment, I'd like to know what is your thoughts about future behavior of funding costs in the Spain.

[Jaime Saenz de Tejada Pulido, Chief Financial Officer]

Okay. On the ALCO side, it's pretty stable versus what it was the last quarter. It's slightly below EUR 26 billion. The average duration is around 3.4 years, pretty similar to the one that we had last year. But of course, we do expect a lower contribution in the ALCO portfolio in 2018 versus the one we had in 2017. Regarding cost of funding. It is true that our retail funding cost is 7 basis points this quarter. And as we said before, it's very difficult to see this continue to decrease. Our -- we do expect mix improvement, and we also saw this significantly in this first quarter. Demand deposit accounts continue to increase and time deposits balances continue to go down. So that deposit mix continues to impact positively our cost of funding. And then, what we continue to have is lower wholesale funding cost as well as lower wholesale funding volumes. And that is also having a very positive impact on NII, and that is a trend that as we pointed out before, we continue to expect for the rest of the year. Let me answer the question that I didn't answer before around Turkey. The one-off on the project finance side is EUR 18 million, between EUR 18 million and EUR 20 million. That's all.

[Gloria Couceiro]

There are no more questions. So thank you very much for joining this call. Let me remind you that the entire IR team will remain available to answer any questions that you may have. So thank you very much, and have a nice day.