Banco Santander - Earnings Call - Q1 2025

Transcript

Raul Sinha (Head of Investor Relations)

Good morning, all, and welcome to the Santander Q1 2025 results call. We are joined today by Hector Grisi, our CEO, and José García Cantera, our CFO. We will start with a brief presentation on our Q1 results and then open the floor for questions. Hector, over to you.

Héctor Grisi (CEO)

Thanks, Raul. Good morning, everyone, and thank you for joining Santander's results presentation. Today's presentation will follow the usual structure. Number one, first, I will talk about our results with a special focus on the performance of our global businesses. José, our CFO, will then give a deep dive on the financials, and I will conclude with some final remarks before opening up for Q&A. We have entered the last year of our strategic cycle well ahead of our plan, focused on disciplined capital allocation, which is further improving our profitability to 15.8% post '81 and our CET1 ratio to 12.9%, with 87% of our RWA generating returns above our cost of equity. Given our solid progress building capital, our diversified earnings, and improving profitability, we rate our target to distribute up to EUR 10 billion to our shareholders through share buybacks for 2025-2026, subject to regulatory approvals.

Remember that we no longer set a maximum price for our buybacks, reflecting our confidence on the group's potential in terms of profitability and value creation. Q1 was another record quarter for Santander, demonstrating the strength of our strategy and the resilience of our business model. Profit reached a new record of EUR 3.4 billion, 19% higher than Q1 2024, with all of our businesses growing. On the back of our solid franchise of 175 million customers, that continues to grow as we improve our customer experience, leveraging our global platforms. We achieve this as we continue to invest for the future through One Transformation and making excellent progress towards a simpler and more integrated model. This has helped us to improve our efficiency by around one percentage point and increase our ROTE post 1981 by almost two percentage points to 15.8%.

Our balance sheet remains solid, with a strong CET1 capital ratio, which ended the quarter with another all-time high of 12.9% towards the top end of our 12%-13% operating range. All this contributed to the strong shareholder value creation, with TINA plus dividend per share growing 14.5% despite the depreciation of sub-currencies across our footprint. Going into more detail in our income statement, our P&L remained very solid. Number one, we delivered strong top-line growth, with revenue up 5% in constant euros, supported by NII, which increased 4%, excluding Argentina, which, as José will explain later, is causing some distortions, and also by record fees, up almost double digits, supported by significant growth of our 9 million customers and the network benefits that we are capturing through our global businesses. Number two, expenses grew below revenue and inflation, showcasing the positive effects from our transformation.

We rate our target of lower cost in current euros in 2025. Third, we are once again demonstrating the sustainability of our results with 7% growth in net operating income. Fourth, our prudent approach to risk is also evident in our robust credit quality trends, with cost of risk that is consistently improving quarter after quarter. Fifth, finally, we have the impact from the different treatment of the Spanish banking tax that this year we are accruing quarterly through taxes. Even excluding this favorable impact, profit rose double digits year-on-year. All in all, as we have shown over time, our results are sustainable and less volatile than peers. This is because we are mainly a retail consumer bank with a business model that combines businesses and geographical diversification with a prudent approach to risk.

We are ahead of our plan in executing our transformation, which continues to boost our operational leverage, structurally improving both revenue and cost performances. Simplifying and automating processes and our active spread management have already contributed 253 basis points of efficiencies since we started, surpassing the levels which we expected to reach by the end of 2025. Our proprietary and global tech capabilities have generated 79 basis points in efficiencies so far. As we said last quarter, there is still more upside over the medium term for our strategy for both revenue and cost. Retail and consumers, which represent more than 70% of our revenue, have significant upside as we progress on the implementation of our common platforms. The rest of our revenue comes from wealth, CIB, and payments, which are more fee-driven and play to our network strengths.

This has delivered 75 basis points of efficiency improvements, with more upside to our original target of 100-150 basis points. Our common operating model supports value creation as reflected in the strong performance of our businesses, with all of them delivering both revenue and profit growth. Retail's performance reflects our scale and the benefits of our transformation, which significantly improved efficiency. In CIB, we are building a world-class business, leveraging on an array of expertise to grow our U.S. franchise without changing the risk profile. Revenue grew 8% to another quarterly record, supported by the good performance in the U.S. and client flows, demonstrating the benefits of our strategy. Wealth continued to grow strongly, improving in both efficiency and profitability, and in payments, we are seeing good activity trends as reflected in double-digit revenue growth both in PagoNex and cards.

The combination of our global businesses and our geographical diversification puts us in a unique position to face the challenges for 2025. Higher interest rates benefit some of our retail franchises, while other parts of our business, such as CIB, consumer, and some emerging markets, perform better with lower rates. It is this diversification that allows us to deliver recurrent strong results, consistent profitable growth, and value creation even under very different environments. Overall, the greatest start of the year, the execution of our strategy, and our diversification puts us on track to achieve our profitability targets for full year 2025. In retail, which is at the heart of our banking business, we are progressing in our aim to become the number one bank for our customers. As we progress in this simplification, process automation, and customer experience, we gain their principality.

Today, we have 3.5 million more active customers than a year ago. We have reduced the number of products by 40% in the last year and 51% since we started the process back in 2023, with a special focus on the front book. As we deepen simplification, our digital sales and our cost to serve improves. Today, our digital sales are 23% higher than last year, and our cost to serve has dropped by 5%. The implementation of our global platform progresses at pace. We have completed the integration of Gravity in Chile, which improves the digital channel performance, reducing the response time and significantly enhances the overall customer experience. As a result, retail profit grew strongly year-on-year, driven by solid revenue, both NII and fees across most of our countries, with cost improving reflecting our transformation efforts.

Going forward, we expect that our global platform rollout and improvements in the consumer and customer experience will drive additional customer growth and lower cost in EUR. In consumer, we continue to advance in our priority to become the preferred choice of our partners and customers by delivering the best solutions and increasing our cost competitive advantage across all of our footprint. First, we are converging towards global platforms. This quarter, we launched Open Bank in Mexico with a full value proposition, and we opened a branch in Germany. In the U.S., we have announced a multi-year partnership with Verizon, offering their customers saving accounts. These initiatives are part of our focus on deposit gathering to lower funding cost, as reflected in our deposit increase of 12% year-on-year, while we continue to improve our customer experience.

Second, we are working to grow and consolidate partnerships, offering global and best-in-class solutions integrated into our partners' processes. CINEA continued processing and progressing with strong partnerships. For example, we launched the Amazon co-branded card in Austria. Finally, we are promoting the network effect, aligning the businesses with the group's operating model and becoming more agile through the simplification and automation of processes. Profit grew 6% in consumer on the back of NII growth and LLP improvements, mainly in the U.S. Gross grew in line with inflation, even after our efforts on transformation, which are supporting double-digit customer deposit growth. During the year, we expect NII to improve as interest rates continue to decline as we execute our strategy to lower funding cost and originate at attractive profitability levels.

In CIB, we are building a world-class business to better serve our corporate and institutional clients across our footprint while maintaining the same low-risk profile. Number one, we're deepening our client relationships by expanding our advisory capabilities in the U.S., building on our areas of expertise to accelerate growth across the group. Revenue in CIB in the U.S. rose 23% year-on-year and is expected to boost cross-border revenue across the group as we originate businesses from the U.S. for the rest of the group and vice versa. Second, we are strengthening our position in our core markets, leveraging our centers of expertise. A good example of this is our record quarter in global markets, with revenue up 23% on the back of the investments we made and cross-selling opportunities with global transactional banking and global banking. Third, fostering collaboration with other businesses is also key.

CIB provides FX solutions to retail, product development, and structuring to wealth, and a full suite of products, including capital markets and advisory to commercial and auto. CIB had solid results with revenue up 8% to a new record high, with fees growing at double digits. All this while we maintain an efficiency ratio that is among the best in the sector and an ROT of around 22%, reflecting our focus on profitability and capital discipline. In wealth, we are building the best wealth and insurance manager in Europe and the Americas. First, in private banking, we remain focused on expanding our fee business by promoting value-added solutions, leveraging our best-in-class portfolio advisory capabilities. We have created a new global family office team, and we have expanded our ultra-high net worth global team, offering world-class specialized wealth management services.

Second, in asset management, we progressed in the implementation of an advisory model for retail customers across countries, supported by a global investment platform that offers enhanced customer experience. Third, in insurance, we are developing new business lines, such as retirement, which we are offering an integrated value proposition while we expand high-growth verticals such as health and motor. Fourth, in collaboration with other businesses, is of the essence in wealth, and it is a major driver for growth. Collaboration fees increased by 10% year-on-year. In summary, all this supports growth and high profitability levels. Profit rose double digits on the back of strong activity and double-digit fee growth across all the three businesses. Efficiency ratio improved close to 1.5 percentage points year-on-year, and ROT stands at close to 70%. Finally, payments, where we have a unique position on both sides of the value chain.

In merchant acquiring, we are one of the largest acquirers in Latin America, Spain, and Portugal, with the right balance between growth and profitability. GetNet total payments volume kept growing strongly, which is helping us to consolidate our presence in our core markets. At the same time, we remain focused on globalizing products and technology. PagoNex Payments is leveraging the best technology to build its own proprietary solution to deliver account-to-account payments processing, foreign exchange, fraud detection, and value-added services. Our payments hub platform processed triple the volume compared with the same period last year. In cards, where we are one of the largest issuers globally with 106 million active cards, we continue to deploy PLARD, our global cards platform. In Brazil, we currently manage more than 16 million debit cards through PLARD.

In Chile, we started issuing debit cards for new customers, and in Mexico, we already authorize more than 160 million transactions per month. Payment delivered a strong quarter with double-digit revenue growth year-on-year, both in cards and PagoNext. Cost is under control, which drove 30% profit growth. Finally, PagoNext's EBITDA margin improved to around 29% backed by GetNet, with one of the best ratios among our competitors. We expect cost efficiency and CapEx optimization to continue to drive profitability in the coming quarters. Our strong operational and financial performance is improving profitability and driving double-digit value creation for the eighth consecutive quarter. ROT post '81 was 15.8%, up close to 2 percentage points year-on-year, reflecting the high levels of new business profitability. Earnings per share rose to above EUR 0.21, supported by strong profit generation and a lower number of shares following the ongoing buyback programs.

As a result, we continue to grow with our value creation, which, in terms of TNAF plus cash DPS, increased 14.5%, reflecting our disciplined capital allocation and, again, the impact of our share buybacks. Buybacks remain one of the most effective ways to generate shareholder value. Since 2021, and including in full the share buyback that is currently underway, we will have bought back 14% of our standing shares, providing a return on investment of approximately 20% to our shareholders. I will leave you now with José, who will go into our financial performance in more detail.

José García Cantera (CFO)

Thank you, Hector, and good morning, everyone. Starting with income statement, as we normally do, we present growth rates in both current and costing euros.

This quarter, there was a difference of around 4-5 percentage points between both, mainly due to the depreciation of the Brazilian real and the Mexican peso towards the end of last year. As Hector has already mentioned, we are yet again reporting record results as our transformation continues to drive operational leverage. We had a strong top-line performance with sound underlying trends as revenue grew 5% and reached a new record high for the fourth quarter in a row, with good performance in cost towards our objective for 2025. As you can see, Argentina introduces some distortions between different lines of the P&L, which are fully compensated in total revenue. In local currency, net interest income is affected by a sharp decrease in interest rates for around EUR 600 million year-on-year, and in other income, there is a benefit from lower hyperinflation adjustment for a similar amount.

Cost of risk remained fairly stable in the quarter, supported by robust labor markets and prudent risk management. Last year, we charged the temporary levy on revenue earned in Spain in full in the first quarter through other results. This year, it is charged in the tax line on an accrual basis. This is the main reason that explains the significant jump in other results line. Even if we exclude this impact and calculate year-on-year growth on a like-for-like basis, profit grew double digits, not only at the group level but also in almost all the global businesses. Finally, on the right-hand side of the slide, you can see the upward trend in profit, which grew 4% this quarter on the back of positive customer activity, lower cost, and better provisions.

Please also remember that the last quarter, we had a full positive impact from the FX accounting of the Argentine peso. This also produces some distortions quarter-on-quarter that I will comment on during the presentation only where relevant. Total revenue increased 5%, which puts us on track to meet the target for the year we provided last quarter. This was underpinned by growth in customer activity across businesses and reflects the benefits of our model. All of our global businesses contributed to revenue growth, which was mainly supported by another record quarter in CIB, up 8%, driven especially by global markets and our growth initiatives in the U.S. We grew 14% in wealth with record assets under management and strong commercial trends. Payments was up 15% with double-digit growth in net interest income and fees, both in PagoNex and cards on the back of higher activity.

Retail and consumer also showed very good figures in retail, particularly due to strong net fee income across most countries, and in consumer on the back of net interest income growth, mainly in the U.S. Groups and AI increased 4% year-on-year, excluding Argentina, even in a less favorable interest rate environment. More than 80% of groups' net interest income comes from retail and consumer businesses, and the positive evolution was supported by our active assets and liability pricing management in retail, most evident in the U.K. and Mexico, and consumer, both in Europe and in the U.S. It was also supported by continued profitable growth across most businesses and countries, mainly consumer, and finally, also by our focus on adapting the sensitivity of our balance sheets to the new cycle of interest rates.

A good example of this is retail and AI, which increased across most countries and remained flat in Spain and Brazil in a context of unfavorable interest rates. Net interest income was resilient also quarter-on-quarter, flat when we exclude Argentina for similar reasons, which also explained the performance of net interest margin, which fell only seven basis points year-on-year without Argentina and was flat in the quarter. This performance is slightly better than our guidance of NII going slightly up in 2025 in constant euros, excluding Argentina, and slightly down in current euros. However, as forward rate curves remain very volatile in our jurisdictions, we reiterate our guidance for the year at this stage. We generated another record period of net fee income, reflecting our transformation efforts to promote connectivity across the group, deploy high-value added products and services, and provide the best customer experience.

Net fee income grew close to double digits on the back of strong activity in general, consumer growth, and in exchange in mix with a higher share of more value-added services. Retail showed good performance across the footprint. CIB grew even further up from record levels last year as we continue executing our growth initiatives, particularly in global banking in the U.S. and GTB globally. We had a 16% increase in wealth with strong growth in all business lines backed by record assets under management. We had double-digit growth in payments, both in PagoNex and cards, supported by high activity levels as GetNet's total payments volume increased 14% and cards spending rose 7% year-on-year. As we guided in last quarter results presentation, this year, consumer is affected by the impact of a new insurance regulation in Germany, which has been offset by strong free growth in DCB U.S.

As Hector elaborated, one transformation is key to understanding why we can continue to get better in every single market leveraging our global businesses. As a result, we expect sustainable improvements in operational leverage as we further implement the structural changes to our model. These improvements are already very evident, as demonstrated by the trends in our efficiency ratio, which is consistently getting better quarter after quarter and remains one of the best in the sector, but more importantly, by the evolution of cost in absolute terms. Retail and consumer are leading our transformation, which is delivering structural efficiency gains with revenue improving and costs flat. These two businesses represent 70% of our cost base, and we expect them to reflect further the benefits of one transformation going forward. CIB, Wealth and Payments, are more fee-driven.

Cost grew 6%, showing positive operating jaws with double-digit fee increase, as I have just explained. As a result, our efficiency ratio closed at 14.8% in the quarter, amongst the best we have reported in the past 15 years. As Hector said, we reiterate our guidance for lower absolute cost in current EUR for 2025. The risk profile of our balance sheet remains low with robust credit quality across our footprint on the back of low employment and easing monetary policies in general. Loan loss provisions increased 7% year-on-year, mainly due to our efforts to reduce MPLs and some deterioration in Brazil in the context of higher rates and inflation. Credit quality continued to improve year-on-year, as reflected both in the P&L ratio, which fell to under 3%, and cost of risk, which improved to 1.14% despite proactive management actions, as I just explained.

Remember that much of our MPL portfolio has collateral guarantees and provisions that account for more than 80% of total exposure. Cost of risk dropped year-on-year to 1.14% and was fairly stable in the quarter. Retail and consumer represent 80% of the group's loan loss provisions. In retail, it improved year-on-year across all our main countries and was flat in the quarter, with significant improvement in Mexico, compensating the weaker performance in Brazil. In consumer, cost of risk was relatively stable, both year-on-year and quarter-on-quarter, with notable improvements in the U.S., where we are seeing favorable payment rates, higher car prices, and an improved labor market year-on-year. As of today, we are not seeing any significant deterioration in employment rates, and our credit quality remains stable. Moreover, it is in periods of higher instability when diversification becomes more important.

For instance, in the current context, we benefit from the fact that tariffs do not equally affect all countries, and Brazil is a good example of it. Nevertheless, it is too early to make conclusions regarding the new geopolitical environment, but as long as labor markets are not significantly affected, we would not expect material impacts to our cost of risk target. Moving on to capital, as you know, we have been working on improving our capital productivity and accelerating our capital generation for some time. This quarter, we delivered exceptional growth again, generating 10 basis points to 12.9% at the top end of the operating range we disclosed during last results presentation, and already very close to our 13% guidance for 2025.

We generated 33 basis points of net organic capital after having absorbed 24 basis points of profitable risk-weighted asset growth, while we had a positive impact from securities portfolios and DTAs. This enabled us to compensate shareholder remuneration accrual, some regulatory charges, as well as to accumulate capital. As we have already mentioned in the past, there was no impact from Basel III implementation on day one. We continue to deploy capital to the most profitable opportunities and leverage our global asset desk asset mobilization capabilities to maximize capital productivity. Our disciplined capital allocation produced a new book return on risk-weighted assets of 2.8% in the quarter, equivalent to a return on tangible equity of 22%, well above that of our backbook. All these actions explain the increasing profitability and great capital performance. That's all from my side. Hector, over to you.

Héctor Grisi (CEO)

Thanks, José.

As you have seen, this is a great start of the year. We are well on track to achieve our 2025 targets, targets that we reiterate. Good business dynamics supported by revenue increase backed by all our businesses, with fees growing high single digits at the same time that we reduce the cost in euro terms. Cost of risk improved, and it's also in line with our target of around 1.15% at the end of the year. We increased the CET1 ratio by 10 basis points as we profitably grew our business organically, accrued shareholder distribution, and absorbed some regulatory impacts. In a Q1 that is normally lower, affected by day count and seasonality in consumer and South America, our ROTE grew year-on-year to 15.8% on track to reach our target of around 16.5% in 2025.

In summary, very positive trends, which we expect to consolidate in the coming quarters, even in an environment of high uncertainty. As José has mentioned, it is precisely in periods of higher instability when our diversification becomes more evident, acting as a stabilizer. This is key and represents one of our competitive advantages that differentiates us from some others. We are happy to take your questions.

Raul Sinha (Head of Investor Relations)

Thanks, Hector. Operator, could we have the first question, please?

Operator (participant)

Thank you. If you wish to ask a question, please press star five on your telephone. We already have the first question from the line of Sofie Peterzens from JP Morgan. Please go ahead.

Sofie Peterzens (Director and Senior Equity Analyst)

Yes, thanks a lot for taking my question. My first question would be on net interest income. How should we think about net interest income going forward?

We have seen quite a lot of changes in rate expectations across your core market. If you could talk about the NII outlook going forward. My second question would be if you could just discuss how you've got to think about any M&A and asset disposal opportunities. Are there any businesses where you would like to grow a little bit more inorganically and equally? How do you think about kind of your business areas? Anything that you would want to reduce your exposure to? Clearly, we have seen headlines around Fodan, but anything you could kind of say around asset disposals and M&A? Thank you.

Raul Sinha (Head of Investor Relations)

Thanks, Sophie.

Héctor Grisi (CEO)

Thank you. Okay, Sophie, good morning.

First of all, I think it's important to say that we have a lot of confidence that we can achieve what we have said in terms of the ROT target of 16.5% under the new economic scenario, okay? I mean, given to the NII. Our business model, first of all, is important for you to know, has a high degree of earnings predictability despite the macro volatility we have seen. For example, and as you were asking, I'm reiterating the NII guidance despite the outlook for rates being lower than we previously anticipated. Q1 2025 ROTE was 16.1%, so 15.8% adjusts for a day count that would be 16.3% normalized. In that sense, we believe that we will continue in that regard. Excluding Argentina, we reiterate the NII. We believe that it's going to be slightly up in constant euros and slightly down in year-on-year current euros.

We're assuming end rates at around 1.5% by the end of 2025. The current outlook is around 0.169, so I believe we are able to get it. It's important to acknowledge that the ALCO portfolio has grown to EUR 152 billion in the whole group. That's around EUR 7.5 billion more quarter-on-quarter. Most of the group's sensitivity to rates is concentrated on retail. It's 60% of the loan book, but we have drivers that offset each other. In that regard, I believe that we have control over it. It's important to understand, as you know very well, that Europe has positive sensitivity to higher rates. Retail is Spain, Portugal, and Poland. U.K. retail NII is positive, even with the decline of the NIM, thanks to the high-end strategy that we have performed in that country. In Brazil, we are very well positioned to lower rates.

Outlook is improving for 2025. We expected a peak of around 16%. Now it's around 15%, and our sensitivity remains at 100 basis points. That's EUR 120 million. That's EUR 120 million. We continue to proactively manage, and we believe that we're going to deliver what we have said. In that regard, in terms of asset disposal, I think I'm going to be very clear about it since the beginning for you, okay? I know we acknowledged a recent speculation regarding a potential transaction involving Santander Sports. I can tell you that this is a great bank, has a great 22% ROTE, and we have interest from several parties, and we are currently in discussions with ERSTE for the potential sale of the 49% stake. At this point, I must say there is no certainty that the discussions will lead to an agreement with them.

In any event, completion of any transaction will be subject to closing conditions and different things and regulatory approvals, etc. If required, we will make a further announcement. At this point, I would not like to discuss any asset disposals or anything like that. We have a fiduciary duty to review anything that comes, and this is exactly what we're doing. I don't know, José, if you'd like to comment anything else.

José García Cantera (CFO)

No, I think you explained very well. We've reduced net interest income sensitivity. We've continued with the strategy that we started last year. Right now, we have less than half the NII sensitivity we have in euros and in the Brazilian real that we had a year ago, for instance. Very little sensitivity.

As Hector said, we feel comfortable reiterating our NII guidance, even if rates in Europe go as low as 1.5% by year-end.

Raul Sinha (Head of Investor Relations)

Thanks very much, Sophie. We have the next question, please, Operator.

Operator (participant)

The next question comes from the line of Ignacio Ulargui from BNP Paribas. Please go ahead.

Ignacio Ulargui (Senior Equity Analyst)

Thanks very much for the presentation and for taking my questions. I have two questions. I mean, the first one is if you could give us a bit more color on how we think, should we think about group cost evolution throughout the year. Is this the run rate that we should expect or incremental efficiency so that further decline to the cost line? The second question is related to DCB Europe. Performance in the quarter has been a bit more difficult than what consensus was going for.

How should we think about the performance of the unit in the year? How much is recurrent or would be seen as a one-off in the net profit of 1Q? Thank you.

Héctor Grisi (CEO)

Thank you, Ignacio. In terms of cost, it is very important to understand what we're doing. Cost is a result of the strategy we have on the change of the model that we are executing right now, okay? It's important to tell you that we reiterate our guidance to deliver the lower cost in current euros versus 2025 versus 2024, despite the potential inflation headwinds and the FX pressure in the current macro environment. Costs were 2% higher year-on-year in Q1 in constant euros, but they declined 1% in current euros. You have lower cost in retail, as I said, lower by one transformation.

It's very important for you to understand the operating leverage that we're generating, in which the model is allowing us to generate actually more revenue while we maintain costs flat or down. That basically is helping us out to have much better results. It is important also to say, and it's important that you acknowledge that we are a consumer and a retail bank. In that regard, that's exactly what we're working on to lower the cost of the operation. We're investing a lot in the platforms, and that also will allow us to basically have lower costs in the future. You are only seeing the beginning of what we're doing. If you look in detail, a retail and consumer, as I was saying, 70% of the group cost, cost is flattish, and revenue grew by 2%.

That's exactly what I was explaining to you in terms of the operational leverage that we're getting. CIB, wealth and payments, is around 30% of the group cost, increased 6%, but well below the revenues, which are at 11%. Very positive, Jose, in terms of everything that we're doing. We see sustainable fee income of around 13% year-on-year, and we continue to aim for positive operational leverage across all the groups. In that sense, I do believe that we will continue to increment efficiencies in the years to come.

Much more while the model is being implemented and where we are basically deploying all the platforms, which right now, I could tell you, is probably, I would call it a transition year, because we're actually changing the engine at the same time we're flying the plane due to the fact that we have still some of the old platforms working. This is going to take probably the next 18-24 months. On DCB Europe, it's important to tell you the facts. It's important to tell you, first of all, that NII continues to do very well and is on track to benefit from the lower rates in the future. Also important to say that market share is growing with the current OEMs that we represent. Fee income was impacted because of regulatory change in Germany, which we indicated last quarter, if you remember.

This has now been rebased by the regulatory changes. Impairments were higher, driven partly by a mix of the items, including Germany, but we are not concerned about the credit quality of our portfolio. New origination is meeting the returns hurdles, and returns were improved with lower rates. Remember that in the past, part of the stock is at lower rates that we are originating today. That basically is helping us out. The cost of risk normalization and the potential macro model adjustment, especially in Germany, should peak in 2025. All right? I do not know if you want anything else or José, anything to add?

José García Cantera (CFO)

No, I think the NII was up year-on-year, which I think is a great performance. Our brands are doing very well relative to others. We are gaining market share.

I think, and obviously, the impact on fees from Germany is a one-off, so it's a rebase of the fee line going forward. I think the return on tangible equity in the year was double digits, and we feel comfortable that we can keep improving the returns going forward.

Raul Sinha (Head of Investor Relations)

Thanks very much, Nacho. Operator, could we add the next question, please?

Operator (participant)

Next question from Andrea Filtri from Mediobanca. Please go ahead.

Andrea Filtri (Equity Research and Senior Equity Analyst)

Thanks for taking my question. You confirmed you are negotiating the sale of the stake in your Polish bank. Can you please share with us the rationale for exiting Poland and how you would intend to redeploy the proceeds? Why selling only 49%? And could the buyer eventually receive exemption from a mandatory bid on minorities? Second question on your digital transformation, which is proceeding ahead of targets.

What percentage of full delivery do you feel you are right now? When will you be able to right-size stuff for the new business model? Finally, can you elaborate on the high other provisions in the U.K. and on the outlook for Brazilian cost of risk? Thank you.

Héctor Grisi (CEO)

Thank you, Andrea. I will take the number one, then I ask José to help me with the percentage of the full delivery, and then we will comment also on the U.K. and in Brazil. In Poland, there is not much I can say at this point. As you know, we have a fiduciary duty, as I said, to basically review any offer that comes, and we are exactly doing that. As of today, there is not much I can tell you about what is going on.

Once the transaction, if it evolves or not, we'll basically give you all the details as soon as we have something. All right? Regarding that, that's all I can say at this point. I don't know, José, if you would like to. No, I don't know. Andrea, I don't think we can talk and give you a percentage of completion of the transformation program. The transformation program is a continuum. What I can say is that by the end of this year, 80% of our customer base will run in Gravity, which is the back-end banking system that we are developing everywhere. We are increasing the speed at which global platforms are being deployed across the group, like the credit card platform Hector referred to. The point is that we should continue seeing the benefits of this transformation for years to come.

This should accelerate as we get the synergies and continue adding more customers with lower costs. This is a virtuous circle. Yeah, just to complement what José was saying, it's important what I said just before, Andreas. We are now at the transition part, probably the most difficult two years of the transformation, given that we are running the old platforms together with deploying the new platforms, and that basically does not help a lot in the cost. Even with this, or despite this, we are basically being able to control cost and even lower it in some cases. That basically is also because we're gaining market share and we're gaining customers. We gained 9 million customers in a year. That basically tells you that the model is working and clients are liking what we're doing. All right?

In terms of what we're doing, of what's going on in the Brazilian cost of risk, I'll be very brief. First of all, it's important to understand that we are taking actions to strengthen the balance sheet. First of all, as I explained last quarter, we're changing the mix toward lower risk portfolio. It's less payroll and unsecured lending. It's down 10% year-on-year. We are also increasing collateralized products, which basically are much better in terms of cost of risk, but that doesn't have as high margins as we have. Also, we have tightened quite a lot on the writing criteria. In a scale of 1-10, we moved from a 6, 7 up to 8 and higher. It's exactly what I was telling you about. What you're going to see is that over time, the Brazilian cost of risk is going to get better.

Probably today, I would say, if you allow me, it's at its worst. Provisions, nevertheless, increased 7% quarter-on-quarter because of also the challenging macro environment. I mean, the higher inflation, and look at the rates. The rates went all the way from 2%, and we're almost going to get to 15%. That affects a little bit of the portfolios in that sense. Also the calendar effect in DCB, lower working days in the quarter that impacted the loan renegotiations. Whatever, at the end, we see better performance in retail due to the cautious approach I was explaining to you about. We also remain very vigilant, as I was discussing, in terms of credit quality. All right? In that sense, in Brazil, I believe that we have seen the worst in terms of the cost of risk at this point.

In terms of, you were asking as well about the U.K. In terms of the U.K., give me one second. Okay, in terms of the U.K., the business is actually performing much better. We have done some hedging on the portfolio. That hedging, basically, in the portfolio has allowed us to have a much better outlook on NII. We are planning to increase a little bit of volumes because we have seen a very good resistance of the cost of risk in the portfolio. I believe that we could have a much better outlook in the next quarter as well. The U.K. is performing quite well. Also, at the same time, we are performing what I would say is much better management of the business, and we're already mentioning what we're doing there.

We have seen very good behavior in terms of all in all the operations on the bank and the portfolio.

Raul Sinha (Head of Investor Relations)

Thanks very much, Andrea. Operator, could we have the next question, please?

Operator (participant)

Next question from Francisco Riquel from Alantra. Please go ahead.

Francisco Riquel (Head of Equity Research)

Yes, thank you. I want to ask about the U.S., which has surprised positively this first quarter. Several questions to assess the quality of the bit, if you allow me. Cost of funding is falling. How much is because of Open Bank deposit gathering, or how much is because of the lower Fed rates? The loan yield is also going up despite the lower rates. I thought you were shifting out of subprime and car lending, so you can elaborate. The cost of risk is falling, but the economic expectations have worsened in the U.S.

Shall we expect any model adjustments related to IFRS 9 in coming quarters? The tax rate, if the first quarter could be extrapolated for the year. Overall, the net profit contribution of about EUR 400 million is a big deviation versus consensus forecasts. How sustainable is this quarterly run rate for the rest of the year? Thank you.

Héctor Grisi (CEO)

Thank you, Francisco. First of all, it's important to understand there is always seasonality in the U.S., and we have always a much better first part of the year towards the second part of the year. That's mainly because what happens is you get the tax by the tax refunds and the tax back to the people, and basically people have more money, and so we have a lot less in terms of the cost of risk.

That basically always helps out, but nevertheless, this was a pretty good year. It is important to say that I'm going to give you all the details of what you have asked. First of all, I could tell you that we're going to have a pretty good year in terms of what we see in the U.S. We rate the adjusted ROTE target of 381 of 15%. Okay, we believe the outlook of the U.S. business has not fundamentally changed. The new tariff scheme from the imported vehicles should result in higher auto prices, but Manheim index is up 4% year-on-year and 1.3% year-to-date. This is very supportive of the consumer business that we have, that is 60% of the U.S. We are focused on the business that, as I can tell you, we have competitive advantage and can deliver profitable worth.

It's important to acknowledge in the terms of the particular things is the cost of funding, yes, is getting better. Just to tell you that we have EUR 3.5 billion more in deposits with 90,000 new customers in Open Bank, so it's working quite well, much better than we expected in the beginning. Now that we launched a Verizon account, I think it's going to do much better. That account basically is really starting to work starting this week, so that basically is helping out. Also is important to tell you that the behavior of the portfolio after 90 days delinquency is actually still much better than expected at around 60% in terms of delinquencies after 90 days. That basically is helping us out, and it's the same exactly what I've been telling you all along this past year and a half, that is much better than we expected.

It was all the way to 90%. It's still at around 60%-65%. All right? It's also important to tell you that CIB build-out continues to be a significant driver for fee growth. We're talking about 47% growth year-on-year. Also, wealth is doing quite well and the Latam offshore high-net-worth clients with very good returns. The multifamily business that we have in commercial is also performing quite well. We have a pretty good outlook for the U.S. and to be able to get to the numbers that we have discussed.

José García Cantera (CFO)

If I may add, sorry, Paco, very quickly, the drop in, so the increase in the yield of loans, which year-on-year is 21 basis points, is coming because of the drop in low-yield loans in commercial banking and in corporate and investment banking. In fact, volumes in auto finance are up year-on-year.

The strategy in auto finance continues as we discussed, but the improvement in pricing is due to the decrease in low pricing in other parts of the business.

Héctor Grisi (CEO)

Yeah, I forgot to tell you, your question in terms of we're doing more subprime. No, we are not. We're exactly at the same level of subprime that we had. I was even looking at the numbers. It was around 40% in terms of what we still have in prime and near prime. Subprime total for the year is not going to go further than EUR 15 billion. That has been exactly the same numbers since five years ago. Okay, no changes from there.

Raul Sinha (Head of Investor Relations)

Thanks very much, Paco. Operator, could we have the next question, please?

Operator (participant)

Next question from Alvaro Serrano from Morgan Stanley. Please go ahead.

Alvaro Serrano (Head of Research)

Hi, good morning. I've got two questions.

One on strategic growth priorities and second on capital. You just discussed US, and I wonder if that's a strategic growth priority market for you. Where I'm coming from is obviously, I realize Poland is up in the air, but if it does go ahead, you're going to be well above 13% CET1. From a strategic point of view, I just want to understand what are the growth priorities. Would you prioritize U.S., prioritize Europe to redeploy that capital, product gaps? How do you think about sort of the medium-term sort of growth priorities by markets considering the discussions we're having? The second question on capital, there was eight basis points model headwinds in the quarter. I guess this might be for José, but is the 60 basis points still what you expect for the full year?

How many SRTs or capital efficiencies, RWA savings have you done in the quarter considering the wobbles in the credit market? Do you still see SRTs and selling of RWAs? Are you seeing the market there? Are you still able to do these operations? Thank you.

José García Cantera (CFO)

Okay, thanks, Alvaro. I will start with capital. Yeah, we're still seeing the base case scenario for regulatory and supervisory headwinds is around 60 basis points for the year. Let me remind you that the technical notes that the EBA needs to publish interpreting the CRR are still pending. This is a central scenario with obviously some uncertainties still going on. In terms of SRTs, the market has not really been very much affected. The private credit market has not been very much affected.

In fact, we've just closed a few transactions at prices which are a little bit better than the prices we had in the first quarter of last year. Demand continues to be very strong. To be honest, we are not seeing any widening or increasing in the cost for Santander. In the first quarter, total asset mobilization was around EUR 2.8 billion. Obviously, it was significantly lower than risk-weighted asset growth. Net risk-weighted asset growth was around EUR 12 billion. There is seasonality in SRTs and asset mobilization because it takes time to prepare the different assets to be sold. We should see a substantial acceleration of asset mobilization in the second quarter already and towards the end of the year. We would expect to see net risk-weighted asset growth much closer to zero every quarter from now on.

Héctor Grisi (CEO)

Thank you, José.

Alvaro, going back to your questions in terms of capital deployment, what we see. First, it's very important to understand that the U.S. is a really important growth market for us. We are still, as I said, very much concentrated on delivering that 15% ROTE. We will continue to deploy capital into the U.S. as long as it's profitable. It's very important, and I'm going to give you the hierarchy in terms of where do we deploy capital. First of all, we're concentrated on organic growth, okay? Because organic growth we've been having is above 20%. We will continue to do that, and we will concentrate again on organic growth. It's very important also that we are deploying money to the buybacks. You have seen the returns that we have done.

I said, I mean, we have reported just over 14% of the capital, and we're returns at around 20%, so quite good. We're going to be very much concentrated on running the businesses we are doing it today. I think the most important thing is concentrate and focus on continuing the growth of our own businesses and continue with the transformation. That's the best way to deploy our capital and to get the best returns to our shareholders, which I believe we're delivering in a quite strong way.

Raul Sinha (Head of Investor Relations)

Thanks very much, Alvaro. Operator, could we have the next question, please?

Operator (participant)

Next question from Marta Sanchez Romero from Citi. Please go ahead.

Marta Sanchez Romero (Director and Equity Research)

Thank you very much. My first question is on the U.K. What is the rationale of a potential spin-off of your motor finance business? We read some headlines a few days ago.

My second question is on Mexico. Could you please provide an update on how the business is going there? You've been rolling out Open Bank, so how many deposits have you been gaining under that franchise? Just what you're seeing generally in terms of loan demand, potential impact from the U.S. recession, etc. If you were to deploy capital for non-organic opportunities in Mexico, do you think you have the political clout and just the right size to buy anything without obstacles? Thank you.

Héctor Grisi (CEO)

Thank you, Marta. I mean, what we're doing in the motor finance business is exactly what we're doing in the rest of the world. I mean, we are actually doing that in every single one of our units due to the fact that it's very important to have them separate from the rest and funded in a different way.

That's why we call it the consumer bank, and that's why Open Bank is together with the consumer bank because that's a model that we would like to follow. It is not a particular thing of the U.K. It is a particular thing of many of the different markets we operate, and you're going to see us continuously doing it in that trend, okay? It is part of the strategy there, and I believe it is the right strategy given what's going on in Europe. We have been, as you know, DCB Europe has been independent all along, and we have been able to grow it very well. Also, it's interesting to know that we have been able to find out that this business can be parachuted anywhere we want.

I mean, we have done it, for example, in Peru, and now we have a very successful auto business in Peru without having a retail bank. The same thing we're doing in Colombia without having the retail bank and doing this combination. We have been able to really grow in an important way in these countries with just this business. We believe that managing it independently makes a lot of sense and allows us to go into further countries. As you know, we are in 28 countries right now with the auto business. We continue to be a big auto lender. We really believe in that business, and we will continue to do so in that regard.

In terms of Mexico, the Mexican business, as you know, Mexico is actually the one that is most more affected not by the tariffs, but by what happens to the U.S., okay? Mexico is very dependent on the U.S. economy. If the U.S. basically has a hard time, Mexico has a harder time because a third of the economy is the U.S. exports. You're talking about about EUR 500 billion in terms of exports that Mexico does to the U.S. with a GDP of EUR 1.8 trillion. That basically gives you a perspective on the size of it and how dependent is Mexico on that. Nevertheless, the Mexican economy is doing quite well, is at a very good level of unemployment, and we have seen a very good behavior for our credit portfolio. The cost of risk is actually behaving much better than we expected.

We have not seen the local economy done bad. The other way around, we have seen consumption and everything going very well. We are positive on Mexico, positive on growth, and positive on the long term in Mexico. Now, going back to your question, we are very much concentrated on the organic growth that we have there. We will continue investing in such things as Open Bank. Open Bank is doing quite well. It's just starting, as you know, and it's actually getting very good momentum. We're growing customers every single week. Actually, I must tell you that we are doing a little better than our competitors in terms of clients coming in week by week, and also deposits coming in at a good way.

We are giving a better treatment in terms of the—we are paying a little bit more on deposits of what we pay in Santander, and that basically is enabling us to increase the client base there, but we are normalizing it as we speak. In that sense, what I could tell you, Mexico, we will continue pushing on organic growth and continue managing our bank the way we have been, and we believe that we have really good room for growth in that market.

Raul Sinha (Head of Investor Relations)

Thanks very much, Marta. Operator, could we have the next question, please?

Operator (participant)

Next question from Carlos Peixoto from CaixaBank. Please go ahead.

Carlos Peixoto (Senior Equity Analyst)

Hi, good morning. Thank you for taking my questions. Some of them have already been answered, but I would probably focus the discussion on where do you see NII in Spain evolving from here.

Previously, you had guided to around a mid-single digit decline, if I recall correctly. First, you seem to perform quite strongly. Do you think that there's scope to surprise positively on that front? Perhaps still in Spain, a bit of a view as well on the expected evolution of cost of risk throughout the year, and if I might extrapolate a bit into the rest of the bank, whether the ongoing uncertainties caused by tariffs and potential downgrades of macroeconomic expectations could lead to a revision of provisioning models inputs, and could that trigger some sort of additional provisioning over the coming quarters? Thank you very much.

José García Cantera (CFO)

Thanks, Carlos. I'll take both questions. NII in Spain, remember that at the end of the year, we said NII might go down mid-single digit, 6%-7%.

At that time, we thought rates could—the terminal rate in 2024, sorry, 2025 could be around 2%. As I just mentioned, we've been working very hard to decrease interest rate sensitivity, lengthening the duration of the ALCO portfolio. Right now, in Spain, we have EUR 44 billion of government bonds yielding 3.3% at an average maturity of seven years. On top of that, in the Eurozone, we have a total of EUR 61 billion in government security. The interest rate sensitivity in euros is very much reduced. Even if rates were to go down and as low as 1.5% by the year end, we still keep our NII estimate where we had it at the beginning of the year. In terms of cost of risk in Spain, we expect cost of risk to be below 50 basis points in 2025.

For the group as a whole, as I mentioned during my presentation, the key variable is unemployment, is the labor markets. Obviously, GDP needs to be updated in the models, but the impact of a downgrade or a slower GDP growth, it's very small compared to the impact of unemployment. As long as labor markets remain where they are and they are very strong everywhere, we do not see any risk to our guidance of 1.15% cost of risk for the year. Again, remember that this 1.15% comprises different behaviors.

Countries where cost of risk is going to be very much flat, like in Mexico, countries where cost of risk could be a bit better, like in the U.S. or Spain, countries that are normalizing from negative cost of risk to very low but still positive cost of risk, like the U.K., and countries where we expect a slight deterioration in cost of risk, as Hector mentioned, in Brazil. Net net, 1.15% is still our central scenario.

Raul Sinha (Head of Investor Relations)

Thanks very much, Carlos. Could we please have the next question, Operator?

Operator (participant)

Next question from Britta Schmidt from Autonomous. Please go ahead.

Britta Schmidt (Senior Analyst)

Yeah, thanks for taking my questions. In Brazil, I'd be quite interested in your thoughts on what you think about the new private payroll initiative through APPS, which has received some pickup.

Are you intending to participate in this, and how do you think this will impact competition and margins for personal lending business overall? Secondly, maybe you can give us a view on what your outlook now is for this year with regards to Porter's FX mortgage charges and also whether you've got any updates on the U.K. motor finance case or the numbers that you indicated in previous calls. Thank you.

Héctor Grisi (CEO)

Britta, in terms of the U.K. motor, I mean, we believe that we're at the right place. We haven't seen any reason basically to increase it, and we believe that that's going to be around the number that we need to have. We don't have any plans basically to modify it at this point.

José García Cantera (CFO)

I'll take the other two questions.

U.K., the mortgage market, in terms of volumes, year-on-year, we've seen volumes up 3% and actually a substantial increase in net interest margin in the U.K. The yield on loans, in our case, is mostly mortgages, as you know. It was 3.83 in the first quarter of last year and is 4.19 in the first quarter of this year. Substantial improvement in pricing and also better outlook for volumes. We are quite constructive on the outlook for activity in the U.K. On the liability side, at the same time, yield on deposits is down from 2.23 last year to 1.99 this year. That is what explains the very good evolution of net interest margin in the U.K. In Brazil, the new legislation on payroll lending, this will clearly widen the possibilities. I think this is going to make the market more attractive.

It's extending the possibility to many customers that before didn't have that possibility, but we still don't have the details. I think, like always, the devil is in the details. I think we need to wait for the details to really have a good assessment of what this could mean for the country as a whole, for the banking system, and for Santander. Generally speaking, it's a good move for activity.

Raul Sinha (Head of Investor Relations)

Thanks very much, Britta. Operator, could we get the next question, please?

Operator (participant)

Next question from Cecilia Romero from Barclays. Please go ahead.

Cecilia Romero (Equity Research Analyst)

Thank you for taking my question. Just a follow-up on Marta's question on Mexico. Nubank has just gained an approval for a banking license in Mexico this past month. Do you see any impact in the competitive landscape from this, especially for your digital bank in the country? Thank you very much.

Héctor Grisi (CEO)

Thank you, Cecilia.

What I would say is, I think that it's pretty good news for us that these guys basically turned themselves into a fully licensed bank because then they have to comply with the same rules as we do as a bank. In that regard, we are happy that they turned themselves into a fully-fledged bank. The competition right now in the market is very tough, very competitive, and we believe that we have all the tools needed to be able to compete head-to-head against any competitor in the market.

Raul Sinha (Head of Investor Relations)

Thanks, Cecilia. Next question, please, Operator.

Operator (participant)

Next question from Ignacio Cerezo from UBS. Please go ahead.

Ignacio Cerezo (Equity Research Analyst)

Hi, good morning. Thank you for taking my questions. I've got three.

The first one is if you can give us some information on when we should be expecting you to take the decision on the extraordinary capital distribution between 2025 and 2026, how that extraordinary distribution is going to be split between both years. Second one is if you can share the fully loaded capital number in the quarter, not just the phase-in. And third, if you can provide an update in terms of the hedging per unit you do in terms of effects for the P&L. Thank you.

Héctor Grisi (CEO)

Okay. In terms of the extraordinary capital distributions, we'll do as we see fit. We see it much more towards the year 2026. The important fact that we are doing now is basically very much concentrated in delivering the capital numbers. As José explained to you last quarter, basically what we need to absorb in terms of the regulatory items, etc.

Once that basically that's having covered, we will continue to build up and we will tell you exactly when the extraordinary capital distributions will happen. Okay?

José García Cantera (CFO)

The fully loaded number. Again, I have to give you a range because the technical notes that the EBA will publish can have a substantial impact long term. We're talking 2030-2033, but I'm referring to the credit conversion factors and the uncommitted credit lines, which we are still pending a final note on that. So the fully loaded could range somewhere between 25-40, 45 basis points. Today, we see more sort of towards the low end of that range, around 25-30 basis points. In our case, most of that impact will come in the next three to five years at most. We would expect, and this is related to the operational risk.

Our central scenario, again, is tha we could have moving from phasing to fully loaded, something around five basis points per year for the next five years. Then longer term, depending on everything related to credit, which is mostly 2029-2033, there could be an additional factor. For us, that should be very small compared to what the industry could see.

Héctor Grisi (CEO)

Sorry, Nacho, I think we missed your hedging question. Would you mind repeating that?

Ignacio Cerezo (Equity Research Analyst)

That is an update on how much of the different units P&L you are hedging for the next four months.

José García Cantera (CFO)

No, right now for 2025, everything is hedged. The expected profits from all countries, with the exception of Argentina, we cannot hedge Argentina, but for all other countries, the P&L is hedging. As you know, we always fully hedge the capital ratio. That is it.

It means the excess capital using European capital rules in each country above the group's capital level, in this case, 12.9%.

Raul Sinha (Head of Investor Relations)

Thanks very much, Nacho. Operator, could we have the last question, I believe?

Operator (participant)

Last question from Pablo de la Torre from RBC. Please go ahead.

Pablo de la Torre (Equity Research Analyst)

Thanks for taking my questions. I had two more on the U.K. I think the first one was Santander U.K. was a signatory to a letter to the Chancellor requesting the abolition of the ring-fencing regime here in the U.K. Could you please provide more color on what the actual financial impact you would expect from the ring-fencing regime being discontinued? More on the trends in the U.K. in the quarter and a follow-up. I guess, could you just update us on the structural hedge and the shape of NII for the rest of the year that you see in the U.K.?

Thank you.

José García Cantera (CFO)

Okay, let me take the second question first. Structural hedge is almost EUR 110 billion at a yield of 2.47%, 2.5% to round it up. We would expect NII to go up in the U.K., low single digits, in line with volumes up, also low single digits. Generally, the same guidance that we gave at the end of the first quarter. The ring-fencing, we are convinced, not only in the U.K., but in Europe, that banks can contribute a lot more to improving competitiveness in Europe and in the U.K. and contributing to growth. We think that having a simpler framework to operate will help. That applies to the U.K. and that applies to Europe as well. In terms of what impact this could have on us, it's negligible. This is not a question of an impact in the near term.

It's just that a simpler operating framework in Europe and in the U.K. should help banks contribute more to improving productivity and growth in the U.K. and in Europe. Thanks very much, José, for that. Thank you, everybody, for all your questions. The whole IR team is available if you've got any follow-ups. We thank you for your time and wish you a very good day.