Banco Santander SA

MAD:SAN

Earnings Call Transcript 2018-Q2

[Sergio Gámez, IR]

Good morning, everyone. Thanks for joining to this First Half 2018 Grupo Santander Earnings Conference Call. As we normally do, our Group CEO will address the group performance for the first half as well as the concluding remarks. And our Group CFO will talk deeply about the different business areas' performance. And obviously, we'll have, as every quarter, plenty of time for Q&A. So without any further delay, Jose Antonio, please.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Thank you, Sergio, and good morning to everyone. Thank you for attending this first half results presentation. Well, I'm going to go through the results in the usual way. Let me to start a little bit talking about environment. We developed the business in an environment that has been for sure more volatile than in the previous quarters, mainly due to political reasons that the translation into our results probably you see more in the currency depreciation that has been fairly strong in the quarter.

We also had some news from European Central Bank in the end of quantitative easing and postponing somehow the potential interest rate increases until the summer next year. Finally and probably the most important thing that is going on in the environment is the discussions about trade, global trade, that the potential introduction of barriers is what has created probably more -- has the highest potential impact to affect the markets.

Having said that, in this environment, our business continued to perform well. On the commercial transformation side, we continue to produce good outcomes, good results. Both the number of loyal customers and digital customers are progressing according to our plans. In fact, the number of loyal customers is already above our yearend target, and we are progressing well on digital customers.

The digital transformation is going across all the units with different speeds, depending on the markets. We're able to translate this into our results. We got in the quarter around €1.7 billion profit after the charge, restructuring charge that we did for -- related with Popular integration of €300 million. As usual, you have in the second quarter the resolution charge for the European Resolution Fund. On a like-for-like basis, the second quarter came -- the profits came better than the first quarter by -- increasing by 6%. Here, first half compared with first half results grew 12% on current euros and 25% in constant euros.

On the capital side, the organic capital generation was good in the quarter, 18 basis points. We always guide you for an average of 10 basis points per quarter on the year. This quarter came better. It's true that, in the quarter, and we anticipate some of these impacts in the previous quarters, we had plenty of movements. And the ones related with the perimeter total bank that was anticipated to you plus 5 basis points, restructuring charge minus 5 basis points [indiscernible] for sale portfolio mark to market was probably the main one in terms of being unexpected, while SCUSA minority interest we already anticipate to you. Having said that, I will elaborate later on, on the specific numbers.

The profitability, we're already above 12% with intangible equity. It's one of the highest in the sector in Europe, and we are progressing well in this regard. Finally, in the outlook for 2018, we are on track to meet all of our targets, and in Popular integration, I will say it's going as suspected. We will expect to have all the authorization approvals to go for the legal integration by September, the end of September, and starting the operational integration at the end of this year, November, December and going into the first/second quarter of next year.

Well, as I said before, good progress on the commercial front. The loyalties that is paying off, you will see in the fee income. The fee income generation for a third year in a row, we are north of 10%. And this reflects the success of the loyalty strategy. We are progressing loyal customers and relating this into the line that reflects this the best.

On digital customers, digital evolution is going on. The number of customers that interact with us through digital channels is growing and growing, and it's growing 23%. And we are close to our target of 30 million digital customers by the end of this year. Our digital customer definition is those who interact with us in one month that normally there is different metrics here. You have one month. You have some people that use three months and even some people that use six months. I would mention it's relatively strict.

So going to the P&L, what we have is the numbers you have here. You have the second and the third column makes the point that I said before, how important was the currency depreciation this quarter. You have constant euros in the last column, current euros in the previous column.

What you have there is, basically, we are revenues around double digit in constant euros. That is fairly flat. It's in current euros due to depreciation. We are the same with expenses. Provisions for bad loans came much better than in previous year. In fact, they are growing only 4%, while the portfolio is growing much faster than that. And in current euros, it's falling. And finally, we have a higher tax rate than in the previous quarters due to the fact that, in Brazil, we didn't apply this quarter the interest on capital. And for that reason, the tax rate went up from 34% to 36%.

The ordinary profit is 12% up compared with the first half of 2017 and 25% up in constant euros, so a good outcome overall for a business that is performing pretty well all across the board, as we will see in the next pages and when the CFO elaborates on a country-by-country basis.

The main lines of the P&L underline one fact, is the recurrency of the business. The business is fairly recurrent. Both net interest income, we are showing constant progress quarter on quarter, fee income pretty much the same, growing quarter on quarter 2% above. So you look backwards to the previous 4 or 5 quarters, you see pretty much the same costs, while we are investing in several countries, although having said that, we are able to keep the costs under control and above or a superior performance compared with our peer group.

The provisions I mentioned before. The cost of risk keeps falling. It's exceeding -- we guide to you for 1.2% cost of risk. We are below 1% already. So it's behaving better than expected. The macro environment is quite helpful on this.

You have on the right side the performance, the P&L of the group in the last couple of quarters, showing a consistent trend aside from the second and fourth quarter, where we have the resolution charge and the deposit warranty fund charge. Aside from that, you see a fairly recurrent set of number that produce growing results.

When it comes to volumes, the performance was -- we saw in the quarter some acceleration in volumes. You see on the -- both on loans and customer funds. Almost all the units are growing, including some that were previously steady or flat or going down, like UK and Spain, growing all across the board. The volumes came better, both in loans and deposits. And the growth tend to be faster in retail and SMEs than in large corporates and corporates. So this happens not only in Brazil. That was the case before. This also happened in Spain and UK. It's more heading towards retail than the large corporates and corporates, both in loan and customer funds.

The profits, you have all the units in constant euros. You see all of them are growing. You have in brackets excluding the resolution fund, but all across the board, the performance is not that based on one unit. The performance overall is very good, and this makes us confident that we're going to continue to deliver towards our goals, year goals.

When we look, going to retail into NII, net interest income, we have the -- in the net interest income in constant euros growing both in mature markets and developing markets at different speed. The different speed come from two facts. We are growing mid-single digits -- high single digits, both in loans and deposits in mature markets, while we are -- there's some margin compression here, basically due to the €IBOR. And that affects the mortgage portfolio in Spain and Portugal that, well, still is a drag in the customer spread.

In emerging markets, we are growing double digits. We'll keep growing double digits and with some margin improvement. This margin improvement comes more from the fact that there's a shifting mix particularly in Brazil and somehow in Mexico than on a like-for-like increase in the NIM.

In fee income, I said before, and you see the numbers here, that we are able to translate the loyalty. Loyalty at the bank is transactionality with the bank. And when it comes -- you see the activity at the bottom. You see that mutual fund balance are growing 9%, the turnover in credit cards, in debit cards is growing at 17%, insurance premiums is growing at 11%. Those are products that represent fairly well what loyalty means. Then it's the customers having more transactionality with us other than the savings and loans traditional approach. And we translate this into a healthy growth in fee income, both in developing and in mature markets, 16% in developing markets, 10% mature markets.

You have some perimeter change here that you see particularly well in wealth management, where we include the asset management that grew 67%, but there is some change in perimeter there, while in retail banking, we're growing at 10% at almost no change in perimeter there. And CIB this quarter came relatively quick, particularly in Spain, where you will see the fee income relatively quick because the quarter was not particularly good in this regard in Spain.

Costs I mentioned before. You have some numbers on here that have significant impact. The perimeter has significant impact, like Spain, Portugal. But basically, this reflects the position we're going. In countries like Brazil, we are growing in real terms just because we are gaining market share. 100% of this is variable cost. It's related with activity, while in markets in which we have an integration in Spain, we are starting to capture the synergies of integration. This year, we are well on track to achieve synergies of more than €150 million, as we anticipate to you. And in the US, we anticipate you also that, once we passed the CCAR last year, we were in a position to be much -- to gain -- to make some efficiency gains in the US and is reflective here.

On the other side, you have Mexico, where we are making significant investments to upgrade our operations in the market. And we still have to improve our infrastructure. I'm not referring here to the digital infrastructure, although we are investing also in digital infrastructure. It's the traditional infrastructure where we're operating in order to improve the quality of the service we are providing to the customers, as you can see on the slide. You see that we are -- have good cost control with the best cost-income ratio in the industry compared with our peers. And we combine this with being top 3 in customer satisfaction in the majority of the countries in which we operate. And this is something that we care a lot about, as we are building on loyalty. Building on loyalty means to keep the customers with very high satisfaction rate to keep the customers loyal to the bank.

In asset quality, nothing to add. The trends are good. The cost of credit is below 1%, 100 basis points. NPL ratio keeps going down. And well, I will say, on final real estate exposure, although it's less than 1% of the balance sheet in Spain, we have the €5 billion, and it's trending down in a market that is in very good shape. The real estate market I mean is in very good shape. And while this allow us to evacuate from the balance sheet, to reducing the balance sheet the risk-weighted -- sorry, the real estate assets that are coming as a result of the CAR process that are ending with the repossession of the assets that came from the bad loans that -- in the real estate crisis in Spain.

So when it comes to capital, we are very much in line to reach our -- the capital targets in the quarter, as I mentioned in the beginning. Organic capital generation was good well, above the average we expect for the year, 18 basis points compared with 10 basis points. Perimeter and restructuring costs offset each other. Perimeter is total bank that we sold, and restructuring costs is the charge of €300 million related with Popular integration.

The 20 basis points come -- basically, the minus 20 that is reflected here as other comes from the valuable for sale portfolio, the ALCO portfolio, the mark to market that basically in the year is basically flat, in the first quarter was a positive, in the second quarter was negative and overall in the year is fairly neutral.

And what wasn't expected was SCUSA minority interest that, while I anticipate to you in the previous quarter, is 18 basis points down. And finally, what you have that we think that we expect the authorization maybe this quarter, maybe next quarter around September, October that will help 9 basis points. So we are at 10.80 on transitional IFRS 9 and 10.62 on fully loaded related without transitional agreement in -- related with IFRS 9.

The only thing new here that we were not anticipating was, as I said before, SCUSA minority interest. That is the only headwind we have in capital. Other than that, we are on track to meet our targets and to be around 11% at the end of the year. And we remain confident that we achieve our target.

Another topic, regulatory topic, MREL, we knew this quarter -- we published that our requirement that is 24.35% of risk-weighted assets. The good news is we already meet this requirement at the end of 2017. So the compliance date is for 2020, at the 1st of January as of 2020. Our MREL compares pretty well with our peers, but well, this is just to tell you that we don't expect to have higher funding cost as a result of complying with MREL. It's already in our numbers.

Finally, the ratios, the RoRWA, we continue to show increasing profitability, balance on return on risk-weighted assets. We are progressing steadily and constantly. It's fairly recurrent. We are going up, and this translating to a higher return on tangible equity, higher EPS, where we remain committed with double-digit EPS growth this year. And tangible net asset value is performing pretty well, although we have had, as you saw, a significant impact of the depreciation in this quarter. If we exclude depreciation, we have a 6% growth, excluding the FX impact. But including the FX impact, we were fairly flattish. That is a good outcome in a fairly volatile quarter in currencies.

Just to finish before I hand it to Jose to comment on the units, just comment to you that we decided to -- in order to have all the numbers of our first Investor Day planned at finish -- at the end of 2018, we decided to postpone our strategy update by probably February next year, once we publish the results of 2018. Well, we update you at that time about our prospects for the future. The main area behind this is, first, to complete our plan before we hand to you a new plan. And another thing, we expect to give you a comprehensive analysis of our digital transformation, how this is going on and incorporate some news that are important for our business, particularly Brexit that is going on, also the elections in Brazil that come, as you know, by the end of October.

Now I hand it to Jose to elaborate about the units, and I come back after at the end to make some conclusions.

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

Thank you, Jose Antonio. Good morning, everyone. Like always, I will make detailed comments on the major main units and quick comments on some of the small ones. In the first half, we had 8 out of the 9 main businesses showing profit, positive profit growth, as you can see, being Brazil the greatest contributor. We still have more or less 50% Americas, Europe, 50% emerging developed economies. The most significant change from the previous quarter is the drop of Spain, but it's basically the reflection of the charge for the single resolution board.

Starting with Brazil, we now have probably the most competitive bank in Brazil. We've been investing in developing these capabilities in the last few years. And in this very volatile environment, Brazil continues to perform extremely well. We are gaining market share in all segments, and we are developing a new business mix that is helping us, despite the drop in interest rates. As you can see, we are -- been able to even increase the net interest margin. So overall, we have a very strong performance in Brazil in the first half, also in the second quarter. And we would expect this trend to continue over the next few quarters. Cost of risk is around 4.3% at the moment, and it should continue its positive trend over the next few quarters.

In Spain, for the first time in many quarters, we see quarter-on-quarter positive growth. We had very strong new production in SMEs, in consumer loans, in mortgages. And this helped the quarter-on-quarter evolution, which coupled with a substantial improvement in the cost of funding, as you can see at the bottom of the page, is helping net interest income growth, quarter-on-quarter of growth of around 2%.

The integration of Banco Popular is going as planned. And we will complete the legal integration in September. And this is helping us in terms of the calendar for obtaining the synergies that we expected. And we are very much in line with the €150 million restructuring benefits or cost benefits that we expect from the integration of Banco Popular this year. The restructuring costs last year were made in the third quarter. We have made this restructuring charge, as Jose Antonio said, in the second quarter, again showing that we are a bit ahead of our initial plan in terms of the integration of Banco Popular.

Finally, the cost of risk should stabilize at around 30 basis points. And again, this quarter, we have the SRB charge, which amounts in Spain -- of the total of €270 million, €160 million correspond to Spain. So when we look at quarter-on-quarter comparison, this quarter is affected by two elements, one, the SRB charge and the restructuring costs for Banco Popular.

If we move to the UK, we see an economy that is performing a little bit better. We have some uncertainties, obviously, associated with Brexit. The environment remains very competitive, and we are working in several regulatory aspects, particularly the refencing process. In this environment, we have a significantly better second quarter than the first quarter. We were able to grow the loan portfolio by approximately £3 billion, mostly driven by mortgages, but also SMEs, and CIB had a strong quarter.

Profits quarter on quarter rose 16%. If we look at year on year, net interest income is down due to competitive pressures. As you can see, the net interest margin is -- year on year is down. Costs obviously are up because we are investing in digital transformation, in restructuring and reengineering the bank. And also, we have some regulatory investments there. Cost of risk remains very low at 10 basis points, in line or even better what we thought, so overall a good quarter in the UK, significantly better than the first quarter.

In Santander Consumer Finance, the trends that we saw in the first quarter and in previous quarters continue. We saw volume growth, loans growing 9%, deposits growing 7%. Not all of that has been translated into revenues, into net interest income because of some margin pressure. Fee income is down mostly due to adjustments in our pricing of insurance products in Germany and the Nordic countries. By the way, in Germany, the integration of all of our operations under a single entity is proceeding as expected.

Cost of risk remains at historically low levels. Year-on-year comparisons here are a bit difficult because of some portfolio disposals that took place and are still taking place, but mostly took place last year. But in general, same trends this quarter than in previous quarters, and these trends should continue over the coming quarters.

Now moving onto the smaller economies, in Mexico, double-digit growth all throughout the P&L. Net interest income, fee income, what we are -- as we mention, is the country we are investing the most. We need to restructure the operations in Mexico, and also, we see there double-digit growth in costs and a much better evolution of provisions. We've seen provisions clearly growing at lower rates than before. And this is obviously helping the profitability that, in this quarter, Mexico got a return on tangible equity of 20%. And we continue to see similar trends in the coming quarters.

Good quarter in the US. We passed CCAR, and we got our capital plans approved. And that means that our -- the dividend distributions from the US up to the group will go up over the next few quarters. We see better trends in volumes, both at SCUSA and the bank. And the bank also, on top of better margins, we see better margins. And we saw very good performance at the bank.

SCUSA is seasonally the strongest quarter. So and this was reflected clearly in the P&L. We have significantly lower loan loss provisions relative to volume growth. And this is a reflection of the fact that our FICO is higher. The new FICO, the FICO new production is clearly higher than before. So we continue to derisk the profile of the company. And it's 18% return on equity this quarter. It's quite outstanding, given the new risk profile that we see at SCUSA. Again, this is the strongest quarter of the year. But when we look at year-on-year trends, both at the bank and at SCUSA, are pretty positive.

In Chile, we have the leading private sector bank in Chile. We saw growth in lending and a better cost to funding and mix of funding. Profit increase basically on the back of strong commercial revenues and lower cost of risk. We, like in other countries, are investing in technology and operational transformation. And that is reflected in a slight growth in cost in real terms.

In Portugal, like I always say, we have the best bank in Portugal by far. It's now in the process of integrating Banco Popular. That integration, like in Spain, is going according to plan. When we look at the P&L, year-on-year comparison is a bit distorted by the fact that we had some portfolio sales last year. Still, profit before tax is up 16%. We have higher taxes this quarter, and that's why the bottom line is not growing, but pretax profits are up 16%.

Good quarter in Poland, where volumes both on the asset side and the liability side are growing double digits, 10%. On the liability side, you see a slight increase in cost of funding, basically because we needed to capture the process to fund the acquisition of the Deutsche operation in Germany, which is mostly private banking, which by the way is doing very well, so overall, a very strong quarter, very strong performance, gaining market share and demonstrating that the bank is and remains the most competitive in the country.

Finally, in Argentina, we had a very volatile scenario with the appreciation of the peso, as a result of that, higher interest rates, which overall is positive for the banking system, and it was positive for us. You see positive evolution all throughout the P&L. For us, the key is the stabilization of this process over the next few quarters. Obviously, the IMF package should help in this sense. Profit growth was up 22% quarter on quarter. And the trend should remain over the next few quarters.

Finally, turning onto the corporate center, lower costs, that means better performance at the corporate center, mostly as a result of the profits associated with our hedging strategies of the profits coming from the countries. The depreciation of the currencies has a negative impact, obviously, in the translation of those profits into euros. But because we have the hedging at the corporate center, we had a gain in the hedging of these profits that is reflected in these numbers, in gains and losses of financial transactions.

Net interest income, higher costs because of the issuances to comply with the TLAC and MREL requirements. As Jose Antonio said, we already meet these requirements. Provisions and other income are up, but this is some of a lot of small issues here. We have the insurance, the guarantee of DTAs. We have pensions. We have litigations. So this is some of a lot of small things, but it's nothing really significant there. So the bottom line is a lower cost of the corporate center relative to the profit of the units, which was the target that we set in our Investor Day.

I'm going to turn it back to Jose Antonio for his concluding remarks. Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Thank you, Jose. Let me to take just a minute to sum up basically looking forward towards our 2018 targets. I already mentioned on the loyal digital customers, that we're well on track to meet those targets. In fee income, we are progressing well. And cost of credit, we are beating clearly our target. The environment is helping in this regard. Cost-income keeps demanding, although we have here Popular. Excluding Popular, that naturally was not in our targets when we initiated this. Well, we are in line to make this target, although as I said, it remains challenging basically because we are making significant investments on the digital side that are not yet producing the increasing productivity we are looking for with these investments.

The EPS double-digit growth, we are on track to meet this target. The dividends, we already announced our policy in the AGM. The Chairman announced our policy looking forward for 2019, where we plan to eliminate the scrip in 2019. So and we're increasing dividends years after years. And next year, we plan to eliminate the scrip, as I said.

In the capital target, the only thing I mentioned in the presentation is the unexpected 18 basis points coming from the minorities at SCUSA. We are on line to be around this number. So we are there. And in return on tangible equity, we are exceeding our target already. And we expect to meet our target. So overall, we are well on track to meet our targets and to deliver on this. The environment continues to be fairly volatile.

And the main drag in the results continues to be the very low -- the ultra-low interest rates, particularly in the Eurozone, where as you know, we run a significant very large deposit book combined with a very large loan book at floating rate. That is the worst combination you can have in this environment. You cannot reduce deposit costs while you have a reduction, continuous reduction on the loan book. And we've been able to match in this environment.

So overall, this is what I need to say. So the volatility in currencies and I expect to remain [indiscernible] in the second quarter. Probably we should expect a more constructive environment in currencies. That will help us to deliver clearly in the current euros.

Thank you. And we remain at your disposal for the questions you may have.

[Sergio Gámez, IR]

Thanks, Jose Antonio. Thanks, Jose. Operator, I think we can jump directly to Q&A. Thank you.

[Operator]

[Operator Instructions]. The first question comes from Jose Abad from Goldman Sachs. Please go ahead.

[José Abad, Goldman Sachs Group]

Yes, hello, good morning. Thank you very much for the presentation. You reiterated this morning your plans to meet your 11% core equity tier 1 target. The question is whether you plan to do it this year. And you said -- you mentioned that the fully loaded capital target as of Q2 was 10.62% fully loaded, including the full impact of IFRS 9, also pro forma for we think. Therefore, there is a 40 bps shortfall to your target. So it would be good if you could actually give us some visibility of how you plan to meet the target this year, given the run rate of organic capital durations of 10 bps per quarter. The second question is on FX. Would be good if you could give us an update on your hedging strategy for major currencies and in particular the Brazilian real for -- and the British pound for half two of the year and 2019 and also whether you could give us some sensitivity of the impact to tangible book of, let's say, every 10% appreciation in these currencies. Thank you very much.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. I will elaborate on the first point. And I pass to Jose, our CFO, to elaborate on the hedging strategy vis-a-vis with the currency and sensitivity around this. It's true that we have 10.62%. Our target is 11%. As I said, I would remain confident to be at the end of the year around 11%. What we do expect is a relatively low growth in the second half of the year of the risk-weighted assets, while the profit generation will remain fairly strong. We already charge -- we charge already restructuring charge. We anticipate, compared with the previous year -- last year, we charged in the third quarter. This year, we anticipate the second quarter. So as I say, we remain confident based on our numbers. We're going to be around there. Need to say that, based on the current numbers, it's better than our internal numbers, the internal numbers we were expecting at this time. But the minority interest in SCUSA, that is the only thing, as I said to you, that came as unexpected. Jose, you want to --

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

Yes, so the hedging, we haven't changed our strategy, the one we communicated in previous quarters. So we have fully hedged the -- our budget, our profits coming from Brazil and Mexico, so fully hedged in 2018. We also have fully hedged the pound for '18 and '19. So in -- as of the end of June, the net gain of all these positions was approximately €80 million. The sensitivity of book value to changes in the currencies, well, it's very easy to calculate just by applying the sensitivity to the actual equity that we have in these economies. We hedge the capital adequacy ratio, which is the axis of the local ratio to the group. So that doesn't really change much the sensitivity of the actual valuation of the book value. So you can calculate that by just applying the changes in the currency to the book values that we have in reais or in Mexican pesos.

[Sergio Gámez, IR]

Thanks, Jose. Next question, please.

[Operator]

Thank you very much. The next question comes from Mario Ropero from Fidentiis. Please go ahead.

[Mario Ropero, Fidentiis]

Hello, good morning. My first question is on the available for sale ALCO hit in the quarter reflected in capital. Could you please elaborate in which geographies this impact was felt? And then also on the cost of risk guidance of 1.2%, do you think that 1% is sustainable in the coming quarters, particularly because it is really -- it continues to be really, really low in consumer finance Europe and in the UK? So maybe you can also elaborate a bit on what you expect for cost of risk in these two geographies in the coming quarters. Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. You want to elaborate on AFS?

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

Well, the amount of the portfolios that we have right now is around -- a bit less than €30 billion between Spain and Portugal, €28 billion, and BRL14 billion. We have a very small portfolio in Mexico. So obviously, it was the change in euros and reais that explain the movement in the quarter. But again, as Jose Antonio said, we look at the first half. Basically, the impact is almost neutral in euros and slightly negative in reais. So in the year, in the first half, the valuation of the AFS portfolio almost detracts just a couple of basis points from our capital adequacy.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Probably yes, to clarify that the portfolio is basically Spanish sovereign bonds and Portuguese sovereign bonds because we disposed the portfolio we had in Popular of Italian bonds at the end of last year, at the beginning of --

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

Beginning of this year.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Beginning of this year 2018. Because of risk, how sustainable it is, you asked specifically about two geographies, consumer finance and UK. Well, it's true that the cost of risk in these units you mention is fairly low. Having said that, in consumer finance, we may even have some reduction before it was -- probably, it will get better before it will get worse because what we are seeing every time when we dispose a portfolio, and you see every year quarter on quarter that we make gains when we dispose the portfolios, have written off the loans that were provide or written off. So probably the expected losses at this time of the -- at this point of the cycle is even better than the ones we are reflecting in the P&L. And this is the experience when we dispose portfolios, while in UK, it's true that the cost of risk is close to zero, other than some events, specific events we have had. Naturally, in our case, depends very much on the behavior of the real estate, particularly the mortgage book, although when we start to -- as you know, IFRS introduced some volatility on -- potential volatility in the way we provide, given the fact that we provide based on models. And if we see -- we start to see the housing prices going down or the GDP going down or a combination of both, we need to anticipate expected losses based on the model, and this will add volatility. What we say incurred losses is nothing new, but maybe in the future, depending on the house price evolution and other factors, macro factors, you may see some quarters, say, some volatility there, but we have not seen any sign that leads us to think that we're going to need more provisions on the UK, particularly for the mortgage book.

[Sergio Gámez, IR]

Thanks, Mario. Next question, please.

[Operator]

Thank you. The next question comes from [indiscernible]. Please go ahead.

[Unidentified Analyst]

Yes, thank you. Two questions, one follow up on capital. Just wondering if you are considering any nonorganic measure to get to the 11% target, and in particular if you can comment on the potential unwinding of the JV with Chrysler for SCUSA and the potential implications or any other measure, like the sale of the real estate assets in Spain, if you're also counting on reducing any capital here. And then second question is on Brazil. Very strong trends in the second quarter with loan growth accelerating, but we have seen also macro prospects deteriorating the last few months with some downgrades in consensus forecast. So if you can update also on your expectations in terms of loan growth and cost of risk for Mexico -- sorry, for Brazil in the full year. Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. On capital, you are thinking nonorganic measures. Now when I said to you that we were going to be around 11%, it's -- well, nonorganic, we're going to be active as usual in securitizations. But other than that, nonorganic measures. You point out to one fact that is the FCA announcement that they did in the Investor Day that they planned or may plan to buy back from us to secure the option they have in the contract they have with SCUSA. Nothing to comment here. Their intention was announced. They have the right to do so. They have the right to take from us basically all the book we generate in operations with Chrysler, the loan book plus the leases. But it's too early to say anything. Well, the potential impact of that in capital naturally depends on price. And we haven't talked to them. And we haven't received any figure from them. And so it's too early to tell you.

So naturally, this has a positive impact in capital. So from one still you can estimate the book is basically 50% of the book of SCUSA. You translate this basically one for one for risk-weighted assets. And you can estimate easily the potential impact on capital. But we are not counting on that for this year. Sale of assets in Spain, I think that you are referring to real estate assets. This is a continuous process. We're going to continue to sell. We're going to continue to dispose risk-weighted assets in Spain. This is -- I state to you many times that this is not core for us. The real estate market is in relatively good shape, and we're going to continue to dispose these. Naturally, this is going to reduce somehow the risk-weighted assets. But this is more -- the reason is not because reduce the risk-weighted assets. The reason is because it's not core for us. And we're going to keep disposing all of this. In Brazil, you say about -- that the quarter was strong.

Well, I've been -- we've been telling you for many quarters that our franchise has improved in a significant way and keep improving. We have several business in which we are gaining significant market share. And I expect to continue in this regard, business that are mainly retail related. We have a phenomenal consumer business there. We have a credit or [indiscernible] payroll-related lending that is doing very well. And we are gaining share. We are gaining share in credit cards. Our SME business is starting to work, while still corporate business that is better than it was is starting to perform better. CIB is not growing. So we have significant growth, significant market share gain on the retail SME side. And well, corporate is improving, and CIB is still relatively flattish. Should this pattern of growth and gaining market share translate into higher cost of risk that you are pointing out? We don't -- well, last quarter, some of you asked me why the cost of risk was four, whatever, 30 or whatever and not going so fast to the 4% we were advising you. The reason was exactly this. So we are growing much faster than we were anticipating in retail and less so in the global corporate and corporate business. Having said that, I do expect the cost of risk to remain where it is or trending slightly down, assuming that we keep this pattern. Naturally, if the pattern of growth changes, probably we can say that we start to grow more in CIB probably because of fiscal down faster than otherwise would be the case. But overall, we remain fairly confident. It's true that the macro deteriorates a little bit. But we remain fairly confident in the capacity of our franchise to keep outperforming our peers in the market.

[Sergio Gámez, IR]

Thanks, Paco. Next question, please.

[Operator]

Thank you. The next question comes from Alvaro Serrano from Morgan Stanley. The floor is yours, sir.

[Alvaro Serrano, Morgan Stanley]

Hi. Just a couple of questions on Spain and the UK. So Spain, the NII recovered quarter on quarter. But you still have the -- I think the 1, 2, 3 count. There was a repricing in March and another one in July. So the question is, can you give us a sense of what kind of NII growth we should expect considering that and considering the volume is also recovering? What kind of NII growth should we expect? And should we expect any NII growth as we go into next year, given it seems like we're not going to have any rate increases now? The second question is around the UK. So the NII is now broadly stable. Can you give us both an outlook both in the NII but also in the costs? There was obviously a lot of front-loaded costs that you've pointed out in Q1. The cost rate hasn't dropped that much, only marginally in Q2. And I'm conscious that management expected 5% growth in costs for the full year, so maybe an update in the UK, both in NII and trends and the cost guidance. Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. Let me to elaborate on the -- I assume that it's the net interest income in Spain. It's a combination -- well, the main driver was funding costs, as you rightly said. There is still more to come in this regard. You also mentioned that it's coming by July. We are building on loyalty at a cost. So and we are balancing this equation. So what is most important probably or the main change is the change we've seen in volumes. Consumer lending plus SMEs is growing. It's growing. Consumer lending was growing last year, but SMEs is the first time. And this is particularly important in our franchise after Popular will hold a significant market share here. And it's critical for us going forward. This is the good news. The bad side continues to be the rates, as I said. Going forward, we expect we still have room to take measures in order to keep our net interest income going. I'll not give you a number, this. But I remain -- I think that we initiate kind of a trend in which we stop the decrease in net interest income.

While in the UK, you mentioned the two sides, the NII stable and the costs stable. But you were expecting apparently to have lower costs. And then I -- the market -- the mortgage market remain fairly competitive, although in the quarter, we've seen relatively flattish the spread compared with the first Q. It's not the case, you remember that the second part of last year and the first quarter of this year, the spread came down from a region of 1.30 to a region of 0.9 or something like that. Now we remain basically there. And for that reason, with some volume growth that we show in the quarter, the NII remained stable. And still, the impact of a standard variable rate is there. But this quarter was less important. Going forward, we're going to continue to have some impact from SBI, although we think that we can keep growing somehow not that much on being constructive on NII, not -- to remain stable is probably the target. On cost, we were flattish this quarter compared to the previous quarter. Probably, we are growing on a year-on-year basis in the 7% -- the region 7%, 8%. Probably, we're going to remain relatively flattish or slightly down in the second part of the year. And we will end up in a kind of cost growth in the region of 5%. This is the result of many investments we are doing and we continue to do. In many fronts in order to -- particularly in projects that are particularly trying to serve customers in a fully digital way. And we continue to do so in order to have a franchise that is able to compete in the market going forward. So that's all, yes?

[Sergio Gámez, IR]

Thanks, Alvaro. Next question, please.

[Operator]

Thank you. The next question comes from Sofie Peterzens from JPMorgan. Please go ahead.

[Sofie Peterzens, JPMorgan Chase & Co.]

Yes, hi. Here is Sofie from JPMorgan. So I wanted to ask you, what's your view on the potential banking tax in Spain? And what impact would you potentially expect on Santander? And then I also wanted to ask about the Chrysler deal. If it goes ahead, how do you think about your US franchise, given that the annualized ROE in Santander Bank USA is still well below or is slightly below 4%? How should we think about the kind of -- how important the US franchise is to you? And then just very quickly, on the Popular cost synergies, when should we expect to see a big decline in the cost line in Spain? Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. Tax in Spain, potential banking tax, difficult to elaborate on this. We have seen so many -- I don't know if you call it ideas in the coming -- in the past weeks coming to the media. That is difficult to elaborate in any specific direction. We have seen ideas in increasing the corporate tax, other ideas pointing to having a labor tax and other ideas having a taxation on statutory profits. So it's difficult to elaborate at this stage on this. Naturally, we are -- it's too early to us to give you a number. So you got all of this information, and we don't have more information than the one probably you got through the media. In relation with Chrysler and the return on equity, it's true that, well, when you look at the business in US and we -- you look at the return on equity, with the asset equity, as you know, we have sales equity in the US that we should upstream in the future. But you take the business with a core capital of 11%, 12%. Our return on equity's around 8% to 9%.

It's true, as you rightly said, that the return on equity of SCUSA is 18% or was 18% this quarter, and while the return on equity in the bank is much lower. This is based on the stated equity. If FSA business goes, probably the return on equity of SCUSA with adjusted equity naturally, reducing the amount of equity there, is going to remain pretty much the same. But the relative size is going to be much lower than it is today. So the combined entity just doing the maths will get a return on equity that is reduced. This is the other things equal. Let me to elaborate on the business. So going forward, this is pure maths. If we take out today FSA business from our [indiscernible], going forward, looking forward, if -- and it's a big if -- FSA business goes, for sure, we will find new ways in the US to replace partially or totally this business. It may take some time, but we're going to replace this business. So I will not bet in SCUSA business being only the subprime piece going forward as it is today without having agreements with maybe with other dealers, maybe with other OEMs, maybe with other partners.

And for sure, we're going to have this. I remain confident we're going to have this. So SCUSA size is not going to be as small as you -- as doing the math of the Chrysler business going. And most important, the US bank, we have seen and you saw in the quarter we are showing encouraging sales in the bank. So you saw the loan book growing for the first time in -- I don't know -- many quarters. Our C&I business is starting to show significant progress. Our CIB business is also showing progress. And I remain confident that the bank is in capacity to deliver faster. There's still some work to do in retail, where it's more work to do, particularly improving the operational side of the business, the systems and the process before we're in a position to show a significant uplift in the capacity to generate profits on the retail, although we've been doing quite good in the reduction of the funding cost in the last year and this year in a more competitive deposit market. So overall, I think that, if we finally sell, because FSA is a good option on SCUSA, we will be in a position to replace partially or totally the business.

And the bank is improving. So overall, I remain constructive and positive our capacity to improve the return on equity in the US with adjusted equity. Naturally, we have significant sales equity there. Finally, the last point you make was cost synergies in Spain. I said in the presentation that we are on track, well on track to get more than €150 million this year. This is in line with our plans or maybe slightly better than our plans. And we remain committed, fully committed to deliver on this. This is in our strategy update. We will update you clearly on this because, well, we are making, as Jose said, good progress on Popular integration. And there is nothing that make us to be more pessimistic, probably quite the opposite in relation with the cost synergies in Popular.

[Sergio Gámez, IR]

Thanks, Sofie. Next question, please.

[Operator]

Thank you. The next question comes from Ignacio Ulargui from Deutsche Bank. Please go ahead.

[Ignacio Ulargui, Deutsche Bank]

Hi, good morning, gentlemen. I have two questions for you, one on the tax rate, if you could elaborate a bit on what should we expect on the tax rate going forward after what we have seen in the quarter. And the other one, coming back to the cost of risk, you have just printed a very good cost of risk. The scope to improve in maybe [indiscernible] at the end of the day from Brazil and the US, how do you -- how comfortable do you think you are into 2019 on that improvement in terms of cost of risk? Thanks.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

The tax rate, as I said, this quarter was 36%, probably for the full year should be a bit lower, probably 35% maybe, in the region, 34%, in this region. So this quarter was particularly high due to -- I mentioned in the presentation to Brazil. And Brazil, there is a -- what they call interest on own funds that this quarter was not applied. And in other quarters, we may have room to apply. And this will reduce a little bit the tax rate that we show this quarter. The cost of risk, particularly you point out to US, Brazil. In US, probably forgot, although Jose mentioned that the seasonality in SCUSA mainly means that the cost of risk in the second quarter tend to be lower due to the fact that there's a tax season in the States where people get rebates, and the recoveries are higher than in other quarters. But overall, we've been, and you see clearly in the SCUSA P&L, increasing the FICO in SCUSA. We did it last year. So the cost of risk -- [indiscernible] also, but the cost of risk is going to be lower, but this quarter was -- is the seasonality play there, while in Brazil, I remain fairly confident that, if we had -- on a like-for-like basis, I feel comfortable with the current cost of risk. I mean like-for-like because changes in the mix have a significant impact, both on NIM and cost of risk. And you saw that we are showing this quarter in a decreasing rate environment an increasing spread due to the fact that the change in mix has been fairly dramatic. If you go back to the beginning of 2017 until now, the change in mix has been seemingly high in Brazil.

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

If I may add to that, when we guided you on the impact of lower interest rates on margins, we guided towards lower margins. So when we look at the net of margins cost of risk, the outcome of what we're seeing today is better of what we actually anticipated. So this business is clearly on a net basis more sustainable, more profitable and better in a lower interest rate environment.

[Sergio Gámez, IR]

Thanks, Ignacio. Next question, please.

[Operator]

Thank you. The next question comes from Andrea Unzueta from Credit Suisse. Please go ahead.

[Andrea Unzueta, Crédit Suisse]

My questions are first on Brazil and the NII. You continue to benefit from an improving loan yield, but you're also benefiting from a funding cost decline. I was wondering that, now that the Selic has stabilized, and assuming it remained stable, is there more room for improvements on that front? And in Spain, along similar lines, your cost of time deposits is at around 27 basis points now. Your peers are between 5 and 10. Considering the 1, 2, 3 accounts and Popular, where do you think that cost can get and when?

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. In Brazil, if we have room, well, naturally, the spreads in Brazil, as you know, are relatively high. Well, as long as we expect over time with the growth in volumes some -- you asked me for the next three or five years, you should expect some spread reduction. If you ask me for the next quarter, I don't expect -- or for the next two quarters, I don't expect a spread reduction in Brazil, while in the medium term and the long run, I do expect some margin compression in Brazil in the retail arena, while incorporates and CIB, I'm not convinced. Probably, it may be even the opposite. So the difference between spreads in CIB and corporates and retail are too big. And probably, we're going to have some reduction in retail. But going forward, maybe corporates and CIB will have the opposite. The most important thing in Brazil is, on competitive grounds, we are gaining share significantly in the market. And we think our franchise is ready to keep going outperforming the peers in a market that, as you know, profitability is relatively high. We've reached already 20% return on equity there. And we are closing totally, or we overtook some of the top banks there. And we are very close to the top performer there. In Spain, you mentioned the capacity. Naturally, we have flexibility, while we need to keep, as I said, the balance between building loyalty and the cost of funding. And we're going to continue to operate in these grounds, in both directions, reduction or increasing, depending on the environment, depending on the rates, depending on our outlook on when the rates are going to increase in Europe. The top priority is to build on loyalty, to keep the fee income line going in the retail and to build on a customer base resilient and able to produce recurrent revenues for the bank in Spain.

[Sergio Gámez, IR]

Thanks, Andrea. One last question, please.

[Operator]

Thank you. The next question comes from Marta Sanchez Romero from Bank of America. Please go ahead.

[Marta Romero, Bank of America Merrill Lynch]

Good morning. Thank you very much. Most of my questions have been answered, but I had a follow up on the AFS. I'm sorry if I missed this. How much of your capital still comes from the AFS and realized net gains? What's the average maturity of your Spanish, UK and Brazilian bonds? And given the vulnerability of your capital base to market moves, do you think being at around 11% is the right mark for Santander, particularly considering that some of the future earnings of this portfolio, the capital that may come from this has already been front loaded today? So I'd love to hear your thoughts there. Thank you.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Let me to answer for the second part of the question, and I pass to Jose the first part. In relation with the 11%, we need to put in context this with the fact that we are widely recognized as one of the most diversified banks in the world that where -- when you go through the stress test, we always come at the top. Our consistency and the recurrency of our business is much higher than the majority of our peers. And I do think that we deserve -- we have lower rates, as is shown in the stress test. And we deserve a capital -- with 11%, we are much more than covered. When we analyze the capital on economic basis, not on the regulatory basis, the sales of capital is very large. It's in the region of 20%, 30%. So it's still very large. And this leads us to think that we are in the position where we should be. And I now pass to --

[José Antonio García Cantera, CFO, Head, Financial Division & Senior EVP]

At the end of the quarter, the AFS portfolio added 15 basis points to our capital. Right now, it's 20. So just in the month of July, we've recovered 5 basis points. But at the end of June, it was only 15 basis points of total capital that came from the AFS portfolio.

[Sergio Gámez, IR]

Thanks, everyone. I'm afraid we need to leave it here. So obviously, the IR team is at your complete disposal for any follow up any time. So thanks, and see you next one.

[José Antonio Álvarez Álvarez, CEO & Executive Director]

Okay. Thank you.