Banco Santander, S.A. (NYSE:SAN) Q2 2021 Earnings Conference Call July 28, 2021 4:00 AM ET

Company Participants

Jose Antonio Alvarez - CEO & Vice Chairman
Jose Garcia-Cantera - Senior EVP & Group CFO
Sergio Martinez - Global Head, Shareholder & IR

Conference Call Participants

I Alvaro Serrano - Morgan Stanley
Ignacio Ulargui - Exane BNP Paribas
Benjamin Toms - RBC
Carlos Peixoto - CaixaBank
Britta Schmidt - Autonomous Research
Andrea Filtri - Mediobanca

Sergio Martinez

Good morning, everyone. Thanks for joining today's Grupo Santander first-half 2021 earnings call. As our normal procedure, our group CEO, Mr. Jose Antonio Alvarez, will start the presentation with the highlights on the group first half this year performance, followed by our group CFO, Jose Garcia-Cantera, who will address in detail the different aspects of the first half by business areas before handing over back to our CEO for the key takeaways.

And obviously, plenty of time for a Q&A session. So Jose Antonio, please.

Jose Antonio Alvarez

Thank you, Sergio. Thank you to everyone for joining us this morning. I would say, when I look at the first half of the year, I would say that we continue to show the main features of our bank in the sense that we continue to grow. Growth has been one of the features that we get during -- on time.

The growth is reflected both in customers, volumes, deposits, mutual funds, and loans. And also, we translate this into revenues, into the operating profit that grew 13% year on year in constant euros. So our operating income consistently keeps growing. We delivered in volumes, well-diversified across regions and businesses.

The performance was supported during this year, particularly in the pandemia, by increasing digitalization with a strong growth in digital customers and digital sales. Q1 profit, we translate this growth in volumes into profitability. Q2 '21 profit was EUR 2.1 billion, including the Single Resolution Fund contribution of almost EUR 370 million. Excluding this, quarter-on-quarter growth was 8%.

No extraordinary items were recorded this quarter. The first half of the year, we reached a recurrent -- attributable profit of EUR 3.6 billion. As you know, we did a charge for restructuring costs in the first Q. So the underlying profit was EUR 4.2 billion, the largest since 2010.

The return on tangible equity increased to 12.6%. Compared to the first half of 2020, revenue was higher, efficiency improved and the cost of credit dropped notably to 94 basis points. Third, we announced the agreement to acquire Amherst Pierpont in the U.S. and a proposal to acquire the minority for -- we don't own in SCUSA, the 20% we do not own today.

Our capital position remains solid. This core equity Tier 1 ratio was 12.11%, above our target range, and we continue to generate organically capital Q-on-Q and risk-weighted asset growth on the accrual for shareholder remuneration inside our range of 40% to 50% payout. Finally, our tangible net asset value per share increased 4% this quarter to around EUR 4 per share. In short, I will say we achieved our targets.

We exceed our targets in the first half, and we remain very focused on building a more resilient, inclusive and greener businesses. So when we go to the revenue generation in the quarter. As I said, we kept growing the customer base, 3%. As you may expect, digital transactions kept booming in this environment, plus 38%, and digital sales increased by 8 percentage points.

As you can see, this is well-spread across the board among the different products, mortgages, consumer, cards, deposits, investments, insurance. So digitalization is making good progress across the board. At the same time, we relate this, as I mentioned before, to our income that kept growing, keep growing. Operating income and efficiency on the back of our efficiency plan, our cost-income ratio improves to 45.7%.

At the same time, and this is important, we are top three in NPS in seven markets in which we work, and this is well-organized by the market. Going to the P&L. Moving to the -- the exchange rate had a difference with all the quarters, has a very small impact in the quarter, but still has a strong negative impact year on year, minus 7 percentage points in revenue and 6 percentage points in cost. Looking at the results on a constant euro basis.

Revenue grew mainly in those related with customers, cost discipline in an environment that inflation is accelerating all across the board. We continue to reduce loan loss provisions compared with the previous quarter, and we improved the cost of credit. I will describe later in more detail. We didn't record any extraordinary items in Q2.

Recall that we recorded the EUR 530 million restructuring cost in Q1. Additionally, in the same period last year, we recorded the adjustment -- the equitable adjustments. We delivered first-half underlying profit of EUR 4.2 billion. Importantly, and this -- I want to underline this, our regions and global business are performing very well.

All our three regions contributed roughly to 30% of the group profits with strong profit increases in all of them. Once again, the U.S. performance stands out with a profit of EUR 700 in Q2 and EUR 1.3 billion in the first half of 2021. Digital Consumer Bank, which contributes to 11% of the group underlying profit, also increased its profit significantly amid a challenging environment in the first month of the year.

Regarding our global businesses, CIB had another excellent quarters, around EUR 500 million net profit in the quarter after record performance in the previous quarter. Wealth Management & Insurance has gradually recovered in recent quarters and grew at double-digit rates, both in volumes and phasing in the first half of this year. This positive performance by region, together with the support of our global business, continues to demonstrate that our geographic and business diversification is a fundamental pillar of our business model. We see trends.

We see consistent trend across the board. NII and fees increase and reached pre-pandemic levels. I will run you through this in more detail in the following slides. Cost control and the cost of higher inflation and increased expenses are related with higher activity.

Loan loss provisions declined 13%, with a widespread improvement in the cost of credit. In short, a very good quarter, reflecting the rebound in activity that was more intense at the end of the quarter, particularly in the month of June. If we go to the NII, grew the NII, up 8% compared with the first-half 2020 and 3% quarter on quarter as a result of higher volumes quarter on quarter and year on year with a widespread growth by region and country. Regarding margin management, we saw repricing liabilities in Europe, in U.K., and Mexico.

In Europe, mainly in U.K., Mexico, and Chile, and improving loan spreads in U.S., U.K., and Poland. In addition, there was a positive impact from the TLTRO. Finally, average in the rates continue to have a negative impact despite the hikes in Brazil, plus 200 basis points since June '20; Mexico, plus 25% in June '21; and Chile, plus 25% -- 25 basis points in July. These increases will materialize positively in NII in the coming quarters.

When it comes to the fee income, they reflect clearly the rebound in activity. In this slide, you have several key products, and you see the growth compared with the first half of 2020 and quarter on quarter. The quarter on quarter -- I'm going to focus more on the quarter on quarter -- was particularly intense on the back of the -- some normalization. I will not say an important normalization of activity levels.

But with this some normalization, you can see that we are growing strongly in the main business of the bank, being from traditional business like acquiring business cars or the business in private banking or CIB that this quarter grew -- decreased versus previous one, but the previous one was kind of extraordinary quarter. We expect, as the normalization progress, this will continue in the coming quarters. In cost, as you know, our efficiency improved, 159 basis points year on year. That's a good track record.

Europe recorded the highest efficiency savings, 8 percentage point reduction. That is a quantum net. We continue to see significant increase in inflation in all countries, particularly in the U.S., where inflation had a big jump since 2008. In this context, group costs rose 3%.

In real terms, excluding the inflation, costs were 0.4% lower after the investments in IT. In Europe, costs were 1.5% lower, making -- we are progressing toward our work reducing EUR 1 billion cost in Europe. Spain had a 7% decrease. The U.K.

is lagging a little bit behind, but the we will accelerate in the second quarter and onwards in the region. Efficiency in the region in Europe stood at 51%. In North America, costs increased 7%, mainly driven by technology expenses and amortizations. In real terms, U.S.

increased 3%, and Mexico fell 2%. Efficiency in the region stood at 43%. In South America, the increasing costs, 7%, was greatly distorted by very high inflation in Argentina. In real terms, costs declined 3% in the region; Brazil, minus 6%; Chile, minus 1%; and Argentina, plus 6%.

Efficiency in the region stood at 34%. Finally, in Digital Consumer Bank, costs increased due to changes in perimeters. Sixt, the leasing business we bought one year ago in Germany, and some investments on digitalization. So we continue to do the transformation of the bank, and this will have reflect in our cost/income ratio as we progress in our transformation, plus particularly intense in Europe, where we are committed to the deeper transformation of the business.

The cost of credit -- well, I mentioned a number point, 94 basis points, 79 basis points in the last six months. This set our expectations, while probably for the whole year, we will be running at this level at around 1% cost of risk for the whole year. The NPL ratio remains basically flat. The loan loss reserves still in EUR 24 billion in the balance sheet with a nonperforming loan coverage ratio of 73%.

While the overall -- what we have seen -- the trends we are seeing in the cost of risk, we have seen better behavior than the one embedded in our models for all the individual spaces, being mortgages, being consumer on the back of lower unemployment than the one estimated in our models and also better house prices in our mortgage book that leads to a lower potential cost of risk in this space. In companies, particularly in SMEs, we are still in a prudent mode. While we are seeing a recovery, we need to see how intense is the recovery. And once we assess this, we will be in a position to assess this.

So compared with our expectations one year ago, the situation is much better than the one we were embedding in our models. The profitability ratios on the back of these strong results, naturally, the return on tangible equity went to 12.6%. The EPS -- underlying EPS north of EUR 0.22 per share. And the TNAV grew 4% quarter on quarter.

Well, I will say is the return on tangible equity and the return on risk-weighted assets are higher than in 2019. So those are the main ratios. And going to capital, we continue to generate capital organically in the quarter, 7 basis points due to profit earning. We are accruing a 50% payout on underlying profit, and this is in the organic capital generation.

Regulatory model-related impact were 24 basis points in the quarter and -- well, basically, the counterparty credit risk -- counterpart risk on derivative operations, 11 basis points, and TRIM on low default exposures where the impact was nine basis points. After that, the core equity Tier 1 phase-in ratio was 11% -- 12.11%. So we are above our target, above the upper limit of the range, 11%, 12%, and we enjoy a significant very large management buffer. So additionally, well, the group stress test conducted by EBA will be published this Friday, we expect to continue to show a consistent performance on this.

If you review the previous one, we came always at the top with the capital depletion being one of the lowest among our peers in Europe. So I will say that our capital generation and the -- organically continues to support our medium, long-term goal. So with our return on tangible equity progressing to our goal of having a medium-term target of 13% to 15%, this should allow us to grow significantly the business to have a payout in the range of 40% to 50% and to face the potential regulatory impacts that may come down on the road. Finally, let me comment a little bit on the ESG.

We made a strong commitment on ESG. On the environmental side, we were -- become a founding member of the Net-Zero Banking Alliance. This requires some specific targets in power generation, oil and gas. And we already published our target for the Net-Zero Banking Alliance in power generation.

We are working in three different directions, in the environmental issues, improving our financial products to support customers, issuing our own green bonds that we issued this year, already EUR 1 billion green bonds as part of our global sustainable debt plan. And finally, mobilizing green finance, we mobilized this year in the first half, EUR 8 billion in green finance, bringing our total of EUR 42 billion since the beginning of our commitment in 2019. So we are the market leader in the renewal sector -- financing the renewal sector, and we continue to lead the newest project finance league tables. On the social side, while the Santander Finance for All helps people to get access to the financial system.

This is extremely important in the micro credit business and also in the financial education. We have, as you know, microfinance alternatives already launched in Brazil, Mexico, Uruguay, and Colombia and will be launched in Peru this year. As a result of this, we were recognized as the best bank for sustainable finance in Latin America by Euromoney. In governance, we have clear and robust governance across group subsidiaries.

We ensure ongoing board effectiveness, balanced tenure and diversity. In addition, we include ESG metrics in our executives' bonus scorecard. And now I will hand the call to Jose that will continue to elaborate about the regional business, how they are performing in different countries.

Jose Garcia-Cantera

Thank you, Jose Antonio, and good morning, everyone. I will start with a brief summary of the regions, and then I will elaborate on the main countries. In Europe, we are accelerating One Santander's transformation, which enables us to progress toward our medium-term targets. We had positive volume growth year on year almost in all markets following the trends that we've seen since the beginning of the year.

Revenue increased 14% year on year. Cost control was maintained, and efficiency improved. In addition, we had loan loss provision reductions in most countries and a lower cost of risk at 49 basis points. In North America, strong profit growth, boosted by cost of credit improvements in the U.S., cost control and revenue increase.

Revenues increased 8%, excluding disposals. Return on tangible equity in the region was 15%. The group announced several transactions, which I will explain later. In South America, we are strengthening regional ties in order to continue growing profitably, supported by record new customer increase in recent months.

We had a strong rise in loyal customers, up 24%, and its digital customers, up 20%, reflected in double-digit volume growth. Return on tangible equity reached 20%. In the Digital Consumer Bank, we also saw positive performance year on year after the significant pickup in activity in the quarter. So in summary, we have delivered robust performance in all regions in the quarter.

Let me now analyze the main countries in more detail. In Spain, as the economic activity started to show signs of recovery, our stock of loans expanded 1% in the quarter. New mortgage lending reached its highest level in the last three years, and consumer lending recovered to prepandemic levels. On a year-on-year basis, the loan portfolio increased, mainly in SMEs and corporates, which lagged after the 2020 boost on eco loans.

Quarter on quarter, underlying profit was heavily affected by the SFR contribution, EUR 116 million in Spain. Excluding these, net operating income was 4% higher, with a positive performance in fee income and costs. In the first half, profits increased 56% year on year. NII grew 10% driven by TLTRO and active management of funding costs.

Fee income recovered to pre-pandemic levels on the back of transactional fees. Insurance and mutual funds, we show record inflows in the first half. We reduced costs by 7%, reaching an efficiency ratio, which is well below peers average. Positive jaws in the period delivered over 16% growth in pre-provision profit.

With regards to provisions, we remain cautious as to the recovery of the key sectors in the Spanish economy such as tourism. For the second half of the year, we expect the trends to continue with a slight increase in loans and deposit volumes. Revenue should recover to pre-pandemic levels at low single-digit rates. And in cost, we maintained -- we expect to maintain the trend -- the downward trend with a 7% decrease in costs by year end.

In the U.K., we had a strong increase in total income driven by NII growth of 29% year on year. This was a result of management actions to reprice deposits reflected in net interest margin improvement of 26 basis points year on year. In addition, volumes grew driven by mortgages and government-backed business loans. Costs continue its downward trend, reflecting progress on our transformation program, which resulted in strong efficiency improvement of 13 percentage points.

Loan loss provision releases of EUR 86 million in the quarter reflect the absence of significant charges and an improved economic outlook. In short, another positive quarter with a strong increase in profitability. We expect to maintain a positive trend in NII for the year end, while costs should drop as the optimization plans are executed. We don't see signs of deterioration in asset quality.

Brazil continued to deliver excellent performance in terms of volumes and profitability. We maintained a strong growth in new mortgage lending to individuals, which reached a record high in card sales and significant income growth in Getnet. In auto, we remained the leader in individuals. As a result, loans grew 15%; and customer deposits, 11%.

Profit was 44% higher year on year, and return on tangible equity increased to 22%. Total income rose 9%, backed by positive NII performance. Here, larger volumes offset margin pressures arising from lower average interest rates, although they increased in the quarter and net fee income growth. Higher productivity and expense management enabled us to continue to reach record efficiency levels.

Loan loss provisions decreased strongly with a positive cost of credit performance, which fell to 3.51%, down 116 basis points year on year. Compared to the first quarter, profits up 6%. Net interest income and fee income up 7%, offset lower gains on financial transactions and higher provisions in individuals. So in short, we continue to experience healthy growth with very positive revenue performance, gaining market share in key segments.

We're reducing the cost of credit quarter on quarter, leading to efficiency and improving customer attraction and loyalty. We expect to see the same trends in the second half. In the U.S., the work conducted over the last few years made us to be uniquely positioned to benefit from improving market conditions. Loan growth was impacted by Bluestem and Puerto Rico disposals.

Excluding perimeter changes, growth was 1% year on year, with auto origination increasing 29% year on year in the first half. Very positive P&L performance. The U.S. was the largest contributor to the group's underlying profit, both in the second quarter and in the first half, reaching EUR 700 million and EUR 1.3 billion, respectively.

Net operating income increased on the back of resilient NII where deposit pricing actions offset lower rates, strong auto leasing as well as wealth management and cards fee income. Excluding the disposals impact, net operating income increased 23%. Loan loss provisions decreased sharply as the improved macro outlook, customer loan relief and increased used car prices led to a strong credit performance. Again, the first quarter, profit up due to better performance on leases and the release of loan loss provisions.

Excluding the Bluestem disposal impact, profit was up 14%. In line with the group's strategy to accelerate growth in the U.S., we announced two transactions: the proposal to acquire all outstanding shares of Santander Consumer, we already don't own, which is around 20%; and the agreement to acquire Amherst Pierpont Securities. These transactions follow our strategy to reduce complexity, increase profitability with minimal additional operational risk and increased businesses diversification by expanding our exposure to corporates. Both transactions follow a rigorous financial discipline and goals, and strengthen our business model and profitable growth.

In the second half, we would expect to maintain our strong performance in net operating income with double-digit growth through deposit pricing, strong wealth management and CIB fee income performance and continued momentum in auto leases. Loan loss provision expense is forecasted to have a significant improvement against last year, although we would expect to see a gradual normalization in the second half after an abnormally low first half, as I just mentioned. In Mexico, our multichannel innovation continued to strengthen our value proposition, which enabled us to increase our loyal and digital customer base at double-digit rates. Lending showed a strong performance in auto loans and mortgages, gaining market share.

However, the total loan portfolio decreased in line with the system, which was still affected by corporate loans normalization. We continued to shift our funding mix toward demand deposits and mutual funds. Profit was slowly down -- slightly down year on year. Total income fell, impacted by NII pressure from lower rates and volumes and lower trading gains due to ALCO sales in the second quarter of last year.

On the other hand, fee income increased driven by transactional revenues. Costs fell 2% in real terms despite higher technology investments and amortizations. Loan loss provisions dropped 21%, leading to a cost of risk below 3%. In addition and in line with the group's strategy, the tender offer to acquire the outstanding shares of Santander Mexico that we don't own, 8.3%, is on track to be launched in the third quarter, subject to regulatory approvals.

In the second half, we would expect recoveries in volumes, fees growing at high single-digit rates and a gradual pickup in NII. Loan loss provisions should decrease against 2020. On the Digital Consumer Bank. In consumer lending, activity trends improved.

New lending performed very well in the second quarter after pandemic controls eased in Central Europe, delivering 20% growth year on year. In the quarter, profit headwinds included the SRF, the Single Resolution Board contribution, excluding profits, would have been up 6%, higher provisions related to the Swiss franc mortgage portfolio in Poland. On the other hand, the recovery in activity was reflected in NII, fee income, and cost of risk improvement. In the first half, profits -- sorry.

In the first half, profit was up 11% higher year on year. Costs grew 5% year on year due to changes in perimeter. Remember, Sixt, TIMFIN, and investments in digitalization. On a like-for-like basis, costs were down.

For the coming quarters, we expect strong cyclical growth in consumer finance demand, delivering a mid-single-digit growth in revenue, flattish costs, and cost of risk that would remain more or less at between 60 to 70 basis points. Let me now review the global businesses started with CIB. As Jose Antonio mentioned, CIB delivered another excellent quarter in activity and results, although, obviously, the quarter-on-quarter comparison was affected by the very, very strong record-high first quarter '21. In the first half, CIB had leading positions in the rankings of structured finance.

We were first globally by number of transactions. DCM, first in Spain and top three in Mexico and Chile, and ECM top three in Spain, Mexico, and Poland. We had outstanding first-half results, backed by overall revenue improvement across businesses, mainly in markets and global transactional banking. We expect that performance for 2021 to continue to be very positive, although probably in more normalized trends.

On wealth management and insurance, total assets under management increased double digit year on year, both by market movement and commercial inflows. In private banking, Santander Asset Management of more than EUR 9 billion, which account for 2% of the total volume managed. In insurance, gross written premiums rose 12% year on year, mainly by noncredit-related protection business. In summary, total fee income grew 10%, and total contribution to the group's profits was up 9% year on year.

In the second half, we expect to continue the same strong business dynamics, delivering double-digit growth in fees and profits. In PagoNxt, as you know, well, payments is the cornerstone of our strategy to grow and reinforce our customer loyalty. In the first half, revenue increased 23% year on year, boosted by the strong jump in fees, 39% higher at constant exchange rates. And we expect revenues to grow strongly in the second half around 50% and reach EUR 1 billion in the medium term.

To provide some context behind our growth in PagoNxt, let me share background on our three businesses. In merchant solutions, Getnet is already one of the top three acquirers in Latin America, and we continue to develop our capabilities across our technological hubs in America, Europe, and Asia. We recorded a solid performance in the quarter, exceeding pre-pandemic levels in active merchants and total payment volumes. Getnet Brazil recorded a strong commercial performance, reaching more than 15.5% market share.

Getnet in Chile launched its commercial activity, and Mexico progressed in its migration plan to the global platform. Getnet also operates in Argentina. We continue to invest in Europe as our former domestic acquiring business in Spain evolved to Getnet Europe, and we'll be providing European customers with integrated offerings before the year end. All in all, we reached a total of around 1.2 million active merchants, up 24% year on year, and a total payments volume of close to EUR 50 billion in the first half, up 53% year on year.

The second component is trade, Trade Solutions, which support SMEs and corporates that operate internationally through state-of-the-art solutions. One Trade is already connected to our customers in eight countries after its recent rollout in Mexico and Poland. This solution has over 6,000 active customers, up 50% versus the first quarter of the year. We expect to increase exponentially as we add new services.

Ebury, we continue to invest in project development and platforms while the volumes and revenues were temporarily impacted by the pandemic. Finally, in consumer solutions, we will be soon rolling out the new global platform in Argentina, Peru, and Colombia. And now let me finish with the corporate center. We can see that results improved 6% compared to the first half of last year, mainly due to the continued positive trend in operating expenses and the decrease in loan loss provisions and other provisions due to the one-off provisions recorded in the first half of last year for certain stakes whose value was affected by the crisis.

On the other hand, net interest income was impacted by the increase in the liquidity buffer, and we also had lower gains on financial transactions. As you remember, we recorded positive foreign currency hedging results in 2020. And let me turn it back to Jose Antonio for his concluding remarks. Thank you very much.

Jose Antonio Alvarez

Thank you, Jose. I'm going to take just one minute to sum up a little bit the result we present to you. I will say our first-half results were solid and consistent across geographies and businesses, supported by volume growth, strong revenue, efficiency improvement, better cost of credit, core equity Tier 1 above our target range, and return on tangible equity is higher, clearly higher than the cost of equity. Looking forward, we continue our strategic transformation, growing and increasing profitability while we help our customers and societies by building a strong customer base, achieving greater customer satisfaction with our services, helping our customers become more digitalized.

Based on the results obtained year to date and our constructive business view for the second half, I believe we are well on track to outperform our full-year '21 goals. We expect to close the year with a cost of credit around 1% and increase our profitability ratios well over 10%. Finally, we remain at your disposals for the questions you may have to us. Thank you.

Sergio Martinez

Thanks, Jose Antonio, indeed. Now we have plenty of time for the Q&A session. So please, operator, let's proceed with the first question. Yes. We can move to the Q&A session, please. We seem to have some problems. Bear with us one minute.[Technical difficulty] -- a high level of confidence in your capital position. But can you give us a little bit more color on how you see capital allocation between the returns and the growth, organic, and inorganic? Should we expect this sort of bolt-on acquisition to be a regular feature of Santander going forward? And can you maybe discuss whether you see any technical or regulatory barrier for Santander not looking at buying back the Brazil minorities at some point in the future?

Jose Antonio Alvarez

OK. Let me elaborate on our -- on the capital. I said to you on the presentation, on the main presentation that looking at the medium term, the way we see our capital are now -- as you know, we established a medium-term target for return on tangible equity of -- in the region of 13% to 15%, starting from this. And given the evolution we have in the business, we think this is achievable, clearly achievable, and will -- I remain very confident that we will achieve this.

If I look at how we're going to deploy the capital we generate to the business, I will look for a kind of risk-weighted asset growth. This is a growth story, particularly we're going to grow double digits in Latin America, yes, naturally maybe some currency depreciation. But well, we are aiming for double-digit growth in Latin America, also significant growth in our consumer business in the U.S. While in Europe, we see a more kind of flattish evolution of the risk-weighted assets.

This will lead us to a kind of growth of risk-weighted asset, let's say, in the region of 3% to 5% probably year on year. And on top of this, we have our payout policy that is to remunerate the shareholders 40% to 50%. And you do the math, we have some spare capacity on top of this to face potential regulatory headwinds that we're going to have, still some to come. The Basel 3 particularly one is still a bit far from us, has been delayed for several times, but it's still there.

And finally, we'll have some spare capacity to, what, maybe to, as you're suggesting, to do buybacks, to do small acquisitions. Now we have not contemplated any kind of bold acquisition of a large size. So this is, in my mind, the capital evolution going forward. I feel very confident that we're going to stay at the upper end of our range, 11%, 12%, for the coming quarters and probably coming years.

So it's probably too early to say. But probably in the coming years, it's pretty much the same.

Question-and-Answer Session

Our second question is coming from the line of Alvaro Serrano from Morgan Stanley. Your line is open. Please go ahead.

Q - Alvaro Serrano

Good morning. Thank you. It's actually two follow-up questions also on capital in the U.S. On capital, I just want to confirm the headwinds year to date, I think, of 37 basis points and your guidance was 40.

Is there anything that's getting better or worse there that you can share for the rest of the year? And also a follow-up to the question I asked in Q1. Have you given any further thought of splitting your distribution between dividends and share buybacks? And any color you can give on maybe helping us quantify any share buybacks that you might be thinking about? And when can you be more precise about that? And the second question, more strategic on the U.S., is you bought the minority SCUSA. You've also bought a [indiscernible] broker in the U.S. I just wanted to ask if you could elaborate on the strategic rationale behind the two.

Presuming on the [indiscernible] broker, you're after the dollar clearing, but it seems -- the timing seems on both acquisitions, I would argue. So can you talk about why now? And what are you trying to build in the U.S.? Is it a universal bank, consumer bank used to be too big to integrate with the retail? Just some thoughts on your footprint in the U.S. Thank you.

Jose Antonio Alvarez

OK. Let me elaborate a -- surprises in capital. Basically, probably, I wouldn't say we have had surprises. Probably, the only one -- probably consequent to comment, probably more because of the regulatory issue than the one we were expecting at the beginning of the year, probably in the region of five, 10 basis points more.

Jose Garcia-Cantera

Yes. We -- the two things that are coming a bit above our expectations are the new definition of default. Remember that the regulators said that they would expect neutral capital impact from that, and it's going to be very far from being neutral, and also a bit worse in the counter-party credit risk for derivatives that we already accounted for in the second quarter. So probably, we would expect, if we said 40 to 45, maybe 10 basis points more this year than we had initially expected.

Jose Antonio Alvarez

OK. The second question, you asked me to elaborate about the buyback. Well, as you know, last Friday, the ECB, well, communicate that the bank on dividends will be over at the end of September. Clearly, our remuneration to -- policy to shareholders stays in the 40% to 50%.

Inside that, naturally, we -- the board by September is going to contemplate different options. Naturally, cash dividends and buyback can be in the table. Mainly with the share price trading clearly below tangible net asset value per share is clearly an option that is -- can be quite compelling at some point. The third question was related to U.S., our strategy in the U.S.

In the U.S., the way I look at the business in the U.S., we have independently -- of the legal structure, we have like three -- four businesses there. We have a pretty strong consumer finance building businesses, basically in SCUSA, with the origination capabilities that are quite strong, as we've shown through, well, many years already. Second, we have a good and growing deposit base in SBNA that is growing. We were able to reprice substantially.

And if you see our numbers, our NII has been performing better than our competitors due to our ability to reduce the cost of our deposit base and at the same time, of the deposit base. We are not taking advantage of this deposit base to fund the consumer business in the full expansion. That is an opportunity clearly there. Third, we are developing CIB businesses that last year probably grew more than 20%, this year keep growing significantly.

And we had this fixed-income broker in order to keep growing in the CIB space. And finally, we have the private banking business in Miami that -- well, as you know, it's a very profitable business and is growing nicely well into double digits. So when I look at the business in -- from this point of view, we have very good opportunities to be much more efficient in the U.S., combining our capabilities in different angles and keep growing, particularly in the CIB, consumer space, wealth management, both onshore and offshore, and developing some specialty business that we have inside the SBNA that offer returns in the 16%, 17% region like the multifamily business that we plan to expand. So taking all of this and looking from this point of view, our business -- we are keen to grow in the U.S.

organically our business. And we think that we can have returned significantly above our cost of equity with this combination of business going forward.

Alvaro Serrano

Thank you.

Operator

Sergio Martinez

Thank you.

Jose Antonio Alvarez

Thank you, Alvaro.

Sergio Martinez

Next question, please.

Operator

Next up, we have a question from Andrea Filtri from Mediobanca. Your line is open. Please go ahead.

Andrea Filtri

Yes. Thank you for taking my questions. I have a just follow-up and one on Spain. On follow-up, therefore, if you get it correctly, you're basically upping the guidance on regulatory headwinds from basically 40 to 55 basis points this year. And I didn't understand if you also had any expectations on 2022 as the stock has kind of reacted in a flattish way to a clear beat to results. So it seems like the capital is holding the stock back today. And on Spain, the cost of risk seems to remain high and certainly not reflecting the same evolution of the other geographies. What is your outlook there? Are you essentially trying to anticipate and bringing forward some future trends or you're being cautious or it's simply that the visibility remains low, and therefore, the cost of risk stays high? And still on the cost of risk front, what is the actual mechanical timing for you to allocate the overlay provisions of last year? And if the macro does not materialize in line with their expectations, so when would you actually release those overlay provisions by? Thank you.

Jose Antonio Alvarez

OK. I will take the cost of risk questions, and I pass on to you, capital question, Jose. So the question -- your question, Andrea, in relation with the cost of risk in Spain, let me share with you my thoughts on this. Yes? So as I said in the presentation, we have on one side the individual families in consumer and mortgages where we are seeing substantial better trends are the one that were embedded in our models last year when we were estimating the overlay based on expected losses in the future.

That's clearly a positive on the back of, I mentioned also before, lower unemployment than the one we were expecting, a better house prices than the ones we were anticipating at the time. Yes? And these apply to individuals. When it comes to SMEs, the situation is much more uncertain, yes? So while it's true that the economies are rebounding, it's also true that the Spanish economy, given the relative specialization in tourist-related activities, the rebound need to be seen. Still, we are midway to this rebound.

And based on the behavior of the economy, I think that it's too early to call the situation -- advise you to be cautious. When do -- I do think that we're going to have more visibility, probably when we see the economy fully open and we see tourist industry recovering or going to more normal activity. Probably, this is three quarters from now, four quarters from now. It's not for sure are going to be next quarter because we are still in the middle of the -- this Delta strain -- Delta is creating some lockdowns here and there and would refer at this stage to be cautious.

So probably for this year, the cost of risk in Spain, my best estimation is going to remain as it is. And I will expect next year to come down significantly, but I will tell you that the environment -- advise you to be cautious, particularly in the SME space. Cost of risk, the mechanical -- the time to release the overlay and to -- well, we're going to go into our internal budget in -- this depends basically how comfortable do we feel to assess a material different economic scenario than the one we embed in our models last year. As of today, I will say that the scenario -- the current scenario I have in my mind is materially better than the one we assessed 1 year ago.

So this will lead to some or significant releases depending on the jurisdictions. When is this is going to happen may happen, and this is a discussion with risk on the research department, may happen in the fourth quarter this year, may happen in first quarter, second quarter next year, depends on the economic situation and how sound the economic situation is, particularly is related with COVID? Yes? As long as we have COVID, some potential lockdowns here and there, probably, it's not advisable to do that. But at some point, we need to do that. Yes? And as of today, this will lead to releases.

When this is going to happen, I'm not in a position to specific -- to put in a specific quarter, but let's say, next three quarters, four quarters. So probably, in this range, you should see some of this. You also saw some in the U.S. and the U.K., yes, somehow in the quarter.

Yes? Now material releases, but we are now -- you look at the numbers in the U.S., provisions were close to zero; and in U.K., the same, where the situation is clear -- it's more clear than in other jurisdictions that we are still not so advanced in the recovery. Jose?

Jose Garcia-Cantera

Yes. With regards to the regulatory expectations, yes, so we initially expected maybe 40 to -- 40 to 45. Maybe now it's 10 basis points higher. Most of the increase from where we are today will happen in the third quarter. But even if we front-load the transactions we have announced and with these regulatory impacts, we are very, very confident we will be at the upper end of our target range this year in 2021. So we don't see a problem there. Thank you, Andrea.

Sergio Martinez

Thank you, Andrea. Next question, please.

Operator

Next up, we have a question from Ignacio Ulargui from Exane BNP Paribas. Your line is open.

Ignacio Ulargui

Thanks very much for taking my questions. Good morning, all. I have two questions on the P&L on operating trends. I mean, one on costs.

I mean, when we will start to see sort of like the benefits from the U.K.? You flagged that second half should be better, but I think that costs have been a bit weaker level we expect -- what I expected at least in the U.K. Also, on the Digital Consumer Bank on the cost side, there has been a bit of an increase in the quarter. I wanted just to get a bit of color on whether it's sort of like the consumer finance business or open bank what is bringing costs up in the Digital Consumer Bank. The second question is on NII in Brazil.

I mean, it has been very strong in the quarter. Next quarter mechanically should be as strong as well because of the FX appreciation. But I mean, just if you could update a bit on what are you focusing in terms of loan growth and what would be the margin impact in 3Q because of the hike in rates. Thank you.

Jose Antonio Alvarez

OK. Let me elaborate. You asked specifically, if not your question about U.K. costs.

Well, I said in the presentation that we expect an acceleration of cost reduction in U.K. on the back of transformation we are having in the bank, and we remain committed with the target in Europe for the four main units, Spain, U.K., Poland, and Portugal, to reach EUR 1 billion. So U.K. will accelerate, and we think that we will reach our targets in the transformation plan.

We already reached the agreement with the units. Yes? So it's a question of time that it will come. On the Digital Consumer Bank, the situation is a bit more complex here, yes, because what you have in the numbers is this is a growing business. Yes? And as we reach new agreements with OEMs that expand our business and we expand our activity, particularly in the leasing space, we are more focusing being more efficient in transaction costs, compared with our revenues, not as much in an absolute number that cost that goes down.

You should look at Digital Consumer Bank as a growth story. And naturally, in the first half, we have had the first, I will say, four, five months where we were lagging behind our -- the normal originations. In June, we got very close to the origination we expect in a normal amount. And for the second half of the year, we think that we're going to have some -- on the back of availability of cars, there is no new cars for sale in the market due to scarcity of chips.

And probably, we -- although I am optimistic that we reach normalized levels, this is going to mean a break. On the other side, in used cars, we are doing significantly better. Particularly our position in Germany, used cars is doing much better. So -- but overall, when you look at the Digital Consumer Bank, the cost side, you should look in relation with the business we underwrite that we expect to grow significantly, and we are growing.

We are reaching new agreements with new OEMs that help us to grow the business all across. And the fourth question was about NII in Brazil. Jose mentioned when he was presenting Brazil that we expect the same trends in the second half. If you look at Brazil, well, you mentioned the interest rates.

Interest rates in Brazil have a not-so-significant impact. So some positive impact on the liability side, not as big as in other jurisdictions due to the fact that the reserve -- the mandatory reserve requirement limited the impact. And the loan book margin has remained -- spread has remained relatively flattish. Yes? So in the last, I don't know, couple of quarters.

Yes? So I do expect to keep growing on the back of loan growth and on the back of market share gains. We keep gaining market share in the country. So we are growing faster than our competitors, and I do expect to keep growing. So I don't expect a big deal compared with the current trends in NII in Brazil.

Sergio Martinez

Thanks, Ignacio. Next question, please?

Operator

Our next question is coming from Britta Schmidt from Autonomous Research. Your line is open. Please go ahead.

Britta Schmidt

Hi there. Good morning. I've got three questions and a clarification, please. The first one is on PagoNxt. You mentioned the EUR 1 billion revenue target over the medium term. Can you give us a bit more color on what you mean by medium term? And maybe also when you consider the business to be breakeven in terms of profits. The second question will be on legal issues. What is your scenario for the Polish FX mortgage is now? You've taken another provision in the quarter. Or where do you see the endgame? And maybe also, you can comment on whether there's any impact on the business in Germany from the BGH ruling on deposit fees, or where do you expect that to have any read across for other geographies at some point? And the clarification is just on the macro provisions. Could you give us an update as to where they are right now after releases in the U.K. and U.S.?

Jose Antonio Alvarez

I didn't get the third question in relation with Germany. What's your comment? Sorry.

Jose Garcia-Cantera

The ruling.

Britta Schmidt

There was a ruling on reimbursing customers for increasing deposit fees without their expressed consent. I was just wondering whether Santander is impacted by that or whether you expect that this might spill over to other geographies where lawyers may start to launch some cases on deposit fees.

Jose Antonio Alvarez

OK. Good. Thank you. So PagoNxt, more color. Well, this is a -- we said in the presentation that we expect to grow revenues 50% in the second half of this year compared with the first half. Remember that we acquired Wirecard assets. And those assets -- well, we have in our P&L the cost. The cost of running Wirecard is, I think, EUR 60 million or something like that.

And the cost that we have and revenue-wise, we started just one month ago. That's the reason why we expect to grow rapidly our revenue base in the coming quarters without changing significantly the cost base. When the breakeven is going to be -- you say EUR 1 billion medium term -- medium term, normally, we doubled revenues. We increased revenues 50% in the second half.

We should reach in the next two, three years a volume of revenues in line with the number we are mentioning. And the breakeven -- well, I do have a -- I will say the acquiring business is going to be very quickly. The trade very quickly -- well, I do expect probably no more than one year, one year and a half. Yes? So in Latin America, the business is already more than breakeven.

In Europe, we need to deploy our network in countries like U.K. and Poland. That is going to take for a while, and significant investments probably takes longer than this. In trade -- well, we are developing also the network, but this is a pretty straightforward business.

Relatively, it's not -- I don't have a specific time frame in mind, but it's not a very long period of time. Yes? So probably, I can elaborate more on this specifically with the specific details about timings and plans that we have in relation with this business. Swiss franc in Poland, we are expecting the Supreme Court ruling by September.

Jose Garcia-Cantera

Second of September.

Jose Antonio Alvarez

Second of September. Our provisioning now is around 15% of the portfolio.

Jose Garcia-Cantera

15% of the EUR 2 billion portfolio.

Jose Antonio Alvarez

The EUR 2 billion portfolio. We're highly uncertain, the outcome of the ruling, and we will see. But in any case, taking into account that is -- we have -- we own 70% of the bank. We don't expect a material impact for the group out of this issue. The German ruling on deposits, we are not charging deposits in Germany. You say, oh, this goes to other geographies. We are charging for deposits only in institutional money and nonoperational deposits of very large corporates. So it's not a significant impact to us unless this affect the professional market. In which case, well, it will go one side or another. Yes? So we have the two sides there. And to be honest with you, I don't know the net of the two sides. Yes?

Jose Garcia-Cantera

No. I don't. But exactly, there are two sides to this.

Jose Antonio Alvarez

You are laughing. So you probably know. OK?

Jose Garcia-Cantera

There was a final question on the overlay. We have not used the overlay but in Spain and a bit in Mexico. In all other countries, the overlay is unused.

Sergio Martinez

Thank you, Britta. Next question, please?

Britta Schmidt

OK. Thank you.

Operator

Next up, we have a question from Carlos Peixoto from CaixaBank. Your line is open.

Carlos Peixoto

Hi. Good morning. Thank you for taking my questions. So I would perhaps start a bit or pick up a bit on the questions regarding the evolution of cost of risk in the U.K. and in the U.S. as well. So you witnessed here the -- this write-back, which I believe has to do with adjustments on the macro inputs on the provisioning model. I was wondering, going forward, what type of underlying cost of risk should we expect on these two business lines? And also on the NII front in the U.K., if you could share some guidance on what to expect throughout the year and possibly for next year. Thank you very much.

Jose Antonio Alvarez

OK. Underlying cost of risk, U.K., U.S. So traditionally, in U.K., where the majority of the business is mortgage business is 90% of the volume or somehow the -- yes. So the cost of risk should be in the region -- you look backwards, and the cost of risk should be in the region of 10, 15 basis points, has been the number that we have had for years.

Yes? So very low cost of risk. And U.S. is quite different. On the back of the subprime business, we run out of SCUSA.

Assuming that the mix remains the same, you should expect a cost of risk in -- the subprime business was more in the region of SCUSA, in the region of 6% or something like that was more -- with some volatility. Remember that this business has seasonality. Look at the cost of risk in one year. Yes? If you look quarter on quarter, you have significant seasonality.

You look backwards, you have this. But 6% is the cost of risk in the consumer business. And the other is fairly low. The remaining is fairly low, probably maybe in the 20 to 30 basis points.

The business that is not consumer. So it depends largely on the mix. NII guidance in U.K. was the other question.

Jose already elaborated on this. So what you are seeing now is the result of repricing liabilities. Well, probably, almost all has been done there. And the increasing spread in mortgages -- well, as you know, last year and the first half of this year has been fairly good.

The mortgage market in the U.K. is very dynamic. The last couple of weeks, we've seen more competition in the market. But we remain fairly constructive on the back of higher volumes and relatively stable mortgage spreads that comes and goes, but we do not expect a big deal there. Yes?

Jose Garcia-Cantera

If I may. As I mentioned, first half against first half of last year, net interest margin is up 26 basis points. So we would expect to see a similar year-on-year figure for the full year, maybe 20 to 25 basis points. We have a sensitivity of around GBP 17 million, GBP 18 million to the basis point, and that is what explains our expectations for double-digit growth in NII in the U.K. this year.

Sergio Martinez

Thank you, Carlos. Next question, please?

Operator

Next up, we have Benjamin Toms from RBC. Please proceed.

Benjamin Toms

Good morning. Thank you for taking my question. Just one for me, please. Santander have been involved in a branch trial in the U.K. There a number of banks have come together in a -- to form a bank hub in one branch. Do you see this as a strategy that can get rolled out across rural areas in the U.K.? It seems like quite a good idea. Thank you.

Jose Antonio Alvarez

OK. The branch model is largely idiosyncratic. Yes? So depends on the different countries. The model in the U.K. where, as you know, we have a -- the IFAs play a very big role in the mortgage market, is a model that is, I will say, is different from other countries, particularly in our wall, where we are, in other countries, more kind of -- the branch is kind of a supermarket, while in U.K. is more specialized in specific segments in which we were particularly on the savings space and mortgage space. And we have the regional centers for corporates. So it's a business that is a model that is branches on one side for the retail specializing savings and mortgages; and on the other side, the corporate -- the regional centers for corporates.

This is a model that in our jurisdiction is probably quite unique. Yes? So we have -- we tend to have more -- the branches tend to be higher -- broader set of products in the mortgages -- in the branches than the ones we have in U.K. given our relative specialization in U.K. And we continue -- we think that the branch distribution -- the physical distribution in the U.K.

is about to be realigned right now with the current presence, and we are investing a lot in improving our digital distribution and all the subset on all the products in which -- with which we operate in the market, particularly in those who are more related with fee income like insurance and wealth management and these type of products that we are investing to improve our offer.

Sergio Martinez

Thanks, Benjamin. Next question.

Operator

Next up, we have --[Technical Difficulty]

Sergio Martinez

Next question, please? Hello? Next question, please?

Unidentified Analyst

-- the second half remaining broader impact? And any other organization drivers in 2022 and 2023 [indiscernible]. That would be helpful. Thank you.

Jose Antonio Alvarez

Sorry. We couldn't hear your question. Could you repeat your question, please because we have some technical problems?

Jose Garcia-Cantera

Sorry. Can you hear me now?

Jose Antonio Alvarez

Yes. We can.

Unidentified Analyst

[indiscernible] if you specify other upcoming impact on capital for the second half of 2022 and 2023? And what level of fully loaded capital ratio will be uncomfortable for you as leaders of the bank? Why [indiscernible]? So I know that the performance has been 11%, 12% and you're comfortable in those levels. But why do you have concerns on the economic recovery? What would be the capital level where you will be taking action? So if this is the level that [indiscernible], or would you be some volatility [indiscernible] those levels are going to be lower?

Jose Antonio Alvarez

Well, we clearly stated our capital target, this is the range, 11% to 12%, and we stayed in this target. So if we fall below 11%, we are not inside our target, and we try to come back to our target as soon as we can. Yes? So that's simple. Well, I will focus much more on the likelihood of destroying capital at Santander.

Yes? So when you look at the pre-provision profit and -- well, this is well established in the stress test -- all the stress test. The likelihood of destroying a significant amount of capital at Santander is much lower than in other -- some of our competitors. That's the reason why in the stress test, we can -- we always tend to come at the top with the less capital depletion than our peers. This makes us comfortable with our range.

Yes? So when we define our range, we took into account the business mix that we have, our pre-provision profit as the first line of defense that may -- that allow us to face the potential shocks that may come from the business as the ones that came last year in the middle of the pandemia. And well, we feel comfortable with this. The range is the result of our assessment where we feel comfortable, 11% to 12%. Where we don't feel comfortable is below the range. And Jose?

Jose Garcia-Cantera

I would add to that, that again, we have a management buffer in the region of 200 basis points. So we are not only we generate a lot of capital, but we are very comfortably above the minimum capital requirements. And obviously, the regulators feel very, very comfortable with our 11% to 12% range. I have already got into details of what we expect for the second half.

For the coming years, I mean, I think it's very early. The ECB, as you know, will let us know in September, October what their inspection and model exercises are for the coming years. And we will update you when we have a bit more detail.

Sergio Martinez

Thank you, Carlos. Next question.

Jose Antonio Alvarez

In relation with the cost evolution in both -- in Portugal and Poland, we -- for sure, we're going to have an acceleration of cost reduction in Portugal. In Poland, we have mixed trends. We are doing a large transformation plan, but the salaries in Poland, as you know, are growing at the region of 6%, 7%. So it's more difficult to reduce in nominal terms, although we're going to have a -- we expect to improve our cost/income in the country.

Nominal reductions in Portugal, for sure, acceleration there. In Poland, largely depends on the situation in the country where the salaries are growing. We're going to continue with the transformation plan, but the efforts have been offset by the increase in salaries in the country. Yes? And second, Brazil, the cost of risk.

We are running 3 60 or something like that.

Jose Garcia-Cantera

3.5

Jose Antonio Alvarez

3.5. Well, in the coming quarters, we don't expect a material deviation from this other than the ones that may come from the mix. Yes? So on a like-for-like basis, I don't expect a bill. It's true that we are growing faster now in retail than we are growing in corporates and CIB.

If this continue, may go up, but this is -- this will be good news, I will say, in the sense that the retail business is highly profitable at this stage in Brazil. But it depends on the mix. Yes? If you ask me with the current mix, I don't expect big deals other than 10, 20 basis points up and down in Brazil. In the current scenario where the country is going to grow this year based on IMF yesterday in 5%; and next year, 2% or 3%.

On the back of this, I don't expect a big deal there. And probably, they continue to increase rates. Yes?

Unidentified Analyst

OK. Thank you. Very clear.

Sergio Martinez

In this case, our last question is coming from Francisco Riquel from Alantra. Please proceed.

Francisco Riquel

Yes. Thank you. Very briefly. NII in Spain, a bit weaker than I was expecting, down quarter on quarter. So I wonder if you may comment on the trends. And I feel that the mid-single-digit growth guidance for the year may look challenging. If you can update also on the guidance in NII in Spain. And then second question on Brazil, if you can comment on the changes in management and any potential implications we should expect. Thank you.

Jose Antonio Alvarez

OK. In Spain NII, we guide you to 35%, and that's around this. So probably, we are -- well, probably, the negative comes from lower repricing rates in mortgages is the only thing that comes to my mind. The rest remains basically in line with our expectations.

Probably, this effect may change 1% more or less, but not a material change there on the trends. We are seeing a bigger activity in mortgages. That trends may -- tend to be lower yields and relatively low activity on the SME and corporate space and tend to have higher yields. Other than that, I don't see significant changes there.

Yes? In Brazil, relation with the change of management, while we did a succession plan, I would say, business as usual. Sergio will become the non-executive chairman in January. And two members of the ComEx, the executive committee in Brazil become -- in the case of Mario Leao, become the CEO of Brazil. And in the case of Carlos Rey, he's going to head the Latin American region.

Well, he's, I will say, it's business as usual, I will say. Nothing specific in relation with the strategy and all these things. Our plans is to keep growing in Brazil. As you know, the subsidiary has had an outstanding performance, and also the region is having an outstanding performance.

Chile is having a great year, and we are growing nicely in other small franchises like Uruguay, Peru, Colombia and in the region. So we plan to keep growing in the region to expand some regional business across like the consumer finance, the one in -- the ones in PagoNxt acquiring and the others, Superdigital in consumer in the area of PagoNxt. And Carlos is going to have this mandate, and Mario Leao is going to keep the mandate of keep growing in Brazil and gaining market share, as we've been doing with outstanding returns north of 20% that we -- probably, we are now among the largest bank in Brazil, the most profitable one. And this -- naturally, we want this to continue into the future.

Sergio Martinez

OK. Thanks, Antonio, Jose. I'm afraid we need to leave it here. Thanks, everyone, for joining today. Apologies for the technical difficulties. Obviously, the IR team is at your joint disposal for any follow-up. Thank you.

A - Jose Antonio Alvarez

Thank you.