Banco Santander SA

MAD:SAN

Earnings Call Transcript 2022-Q3

[Begoña Morenés, executive]

Good morning, everybody, and welcome to Banco Santander's conference call to discuss our financial results for the third quarter of 2022. [Operator Instructions]

I'm joined here today by our CEO, Mr. Jose Antonio Alvarez; and our CFO, Mr. Jose Garcia-Cantera. Following their presentations, we will open the floor for any and all questions you may have in the Q&A session.

With this, I will hand over to Mr. Alvarez. Jose Antonio, the floor is yours.

[José Alvarez, executive]

Thank you, Begona, and good morning to everyone. Thank you for attending to this conference. So I should say, to start this presentation, that while we've been developing our activity in an unusual highly uncertain macro environment, in this environment, we've been able to keep growing our customer base and translating this into volumes growth and revenue growth. So the most remarkable change in the quarter probably has been starting the acceleration of NII with a growth of 5% quarter-on-quarter. Probably this is the main event on the back of activity levels and just starting to raise interest rates, particularly in the eurozone, where our exposure to high rates is high.

Our profitability improved significantly. Our return on tangible equity stays at 13.6%. EPS is growing at 31% on the back of the profits we got in the quarter, EUR 2.4 billion. After absorbing EUR 181 million charge net of tax and minorities in Poland, the gross number was north of EUR 300 million related to the new payment holiday regulations. Excluding it, profit grew 11% quarter in the quarter, 10% in constant euros.

In the 9 months, our attributable profit, we got EUR 7.3 billion, increasing 25% with a positive impact of the currencies being plus 14% in constant euros. The credit quality on our balance sheet showed no signs of derangement so far in the quarter. Overall, the cost of risk remained below 1%, and we continue to generate capital at good pace.

Finally, as you already know, we continue to pay value to our shareholders, both in terms of shareholder remuneration with the cash dividend we announced the Board approved last month and the growth in tangible net asset value per share that provides a combined TNAV plus cash dividend per share of 11%.

Going into more detail into the regions. You see that the growth is well spread across the board, [indiscernible] on deposits is fairly balanced growth. We cannot say that we are growing just in one part of the business. We are growing well across the board and constant euro loans increased 2% quarter-on-quarter, EUR 17 billion, with increases in almost all countries. Deposits were up 2% also in the quarter with some shift towards time deposits given the current interest rate environment.

In the last 12 months, loans and deposits grew 7% and 6% in constant euros. Regarding our loan portfolio, naturally this doesn't change quarter-on-quarter. Just to remind that our portfolio is fairly balanced and 1/3 is individual mortgages, mainly U.K. and Spain by this order, being U.K. by far the largest, more than 50% of the total portfolio. The other less than 1/3 at close to 30% is consumer lending, the majority is auto lending in Europe and in the U.S.

And finally, we have an exposure north of EUR 400 billion, close to 40% of our loan book, the majority in SMEs and corporates and in CIB. You see that all the main portfolios are growing, so 7% individual mortgages, 7% consumer, 6% corporate. So as I said, balanced growth across the board.

Looking at the income statement. We provide you growth rates both in euros and constant euros for you to analyze in the best way you can analyze. As you can see, there was a positive impact from exchange rates of around 5, 7 percentage points, partially offset by the FX hedge in the Corporate Centre that is included in gains on financial transactions. In constant euros, revenue grew at faster pace than in Q1 and Q2 and costs faced inflationary pressures, but continued to grow below inflation.

Thanks to this performance, net operating income reached EUR 21 billion, a record for the first 9 months of the year. In loan loss provisions, that is one of the recurring topics in this particular environment, there were 2 opposition forces impacting the year-on-year performance. On the other hand, in 2021, there were COVID-19 related loan loss provision released in Q2 and Q4 of 2021 due to better-than-expected credit performance. On the other hand, in 2022, loan loss provisions include an additional EUR 1 billion -- circa EUR 1 billion in provisions related to updated macro assumptions, mainly in the U.S., Spain and U.K. The market provision, roughly speaking, was EUR 1.1 billion. Spain represents EUR 200 million, U.K. EUR 300 million and US EUR 500 million, and other countries EUR 500 million, of which EUR 500 million expenses against P&L and the other EUR 600 million is reassigned funds mainly coming from COVID provisions that were unused in the balance sheet.

So we are seeing, and this is an important development in the quarter, some normalization in the U.S. as we anticipate to you. And in Brazil, some stabilization of the cost of risk. I will elaborate on this -- of course, I will elaborate on this further. Additionally, this year, we record higher charges related to fund contributions and new rotation schemes plus lower minorities and tax borrowing. The net result, as you can see, is EUR 7.3 billion.

Elaborating a little bit on the P&L trends led me to say, well, positive trends in customer revenue, especially NII in the last quarter, which we expect to continue as the positive impact of interest rate hikes and activity growth are fully reflected in the different regions. The positive impact is just starting in Europe and somehow more advanced in other countries like U.K. and U.S., more so in Poland and in Mexico. The opposite happened, the negative impact has happened in Brazil and Chile, as you know, that they are gearing toward low rates.

Secondly, our costs grew below inflation or reduced in most countries. Our efficiency improved slightly to 45.5% compared with full year '21, but this is being eroded by inflationary pressures in some regions by the lack between the almost immediate impact on cost and the revenue benefit from higher rates coming later.

Thirdly, in general, we did not see any deterioration in the cost of risk or in the credit quality variables such as arrears. We have very good cost of risk in Europe and ECB and also in North America, where both the U.S. in process of normalization and Mexico are performing better than expected.

In South America, the cost of risk in general was stable. You know that Brazil went up this year, now for 2 quarters in a row has been stable. And we believe that we already reached the peak and some indicators are more -- we are constructive on this going forward. All in all, we are confident for the whole group to achieve our cost of risk target.

In relation with the profitability. I mentioned our RoTE stood at 13.6%. Earnings per share grew 31%, unpacked by higher profit and share buybacks. We bought back 3.2%, and we amortized 3.2% of our group's capital.

Finally, regarding shareholder remuneration policy for 2022, our intention, the Board already approved 40% payout of this in cash, EUR 0.83 in cash and EUR 979 million in buybacks that we expect to be approved by the ECB soon and we start to execute as soon as it's approved. As a result, the total remuneration in this first dividend is going to be EUR 1.9 billion.

Positivity in our performance. I mentioned before, that is increasing for several quarters in a row given the performance, the profitability of the group and a more constructive exchange rate combined.

Finally, on capital, we are very comfortable with our core equity Tier 1 ratio remaining above 12%, a level that we consider to be very appropriate for our business. In the quarter, net organic capital generation of 26 basis points after 8 basis points accrual for the future cash dividend. The increase was partly offset by negative impacts from markets, available-for-sale portfolios, and some from others, mainly more markets and models.

At the same time, we continue to deliver our commitment of disciplined net capital allocation. As you can see on the slide, risk-weighted assets grew well below loan growth, higher book from book profitability, and lower rate of risk-weighted assets with return on equity below the cost of equity.

Now our CFO, Jose Garcia-Cantera, will take you through the results in more detail.

[José Antonio García Cantera, executive]

Thank you, Jose Antonio, and good morning, everyone. After the CEO's presentation, I will go through our performance in the quarter in more detail and will look at the progress in terms of country and business.

Starting with profit. On the right-hand side, you can see the upward trend in profitability, driven mainly by revenue, which increased 5% in the quarter. This increase was supported by NII, which also increased 5%, which as we can see has accelerated in the last 2 quarters, primarily as Spain and Portugal are beginning to benefit from interest rate increases in addition to the growth that we have already seen in countries like U.K., Poland, U.S., et cetera.

In North America, NII rose 6% with both countries growing more or less at the same pace. And in South America, it was up 5%, supported by strong growth in Argentina. While Chile and Brazil show negative sensitivity to rates, especially Chile, where we had lower inflation in the quarter. In Brazil, NII remained stable, following declines in previous quarters. I will explain this in a bit more detail when we go through Brazil.

The digital consumer bank was practically flat due to the -- although we have a neutral position into rates in DCB, it's slightly negative in the first couple of quarters and then it neutralizes and that's what explains this behavior. Net fee income was flat in the quarter, mostly due to a weak performance in Europe due to seasonality. We had lower fees charged on deposits from CIB large corporate clients and one-off in credit cards in the second quarter in the U.K.

On the other hand, South America increased 5% with an excellent performance in Chile and Argentina. Gains on financial transactions were higher, driven by CIB. Obviously, quarter-on-quarter comparison in other income was affected by the contribution to the single resolution fund in the second quarter. This is our net interest income sensitivity to rates. This is consistent with which we have shown in previous quarters. This time around, we thought it would be better to look at forward rates rather than a sensitivity to 100 basis point change.

So this is the sensitivity of forward rates relative to rates remaining stable over the next 12 months. Obviously, it is fully comparable because now forward rates are almost 200 basis points and the sensitivity we showed in the previous quarter was 100 basis points for the eurozone, for instance. So this is the sensitivity, again, of forward rates relative to rates remaining stable. As expected, obviously, we have very high sensitivity in euros.

In Sterling, we have some additional sensitivity from current levels, but obviously, the higher the rates, the higher the EBITDA as well. So the EBITDA we have here is around 50% to 60% in this exercise. And in Brazil, as interest rates remain flat, asset repricing should gradually compensate the increase in the cost of deposits, which as you know, is almost automatically repriced.

It's important to note that this sensitivity is based on the maintenance of the TLTRO depo conditions that exist at the moment, and we all know that they will change tomorrow. We don't know what the change will be, so we'll adjust that accordingly in the next presentation.

Looking at costs. The CEO has already mentioned that costs are growing below inflation, which, as you know, is one of our targets. And as you can see on the slide, we are achieving, thanks to the transformation plans underway in all countries, particularly in Europe, a very good performance. We had in Europe a 4 percentage point improvement in the cost to income at the same time. As costs automatically adjust with inflation in emerging markets, it takes a bit longer in Europe for that to happen.

As I said, in South America, the rising cost is explained by the automatic adjustment of cost to inflation, particularly in salaries in Brazil, Chile or Argentina. Even so, cost in the region fell a little bit in real terms and efficiency remained excellent despite a slight increase. And in North America, it's worth mentioning the investments that we continue to make in Mexico to modernize our infrastructure.

In terms of credit quality, we are not seeing any significant deterioration. The NPL and coverage ratios have been stable in recent quarters, as has the cost of risk. Stage 3 exposures increased in line with the credit portfolio. As previously mentioned by our CEO, you can see the COVID-19 related provision releases in the second quarter and the fourth quarter of '21 and the additional over EUR 1 billion of macro provisions in '22. Jose Antonio already mentioned half of which came through the P&L and half were reclassifications of previously created COVID-related provisions.

Compared to 2021, there were loan provisions increases in the U.K., in the U.S., Brazil and Poland, but very much in line with what we expected. Going into a bit more detail about the quality of our portfolio, we maintain a low-risk profile balance sheet. It's mostly concentrated in mature markets, 80% of the total exposure with approximately 65% in secured lending, mostly by real estate collateral. Additionally, the main macroeconomic variables that affect our businesses, particularly unemployment, are expected to remain resilient across our footprint.

Looking at the main countries. In Spain, 75% of our mortgage portfolio is floating. We have significantly reduced the average loan-to-value and the percentage of mortgages with loan-to-values over 80%. And our corporate portfolio improved its rating. And as you know, the ICO portfolio is performing very well and better than expected. Unemployment is low and stable and is expected to remain so. Housing affordability has improved significantly in recent years and house prices are, on average, 30% lower in real terms than in 2008.

In the U.K., 12% of the portfolio is floating. The simple average loan-to-value of mortgages is 40%, and less than 5% have loan-to-values over 80% versus 12% in 2015. In terms of macro, the U.K. has a very low unemployment rate, which we believe will help avoid a sharp fall in prices. Moreover, affordability is currently at 34%, 10 percentage points lower than in 2008.

In the U.S., we've changed the mix recently towards more prime, which currently represents 80% of the total auto portfolio, and therefore, it's a better quality portfolio. Used car prices are clearly above historical levels. They should gradually normalize, but this normalization should take place gradually, as I said, because of the scarcity of new vehicles. And also U.S. unemployment is at very low levels. It's expected to go up a bit, but by no means reaching the levels of previous crisis.

Lastly, in Brazil, activity is gradually recovering. We are growing in low-risk products, 65% of individual portfolio is secured. The average maturity of our balance sheet in Brazil is a bit less than 1.5 years, which means that asset quality deterioration surfaces very quickly.

In summary, we remain constructive on the future of our asset quality. Now let me go in a bit more detail through the main countries. Starting with Spain, we continue to see a very dynamic market. Net customer, we have had positive net customer growth every month since December 2021. We have increased transactionality and we've seen robust volumes growth. Year-on-year profit was reported by our efficiency plans. Cost-to-income is down 2.4 percentage points and the reduction in loan loss provisions. The 9-month annualized cost of risk is 62 basis points, including EUR 200 million from macro adjustments.

In revenue, NII was under pressure in the first half, but started to ease in the third quarter, growing 10% quarter-on-quarter, starting to reflect the hike in interest rates. Looking forward for the next few months, we continue to see positive trends in NII, lower cost base in absolute terms and controlled cost of risk.

In the U.K., we continue to have positive new lending trends and higher interest rates, obviously, are supporting NII growth. We had double-digit growth in revenue together with strong cost control. Costs were down 6% in real terms, which resulted in an over 4% improvement in the cost-to-income and drove the strong operating performance, which was up 20%. Underlying profit was flat due to higher loan loss provisions versus releases in '21.

We are comfortable we will reach our targets, both for return on tangible equity and cost-to-income with double-digit growth in NII year-on-year and flat costs.

Turning to the U.S. Again, also very solid business dynamics, both in loans and deposits. Underlying profit remained high at EUR 1.5 billion, well above average pre-pandemic levels despite falling year-on-year following a record 9 months of '21 affected by competitive pricing and obviously, the normalization of the cost of risk. We continue working on normalizing our capital levels in the U.S. So far this year, over $3 billion have been upstreamed to the Corporate Centre. So gradually, we will show more sort of transparent profitability levels in the U.S. which, as you know, our objective for the long term is to keep returns on equity at around 15%.

We maintain our outlook for the year of 22%, lower revenue impacted by leasing, flat costs and better than initially anticipated cost of risk well below normalized levels. In Mexico, another excellent quarter. Profit increased quarter-on-quarter driven by a strong upturn in NII and lower loan loss provisions. Costs were affected by the salary revisions that took place in July. We also delivered higher profit and greater profitability year-on-year, supported by volumes growth, interest rate management, higher fees and excellent risk behavior.

For 2022, again, we maintained our expectations of double-digit growth in NII and fee income, higher growth in costs affected by our investments in digitalization and obviously inflation and a cost of risk of around 2%. The performance of asset quality in Mexico is excellent.

In Brazil, we continue to grow our customer base and volumes, dealing obviously with the pressure on margins coming from repricing. As you know, we tightened our credit standards in the high-risk portfolios, particularly unsecured individual lending last September, and that still continues. We are growing in low-margin businesses more, particularly CIB and mortgages, and that change in mix is obviously affecting NII. But NII, repricing of assets, it starts outweighing the repricing of liabilities is flattening. The quarter-on-quarter NII is basically flat already in the third quarter and we would expect to see a very gradual improvement until more or less the first half, second quarter and starting to grow more after the third quarter of next year.

Interest rates have already picked. We have a 12-month repricing gap. So we would expect to see a gradually increasing NII in the second half of next year. Costs rose because of the automatic pass-through of inflation to cost in the country. Salary agreement in September for '23 was 8% relative to the 11% of last year. So we have some positive news for cost in 2023.

Cost of risk, around 4.5%, very much in line with our guidance. We would expect this to remain more or less at these levels in the fourth quarter, maybe a touch higher, but around 4.5%, 4.6%, and gradually starting to come down next year.

If we turn to the Digital Consumer Bank. Here, the activity remains strong despite continued market contraction. We are gaining market share, particularly in used cars. We had double-digit profit growth supported by fees, leasing, and a very good cost of risk performance. A challenging environment for new cars, but we think we will be able to continue to gain market share, and we should be able to maintain high returns on equity in the coming quarters.

In the global businesses, CIB reported its best quarter in its history, gaining market share in all businesses and products. We expanded in the U.S. and we maintained our leading positions in the different countries in Latin America. We are leaders in sustainability, ranking #1 in Latin America, Europe, and globally in structured finance in the renewables sector.

In terms of results, underlying profits grew 36% year-on-year with double-digit growth in all core businesses. Underlying attributable profit represented 27% of the group's total operating profit. In Wealth Management & Insurance, the contribution of this unit to the bank was 17% on a like-for-like basis, so very good performance. Private banking is attracting new customers, up 6%, also new money, up EUR 10 billion, and profits grew 30% year-on-year.

In Santander Asset Management, the asset management business was affected by market volatility, but it increased its contribution to group profits to 8%. Finally, in Insurance, we had sustained growth in gross written premiums and the total contribution to profit increased 15%. We expect to maintain double-digit growth in profit contribution in this unit in the coming quarters.

In PagoNxt, total revenue increased 75% year-on-year in constant euros, almost 100% in euros, fueled by all 4 main businesses, especially merchants and trade. So we are doing better than our guidance of 50% revenue target for the year. Activity is really going very well here. And finally, in cards, I would like to highlight the efforts that we are making to improve our credit card business. We currently manage almost 100 million cards across the group. And thanks to active customer management, 9-month revenue was 25% higher year-on-year in constant euros, 36% in euros, with very positive performance in both credit and debit cards across the regions, particularly in South America.

Let me now turn it back to Jose Antonio for his final comments. Thank you.

[José Alvarez, executive]

Just a few words in relation with the outlook. So I should say that we expect significant revenue growth on the back of activity levels that will remain healthy, particularly in our global business with the capacity to generate additional net fee income and while the additional NII growth that are benefiting from activity and interest rate hike. So I'm fairly constructive on our capacity to keep growing our revenue in the coming quarters.

On the cost side, well, we face inflation pressures, you've seen through the P&L. But I'm confident that we'll continue to improve in our productivity and efficiency, not only on the back of expansion of revenues that for sure is going to happen, also for our demonstrated capacity to run the cost well below inflation.

On credit quality, I do recognize that the environment is highly uncertain. But when I look at the balance sheet and the loan book, well, I feel comfortable that we are ready and prepared to face a more difficult environment, particularly the one in the consensus as the consensus is today for the macro, it doesn't worry me that much. Even harder scenarios, we are in good position to manage given the very nature of the portfolio.

On capital, well, we're going to be above 12%. But I feel that we have handled better than the average the impact of the value of for sale portfolio that has affected the capital across the board less than our competitors. And at the same time, we continue to be extremely disciplined in our capital allocation.

So all in all, we expect revenue growth to more than offset cost inflation pressures and the potential increase of cost of risk. And on the back of this, improve our profitability and the value creation for shareholders. That's all on our side. So we remain at your disposal for the questions you may have. Thank you.

I forgot to mention that we have an Investor Day -- on the very last page. Probably I forgot because I am not going to be there. So on the 28th of February in London, we have an Investor Day where we'll update you on the prospects for the group. Back to you, Begoña.

[Begoña Morenés, executive]

Thank you. We can start with the Q&A session, please.

[Operator]

[Operator Instructions] The first one is coming from Ignacio Ulargui Lopez from BNP.

[Ignacio Ulargui, analyst]

Jose Antonio, I'm not sure if this will be your last results call, but I just wanted to wish you all the best. And thank you for the support all these years. I have 2 questions on the numbers. One is on the European loan book. How big has been the repricing of the asset side so far? I just wanted to get a bit of a sense of where are we standing in terms of the NII uplift that will come in coming quarters? Also linked to the NII, I wanted to understand a bit better what has been the contribution of the TLTRO in the quarter.

The second question is basically linked to the cost-to-income ratio. You have flagged in your final remarks that you aim to keep on improving the cost-to-income ratio. Target is going to be a bit high probably for 2022. What can you do to keep on improving both, which looks to me very sticky in terms of growth, particularly in Latin America?

[José Alvarez, executive]

Okay. In the first question, I mentioned a little bit European loan book, I said that NII expansion is just starting in Europe, particularly in the eurozone. I mentioned that we have -- as you know, the central banks have reacted. The function reaction has not been the same across the board. In this particular cycle, Latin American Central Bank reacted first. And we saw Brazil going from 2% to 14%, Chile going from 1% to more than 10%, Mexico reacting along with the Fed, but starting at higher levels. And U.K. and U.S. came later. The ECB being the last one. I forgot to mention Poland that the reaction was one of the first also.

So when you go to the different books, I mentioned in the presentation that you've been seeing the impact of higher rates for a while in Brazil, and the particular pace was negative. And in Chile, that is more complex because it's a trade between inflation and nominal rates, as you know. We saw some reaction coming from U.K., U.S. and Mexico, that are not just midway but somehow midway. Poland is advanced. It's like Latin America, you see the margin expansion. And Europe is starting.

The loan book, specifically in the loan book, remember, in the quarter, we barely had reappreciation other than the new origination and some loans related with LIBOR 3 month. The mortgage book that everybody follows, we reappreciate in September. The book that repriced in September was repriced with the EURIBOR in July, that was not that high compared with the one we have right now. I should say that the big reappreciation is going to go along the next 12, 13 months.

And it's going to be pretty significant. So you asked the TLTRO in the quarter. The number I have in mind is EUR 60 million -- EUR 69 million or something like that.

[José Antonio García Cantera, executive]

For Spain, yes. So for the whole, it's EUR 216 million to EUR 91 million. For Spain, it's EUR 150 million to EUR 70 million.

[José Alvarez, executive]

In the quarter?

[José Antonio García Cantera, executive]

Yes.

[José Alvarez, executive]

Okay. So this is the impact of the TLTRO. The cost-to-income keeps improving. What I said in my final remark that naturally, the cost-to-income, with the revenue expansion we expect, and keeping the cost growing below inflation, naturally, this leads to an improvement in the cost-to-income. I do recognize that to reduce nominal costs as we are doing in Europe, but CIB is difficult in the current inflation environment and probably it's impossible. We need to renew some agreements with the unions, and this is going to put pressure on this.

Cost-to-income, for sure, on the back of higher income is going to improve. But also remember that, well, in South America, at some point, with the outlook that we have for Brazil, and becoming more constructive on the trends at some point, and in Chile at some point, we will start to recover. Overall, I'm fairly, fairly confident that the cost-to-income should go down, but you're going to have specific details on the Investor Day in relation with the specific target for this.

[Begoña Morenés, executive]

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

[Operator]

The next question is coming from Francisco Riquel from Alantra.

[Francisco Riquel, analyst]

I wanted to ask about Brazil in particular. First of all, about the NII. You mentioned in the past presentation that there was a 2-quarter lag between the peak in the selling rates and the trough in NII. Now I hear from your comments that the NII in Brazil will not grow fast until the third quarter '23. So if you can please update the NII dynamics in Brazil? And if you can please update on your NII guidance here as well.

And second, in Brazil, it's about asset quality. If you can comment on the unsecured lending for individuals. If that is still driving NPLs up this quarter? And if you can update on the 4.5% cost of risk guidance for '22, how much of a deviation? And then where do you see cost of risk normalizing from here and going with.

[José Alvarez, executive]

Okay. Let me give you the big picture on Brazil and specifically the question you raised. So we've been in a situation in which we've been suffering a margin compression of the back of 2 things: higher interest rates that the balance sheet is geared toward lower rates. And second, we changed our underwriting standards back last year in September last year that leads to a change in mix with a lower origination in the low end of the mass market. And these naturally impact the yield of our new origination and the yield of the portfolio. That's the impact on the NII.

Where are we right now? So we are now more constructive for 2 quarters. We've seen the cost of risk in line with our expectations. So that means that we are in a position to start to grow a little bit more, little by little, checking this, and start to offset, as I also said, to pass through the growth in activity to some growth in NII. Still, volume is going to grow faster than NII for a while, but this gap is going to get reduced over time as we reprice assets in the book.

And maybe at some point, if we are confident, the mix becoming more normalized like compared with the one we have today and the one in the past. So that's the expectation for NII. So more constructive, little by little, more activity, more pass-through to NII in this environment. The asset quality, Jose mentioned the 4.5, 4.6 like at the end of the year. We were guiding you between 4 2, 4.5. We are growing particularly in non-individual sector less than expected. Growth has been limited in corporate sector and in CIB and SMEs, where credit quality is good and the denominator push us up a little bit our expectation on the asset quality. But nothing that we see fundamentally wrong in the vintages.

We are analyzing on the generation in the mass market -- in the low end of the mass market where is where we got the problem. So all in all, I feel I'm more constructive on the outlook for Brazil. So I think that little by little we're going to show these trends, I hope, and show to you in the coming quarters.

[Begoña Morenés, executive]

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

[Operator]

The next question is coming from Alvaro Serrano from Morgan Stanley.

[Alvaro de Tejada, analyst]

A couple of questions from me. I won't touch on Brazil because I think you've been pretty clear, but one question on U.K. and another one on U.S. In the U.K., you've now raised your 1|2|3 account and you've got a pretty competitive remuneration on deposit remuneration. When we think about the next few quarters going forward and considering what's going on in the mortgage market, do you still have capacity to grow the NII? I'm just thinking your overall ability to grow profits in the region, given the NII potential headwinds from repricing of mortgages, sort of minimum deposit sensitivity, and obviously, the economic outlook sort of deteriorating. So maybe an update on the outlook on the U.K. more thinking about next year?

And the second question on the U.S. I think you called out -- Jose, I think, called out the gradual normalization. Some of your peers have profit warned. Some of your competitors in the auto space have profit warned during the results season. Could you update us as how sort of delinquencies are performing? Are we back to normalized levels, and it's just about normalizing secondhand prices? And in that context of normalization, is a 300 basis point provision charge for 2019 that you posted in '19 a reasonable sort of fully normalized provision charge? Or what's the fully normalized look like for you?

[José Alvarez, executive]

Okay. Thank you, Alvaro, for your questions. In the U.K., you mentioned the 1|2|3. Well, overall in U.K., as you know, there is a fairly dynamic and competitive deposit market. So we have a large loan book, not only mortgages, but mainly mortgages. And while we plan to keep the retail funding in line with the loan book that we have and for the reason we need to react. Your question goes straight, can you grow the NII having to react to the more dynamic and competitive deposit market? Yes, I think we can.

Jose mentioned about the EBITDA. So we think that we still enjoy margin expansion outstanding that we need to react as we react in 1|2|3, but taking into account all of this, I do expect the NII to keep very constructive in the U.K. and growing nicely in the U.K. in the coming years. The market is complex. You remortgage basically 1/3 of the mortgage book, in our case, roughly speaking, EUR 60 billion along the year. And while this is may raise some questions because all in all, it's going to go from 2, 2.5, 3 to double of this as of today. And this increase should be more than enough to -- along with the corporate book that reprice faster, should be more than enough to offset the increase in deposit cost that is going to happen and is happening, okay? But I see margin expansion next year in the U.K., all in all.

In the U.S. -- well, your question goes in our P&L in the U.S., particularly, you are referring to the auto sector. What is happening there is margin expansion on the back of the deposit base of the bank. Fairly competitive market in prices in the auto space, fairly, fairly competitive, more than I was expecting.

And what we are seeing in the cost of risk, Jose mentioned that the cost of risk is increasing less than expected. We have several factors there. One factor that is fairly negative is the leasing, because on the back of the very high second used car prices, we are not having gains on the disposal of the cars that we have leases as we had the previous year. And on the other side, the cost of risk, you mentioned 300 basis points up, probably is not going to be the same than previously. Our book is more prime than it used to be.

And so as Jose said, 80% of the book in the U.S. is prime, only 20% is subprime. And we do not expect to go back exactly to the levels we had in 2019 because the mix is to that some of our competitors show some increase in rates. I haven't gone through the numbers and I don't know if they changed the mix or they changed -- but we are not seeing this. And on the back of this, I feel comfortable we are fairly, fairly well provided in the U.S. In fact, we reassigned EUR 500 million of provisions that we built for COVID to the new macro scenario.

So in that regard, normalization will happen. I don't expect to go back to the levels of 2019, just because of the mix overall. But on a like-for-like basis, it makes sense that at some point we get there. Overall, not due to the mix, but this is going to happen little by little, and it's taking longer than we were expecting.

[Begoña Morenés, executive]

Thank you, Jose Antonio, and thank you, Alvaro. Can we have the next question, please?

[Operator]

The next question is coming from Sofie Peterzens from JPMorgan.

[Sofie Peterzens, analyst]

Sofie from JPMorgan. Sir, my first question would be, if you could just repeat the TLTRO NII benefit. Sorry, I couldn't quite hear that. But then the kind of more broadly the question, sorry. The first one is on kind of cost growth in Europe. You still have very strong cost performance in Europe, but how should we think about the wage agreements that are coming up, also higher kind of investment, higher IT costs, or higher general expenses. So how should we think about kind of cost growth in Europe going forward?

And then my second question would be, when would you expect the cost of risk for Santander to peak? It sounds like Brazil will still be relatively high cost of risk, Europe cost of risk is going up, U.K. cost of risk is trending up. So how should we think about the cost of risk peak for Santander? And at what level could that come into...

[José Antonio García Cantera, executive]

So let me give you the figures. The group has EUR 88 billion in TLTRO. EUR 60 billion in Spain, EUR 20 billion in Santander Consumer Finance, and EUR 7 billion in Portugal. So you can do the math very easily. Thank you, Sofie.

[José Alvarez, executive]

Cost growth in Europe, the wage agreements. So where are we in different jurisdictions? I should say in Poland and U.K., we've been updating salaries along with inflation. So I should say, BAU, business as usual is in Spain and Portugal, where we had agreements for several years. In Spain, that is the most important one due to size till the end of 2023, and we are starting to negotiate a new agreement with the unions probably mid-2023, okay?

Before that, maybe some minor adjustments, but will be minor. So we expect the unions to be quite demanding, naturally. And difficult to forecast the final agreement. But well, looking into what has happened in Spain, wages in 2022 are growing at 2.6%. We are growing wages north of 1.5% or 1.6%. And naturally, I do expect the wages in Spain to accelerate a little bit. We've seen the agreement of the government with the civil servants, roughly speaking, 9% for 3 years. This established a kind of benchmark because it was an agreement for 3 million people or 4 million people.

Along these lines, I do see having a negotiation with the unions. So this is my expectation. It's going to be possible to keep the costs below inflation, I think so. With this kind of agreement, this will be below inflation and probably growing the cost in the region of 3% is something before efficiencies should be something -- 3% to 4% will be something doable, overall, in some countries, less in CIB. Probably, as we are gaining share and we are expanding the business, probably we're going to grow the cost faster than that probably, as I mentioned in the presentation, or Jose mentioned in the presentation, CIB as the main driver of positive cost growth in Europe, while the retail units in Spain and Portugal are deeply in nominal negative growth.

So CIB, I expect to continue to grow faster than the retail units, where the transformation is going to go on and overall being in the 3%, 4% region for the next couple of years.

Cost of risk peak. Difficult to say. So the macro, as you know, we are providing due to the macro right now. We had EUR 1.1 billion due to the macro. Probably, overall in the year, if the macro remains the same, or the scenario we have remains the same, we're going to add this year EUR 1.4 billion. Adding this EUR 1.4 billion for this year, the cost of risk remains below 1%.

If the market deteriorates further, naturally, it's expected that macro deteriorates further, we may need to increase the cost of risk next year. When it's going to peak. Based on the consensus, it should be next year, yes? But that's really difficult to say, yes. So based on current expectations, the end of 2023, 2024 is going to be the worst period with a significant economic slowdown being predicted.

Having said that, this is based on the scenario, the peak. But in any case, our expectation on the cost of risk is not to have anything close to what we had in the COVID. So well below this, yes? So going up, but not that much. That's our expectation. And with the current scenario going up, but very much for levels and for sure including what I said before, increase in revenues will more than offset potential increase in ordinary cost and cost of risk.

[Begoña Morenés, executive]

Thank you, Jose Antonio, and thank you, Sofie. Can we have the next question, please?

[Operator]

The next question is coming from Carlos Cobo Catena from Societe Generale.

[Carlos Cobo Catena, analyst]

A quick question on the NII sensitivity, please. For Spain and Europe, you mentioned you've updated the way you calculate the sensitivities. But could you touch quickly on where do you see the mix of deposits between site and term evolving and what is the term deposit EBITDA that you think is reasonable to assume going forward? The same thing for Brazil. You've already explained how do you expect the NII to evolve over the following quarters. But how that compares with the slide where you show that NII upside in NII in Brazil is only EUR 100 million. If you can explain or reconcile both two guidance, that would be helpful.

[José Alvarez, executive]

Okay. NII sensitivity in Spain. Well, currently, almost 100% of deposits are current account. It's not 100%, but it's 90 something, yes? So gradually, this is going to go from current accounts towards, well, a combination probably of money market funds, term deposits, some kind of life insurance products. Overall, what this means is, well, based on the past, this used to have a beta that was between 60% and 80%. So in relation with the official rates and which is the percentage that is going to go to term deposits, difficult to say at this stage.

What I can say to you, in the past, it was a long time ago, yes, so we have had negative rates for so long that probably we almost forgot this, we used to have a kind of 30% to 40% current accounts with no remuneration. We used to have another 20% to 30% what we call medium remuneration that was kind of a lower sensitivity and another 30% kind of high sensitivity. Overall, the EBITDA you are using is 25% for the whole deposit book. This is what we are using, and this is what's embedded and what Jose said in relation with expansion of NII.

Naturally, you may say that there are some new factors here, difficult to measure. So online deposits is somehow new, or the extension of potential players in online deposits is there. Now they are playing. They are the only ones that are offering higher rates. I don't know how important it's going to be. If the rates remain in the 2% to 3% area, it's not going to be that big. If the rates -- naturally, the higher the rates go, the more impact of this. You mentioned NII in Brazil, the plus EUR 100 million. The plus EUR 100 million is exercise like-for-like taken into the forward rates. The forward rates means for 1 year.

And what we guide to you is being constructed every quarter. The pass-through from volume growth to NII is going to be higher. That's what we're telling you. In the overall 1 year, using the forward rates and no volume growth is plus 100, okay?

[José Antonio García Cantera, executive]

Basically because interest rates just stopped increasing. So obviously, because you have the 12-month lag, it will be -- as we said, we are using end of September figures, 12 months is end of September next year, and you would only have 3 months of full repricing of assets and liabilities. So when we look 12 months in advance, the sensitivity is what I say. If you look beyond the 12 months, obviously, the sensitivity is greater.

[Begoña Morenés, executive]

Thank you. And thank you, Carlos. Can we have the next question, please?

[Operator]

The next question is coming from Marta Sanchez Romero from Citi.

[Marta Sánchez Romero, analyst]

The first one is a follow-up on the U.S., just a clarification on the cost of risk. Jose Antonio mentioned that we won't go to 2019 levels, which if I'm right is roughly 310 bps. I think in the past you've guided for, through the cycle, level of 250. Are we going to be somewhere in between for next year? How do you see that? And also in the U.S., if you could elaborate as well on the loan growth expectations, your risk appetite generally for the auto lending business.

And the second question is on deposits in Europe. You have a loan-to-deposit ratio above 200% in the digital bank, 115% in the U.K. It's true that you've got excess deposits in the Spanish balance sheet, but what are you going to be doing strategically in terms of deposits? Are you going to be chasing deposits to balance the books in the digital banks? Are you going to be setting the price and going to be potentially pushing prices higher? I think you've already launched a new platform in Germany to gather deposits. So where do you see the cost of deposits? If you can give us a little bit more clarity on betas across the different businesses for the next 12 to 18 months?

And just, sorry, quickly, if the ECB changes the terms of the TLTRO tomorrow, would you be repaying all your TLTRO funds or you will be holding on to them?

[José Alvarez, executive]

Okay. The last question is the easiest one, depends on the terms.

[José Antonio García Cantera, executive]

We are prepared. We were, as you know, planning to repay the full amount next year. If the terms change and it no longer makes sense to hold on to those funds, we will repay. We could immediately repay almost in full. The excess liquidity we have today, the liquidity that we've been building to repay next year would let us pay almost in full that. But again, as Jose Antonio says, we need to look at the terms.

[José Alvarez, executive]

Marta, going to the other questions. U.S. cost of risk. In 2019, our cost of risk was close to 3%, it was 280 or something like that, yes. So normalization should be lower than that. So on the back of the mix, the growth in prime and net prime and the Bluestem sale, yes. So we sold Bluestem where the cost of risk was extremely high. And this, we think that this is going to be below these levels in 2019 for these 2 reasons.

So you asked the loan growth. Well, loan growth, you know that we have 2 main sources of origination and others that are work in progress. As you say, Stellantis, we are being -- I think last month, our penetration last month, meaning September was our best month ever in penetration in Stellantis. So that means that we continue a good pace. Naturally, they sell less cars, and this is affecting -- new car sales is affecting this.

On the traditional subprime space, our appetite. Well, we increased a little bit the FICOs, and this affect the loan growth. But largely, it's going to depend on the car market. We are trying to add and we have some agreements with other OEMs. We already signed Mitsubishi, and we are working with dealers association in order to sign agreements with them, in order to diversify our loan growth. We have appetite for this type of loans at the right price, naturally. There are some -- as I mentioned, the market is fairly competitive now. But we want to grow this provided that we can obtain the profitability we are targeting for this business.

You mentioned deposits in Europe. You rightly said that our loan-to-deposits is higher than 100% in U.K. And Consumer Finance, significantly lower in Spain and somehow in Portugal. What we plan to do? In the Consumer Finance in the Digital Consumer Bank, we expect to grow significantly. Now the figures are the following. We have a book of, roughly speaking, EUR 120 billion loan with a deposit book in the region of EUR 50 billion to EUR 60 billion.

So in the next couple of years, we do expect to add a couple of billions in deposits, maybe in the region of EUR 20 billion to EUR 30 billion is a figure to think about in order to close the gap, not that much, but close the gap between loans and deposits. We are in a position to do that. As you know, this is a business that we have more or less advanced deposit platforms in several countries, meaning Germany, Netherlands, also some in Belgium.

And in the past, we were active in deposits also in the Nordic countries, and we are reactivating this in order to increase the percentage of funding coming from deposits in this business. We are in a good position to do that, and we think we're going to be successful on this. In the other markets, I already elaborated in the U.K., where we plan to keep growing in line the assets and liabilities. And well, that's the reason we think our EBITDA is higher in the U.K. than it is in Spain, because of this position. And basically, that's it.

[Begoña Morenés, executive]

Thank you, Jose Antonio. And thank you, Marta. Can we have the next question, please?

[Operator]

Absolutely. The next question is coming from Carlos Peixoto from CaixaBank BPI.

[Carlos Peixoto, analyst]

So my question was actually on NII in Spain. So you gave the sensitivity to a stable interest rate scenarios, but I was wondering if you could complement that with the sensitivity to further hikes considering that the expectation is that we will get some additional hikes this week and possibly before year-end. And then finally, on NII in Poland. I was wondering what type of evolution you expect going forward, whether you think there could be some margin compression given the higher deposit costs as the political pressure on that front seems to be mounting?

[José Antonio García Cantera, executive]

Carlos, as I said, this analysis that we show here is consistent with the previous one in which we showed that sensitivity in Spain to 100 basis points is EUR 750 million. So that's the sensitivity to additional increases over the forward rates, in Spain only, not in the eurozone, which obviously is higher.

[José Alvarez, executive]

Well, NII in Poland, you've seen, I would say, a very significant margin expansion on the back of increasing rates. It's true that we enjoy the cheapest funding cost in Poland. Naturally, additional margin expansion probably is going to be difficult. But I remain comfortable that we can keep the NIM, the net interest margin going on around the levels we are having on the back of repricing assets, as we recognize that the liabilities cost, we should pay more for deposits given our position being having the lower funding cost in the market. But probably working with an assumption of NIM being around where it is a fair assumption to me .

[Begoña Morenés, executive]

Thank you, and thank you, Carlos. Can we have the next question, please?

[Operator]

The next question is coming from Pamela Zuluaga from Credit Suisse.

[Pamela Zuluaga, analyst]

The first one is on the provisioning outlook. You've now built a EUR 1.1 billion overlay, yet you've been mentioning that you have not seen a significant deterioration in credit quality across the majority of your footprint. You flagged also the consensus sees cost of risk peaking next year. However, how are you thinking then about the timing to either use or release these provisions? Are you expecting to allocate some of these provisions to keep some stability in cost of risk in 2023?

Then a question on your capital optionality. You have managed to build capital above your target now to 12.10% CET1. Would you be open to increasing your current 40% payout? Or is there a particular headwind that you're foreseeing and therefore, you're deciding to be more cautious?

And then if I may, 1 follow-up. Can you give us some color on specifically the AB's negotiations with the trade unions to address the loss of purchasing power in Spain. I understand the last meeting was on Friday. Have we heard anything about the proposals from the unions? And what would this mean specifically for the cost inflation in Spain?

[José Alvarez, executive]

Thank you, Pamela. Let me do -- well, we are providing based on expected losses, and you're asking me about the use of this overlay. Naturally, we are providing within a scenario. The scenario we are providing is a scenario that sees some mild recession in some countries in 2023, more towards the end of 2023. So if these materialize, and our models are right, in theory, we will use this provision, okay?

If we are wrong, one way or another, we may be in a situation like the scenario deteriorates further and into 2024 the scenario is worse than the one we are expecting, we keep building. The other way around is releasing. So everything is based upon if our scenario is right. Our scenario is not far away from IMF, just to understand among us, yes, not far away from the IMF that says that second part of '23 we will see some recession. And in that case, we will use this.

The 1.1 we already built and the extra 300 we expect to build from now until the end of the year. But again, this is based on the materialization of the scenario or not of the scenario goes into 2024.

Capital optionality, well, we stated clear that the Board -- when the Board approved 40%, expressed the idea of going to 50% at some point. So it's a decision that the Board is going -- it's up to the Board and it's not a decision taken.

Having said that, I said in the presentation that we think that the 12% is an appropriate level for us. and we keep building capital.

AB negotiations, yes, while there have been some negotiations about kind of one-off for the employees or some employees or the employees this year, aside from the negotiation from the unions in the future. So this is not going to be a -- this is not going to substitute the big negotiation that is the one who matters in terms of cost. This one is more about some compensation, but a small one. And it's not a negotiation of the full agreement with the unions that will come, as I said before, start in 2023 and mid-2023.

[Begoña Morenés, executive]

Thank you. And thank you, Pamela. Can we have the last question, please?

[Operator]

The last question is coming from Fernando Gil de Santivañes from Bestinver.

[Fernando Gil de Santivañes d´Ornellas, analyst]

A couple of questions, please. First one on Spain. What is your view on the potential impact that you may have if there's a change in the code of good practices on those vulnerability families that might be implemented? This is one. Second, on Poland and the payment holidays provision that you have done, are you forecasting or seeing any more coming in the next quarter? And finally, if you can comment a little bit on the ALCO strategy and the mix that you have in the Spanish portfolio, that would be great.

[José Alvarez, executive]

Okay. In Spain, well, I should say that this agreement, the way we match vulnerable customers that have a mortgage with us, I should say, is business as usual. The agreement we try to reach is, which are the ways that how do we match this. And the ways, I should say, we are discussing is business as usual. And naturally, the extra provisions, if any, are embedded in our macro scenario. Naturally, the macro scenario, when it comes to mortgages, contemplate the real mortgage book and the capacity of the customers to repay, the affordability, the loan-to-value, and all these things.

If these deteriorate as a result of the higher inflation or lower disposable income, this is already included there. So I do not need to change anything because we changed this, because supposed to be included in our expected scenario. Naturally, the expected scenario is worse. The most sensitive issue here is unemployment. So unemployment is the key. Because when I look at the real estate market in Spain, it's not in any dimension overvalued. So it's not the case that we had 14 or 15 years ago.

It's more a question of affordability ratios for those customers in the low end, with low income or medium low income, with high affordability ratios, that suffered in the disposable income is more of this. But it's included, as I said, in our macro scenario.

Poland payment holidays, we need to see what's going on. So we think we've done, I don't know, all or at least the majority of the provision.

In any case, well, if we're going to assess how many customers come to claim in the payment holidays, and we adjust accordingly to this. I expect it not to be significant, but maybe we need to add more. We will see quarter-on-quarter if we need to add more. Having said that, the revenue generation of the bank and operating profit that the banks generate. And as I said before to a question of one of your colleagues, I feel very constructive that we're going to keep relatively or very high NII that allows us to face potential higher requirements from the payment holidays.

ALCO strategy, I don't know if I should pass while we start to build our portfolio little by little, so more to do. Jose, you want to elaborate on this?

[José Antonio García Cantera, executive]

Yes. As we mentioned in the first half results presentation, we didn't have an ALCO portfolio at the time in euros, which obviously was a conscious decision that cost us some net interest income compared to our competitors, but obviously, put us in a much better position in terms of balance sheet value and the opportunity to rebuild the ALCO portfolio going forward. We have, today, EUR 6.5 billion already in the eurozone. We are building the portfolio through diversified tenors, through diversified countries. Not only Spain, we have France, we have Italy. And we would gradually continue building the portfolio over the next probably 2 years.

We don't have a figure in mind, but clearly, we have an opportunity to rebuild the portfolio earning more than 3% yield, which is what we have so far in the EUR 6.5 billion. We will make purchases again depending on the opportunities that we see. But again, from 6.5 today, gradually growing to a much larger figure over the next couple of years.

[Begoña Morenés, executive]

Thank you, Jose and Jose Antonio. There are no further questions.

[José Alvarez, executive]

Okay. Thank you, guys. Thank you for all the years following this results presentation. I tried yesterday to count the number of times I faced you and I got a number of 72 times in the last 19 years. So good luck guys and keep following Santander. It's always an interesting equity story and with the improving profitability going forward. Thank you. This is my last message to you, and good luck. Bye-bye.