Edited Transcript of CREAL*.MX earnings conference call or presentation 20-Feb-20 4:00pm GMT

Before going further on the analysis of our performance by geography and business segment, allow me to take you through some significant milestones achieved in 2019. First, we showed our commitment for delivering incremental value to our investors, we canceled over 12 million shares, equivalent to 3.2% of the outstanding stock in year 2019, ending with 379.7 million shares outstanding, driving on an ambitious MXN 8.5 billion buyback program while paid over MXN 266 million in cash dividends. The highest distribution ever made in Credito Real’s history.

Second, through the international offering of EUR 350 million senior notes due 2017, we became the first Mexican nonbank financial institution to issue euro nominated debt, and the only high-yield Latin American company to perform this type of issuances in the last 5 years. This transaction was particularly significant as it enabled us not only to bring forward our branding strategy, but also to strengthen our Investor Day as we were able to attract blue-chip into institutional investors lured by our differentiated value proposal and our financial inclusion.

Lastly, we held our first ever Investor Day in New York City where I and other senior officers had the pleasure to meet them and speak with our share and stakeholders. In this space, we were also able to gather very valuable feedback to better align our core strategies and overall business plan to our shareholders’ interest going forward.

Turning to the business segment development. In Mexico, our operations showed wider stability in terms of loan origination across all credit portfolio despite a lower economic activity, which certainly led us to adopt a conservative approach to guarantee the asset quality preservation. In the case of payroll, origination normalization expanded as this quarter contraction was around 1% after reaching double-digit write rate of decline in the previous quarters as we started to regain traction in the additional clients with solid credit profiles in our target markets. On the other hand, origination growth rate in the SME segment kept its strong pace, increasing 1.5x year-over-year this quarter at the back of the success achieved by our comprehensive offering. Consequently, we feel confident to capitalize on the vast underserved base of potential customers.

In this regard, we have recently arranged a great facility with the IDB invest for $50 million, seeking to estimate incremental credits for the entrepreneur agreement of Mexico. Likewise, it is relevant to underscore the increasing participation of SMEs in our consolidated loan portfolio since the introduction of the pure leasing product in 2018. Put that in perspective, SME’s loan portfolio accounted for only 10% of the consolidated loan portfolio as 4Q ’18 compared approximately 16% as of year-end 2019.

On the Used Cars business in Mexico, origination momentum continues, fueled by the Medsurg or preowned cars. Wrapping up, our loan portfolio in Mexico still above the MXN 37 billion mark, 27% more than that of the same period last year. Meanwhile, its nonperforming loan ratio stood at 1%, its lowest mark in 5 years posting sequential and annual improvements of 30 and 10 basis points, respectively. As we continue to seeding in the implementation of a smart origination standards.

Moving to our international businesses. The turnaround started in United States last year, continues to grow positive results at Credito Real USA reported a solid quarter with a loan origination growth of 1.7x, delinquency improving to 0.9% from 1.1% as of year-end 2018 alongside a positive generation of cash.

This performance was driven by the efforts oriented to stimulate cross-selling and consolidate the commercial structure of higher penetration among the Hispanic population. On Central America, we continue seeing a further recovery in line with a more stable environment, but loan origination dynamics regain — remained positive. In this segment, we posted a double-digit growth rate and a nonperforming loan ratio improvement, which allowed us to obtain a quarterly net income of approximately MXN 110 million.

Now I would like to take a moment to walk you through some revenue achievements that positively impacted the balance sheet. As I mentioned earlier, we signed a $50 million tranche loan with the IDB Invest, our third cheapest source of funding, allowing us to improve our debt mix. In this end, it is important to underscore our team interest to increase the participation of this type of financing going forward, as we stick to tap into the attractive conditions offered by development banks. Additionally, we successfully completed the issuances — the issuance of MXN 750 million, local notes under our portfolio securitization program. The aforementioned, coupled with the record collection registered in December contributed to bolstering liquidity, as shown by our cash balance for the year-end, surpassing the MXN 1 billion mark.

Likewise, seeking to channel all possible resources to other businesses that best beat our profitability standards, we’ve reduced our stake in Resuelve. It is important to clarify that this action will not take any toll to our consolidated resources and will allow us to maximize the use of resources for our strategic assets. All in all, we head into 2020 on a solid footing as the foundation we have laid out in the last decade has resulted in a resilient and flexible platform capable of base topper and efficiently from these challenges and confident to reach positive results driving on our compact for efficiency structure and our solid financial position, which will allow us to cash in the favorable environment of interest rates that follows the recent cycle, we started by Central Bank in North America. In this context, for our 2020 guidance, we set a 15% to 20% growth target for our consolidated loan portfolio and a double-digit net income growth.

On a final note, I would like to express my gratitude to our customers, partners, associates and shareholders who helped us achieve another successful year in our crusade to provide accessible credit products for the underserved segment of the population.

Moving to discuss our financials in greater detail. During the fourth quarter of 2019, interest income totaled MXN 3.3 billion that’s over 20% more than that of the same period last year as a result of the fall of the strong growth registered in the consolidated loan portfolio. For the full year 2019, interest income increased 17%, reaching MXN 11.9 billion. Interest expense recorded MXN 1.3 billion, an annual increase of MXN 619 million, roughly 89%, mainly derived from the company’s larger net debt. For the year 2019, interest expense amounted MXN 4.7 billion, up nearly 50% on a year-over-year basis. Consequently, financial margin was about MXN 2 billion for the fourth quarter, down 3% or MXN 61 million when compared to that of the last year. This regulation is explained by a nonrecurring effect associated to the liability management exercise that we performed in the quarter, higher debt costs and changes in the product mix from the addition of the above-average quality assets. 2019 financial margin totaled MXN 7.3 billion, an increase of 2.6% when compared to year 2018.

Net provisions for loan losses, including the recovery of charge-off accounts, as requested by the CNBV, was MXN 350 million, decreasing MXN 32 million or 8.3% on an annual basis, reflecting an overall improvement in delinquency levels. The annual fee were for this P&L item obtained about MXN 1.3 billion, contracting 15.2% against 2018. The coverage ratio stood close to 220 compared to 178.8% and 173% in the previous quarter of the same period in the last couple of years reflecting the ongoing improvement of the asset quality.

Administrative and promotional expenses summed up MXN 972 million, increasing MXN 193 million or 28 — 24.8% against the million recorded in the same period last year, explained by portfolio growth related expenses and debt issuances costs. 2019, the administrative and promotional expenses rose 3.6% totaling MXN 3.6 billion. It is important to mention that during the quarter, a nonrecurring expense for MXN 143 million was recorded following the premium price for the senior notes 2023 tender offer as a result of the liability management of the euro-denominated senior notes.

Consequently, net income amounted to MXN 427 million. Excluding these nonrecurring effects, comparable net income rose to MXN 570 million. Return on average equity stood at 12.3% in 2019. While excluding the perpetual notes premium, this metric stood at 16.6%. On the other hand, return on average assets was 3.6%. Capitalization ratio contracted by 970 basis points on a year-over-year basis is standing at 34.2% in 2019. The average cost of funds remained flat on a sequential basis at 13.3% as a result of lower borrowing costs associated to the credit facilities arranged over the past month, and recent reference rate cost having in a normalized basis, right below the 12.5% mark. For the year 2020, we anticipate our stable funding cost and foreseeing arising opportunities for more competitive reference rates.

Turning to the loan portfolio performance. Consolidated loan portfolio totaled MXN 46.9 billion as of quarter-end on an annual growth of 29.3%, fueled by an overall positive performance of our businesses segment, outstanding SME and in the United States businesses. Consolidated small and medium-sized enterprises portfolio reached MXN 7.4 billion, increasing 103% year-over-year driven by a strong demand for our credit solution, especially leasing.

And as I just mentioned earlier, the participation of this segment in the consolidated portfolio has solidly increased, improving our product mix. Payroll portfolio amounted to MXN 28.2 billion, up 13.8% when compared to the MXN 24.8 billion recorded in 2018. Here, it is important to mention that our growth trend has started to surge during the fourth quarter and possibly gain further traction in the periods to come.

As for the Used Cars car business in Mexico, this amounted to MXN 1.4 billion of 52.7% versus year-over-year, the growth in consignment with a growing demand. In the United States loan, our portfolio reached MXN 4.1 billion, a 101% year-over-year growth, slightly contributing to our consolidated portfolio expansion and financial margin growth. In that regard, we have brands to expect resilient dynamics in this segment towards 2020 of the prospects of economic activity seems stable. Driving from a controlled inflation, lower interest rates and lesser uncertainty, given the USMCA approval by both the presidents of congress of both countries, United States and Mexico.

Meanwhile, Instacredit loan portfolio reached MXN 4.9 billion, a year-over-year growth of 10.2%, mainly derived from the ongoing implementation of initiatives aimed at consolidating wider resiliency and efficiency, coupled with a more stable environment. At the light of these developments, it is important to state that we are heavily carrying origination standards as we seek to preserve our asset quality and financial resources. Therefore, the consolidated nonperforming loan ratio declined to 1.3% from that of 1.7% in the fourth quarter of 2018.

Now turning to the balance sheet. As of December 31, 2019, total assets increased 24.3% or $12 billion when compared to that of the same period of 2018 to reach MXN 61.6 billion driven by the achieved growth in the consolidated loan portfolio and a wider base of funding services. Outstanding debt totaled MXN 41.5 billion of 35.5% or MXN 10.9 billion when compared to last year’s, primarily attributed to the placement of the senior notes due 2027, the issuance of local notes and the arrangements of different bank loans, including the IDB Invest credit line.

Here, it is important to mention that given our success in international debt placement, solid growth origination standard and a record high collection in December, our cash levels surpassed for the MXN 1 billion mark, bringing forth a strong financial position to start the year 2020. Last, but definitely not least, out of year and the stockholders’ equity totaled MXN 16 billion, an annual increase of almost 1% to MXN 120 million, following the already discussed factors and the cancellation of the stocks that we just mentioned earlier. With this, I conclude my remarks, and now let me turn back the call to the operator to open the line for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ernesto Gabilondo with Bank of America.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [2]

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Carlos, I have a couple of questions. On the first one, with respect now that earnings should be meaningfully improving in 2020, as you mentioned, you have improved your loan mix, we should start to see funding costs declining. And probably you should maintain OpEx and asset quality under control. So can you elaborate on your expectations for NIM, cost of risk and OpEx growth in 2020? And then for my second question, you have seen — you have been reducing your participation in Resuelve. So how should we think about growth in net lease going forward?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [3]

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Thank you for participating in the conference. When it comes to the net income, to tell you the truth, we are optimistic. I mean, on the one hand, I mean, our view in terms of cost of funds is that the work has passed, and that happened in 2019. And in that same time our view for the remaining of the year is that if the cost of funds at the end of the year remain in a range of 12.3% to 12.5%, which seems something very attainable. That should be helping us in terms of the NIM to start trending upwards from the 17% to something closer to the 18%. So as long as the NIM in general terms trends above the 18% mark I would say that in terms of net income, we resale this (inaudible) passing whatever we did during this year. But if you think about the net income this year and year in a row, excluding the nonrecurring items, this was an extraordinarily good quarter. So we would expect in general terms to attain at least double-digit growth for the remaining of the year. Something definitely above the double-digit growth. That’s our view in terms of the net income. I don’t know if that answers your question.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [4]

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No, yes. And just in terms of OpEx and asset quality for getting this at least double-digit growth?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [5]

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Yes. I mean, if you look at — one of the good things and a lot of people asked us that when — about the way we are growing the SME portfolio. However, one of the very good things about that one not only comes from the growing part, but also in terms of the asset quality, especially because if you think about our business model, which relies heavily in cross-selling and on recurring customers and with higher average ticket size, that helps us a lot in terms of the cost of risk so our view in terms of the SMEs business is that we are not compromising profitability due to product mix because of much lower cost of risk. That’s definitely our view. We don’t expect, on the other hand, we do not expect changes in the asset quality. I mean, if the NPLs remain something around the 1.5% range, we definitely will be satisfied at the end of the year. But that’s definitely what we are doing. On the other hand, one of the things that we are trying to do for this year is that if you think that out of the total liabilities of the company, only 5% or not even 5% come from development agencies. What we intend to do is to increase this portion of the of funding to at least with the 10%, and that should definitely have a positive effect on that on the cost of funds overall.

Having said that, I mean, similar to the IDB line, I mean, what we intend to do is decrease the line with that mapping, which has already been approved. And moving forward in that regard. And that the combination of these new facilities would definitely help us to improve profitability for the SMEs business overall.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [6]

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Okay. So just wondering, so what you mentioned that you will be growing SME, but we put asset qualities. So overall, we should expect, as you mentioned, NPLs remain stable, and it will be strikes for the cost of risk?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [7]

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Yes. I mean, right now, if you look at where the cost of risk stands I mean, at 3.5%, I mean, at — yes, sorry, I have a year-over-year, at 3% range, whereas for the year was a 2.8% mark, that’s a very healthy cost of risk I mean, our target will be how we target this day is focusing heavily in collection focusing heavily in terms of asset quality, and I think that the cost of risk should be stable, should remain stable within this range. I mean, we feel comfortable with those figures, and we believe that, that’s something that’s sustainable.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [8]

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Okay. Perfect. And then just my second question?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [9]

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Yes, when it comes to Resuelve, I mean, basically, what we are doing, I mean, and that’s something that we — that I — that both Angel and I have talked to many of you in the past months. I mean, what the company intends to do this to invest and see it was our last million. And by saying that, is that we are focusing on protecting the NIM overall and only in the most relevant and most productive assets that we have. So concurrent — consistent with that, basically, the — consistent with that which was the initiative to sell a small portion of the Resuelve participation of the and as for what we would expect, I mean, given that we are not going to be consolidating anymore of that one. In terms of the line of commissions and fees collected, which was mainly Resuelve that — well, for the next year, it’s not going to be as relevant. It used to be something around 100 million mark, so MXN 100 million per quarter that’s what happened in the past. And probably, it should remain something in more — something, I don’t know, MXN 400 million, probably less for the full year. But in any case, we will be compensating that income in the other line.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [10]

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Can you repeat again how much?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [11]

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MXN 100 million, that was roughly, I mean, what we use to — what we used in the commissions and fees collected line on the third quarter was roughly MXN 100 million per quarter.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [12]

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And now?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [13]

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Given that we are not going to be consolidating Resuelve. You won’t be seeing that figure again.

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [14]

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But you guided something around MXN 30 million per quarter.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [15]

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Excuse me?

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Ernesto María Gabilondo Márquez, BofA Merrill Lynch, Research Division – Associate [16]

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Should we expect uptick?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [17]

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Yes, it’s probably going to be something around, I don’t know if it’s going to be something around the MXN 20 million or MXN 30 million net range. It’s not material. I mean, because I want to emphasize at this point that we do not rely on commissions or we do not charge commissions and things like that, in most of the products over here in Mexico, whereas in other places, I mean, we might be charging something as (inaudible). So that’s probably the only thing that you will be seeing. Something around, I don’t know, probably MXN 20 million, MXN 30 million per quarter.

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Operator [18]

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Our next question comes from Carlos Rivera with Barclays.

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [19]

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My first question is regarding the loan growth for this year, you shared your expectation of between 15% to 20%. So if you could give us a little bit more color here in terms of growth by segment, particularly the SME portion has been growing pretty fast. And I remember from the Credito Real Day in New York that you mentioned a target of about between 15% to 20% of your portfolio there. I think you’re already there, 16% in Mexico, 4% in the U.S. So what are you thinking for each segment? And what are the implications for the funding needs of 2020, in particular, if you are thinking about any bond issuance in addition to increasing the lines from the development banks that you mentioned? That will be my first question and I’ll ask the second one after.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [20]

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Carlos, when it comes to the SMEs, yes, I mean, what we like a lot about the SMEs is the asset quality. The improvement that we get on the cost of risk, on the consolidated cost of risk even the much larger average ticket size that we have on that business. So like that, by increasing the participation of the SMEs to somehow put some pressure on the yield. On the other hand, releases a lot on the (inaudible) in terms of the cost of risk. So that’s what we like. However, I mean, what we see and consistent to what we said over there in the Credito Real Day while we were in New York. Yes, it should remain something around the 15%, probably to the 20%. But that’s going to depend also in terms of the funding that we might get on the developing nature of this.

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [21]

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I’m sorry, I’m listening a lot of noise in the line operator.

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Operator [22]

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Yes, sir, that’s coming from Mr. Rivera’s background.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [23]

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Okay. The going back to the question is, if at some point, we increase the funding from development agencies, that should help us in terms of growing the SME portfolio and also to improve the profitability for those products. So that would be the only case in which the SME business should grow above the 20% mark. But as I stated at the beginning, we don’t see that happening. It’s probably going to remain within this range of the 16%, 15% to 17%, overall.

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [24]

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Okay. And in terms of the implications for funding for 2020? Any color there?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [25]

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Yes. I mean, what we intend to do is that we intend to tap the Swiss market next year — next week, and if we are successful in that one, probably we won’t be needing any money for the first half of the year. And as for the second half, it’s going to be — it’s going to depend on market conditions, definitely, and it’s going to depend on whether we expect to do something on the liability management front. But at this point, we are focusing our efforts on the — we are focusing our efforts on tapping the Swiss market next week.

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [26]

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Okay. Great. And my second question is going to be on the, again, also in the SME portfolio, in particular, that you mentioned the low cost of risk there. If you could share with us your cost of risk for SMEs. I’m just making sure, I mean, the NPL ratio there is pretty low, 0.5%. It’s even very low compared to 2 other peers that are focused on SME leasing. So I just want to make sure that this low ratio is true to this level, and it is not distorted by any other effect, like the strong growth of the denominator on that ratio or make sure that on the accounting side that if our credit becomes overdue, if you are registering the full outstanding balance of our client that becomes overdue as NPL? Or if it’s only a portion that is overdue? So just making sure that the asset quality is not distorted by any other factor.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [27]

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Yes. Yes, it makes sense. Your question, it makes sense a lot. I mean, first, I mean, you have to think about our business model. We started the business in the SME front, I mean, that was 5 years ago. And basically, the business model consisted in — we relied on a relatively customer base and it continues to be the case. I mean, if you look at the line of the number of customers that we have on the SME are not even 1,000 of them. So basically, we have a very reliable — we have a very recurring customer base. It’s about 75% of our customers are recurring.

So what we’ve started to do in the last year — in the last couple of years with the leasing product is adding new products, in order to increase the cross-selling opportunities to the same customer base. I mean we saw a very attractive opportunity in the leasing business to do some cross-selling and something similar to that is with the factoring business. So that’s basically what we’ve been doing. And also, when it comes to new customers, it’s also important to mention that the approval rates are very low. The approval rate in that business here on the Mexico’s front is something around 25% to 30%, not even 30%. And basically, what that translates into is that we are cherry-picking customers. So we do not see changes in terms of the asset quality.

And when it comes to the NPL definition that we use not only for this product, but for all the products, is consistent all across the board and is consistent with the CNBV, with the Mexican regulator, meaning that if the NPL definition that we use all across the board is 90 to 180 days, and we charge it off at 188 — 180 per day, and it amounts for the full loan. So basically, that’s how it works. And when it comes to the provisioning, well, the provisioning is based on expected losses. The provisioning are based on expected losses completed with the CNBV requirements.

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [28]

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Okay. And what is about the run rate for that provisioning for that portfolio?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [29]

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What is — excuse me?

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Carlos Rivera Zermeno, Barclays Bank PLC, Research Division – Research Analyst [30]

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So what is the level of loan loss provisions as a percentage of loans that is going on the SME portfolio?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [31]

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I can give you the figure, give me a sec. I can give you the figure for that one. You have on the earnings release, and that amounts for 80 — close to MXN 85 million as of the end of the quarter. And for the full year, amounts for MXN 130 million, about MXN 130 million for the full year.

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Operator [32]

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Out next question comes from Nicolas Riva with Bank of America.

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Nicolas Alejandro Riva, BofA Merrill Lynch, Research Division – Research Analyst [33]

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Just one question, which is a bit of a follow-up on the prior question on liability management. If I look at the — specifically looking at some of your bonds, if I look at the 2023s, you’re trading basically to call in July of this year. You mentioned you’re going to be looking to tap the Swiss market next week, and with debt already done in terms of new issuance for the first half of this year. For the ’26s, we have seen a lot of other nonfinancials doing tender offer on some of these bonds and they are issuing new longer-dated bonds. Does it make sense to think of you, call, in the 25th in July and potentially doing a tender offer on the ’26s?

And then on the perps, I would put it — I would assume that, that one is only going to be calling 2022 given that it counts as equity for accounting purposes and also partially as equity for the rating agency. But what are your thoughts in terms of these bonds in terms of liability management?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [34]

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Look, I mean, we are limited — and when it comes to the liability management, if we think that for this year, we will be focusing a lot in terms of our profitability, when you have a bond trading at 1.17 such as the 2026. Well, thinking about liability management, for that one, it sounds kind of expensive, right? So in that sense, we might be thinking to do something about the 2023s or something, but that’s not sure at this point. Basically, the view that we have when it comes to tapping the market, either of the market, it’s more in terms of refinancing rather in terms of issuing. So basically, what I’m trying to say is that we feel comfortable.

If you look at the form that our debt profile is taking these days is we feel comfortable by having 400 million outstanding facilities and not large — or not much larger than that, because we are thinking that it’s a much more cautious approach to compare to what we did in the past. For example, $625 million of the 2023, that sounds complicated for refinancing these days. So basically, that’s going to be our view. But for these years, whatever we intend to do in terms of the liability management is going to be limited for the — on the effect that, that has on the P&L, basically.

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Nicolas Alejandro Riva, BofA Merrill Lynch, Research Division – Research Analyst [35]

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Okay. So it’s fair to say that the ’23s would be the priority for liability management this year?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [36]

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Yes. Most likely, most likely. However, well — I mean, we already did the liability management of those a couple of months ago. So yes. In any case, I think that if something like that happens, that’s going to be on the second half of this year, assuming that market conditions should prevail at the time.

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Operator [37]

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Our next question comes from Natalia Zamora with GBM.

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Natalia Zamora Madrazo, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division – Equity Research Analyst [38]

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I have 2 quick questions. How do you see the portfolio’s breakdown going forward? With SMEs being relevant within the consolidated portfolio, what do you expect the breakdown to look like in the coming years? And for my second question, at the beginning of the call, you mentioned the cancellation of shares. Now that you’ve canceled that many shares, do you expect to remain as active in terms of buybacks?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [39]

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Yes. Well, when it comes to the breakdown of the consolidated portfolio, probably the most — we have 2 elements. I mean on the one hand, this would be the SMEs, because of the pressure that, that puts on the NIM. But as I was telling you, there are a number of factors that I already mentioned that could improve the NIM for the SMEs product could lead to increase the size of that one to probably maximum of 17% or probably something within that range. That’s the view. Probably the most interesting parts are going to be on the other front. Like for example, Central America, Instacredit was — Instacredit have an extraordinary year. It was an excellent year, especially when compared to the previous one for the 2018. And what we intend to do is to continue that same — we have to continue the trend for this year. So if at some point, the Instacredit business gained weight to become something around 12%, that’s going to help us a lot in terms of profitability. And that’s our view and also to compensate whatever pressure we put on the NIM. So the intention should be to growing healthily on the integrated business to improve the NIM in the SMEs front.

And when it comes to the States, it’s also very important to mention, I mean, that we finally are making money in this States. And it looks — and it looks very promising. The businesses over there. The SMEs should continue to grow. I mean, we have a really nice business model over there, targeting Latino-owned business, and we are confident that, at least not for this year, but at least for the next couple of years, we will attain our target of the U.S. becoming something around the 30% of the consolidated portfolio. Interestingly, as well, it’s going to be the favorable portfolio that my view is that it should remain something around 60%. So basically, that’s going to be how it works. You have other lines of business, such as the used cars, but you cannot be very aggressive for growing the used car business here in Mexico. And it’s something similar to what we do in the States. So overall, that would be kind of what we expect for the business, at least, in the next couple of years.

And overall, I think that if you look at the growth trend, the consolidated growth trends that we’ve been having over the past 3 years, we are definitely growing 20%. Growing 20% this year is that — is something doable. And that’s our target for this year.

And now when it comes to the other one, I mean, if you think at what we intend to do in terms of the buyback and things like that. I mean, it’s basically stating how confident we are on the future of the company. That’s at the core of the buyback program of the company. If you look at the figures that we — especially, if you look at the resources involved to the buyback hasn’t been that material. It has been more on the market-making form. But definitely, what we believe our view over here is that our stock is trading at a huge discount. And if there’s something we can make to enhance that valuation, especially through the buyback front, yes, we would continue to do it, but not without changing — without materially changing what we’ve done in the nearly — in the past couple of years.

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Operator [40]

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Our next question comes from Gilberto Garcia with Barclays.

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Gilberto Garcia, Barclays Bank PLC, Research Division – Assistant VP & Equity Research Analyst [41]

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You had very strong growth in SMEs during the quarter, a record origination for any segment. Can you tell what drove this performance? Was it that you are extending greater credit to existing customers? Or was there any particular new customers with high balances that drove this performance?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [42]

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It can be a mix of them. But in any case, I mean, it’s at the core are the cross-selling opportunities for the — for our customer base. That’s at the core of the SMEs business. Yes, at some point, we have rather large operations, not very large because if you think what limits the SMEs, it’s our cost of funds itself. I mean if you looked at for the past year, it was above the 13% mark. I mean, how much do you expect to charge when you have such a large cost of funds. So that definitely limits the type of operations that we have — that we serve on the SMEs front.

Probably, it’s worth mentioning, other than the cross-selling opportunities is the fact that we have no concentration whatsoever. The only concentration that we have by geographically and by geographically, I mean, most of our customers, there are Mexico City or the surroundings or — and a couple of cities outside. So we have no concentrations in terms of industries. We have no also concentration — we have no exposure to federal agencies or government or so on and so forth. So that’s basically the — our business.

And also — it’s also important to mention the fact that we acknowledge, as I already mentioned, that the SMEs business is going to remain something around the 15% to 20% at most. So basically, we are acknowledging that this is not going to become our core business. So by saying that, and I want to be emphatic about this one is, because we are not constrained to continue to grow in that business. And it’s just basically who is growing in the — with the right a risk premium approach, and that’s basically what we’ve been doing for the SMEs business. Did I answer your question?

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Operator [43]

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Our next question comes from Natalia Corfield with JPMorgan.

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Natalia Corfield De Melo Monteiro, JP Morgan Chase & Co, Research Division – Head of Latin America Corporate Research [44]

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Carlos, my question is with regards to capitalization. I’ve seen that you’ve been very excited about the growth in the SME portfolio, and you’ve been growing quite a lot. This year was 29%. Next year, it seems that there’s going to be a little bit of a deceleration of 15% to 20%. But I’ve been looking like your capitalization has been declined now for a number of quarters. So I’m wondering what are you thinking about that. And does rating agencies have spoken to you about this? What are your main thoughts?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [45]

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Natalia, well, first, if you look at the breakdown of the equity, what happened this quarter was the most visible thing about the capitalization for this quarter comes from the hit that we took from the valuation of cash flow hedges. If you look at that figure, that amounts for 700 — MXN 708 million, and that’s what put some pressure on the capitalization, at least for this quarter. If you ask me, I mean, clearly, this is associated to a strong peso that we are seeing. And especially when you see that most of the derivatives, I mean, that we have a very conservative approach to the — in regard to the hedging, and the effect of that conservative approach that we have on the hedging is the pressure of the capitalization of the equity.

So what I’m saying is that if at some point, I mean, I don’t know what your view on the FX for the end of the year. But we believe that for the end of the year, the FX should be above MXN 20 per dollar. That should release a lot of the pressure that we are seeing on the capitalization. So basically, what we’re — what I’m saying is that the pressure that we are seeing over the capitalization is mostly attributed not only to the growing in the — in high intense — in high capital — in high intensive in terms of capital products, such as the SMEs, but it also comes from the FX front that definitely, there’s not much that we can do on that end, right?

So what we would expect, I mean, something that we’ve been in very close touch with the rating agencies clearly, because we acknowledge that our rating is a key differentiator. So in that regard, we are closely looking at the capitalization and closely looking at how to improve the capitalization. And basically, the views that we have of protecting the NIM overall comes also on that end, because the NIM reflects our capacity to generate the equity. So that’s what I can tell you that mostly, I mean, we were hurt this — for this quarter. We were hurt by the strong peso here in Mexico.

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Operator [46]

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Our next question comes from Nik Dimitrov with Morgan Stanley Investment.

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Nikolai Krassimirov Dimitrov, Morgan Stanley, Research Division – Research Analyst [47]

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Most of my questions have already been answered. But if you don’t mind, can you kind of compare and contrast your SME business in Mexico versus the one in the U.S.? You mentioned in Mexico, you do a lot of leasing, then there’s some factor in low approval rates, kind of low cost of risk. How has this relate to your U.S. business?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [48]

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I would say that the biggest difference between the two of them are the average ticket size. That’s definitely for starters. I mean if you think about our customers, our customer base over there in the States are mostly 93% of the customers are Mexican Hispanics, I mean, the average ticket size is way, way lower. So the way to approach them, I mean, a typical customer over there could be someone in the food truck industry or something like that. In the case of the States, we’re over here, what we are doing is that, first of all, you have to think that the SMEs are largely underserved here in Mexico. And for these customers, if you think in terms of average ticket size, I mean, for example, right now, with the leasing products involved, they are in the $500,000 range. If you think about someone trying to borrow that amount of money over here, it has to rely on their own personal resources, whereas in the States, it’s different.

So basically, that would be the main difference between the two businesses is, that we are targeting different segments of the populations. Over there, Hispanics for the Latino-owned business, whereas over here are the stable business that pay taxes and that have been in the business for a number of years, and that’s basically what we do.

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Nikolai Krassimirov Dimitrov, Morgan Stanley, Research Division – Research Analyst [49]

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So it’s fair to assume then that most of the SME lending that you’re doing in the U.S. is driven by leasing, right, similar to Mexico?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [50]

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In the U.S.?

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Nikolai Krassimirov Dimitrov, Morgan Stanley, Research Division – Research Analyst [51]

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Yes.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [52]

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Mexico? No, not only that, but the thing about the — I mean, if you think about the 3 products that we grew from the SMEs portfolio over here in Mexico, you have leasing with duration on the average, something around 48 to 50 months whereas on the other 2 cases of the credit, the credit products here in Mexico multiple working capital needs. So in terms of duration, those are probably 6 to 12 months. And that’s something similar to what we have in the case of the factoring. I mean, in the case of the factoring is much smaller. It’s something around 3 months or something like that. So basically, yes, when you think about the average, the outstanding balance in the SMEs business, largely the SME, it gives the leasing. However, in terms of our origination, it’s not probably the case. I mean given the difference, I think that leasing — given the different situations in the 3 products.

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Nikolai Krassimirov Dimitrov, Morgan Stanley, Research Division – Research Analyst [53]

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Understood. And just one last question on funding. For a while, you were saying that you have converted your funding to primarily all fixed, right, because of the rising interest rate environment. Rates are coming down in Mexico. I think now it’s 60% fixed, 40% floating. How do you want to manage that going forward?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [54]

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Look, I mean, the — to tell you the truth, if you think about, for example, the last transaction when we printed the euro deal, we printed that one, and we fixed that one — we fixed those at 11.33 if I recall correctly. So basically, that’s for us, 7 year — for a 7-year duration or something like that. So basically, the interest rates, what I’m saying — what I’m trying to say is that the interest rate cost were already priced in at 11.33. So that was the assumption that we made at the time to fix that.

Clearly, fixing the rate has another advantage. It reduces volatility, both on the equity front as well as on the — it reduces volatility, both on the equity front as well as on the P&L. So that’s another advantage. If you look at the, for example, the MXN 708 million that I mentioned earlier, yes, a lot of that amounts for the unfixed part of the — of our liabilities. So it could be a mix of that. It’s going to be — it could be a mix, but in any case, we will be — we will continue to focus on the most efficient cost of funds. And without FX risks. That’s basically the rationale behind our decision.

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Operator [55]

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(Operator Instructions) Our next question comes from Gilberto Garcia with Barclays.

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Gilberto Garcia, Barclays Bank PLC, Research Division – Assistant VP & Equity Research Analyst [56]

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Apologies for I got disconnected. I had a follow-up question on guidance. Since you had a number of extraordinary items in the quarter and throughout the year, when you talk about double-digit net income growth, are you referring to the reported net income growth or to the adjusted figure?

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [57]

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To the reported net income.

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Operator [58]

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With no questions in the queue, question-and-answer session concludes. I’d like to turn it over to the speakers for closing comments.

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Carlos Enrique Ochoa Valdés, Crédito Real, S.A.B. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada – Deputy Director General & CFO [59]

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Well, thank you, everyone.

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Operator [60]

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Ladies and gentlemen, thank you all for being in today’s conference call. You may now disconnect, and thank you for joining us this morning.