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Edited Transcript of SAB.MC earnings conference call or presentation 26-Apr-19 7:00am GMT

Q1 2019 Banco de Sabadell SA Earnings Call

Barcelona May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Banco de Sabadell SA earnings conference call or presentation Friday, April 26, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Cecilia Romero

Banco de Sabadell, S.A. - Head of IR

* Jaime Guardiola Romojaro

Banco de Sabadell, S.A. - CEO, MD & Executive Director

* Tomás Varela Muiña

Banco de Sabadell, S.A. - General Manager & CFO

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Conference Call Participants

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* Alvaro Serrano Saenz de Tejada

Morgan Stanley, Research Division - Lead Analyst

* Andrea Filtri

Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst

* Britta Schmidt

Autonomous Research LLP - Former Partner, Spanish and German Banks

* Carlos Peixoto

Banco Português de Investimento, S.A., Research Division - Analyst

* Daragh Joseph Quinn

Keefe, Bruyette & Woods Limited, Research Division - Analyst

* Francisco Riquel

Alantra Equities Sociedad de Valores, S.A., Research Division - Head of Research

* Ignacio Ulargui

* José Maria Abad Hernandez

Goldman Sachs Group Inc., Research Division - Executive Director

* Mario Ropero

* Stefan Rosenov Nedialkov

Citigroup Inc, Research Division - Director

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Presentation

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [1]

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Good morning, everyone, and thank you for joining our audio webcast today. My name is Cecilia Romero, I'm Head of Investor Relations. And today I'm here with our management team, who will be presenting our first quarter results. Our presentation this time will follow a slightly different structure to previous quarters. Our CEO, Jaime Guardiola, will start by going through the key highlights of the quarter. I will then provide details on our commercial activity. Our CFO, Tomas Varela, will then discuss financial results, capital, liquidity and asset quality, before our CEO comes back to conclude with some closing remarks. We plan to spend a maximum of 30 minutes on the presentation and then we will give you the opportunity to ask questions. You should have already received details on how to participate in our live, this time it's live, Q&A session. And now I will hand it off to Mr. Guardiola to kick off our presentation. Good morning, Mr. Guardiola.

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [2]

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Good morning. Thank you, Cecilia. Good morning, everyone. Let me begin by highlighting that we are starting the year with a strong set of results. We have improved our profitability and we remain focused on increasing shareholders' return. We recorded a net profit of EUR 258 million this quarter and a 2% increase in our tangible book value per share, which sets us on the right track to achieve an increase of more than 5% in our tangible book value per share in 2019. Return on equity in the quarter was 7.2%, while return on tangible equity was 8.9%, both of which are higher than one year ago. Now let me share a quick recap on our year-end guidance.

On this page, you can see that we are expecting to generate 50 basis points of organic capital in the year. This guidance currently assumes a cash dividend payout of 50% of recurrent profit; at the same time, we expect to increase tangible book value per share by more than 5% in the year as I've said a moment ago. The results will be achieved by increasing Group net interest income by between 1% to 2% and obtaining an increase in fees in the high-single digit. Trading is expected to contribute between EUR 80 million to EUR 100 million to our 2019 results. Cost/Income will end the year at a maximum of 55%, which includes efficiency initiatives that maybe carried out at TSB this year. We anticipate that the cost of risk will fall to 45 basis points. And we expect TSB to have a neutral contribution, excluding items such as potential fines or insurance recoveries, but including cost for efficiency gains. However, after Debbie Crosbie joins 1st of May, she will work on updating that the TSB plan and the guidance will be updated after this is finished.

All of this implies that we should finish the year with a return on equity close to 7% and a core equity Tier 1 fully loaded at or above 11.6%. With regard to the summary of our performance in the quarter, we saw positive volume growth momentum at the Group level with both gross and performing loans increasing year-on-year. Core banking revenue continued to rise steadily supported not only by a good performance in volumes, but also by a solid delivery on fees, which were up nearly 9% year-on-year. We have also continued with our efforts to digitalize and transform our business model to make it more efficient.

At the end of the quarter, our cost/income ratio stood at 52.1%, which was significantly lower year-on-year. Our risk profile continues to improve with our key asset quality ratios down further this quarter. The non-performing loans ratio stood at 4.1% and because of which continued its downward trend to 51 basis points. Liquidity remained strong with liquidity coverage ratio at 163% and loan-to-deposit of 101%. In terms of capital, our position was stable in the quarter. Our fully loaded CET1 came to 11% after factoring in the 48 basis points impact of IFRS 16 and TRIM, which were accounted for this quarter. And finally, our fully loaded CET1 was pro forma 11.3%, if we include the impact of the disposals of institutional NPAs, which was a agreed as announced last year and the disposal of Solvia Desarrollos Inmobiliarios, which closed earlier this week. Moving on to business performance, in regard to performing loans by region, you can see that this quarter's growth was mostly driven by the strong performance of Spain, which includes foreign offices and of Mexico. Volumes in Spain grew by 0.2%, 4.5% in the year; while in Mexico, they were up 1.2% quarter-on-quarter and 28% year-on-year’s volumes remained stable in the quarter and fell 3.4% year-on-year as a result of the slowdown of commercial activity before and after the IT migration. Overall, Group performing loans increased slightly in the quarter and were up by 2.8% in the year. The following slide shows a summary of the different figures related to the commercial activity ex TSB.

On left hand side, you can see the breakdown of performing loans by customer segment. Overall, performing loans were up by 0.4% in the quarter and 5.3% in the year. As you can see in this graph, SMEs and other lending to individuals were the main drivers of credit growth in the quarter, more than offsetting the deleveraging in other segments. On the right hand side in customer funds, we registered a 0.5% increase in the quarter, representing an increase of more than 3% in the year. The growth in our balance sheet funds was driven by sight accounts, which increased by 11.7% in the year, demonstrating the strength of our banking franchise. Our balance sheet funds decreased in both the quarter and the year, impacted by the decline in mutual funds performance, which in the quarter was partially offset by positive dynamics in pension and insurance. In Spain, commercial momentum across products remained strong in the quarter. Compared to the first quarter of 2018, we can see a slowdown in new lending to individuals, basically mortgages caused by regulatory uncertainty at the end of the year in relation to the allocation of mortgage costs. That aside, we continue to show significant growth in new lending to companies and we achieved double-digit growth rates in other significant areas such as credit cards and retailer payment service turnover. This positive performance was reflected once again in market share increases. We increased our market share in both customer loans and customer funds. In addition, we continue to improve our share year-on-year across other products and we also increased our market penetration in SMEs by 125 basis points.

A key factor in sustaining this positive commercial momentum in Spain is our continued focus on customers' experience and service quality. In this regard, we performed better than the industry average in terms of service quality and would retain our place at the top of NPAs ranking both in SMEs and large enterprises. In the UK, TSB core business show growth this quarter, showing a renewed commercial momentum for the bank post migration. On the asset side in terms of net loans, quarterly growth was driven by core mortgage volumes as the strong applications performance in Q4 impacted completions this quarter. Core mortgage growth was partially offset by the run-off of the banks' Whistletree portfolio and lower unsecured lending volumes. Year-on-year, performance, as I explained before suffered as commercial activity declined before and after our IT migration. On the liability side, current accounts increased by 2.4% in the quarter and 2.5% in the year, driven by higher balances. The reduction in saving deposits both quarterly and in the year reflects pricing decisions taken earlier -- early last year to manage deposits volumes given the TSB's strong liquidity position. On this slide, we can see several indicators that show how TSB has regained its commercial momentum. In regard to new mortgage lending, we performed better in the first quarter of 2019 than in any of the quarters of 2018. On the personal current account side, we continue to see a positive trend in switchings and current account openings. Bank NPAs well as mobile NPAs continue to improve. In this regard, it should be noted that the banks' NPAs have returned to positive figures in this quarter. And moreover, mobile NPAs is almost back to pre-migration levels.

And finally, I would like to highlight that all the complaints related to migrations have now been resolved. To finish this part of the presentation, a slide regarding the transformation where we can see how the performance of our key metrics was very positive. For example, the Group digital and mobile customers were up 7% and 14% respectively year-on-year. Digital sales of unsecured loans in Spain increased by 72% on a year-on-year basis. Meanwhile, digital sales in UK are still below pre-migration levels showing a decline of 11 percentage points. However, they have been steadily rising since migration. Lastly, I would also like to highlight that we have recently launched 2 new digital initiatives, Blink in Spain, digital franchise loans in the UK. Blink is a digital insurance platform that allows our customers to acquire insurance through online and mobile channels while the digital franchise loans initiative allows our TSB customers to contract and secure loans via digital channels. Well, I will now hand over to Tomas, who will discuss financial results, capital, liquidity and asset quality.

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [3]

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Thank you very much, Jaime, and good morning everyone. Regarding our quarterly results, our reported net profit in the quarter was EUR 258 million, representing a significant growth quarter-on-quarter. It is also important to note that This comparison has been impacted by the year-end payment to the Deposit Guarantee Fund and the deposit tax things that always are paid in December. Most importantly, results were flat year-on-year despite significantly lower trading results and this performance was possible thanks to the positive underlying performance of our core business in particular fees, lower operating costs and significantly lower impairments. NII operating expenses and amortizations were impacted by the implementation of IFRS 16 in this quarter. You can see the retail summarized in this page on the lower left hand side and overall the impact of this reclassification so to speak is neutral in the quarter.

Moving now on to the quarterly evolution of net interest income. Group NII decreased by 1.7% in the year and by 3.8% in the quarter. This was in the quarter negatively impacted by fewer calendar days that represented a negative of EUR 19 million. The cost of our Tier 1 -- sorry, Tier 2 transaction that corresponds to the issue that we did last December, which has impacted EUR 5 million, a lower contribution of the fixed income portfolio given its smaller size during in the quarter, that was a negative of EUR 5 million and the impact from IFRS 16, which impacted in EUR 4 million. We were already expecting this seasonality in Q1. And overall, we are on track to meet the Group guidance of growth between 1% and 2% in the year. This will be driven by a healthy volume growth and broader resilient deals, we've included to illustrate this further a chart in the right-hand side, at the lower right hand side of this slide, where we see that the average balance of lending of the loan portfolio in the first quarter stands at EUR 138 million, that is, of course, higher than all the 4 quarters of last year. We show also the path of growth leading to a level circa EUR 142 billion in the last quarter of this year. This expected path is supported by the growth that we've seen in the quarter already year-to-date. In terms of from book price in Spain, we have continued to defend yields across segments. We've grown more in segments with higher yields in the quarter such as SMEs and consumer loans and that is at the same time from book yields continue to be higher than [bad book] deals across most products. Overall, these are positive dynamics that have helped our yield ex TSB to increase quarter-on-quarter. Overall also, our customers spread was 3 basis points lower in the quarter, driven by an increase in yields at ex TSB level. This was offset by the higher cost of ForEx deposits, except in Spain, where they remain stable and by lower deals at TSB, which were brought down by increased competition and a greater weight of mortgages in TSB's business mix. We’ve included an additional detail in the slide showing the evolution of the deposits in Spain.

Of course, the increase that we see in evolution of ex TSB deposit is mainly driven by deposits in Mexico and in America in dollars and in Mexico what we're seeing is an increase and enhanced performance in deposit growth, which is set at a cost level that is improving the average cost of funding because it's replacing more expensive funding such as markets or wholesale funding in dollars and also the funding provided by (inaudible) in Mexico. The NIM of Mexico stands at 3.62% in the quarter and shows a positive trend. Additionally, net interest margin was also impacted by higher wholesale funding costs. We can see that pickup here in the quarter caused by the issuance of our Tier 2 back in in December, as I just mentioned, and increased liquidity in the quarter that, of course, in this situation, in this environment has an additional cost.

Group fees were lower in the quarter, impacted by seasonality and fewer calendar days. In the year, fees increased 8% and 8.8% in line with our year-end guidance. In terms of segment evolution, it is worth highlighting that services were also down in the quarter due to lower syndicated loan [FINS], which have a more volatile nature were especially higher last quarter, year-on-year service fees grew at 14.7% and we expect them to lead the order drive, the overall growth of fees in 2019. The decrease in asset management and credit and contingent risk was mostly due to the seasonality in the quarter, and TSB's fees also increased both quarter-on-quarter and year-on-year as we continue to rebuild commercial momentum. Group total costs both recurrent and nonrecurrent declined significantly in the quarter. The fall in recurring costs in the quarter was driven by lower general expenses, which here is worth noting that in this case was affected by some positive seasonality and lower year-end bonuses. As I explained earlier. the impact of IFRS 16 also has been positive for general expenses but negative for amortizations, although the overall impact on the cost was not material. The bottom line here is that we are on track to meet or beat the year an efficiency guidance of 55%, which already includes the cost of any TSB's efficiency initiatives to be taken in the year. Cost of risk continued its onward trend in the quarter and currently stands at 51 basis points. As you can see on the left hand side, provisions have decreased significantly since the announcement of the institutional non-performing asset sales in Q2, as we have started to accrue a good part of the savings.

Overall, provisions were down by 22.5% year-on-year and are expected to fall further during the rest of 2019 as credit conditions or the behavior of the portfolios will continue to improve. In this regard, it's worth noting what we show in the slide, in the quarter provisions were impacted by 2 items that will not occur during the rest of the year. The first one is a single name impact of EUR 8 million -- sorry, it's the other way around, it's an EUR 80 million effect due to seasonality on a specific portfolio decreased significantly in the other quarters and a single name impact of EUR 9 million that will be recovered probably in the second quarter. We've made significant progress and we can confirm that we are on track to achieve our 45 basis points year-end target with the visibility that we have today. Moving on now to the balance sheet section of our presentation. Starting with liquidity, the Group has a strong liquidity position, with an LCR of 163%, a loan-to-deposit ratio of 101% and a high quality liquid asset amount of circa EUR 43 billion. Another point to highlight is that Fitch has initiated its rating coverage of Sabadell this quarter. They had signed a long-term issuer before rating us BBB with a stable outlook, and in fact all that instruments are rated investment grade by Fitch, including our Tier 2. Furthermore, we currently have EUR 20.5 billion of TLTRO outstanding and around 80% of this, i.e., EUR 16 million is deposited back at the European Central Bank. In order to repay the outstanding amount, we are planning to use part of our excess cash as we can see in the right -- lower right hand side chart.

Also the cash received from the NPA portfolios and Solvia sales, the cash received as payment for the Deposit Guarantee Fund receivable related to the Asset Protection Scheme and also net debt issuance. So the inflows coming from the net debt issuance that we undertake in this year and the coming year. LCR will remain comfortably above requirements at 140% after the TLTRO II repayment. With regard to our funding plans, we received an MREL requirement based on our December 2016 balance sheet, which was 22.7% of RWAs and we are on track to meet the requirement before year-end. The funding plan that we have prepared in order to do this is outlined on the right hand side of the page, in terms of AT1 and Tier 2, the buckets are nearly completed. So we are expecting no new transactions in 2019. We will launch our inaugural senior non-preferred transaction in Q2. Overall, we expect to issue EUR 1.5 billion annually over the next 3 years of senior non-preferred. In terms of senior preferred debt, we have already issued EUR 1 billion in the domestic market year-to-date with an average cost of 0.6% and we plan to issue an additional EUR 1.5 billion in 2019 and a smaller amount in the following years. In terms of covered bonds and securitization, TSB has issued GBP 750 million year-to-date; overall, there will be additional issuance of EUR 1.5 billion combined sterling and euro in the rest of the year.

With regard to maturity, it's also important to highlight that EUR 1.8 billion will mature during the rest of 2019 at an average cost of 1.42%. We have continued to make progress in terms of asset quality. The nonperforming loan ratio fell further to 4.1%, the non-performing asset reduction was EUR 93 million in the quarter, which brings our NPA balance to EUR 8.2 billion, an year-on-year decrease of almost 50%. The NPA coverage was largely stable. As usual, on this slide, we also provide details on the assets currently included in the available for sale portfolio, which will be completely removed from our balance sheet once the institutional sales had closed later this year. Those are shown in gray, as well as details on the pool of assets that are managed by our developer, Solvia Developments, that are shown in orange.

On the following slide, we have included details on the quarter-on-quarter evolution of the Group's fully loaded CET1 ratio as well as the expected capital passed through the end of 2019. We ended 2018 with a reported fully loaded CET1 of 11.1% and we can follow on the graph to the right going to the right, we can see the different drivers that has impacted capitals in the quarter. Hence, we have seen 20 basis points of organic capital generation in the quarter, including net profit AT1, so the payment of AT1 coupons, dividends, intangibles and organic RWA reduction. This reduction in RWAs, inorganic RWAs, have been driven by DTA recoveries. So that RWAs related to DTAs decrease because of that recoveries. Lower equity investment related to insurance due to the fact that we received dividends from our stake in the insurance joint venture that we have, and other balance sheet dynamics such as reduction in other risk RWAs. The decreasing capital reductions were in connection with the recovery of mature assets that were related to a -- in connection with related parties.

Tax loss carry-forward and capital threshold, that in total meant a contribution of 14 basis points of capital. And finally, the impact of the regulatory RWAs' growth was 48 basis points in the quarter, that included 15 basis points for IFRS 16 and 33 basis points for TRIM. The impact of TRIM includes a review of the SMEs and corporate portfolios in this quarter. The review on our mortgage portfolio had occurred already last year and therefore, the total impact of those reviews that are the most part of our portfolio has been already absorbed to date. The review of TRIM, as I said, is largely covered or completed, there is one portfolio with EUR 3 billion in RWAs and a 50% density, which is a low default portfolio that is still pending conclusion of the process and given the nature of these amounts, we don't see a significant potential impact coming from this. And this is likely to close in 2020. Taking all of this into account, our fully loaded CET1 ratio was 11% at the end of Q1 and going forward for the rest of 2019, there are a series of additional factors that are expected to impact capital positively.

The capital gain on the sale of Solvia Servicios, which was announced last year and settled earlier this week, will add a total of 15 basis points. The institutional disposals of NPAs also announced last year and expected to close later in 2019 should add a further 18 basis points as shown in the slide. And organic capital generation that we expect for the rest of the year should add a further 30 basis points or so for the next nine months of the year and these together with what we generated in Q1 is in line with our organic capital generation guidance of circa 50 basis points for 2019. Also it is important to highlight that this organic capital calculation as you can see also in the slide assumes a cash dividend payout of 50%. Considering all of these impacts, we expect our fully loaded CET 1 to go from 11% reported at the end of Q1 to 11.6% by year-end. Additionally to this, as also shown in the slide, there are other opportunities, potential measures, some of them ongoing, that include Solvia Developments and the disposal of very small assets or divestitures, this doesn't include any sale of businesses and those could increase our capital level further by year-end above the 11.6%. On the following page, you have the details of our current reported capital base in both fully loaded and phase-in terms, vessel requirements. As at the end of Q1, our reported phase-in total capital ratio stood at 14.89%, which was 175 basis points above our requirements of 13.14%.

Our phase-in leverage ratio was 4.94% as at the end of March. As you know, TSB is primarily our mortgage bank and as such, it has a lower leverage ratio, which impacts the ratio at the Group level. We are comfortable with the Group leverage ratio at about this level. And with this, I will hand over to Jaime to close our presentation today.

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [4]

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Well, thank you, Tomas. To finish our presentation today, I would like to reiterate that with this quarter set of results, we are back to increasing profitability and we are fully focused on creating value for our shareholders. We have a clear set of targets for the year linked to both capital generation and shareholder remuneration, which are supported by high commercial dynamics in Spain and Mexico, core revenue growth, lower impairments and costs and the new momentum in TSB. I can also now confirm that TSB new CEO Debbie Crosbie will join the Company this upcoming May 1. In regard to our capital position, we have a strong commitment to continue to grow capital during the year and we are set to reach 11.6% or above by year end. And with that, we open the floor to questions. Cecilia?

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [5]

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Thank you very much, Jaime, and thank you, Tomas. We are now going to start the live Q&A. I would like to remind our audience that we will be limiting the questions to a maximum of 2 per person and this is in order to give you all more time and chance to participate in the Q&A. Please kindly take this into account when participating during the session. And with that, operator, please, can we have the first question?

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Questions and Answers

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Operator [1]

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The first question is coming from the line of Jose Abad.

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José Maria Abad Hernandez, Goldman Sachs Group Inc., Research Division - Executive Director [2]

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I have 2 questions, first one is on IRPH (inaudible) was your exposure, the one you reported to the market was around EUR 1.4 billion that was as of Q2, Q3 '18, could you please give us -- I believe that you've been reducing this, so was the exposure as of today? And what's the strategy that you are following here? And maybe if you could also comment if you can on expectations of ahead of actually the ruling, which is expected for actually Q3? The second question is on the NPA sale, which I believe was expected to be closed by Q2. I mean, just to make sure that this is still the case. And also with regard to the negotiations you communicated to different parties, one is investors, the other is the Deposit Guarantee Fund. So I guess the question here is whether given that the slowdown that we see in the Spanish economy and, in particular, in the real estate sector, whether we should expect there is any risk for any change in the terms with either of these 2 parties? And whether we should expect this possibility of some sort of unexpected one-off impact to P&L or even a lower positive impact to capital from a potential change in terms?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [3]

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Regarding the first question about the IRPH, well, first of all, it's important to note a remark that the index, the IRPH index is a transparent index calculated and published by the Bank of Spain. So I think that is quite difficult to consider this as a [opportunity], we have one of the lowest exposure of the IRPH in Spain, which comes from basically from our acquisition of CAM and Caixa Penedes. Our current exposure to the IRPH mortgages is below EUR 800 million, do you know that we have been permanently during the last years offering to our customers that have this index or even the EURIBOR having no floors. We have offered the alternative to move their mortgage from variable to fixed and this strategy has been very successful in terms that there are a lot of customers that has made this change and obtaining very cheap pricing because of the very low interest rates that we are having in the last years.

Well, we don't know what's going to be the final impact, obviously, we have to expect to wait for the final court ruling that is expected to happen in September or October. Regarding the NPA sales and my answer is if you can Tomas add anything? The deals are now waiting for the antitrust approval. In fact, we expect to close the deal regarding NPLs in the next month of May. And the deals regarding NPAs coming in the second part of the year. The process of obtaining the antitrust approval from the government is longer than the case of the NPLs. There we've don't expect any gain of change in the deals that we have announced last year. So I think that there is not the expectation about any kind of impact from potential change. You want to add anything?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [4]

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No, I don't have anything else to add.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [5]

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Operator, please next question.

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Operator [6]

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The next question is coming from the line of Francisco Riquel.

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Francisco Riquel, Alantra Equities Sociedad de Valores, S.A., Research Division - Head of Research [7]

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Yes. Two questions also from me on the capital side. I wonder if you can comment on the plans for asset disposals beyond Solvia Desarrollos Inmobiliarios and in particular the asset management business? And then also on the dividend, I wonder how committed you are to the 50% dividend payout given the depressed valuation multiples and that you are still below the capital targets that you have for the year-end? And just a follow-up on the capital you have included on the Slide 27 on the way to get to the 11.6% on the positive tailwinds. But I wonder if there is -- we should expect any headwind beyond the IRPH that we should take into account this year or next?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [8]

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Well, no, I don't. But your view refers to the allocation -- the asset management business. Well, we are in the process of selling of Solvia Desarrollos Inmobiliarios and if finally, the transaction is done, we will have a positive impact in capital. We don't have any plan to sell more assets but, obviously, the different businesses that are related with alliances with us, and thus that are evolving in strategical terms could be analyzed in the sense the asset management industry is evolving very quickly. We have been different processes of consolidation in different countries, and we are analyzing which options we have. But my view is, that is not done in terms of capital is more than in terms of our strategic view about how this kind of businesses are evolving. Regarding the second question, we really are committed to this -- we have done the figures of the presentation with a 50% in payout ratio. Our commitment, traditional commitment, is more between 40% and 50% payout ratio. Obviously, this issue has been taken by the Board, but our view is that the situation of the Bank allows perfectly to reach this level of payout. Do you want to say anything?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [9]

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Yes, Jamie. There is an additional thing in the first question is whether we are expecting potential headwinds since we are showing the tailwinds to build the capital ratio and [Parker] was asking if we have any views on IRPH.

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [10]

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Well, I think -- Tomas.

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [11]

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Well, as Jaime said, we think there are many reasons for considering that any adverse ruling shouldn't happen. Anyway if it happens, there are a number of potential scenarios and the thing is that our exposure today to this kind of index is EUR 800 million. And therefore, we don't know what can happen. But in any case in our case, as I said, this corresponds to one of the lowest exposures in Spain and any potential impact coming from this would be manageable.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [12]

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Now Tomas, what Parker was asking as if in addition to IRPH, if you think there is any other headwinds for the rest of year in capital?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [13]

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No, no. In addition to this, I don't see any other things.

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Operator [14]

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Next question is coming from the line of Britta Schimdt.

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Britta Schmidt, Autonomous Research LLP - Former Partner, Spanish and German Banks [15]

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Yes. I've got 2 questions as well please. On the TLTRO II, you've detailed how you will confront the repayment and you've included in there the EUR 3.1 billion APS account receivable payment. How confident are you that you're going to receive the cash payment or this timeframe? And if not what other measures could there be and maybe you can comment also a little bit on your views on TLTRO III? And my second question is on the non-recurrent costs. There were some non-recurrent costs in TSB in this quarter, EUR 25 million or so I believe. Could you tell us what this was related to? Were there any other kind of charges still related to the migration. And what is the outlook for nonrecurrent costs at TSB this year?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [16]

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Britta, in the quarter, we received a - so far for the first question, in the quarter, we received already EUR 1 billion, as you mentioned from the Deposit Guarantee Fund. The amount previously of the receivable that previously was standing at above EUR 4 billion has now been reduced to EUR 3 billion and the payments, the inflows will come with the process of -- the usual process of authorization of the sales, certain recognition settlement and therefore we are fully confident that we will receive the whole amount of the receivable within that timeframe that we need to see consider for TLTRO repayment. In terms of the additional things for TLTRO repayment, we have the funding that we will be doing in the rest of this year and also in the coming year.

We have all the potential success for the repo market, which are as you know very usually used by us and very accessible to us. In terms of costs of TSB in the quarter, I think you referred to the extraordinary costs or non-recurring costs, right. There is [12] non-recurring cost of EUR 28 million, EUR 3 million of them are for severance payments in ex TSB, the remaining EUR 25 million are TSB's, a significant part of those are related to legal costs still helping throughout the investigation processes in TSB. These are more than 50% lower than they were in the fourth quarter, but also there is some other item there as the costs related with discontinuation of some banking agreements, business banking agreements, in the quarter. So those are really don't have a recurrency and neither are related to the post migration situation.

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [17]

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And Cecilia what was the --

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [18]

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Britta, you also asked about TLTRO III, or am I mistaking?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [19]

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Yeah, about the TLTRO III, we don't a special view on that. We will be just vigilant to it, but this is not part of our plans today.

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Operator [20]

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Next question is coming from the line of Alvaro Serrano.

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Alvaro Serrano Saenz de Tejada, Morgan Stanley, Research Division - Lead Analyst [21]

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Two questions for me. First of all on the capital, I realize that you have Solvia Desarrollos re-mortgage still to close -- still to agree, but it looks like that's also going to take your company above the 11.6%. Considering your SREP is at 9.6%, is 12% the capital you can run with, that you aim to run with or should we expect next year a further buildup of capital? I just want to get a feel of if there's any further journey or you - and if you could end the year closer to 12% if you do close Solvia or somewhere in the middle? Just a bit of color on where the end journey is given where we are now and given the pipeline of disposals? And the second question is on NII, and apologies if you've gone through it in the presentation because I had to skip out. But the run rate on my numbers point to a minus 2, if you annualize Q1, it's minus 2% for the full year versus -- growth versus 2018. I realize, obviously, there's seasonality in Q1, but can you maybe give us a bit more color on why you're still confident to grow NII, I think you said 1% or 2%? Is volume growth going to recover, is it just the seasonality, is there anything else?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [22]

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Thank you, Alvaro. In terms of capital, what we've seen after the capital formation that we've experimented in the quarter and our views for the rest of the year, of course, I think this shows that further capital formation on the normal course of business would lead us to above 12% next year. But we are not -- consider it necessary to build. So the formation could take us further north of 12%. We don't have a specific target to build both the 12%. 12% appears to be these days the new normal in the market since our capital formation capacity take us there, it is where we will find ourselves comfortable. So nothing else to highlight further in this space. In of terms of NII, if you take into account the impact of the EUR 19 million of seasonality, actually I take it that your numbers should take you to a different level. But on top of this, you need to take into account that, of course, there are things there that are permanent for the year, like the impact of the wholesale funding cost increase by the issuance of the subordinated debt and the lower contribution of the ALCO portfolio. But the loan growth that we've seen in the first quarter, the fact that we've introduced this - included this information for your benefit on where we stand in terms of average balances because actually average balances is what drives the NII growth.

And you can see the relevant progression that we've had in the quarter in comparison with last year's last quarter, but also the older previous quarters and also the behavior we've seen in the quarter in terms of loan growth supports our view to end the year with an average of circa EUR 142 billion for the last quarter of the year. This drives NII growth to the levels that we are guiding to.

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Operator [23]

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Next question is coming from the line of Mario Ropero.

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Mario Ropero, [24]

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My first one is on TSB NII. You mentioned margin pressure, if we assume that NII just keeps constant in the UK, it would be down by 2.5% in the year. So since there is margin pressure going on, can we expect a [sincerely south] of this, can you give us some color there? Also you mentioned, if I'm correct, that TLTRO III is not in your plans. Does this mean that the size of the fixed income portfolio should reduce significantly in 2020 in line with the TLTRO II maturities? And finally if I may a very quick follow up on the Solvia Desarrollos sale, if you could comment on the timing of this deal?

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [25]

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Mario, we didn't get your second question on the TLTRO II, sorry, can you repeat?

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Mario Ropero, [26]

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Yes, the second question was that if I'm correct, I think that the CFO said that TLTRO III is not in your plans. If this is the case, does this mean that you are happy to see a reduction of the fixed income portfolio in 2020 and 2021?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [27]

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Thank you, Mario, thank you very much. In terms of TSB, yes, the margin pressure we've already seen, we've seen loan yields for mortgages reducing significantly in the market since 2014, for instance. Still this is a business that is dawning in the UK market at double-digit ROE. So it's a profitable business, but, of course, there's been this compression. To give you an idea, the TSB NIM in the quarter is being 2.12%, if I'm not mistaken, we could precise this more in detail, but I think it's that and we see potentially an erosion of 5, 6 basis points for the whole year. This is the intensity of the pressure. It could be that this is reduced because, of course, in terms of volumes performance, what we've seen in the quarter is been an increase of the weight of mortgages due to the fact that still some business banking lending products in digital are going to be launched and haven't been viable in the first quarter.

And therefore there has been a decrease in the business banking lending portfolio and those, of course, have higher margins. So this is the landscape in terms of what we expect from TSB in that regard. In terms of the TLTRO, you asked about whether us not having plans for using the TLTRO III would mean that we are happy reducing the size of the portfolio. We don't need it. We don't need this. So because as we show in the presentation, we can repay these with cash flows coming from the sales of the assets, with the inflows coming from them, unwinding of the receivable from the Deposit Guarantee Fund and also using part of the liquidity, they excess liquidity, which is cash, that is deposited now at TSB. Less than half or circa half of this, so they offered it, it still will be very significant. So we don't need to reduce, we don't need to act on the size of the ALCO portfolio, so the size of the ALCO portfolio we expect it to remain stable throughout this year. The contribution to NII in the quarter has been slightly above EUR 100 million, we expect it to be stable. This is basically 12% of total NII and actually remains very, very, very similar to what has been in there. It's a little bit less. It always stands around between 12%, 15%, 16%. And then I think --

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [28]

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For the last question about the Solvia Desarrollos sales. Well, as I said before, we have launched the sale process, the perimeter in consideration for sale has a net asset value that ranges between EUR 700 million and EUR 900 million and we expect to close the sale during this year.

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Operator [29]

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Next question is coming from the line of Carlos Peixoto.

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Carlos Peixoto, Banco Português de Investimento, S.A., Research Division - Analyst [30]

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A couple of questions as well. The first one is a bit more on the specific slide, which is related with other income and I saw in you release, that there was a positive effect from the negotiation - from the renegotiation of some [big] contracts at TSB, namely the VISA contract, whether we had positive impacts on other income? My doubt is whether this is a recurrent positive impact that we in the quarter? Should we expect that to maintain over the coming quarters or was this more of a one-off? And so this was on the other income. Then on fees, I was wondering as well if you could give us some color our how do you expect it to evolve throughout the year? First Q was, I would say, particularly -- or quite a good performance considering the market environments. At the environment, I was wondering how you expect it to evolve throughout the rest of the year?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [31]

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Thank you, Carlos. Thank you very much for your questions. Regarding the first one, what we see in other income is basically fees. So revenues coming from the recurring activities. So we should expect that this level is, not exactly this level but more or less the activity is maintained throughout the year. And actually we are expecting growth in TSB for this line of the P&L throughout the year.

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [32]

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Regarding fees, as I said before, for this year we are targeting high-single digit growth, driven by several factors. I think that the first quarter reflects this evolution. Basically, we are having a very good commercial moment in Spain with higher transactionality and increasing our customer base. We have also since last year launched a strategy to increasing customer loyalty. This first quarter, we are launching new policies, increasing this or developing this strategy of increasing customer loyalty. We are also doing very well in terms of insurance production, so we are optimistic about us achieving this target of a high-single digit for the end of the year in terms of fees.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [33]

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Thank you. Next question, operator, please.

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Operator [34]

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Next question is coming from the line of Daragh Quinn.

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Daragh Joseph Quinn, Keefe, Bruyette & Woods Limited, Research Division - Analyst [35]

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It's Daragh Quinn from KBW. One question on the UK, if you could just maybe highlight again your outlook for the year in terms of one-off or non-recurrent items that we need to consider in both revenues and costs? And then a question -- maybe more a medium term question relating to Mexico and still showing very strong loan growth. It's now roughly what about 2.5% or just under 2.5% of the performing loan book. Over the medium term, how big or how much bigger should the Mexican business become in the context of the Group?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [36]

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Thank you, Daragh. Regarding the UK, in terms of revenues, I think we shouldn't be expecting any non-recurrent in particular. So I think what we've seen in the first quarter has been again catching up with us towards loan growth. We are expecting further loan growth in the UK in the coming 3 quarters and also a behavior or performance from other income more or less similar to this quarter. In terms of costs, we see that there's been some reduction in the recurring costs and that we still have some non-recurrent and this non-recurrent are linked to what I just explained. So some legal costs still running in parallel to the investigations. In the guidance, we've included, but we don't disclose, but in the guidance we have included costs related to the efficiency initiatives that in theory will be undertaken or are being undertaking. And so this makes part of the guidance more details and, of course, the guidance and the outlook will be updated when the new CEO that starts May 1st, Debbie Crosbie reviews the plan and updates it. And in this moment there will be, as I said, the communication on the targets of the plan, more disclosure and more details on how it is going to look like.

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [37]

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Regarding Mexico, I think that - so I think that the quarter, in fact, has been better in terms of income and profit than in terms of growth, of lending growth. Our view is that at this moment in Mexico, we are beginning to take -- to benefit from the increase of the offer with more cross-selling activity, offering more products and services, also obtaining a cheaper funding because we are consolidating our position in the market and looking for ways that from this year, probably we will see better performance in terms of income and profit in Mexico and lower level of growth that we have experienced the last years. We are thinking a lending growth above 5%, taking into account the economy and the situation of some kind of uncertainty that there are in the market. So my view is that Mexico now is more an asset that is going to contribute positively in terms of income and profit and probably we will see more slow [pass] of the lending activity.

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Operator [38]

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Next question is coming from the line of Ignacio Ulargui.

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Ignacio Ulargui, [39]

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Yes, I have one question on the margins in Spain, and I have gone through the new production and the offering that you have had in 1Q. My question is more on the recent offering that you have done in the mortgage market where you are just offering like [1.90] flat margin for fixed rate mortgages, which looks to me like a very competitive particularly in the long end of mortgages above 25 years. Well, I mean do you see this as a temporary offer ahead of the new mortgage law or that's something to stay? And what will be then the impact that you see over the new mortgage law in terms of the cost of the product itself going forward?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [40]

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Well, I think that this offer was done just to targeting our best customers with a strong consumption of other products and very loyal. And I think that was more, let me see, a commercial - was offering a commercial and add aim that's really the average of the offers that we are doing. In terms of mortgages, what we have seen in the quarter and probably also in the second quarter is an increase of the spreads, the average spreads of the mortgage activity. So I think that in general, the market because of the new law and because of the new situation of the market, we are going to see better spreads in the future.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [41]

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Thank you very much. I believe this gives us time for just one last question. Please, operator.

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Operator [42]

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Next question is coming from the line of Andrea Filtri.

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Andrea Filtri, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [43]

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My questions have all been answered already.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [44]

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Okay, well, one more, Operator, please. Thank you.

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Operator [45]

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Next question is coming from the line of Stefan Nedialkov.

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Stefan Rosenov Nedialkov, Citigroup Inc, Research Division - Director [46]

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Yes. A couple of questions, hopefully pretty quick ones on my side. Number one on TSB. So from what I understand, you are assuming some of the GBP 160 million of synergies coming through this year, but you're not disclosing how much. If I can just confirm that? Number two on the IRPH mortgages, could you just comment when you convert these mortgages, what's the rate that you offer to the people versus the sort of 190 to 200 basis points that's available in the market. And how comfortable do you feel with the legal risks embedded in the waivers that you ask your clients to sign. And lastly on the ALCO portfolio, there was another reshuffle from fair value through OCI into HTM. Can you just explain what the reasons are for that and what we should expect going forward? Are we eventually going to see most of the ALCO portfolio and the securities portfolio as HTM rather than fair value?

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [47]

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Thank you, Stefan. About TSB, no, we are not assuming the total GBP 160 million synergies coming this year in TSB. I confirm this. Yes, some of them are already built in, in their cost base. But the extent of the synergies and their cost efficiency achievements will be part of the disclosure that will be made, as I referred to earlier, when Debbie Crosbie reviews and updates a plan. So we should expect that at least she will need 3, 4 months and then the plan will be communicated. We think that the potential for synergies remains there. And the timeline will be confirmed with the finished plan. In terms of IRPH, Jaime is going to answer?

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Jaime Guardiola Romojaro, Banco de Sabadell, S.A. - CEO, MD & Executive Director [48]

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Well, we are doing this strategy of offering fixed rates instead the variable to customers since the moment where the interest rates were very, very, very low and we have done this - we have followed this strategy with all types of variable mortgages, what are rated to EURIBOR, what are rated to with or without floors, and also IRPH and other variable index. And at this moment more or less the offer is about a 2% rate for mortgages that have a maturity of 15, 20 years more or less. But, obviously, the offer depends on the different type of customers and the different type of assets and the loan to values and all this kind of thing that are material in the decision of pricing.

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Tomás Varela Muiña, Banco de Sabadell, S.A. - General Manager & CFO [49]

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Thank you, Jaime. Stefan, about your last question on ALCO. There hasn't been any reclassification between the OCI and the HTM portfolios. What happened was that there has been sales on the OCI and there have been purchases on the HTM, but no reclassifications. So as you know the HTM corresponds us at a perimeter that is a different business definition and [reference] and it has its own dynamics, but there haven't been any reclassification.

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Cecilia Romero, Banco de Sabadell, S.A. - Head of IR [50]

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Thank you, everyone. Thank you very much for listening. Thank you for participating, I am afraid this is all we have time for today, (inaudible) this quarter and so again, thank you for listening. In the Investor Relations department, we are obviously available to answer any other questions that you have throughout the day. And have a great day.