Grupo Financiero Banorte, S.A.B. de C.V. (GFNORTEO) Earnings Call Transcript & Summary

Good morning to all. Thank you for being here at Banorte Day. This is not a typical Investor Day. What you will experience today is really how the transformation journey at Banorte has happened in the past few years, and how we envision the future, a pretty bright one for Banorte. So what you will see today, and let me guide you through the agenda. As you can see, it's a very detailed process in which we'd like to answer the main questions that we get on a repetitive basis by our investors and analyst. The first one will be the opening remarks by our Chairman, Carlos Hank, and Marcos Ramirez, our CEO. Then we will address the near showing opportunity for Mexico, what it means by Alejandro Padilla, our Chief Economist. Then we will move into the wholesale banking piece and how the wholesale banking has moved to a personal way to address the clients and also to look at how the capacities of the transactional banking that Banorte has. Then we will move to the personal banking and the SME and how the personal banking mixes in a pretty good way, the human interaction with the digital interaction on that part. And how we really solve the issues with our clients. On next, because I think it's -- at this point in time, there are many questions about the risk management of Banorte, what the capabilities that Banorte has on the risk, you know the risk numbers are really the best in the market. The numbers are -- that's 2 key questions through the -- through many -- through the last days. And also we will touch the AT1 capital notes. What's the position of in the AT1 capital notes and how we manage the capital notes. After that, we will move to a break, a 15-minute break, then we will start to move into the present future that we see at Banorte and it's really what we call hyperpersonalization that you will see peak with the wholesale banking, but you will see in a more detailed way on the personal banking piece. Then we will move to a an issue that is really close to the way Banorte managed the company, the ESG part. Our Chairman, Carlos Hank will guide you through the evolution of the ESG at Banorte. And then basically, that also is a very important part for you, because you know that Banorte is used to give commitments to the market, we will guide to the financial numbers and also our guidance for the next 5 years on that part. That will be shared by Marcos, our CEO and myself on this part. So please, one thing that I should ask you is, if you could save your questions by the end at the end of the process, we will have a Q&A session in order to do this as smooth as we can through the presentation, okay? Thank you very much, and very welcome to the Banorte Day. Now I would like to introduce for the opening remarks, our Chairman, Carlos Hank Gonzalez and Marcos Ramirez, our CEO. Okay. [Presentation]

Now we'll start with the opening remarks our Chairman, Carlos Hank Gonzalez; and Marcos Ramirez, our CEO.

Thank you very much, Rafael. Good morning, everybody, and welcome to the Banorte Day. I thank you for taking the time to meet with us again face-to-face as we did back in 2014. As Rafael previously mentioned, we have prepared a very comprehensive agenda for you to deliver a very strong message. This message will be supported by already in-place initiatives. And as you know, Banorte has a results delivery reputation to maintain. And in the long run, and you will experience the potential firsthand today. Eight years ago, when we met in this very same city for the first time, Marcos and I were taking on new roles as CEO and Chairman, respectively. Our aim was to really listen to your concerns, your requests and expectations. The generalized petition at that time was very clear, a strategic certainty. And therefore, by that time, we established right after our 5-year 2020 perfect vision plan, about which we will talk thoroughly in brief. When we presented those goals in 2014, we were seriously questioned by the market. For the market, it was hard to believe we were prepared to achieve such ambitious financial goals. For start is one of those goals was doubling our net income by 2020, a challenging task to say the least. All of you walked alongside us in year-by-year witnessed the holistic transformation that Banorte was revamped from head to toe, our technology, our processes, our culture and corporate governance.

You have questions about how Banorte retains, develops and integrates talent. The answer is our culture, which transforms customers' needs into unique offers. And by the way, we have a very competitive retention plan for the organization's top talent. After Carlos' opening remarks, we will show you what this organization is capable of.

Banorte, by the time, was doing well in this arena, but we pushed ourselves to be an international benchmark and governance, one of the most public companies in Mexico. We improved transparency to the market, and that has always been top of mind across the organization, but also to maintain independence and diversity across the board. In the next annual assembly to be held in April, we will propose our shareholders voting for Alicia Lebrija and Mariana Baños, potentially improving and enriching the Board of Directors perspective. Moreover, the approach to ESG, a Banorte has changed from a priority, acting separately to a foundation acting across the whole organization. We are convinced that ESG is an extremely relevant source of value creation, as you will see later. Finally, this transformation and steps taken to be the best financial group for customers, investors and colleagues could not be possible without the leadership of our management team. In December 2014, it was a flash point. the market questioned whether the management transition would be capable of delivering accomplished miles -- and accomplished milestones speak for themselves. But it's not only our management, but also our colleagues, who differentiate us at Banorte. The extraordinary is ordinary.

Join us on a brief trip to the past, to have a better view of the future.

Since our last Investor Day in 2014, and thanks to all your feedback, we've made a lot of things happen. Back then, we ranked fourth overall in the market.

We brought in net profits of MXN 15.23 billion and a significant amount of tech debt. Our cost-to-income ratio was above that of our main competitors. And our capitalization index was lower than theirs. Management was focused on volume, and we were highly dependent on a network of aging and mixed branches. Our segmentation process was very basic. Decisions were centralized with senior management and the culture was hierarchal and nonstandardized and we operated in silos. Although employees high level of commitment and pride of belonging stood as a founding block. We also like the technological tools needed to design more efficient and secure processes. In cybersecurity, our monitoring and protection systems were significantly out of date, and fraud prevention was a highly manual process with no in-house risk models or appropriate analytical tools.

It was obvious that we needed to modernize and that we had tremendous areas of opportunity and growth potential. We had a vision to become the best financial group for our clients, our employees and our investors. Through our strategic plan, we call 2020 Vision. The aforementioned with precise goals such as doubling profits, achieving extraordinary profitability levels of 20% in ROE and 2.2% in ROA and improving our cost-to-income ratio to below 40%.

On those days to fulfill this vision, we tracked the following financial indicators. ROE reached 23.5% at the bank level and 2.1% at the group level, a growth of nearly 683 basis points between 2014 and 2019. By 2019, our ROE stood at 2.3%. Our net interest margin in 2019 was 5.62% at the group level and 6.39% at the bank level. We reduced the NPL ratio to 1.65%, reaching the best asset quality levels in the market. On the same down trend, our cost of risk reached the lowest levels in the market by the year 2019. We also needed to improve our cost-to-income ratio. In 2019, we reached 39.1%. At the end of 2009 (sic) [ 2019 ], our capital adequacy ratio stood at 18.6%, and our CET1 ratio at 12.7%, with double net income by 2019, 1 year earlier than we promised. We migrated towards more sustainable products with higher returns. Our portfolio yield increased in this period and we increased our market share to the second place from 4 position in consumer portfolio, which means auto, payroll and mortgage. To sum up, we met our 2020 plan commitments leveraged by the great performance of other relevant indicators. To achieve these strong results, we undertook a sweeping transformation of our financial group, always guided by our customers' experience.

We gave the multiple ways to do their banking in person or online, in supermarkets or at our branches. We make branches much more efficient, upgrading their image and functionality. We allocated more expenses and CapEx to IT. We build a central data warehouse. The key to learning more about our customers and the foundation of all the interactions of our omnichannel structure. We developed a technological infrastructure consisting of flexible, agile and high responsive layers. We created an analytics team, a leader in machine learning and behavioral analysis, which developed different architects a foundation for personalizing offers through targeted campaigns as well as to have a clear view of our customers' value. In fraud prevention, we incorporated automatic predictive models and online monitoring based on behavioral analysis. In cybersecurity, we quickly reduced known vulnerabilities, following best practices and continually certifying processes. In risks, we developed in-house models bolstered by analytical capacity, which made us a benchmark in risk indicators.

We have been migrating towards profit-centric management with a customer-by-customer approach. We became a benchmark in corporate governance and won various distinctions such as Best Bank and best management team. All these changes were supported by a high-performing meritocratic and collaborative culture, represented by hundreds of cells as living cells operating across the organization. These multidisciplinary teams share the same goal, permanently satisfying customer needs. Let's have a look at the cellulase experience, the cells. [Presentation]

The achievements of this transformation process were significant, but more needed to be done. In 2020, the pandemic took us all by surprise, and we had to adapt swiftly. We had to rescale strategic decisions. In 2021, we launched the 123 plan, taking in fact in 2023. While maintaining our vision to become the best financial group for our clients, investors and employees, along with a clear mission to become the #1 financial group for banking in a digital world, maintaining our leadership and profitability and sustainability. This strategy was based on 3 pillars: accelerate Banorte transformation, seek-out partnerships or alliances that bring us into customers' day-to-day life and build a digital bank from the ground up. We continue to focus on improving the customer experience.

Banorte ranked second with an NPS score of 64 as of 2022. Today, Banorte is equal to or better than its peers in most customer interaction processes and...

Totally capable of achieving its highest goal focused on profitability and efficiency, therefore, spending more on transforming and reducing operating costs. Where do expenses and investments in technology go, 148% increase in value deliveries and 46% reduction in average cost per project.

At Banorte, we have a history of milestones accomplished. We're confident that we can continue, not only meeting, but also exceeding the expectations of our customers and the market. We have the talent, the technology and the strategy to achieve it. Join us today to hear about the growth potential of all the initiatives we have underway. And stick with us as at the end of the event, we will present the next milestones to be achieved. Thank you very much.

Let's move on with our Chief economy, Alejandro Padilla, who will walk us through the near-shoring opportunities for Mexico.

Hello, good morning. My name is Alejandro Padilla, Chief Economist. I will walk through Banorte's view over the Mexican economy and also the opportunities coming from near assuring. In this brief presentation, I will analyze some short-term factors, but also I will talk in detail about all the long-term opportunities that we have as a country. And let me just start talking about 2023. I think that all of us are aware that there are significant headwinds or risks associated with banking news in the U.S. and Europe -- the effect of the tightening cycle of the Federal Reserve and other central banks on the economy. But regardless of that situation, I'm very confident that Mexico will have a positive year in terms of growth. In this, I think that the Mexican economy will be resilient. Why? Because first, we have a stable macroeconomic outlook. The second one is that we have a strong relationship with the U.S. And in this regard, we are factoring in our models that maybe we might see a U.S. recession, a mild recession, soft lending. But despite that, I think that the Mexican economy can continue performing quite well. In this, what we have been observing is that the positive performance of 2022 has prevailed throughout this first quarter, and I think that this inertia will continue at least in the next 3 or 4 months. And the third one is that we have favorable effects coming from nearshoring. Now let me just quickly talk about 2023. So then I can move forward with midterm factors. Well, in terms of GDP, we are forecasting that the Mexican economy can grow 1.5% this year after a strong 3.1% in 2022. This number is slightly above market consensus that is at 1.4%. But let me tell you something. Despite all these news having in the rest of the world, I think that this 1.5% has upside risks, which are the drivers that we are analyzing behind this 1.5%. Well, the first one is private consumption, which accounts for nearly 2/3 of total GDP. I think that the positive performance that we observed in the last quarters of 2022 will prevail in 2023, especially services. Services are catching up from this huge gap observed throughout the pandemic. The second one is the government spending in social programs and also infrastructure. The third one is the link with the U.S., okay? The 56% of Mexico's GDP is highly dependent of the U.S., especially non-oil exports and also tourism. And although we might see risks of a mild recession in the U.S. This will be the second consecutive year in which Mexico will outperform the U.S. economy. Why? Because Mexico is closing this huge gap observed just in the immediate years after the pandemic. And the fourth one, I'm very appealing is nearshoring. Nearshoring is a long-term story, but we are observing short-term opportunities and short-term factors that are coming from a higher demand for industrial parks, also very important investments that have been announced since last year. So all in all, this is the view that we have for 2023. And this topic that we have been listening in the news about the banking sector in Europe, in the U.S., I think, will be well contained and short-lived at least the effect on the Mexican economy. Moving forward and talking about what can happen in the midterm. Let me just point out some of the competitive and comparative advantages that Mexico has. And I think that these advantages will be very important to weigh in, in this story of nearshoring. First of all, we have to take into account that Mexico has a lot of demographic advantages. Just look at this chart. This is the population pyramid of Mexico and the U.S. And as you can notice there, they complement each other quite well. I think this supports the idea of greater trade integration. According to the 2020 Census, Mexican population stands at 126 million people. This is the 10th largest in the world. But most important -- when we analyze this demographic dynamics, we will notice that working age population, the ones that are between 15 and 64-year-old accounts for nearly 67% of total population, which is larger than the 65.2% on average of the world, according to OECD. This tells us that Mexico has a demographic bonus that will last at least for the next 30 years. But it is not only about population and age. It is also about the capabilities that Mexico has in terms of skilled workers. You will see there the amount of engineering graduates that Mexico has every year. It is within the top 10 worldwide. This is telling you that Mexico has enough human capital in order to fulfill all of the requirements of the industries that will come to our country given this new paradigm in terms of international trade. So nearshoring is a reality in Mexico. Other important advantages that we analyze in Mexico are the ones that you will see there. First of all, market axis. We have USMCA in full implementation plus 12 free trade agreements with nearly 50 countries. The second one Mexico has a very appealing geographic location. We share 2,000 miles of border with the U.S., one of the most attractive markets in the world. As you can see there, the Northern American region represents 28% of total GDP. So imagine the potential that we have in terms of near shoring. And another huge advantage is coming also from cost efficiency. You will notice there that, for example, average hourly earnings in Mexico are way below what we observed in other competitors, for example, the U.S. or even China. So if we put all of these factors within the equation, we think that we might see a very positive story in terms of nearshoring. Now let me walk you through one research note that we released early this month. We call it Zoom Nearshoring, the Banorte report. In this one, we found very interesting results. First of all, nearshoring is not new for Mexico. Nearshoring has taken place in the last 10 or 15 years. If you want to put a name on it, you can call it nearshoring 2.0, nearshoring 3.0 or whatever. Mexico has been an important investment destination in the last years, and we have been observing it in several sectors. For example, the auto sector. So you will notice here that regardless of nearshoring or not, the trend of Mexican exports will continue with a very fast pace. Indeed, we are calculating that from that $539 billion of exports that we observed last year, imagine $0.5 trillion of exports we sent abroad. That's almost the size of a midsized country, the GDP. So imagine that amount, well, Mexico can keep on growing between 6% or 7% in terms of normal exports. We're talking about nearly $35 billion of additional exports each year. This is regardless of nearshoring, but if we have nearshoring into the equation, then this number can move up to $69 billion per year. In this, our study suggests that in the next 5 years, the potential gains of exports in Mexico are hovering around $168 billion. Imagine that amount, it's something really worth mentioning. Now we have to analyze what's happening within trade dynamics in Mexico. You will notice that from those $539 billion, 82% go to the U.S. But most important is that 58% of what we sent to the U.S. is concentrated only in 3 states: Texas, California and Michigan. We have a low market penetration, for example, in the East Coast. So this gives Mexico also a good opportunity to open new markets even within the U.S. Then we have to also observe what has been happening in terms of the sectors in which Mexico has been an important player. Well, we especially export vehicles, computers and monitors. Where do we see the advantages in terms of nearshoring Well, in several industries. For example, the agro industry, we see pharma and medical devices, electronics household appliances. We also see a big potential in logistics, in warehousing, in transportation, even in services associated with knowledge economy. So we honestly see a lot of positive news coming not only in the auto sector, but in several other components of the economy. And also to be fair enough, we have to think about some of the bottlenecks or the challenges that Mexico needs to face or to tackle in order to really unleash the potential of nearshoring, coming from electricity, coming from access to water, other infrastructure topics even the rule of law. So if Mexico can cope with the situation and tackle these things, this number of $168 billion can be even larger. So imagine the potential that we have in this regard. And it's not only about what we have been observing in terms of exports in recent years. Let me just talk about FDI because FDI, I think, can really makes us understand what can happen in terms of trade in Mexico. Here, you will notice the FDI figures in Mexico in the last years. There was a modest increase last year, but the most important thing is the breakdown of this foreign direct investment. 10 or 15 years ago, new investments accounted for 20% or 25% of total FDI. You know something. Last year, this number was 48%. This is telling you that fresh new money was coming to Mexico to the manufacturing sector to tourism to several other productive sectors that will allow also Mexico to grow at a faster pace in coming years. And I think that one other way to observe these things is the announcement of investments that we have been listening since last year. For example, let me just talk about 2022. These are the top 5 investments only in the auto sector. They account for $3.2 billion. But let me tell you something. If you see the names, Volkswagen, Nissan, KIA, most of them are already located in Mexico. They are important players. This is telling us that these firms are giving a lot of confidence to Mexico. And to all the conditions that will make Mexico really take advantage of all of the conditions that I mentioned before and will keep on growing in terms of exports. And now let's look to '23. I mean we're March 2023, only 3 months. And we already have Tesla, $5 billion investment; BMW, almost $900 million. And I can keep on here for hours and hours just analyzing all of the investment announcements that we have been observing in Mexico in the last 12 or 18 months. So this is also one thing that clearly suggests that Mexico has a big potential in this regard. Let me just move quickly with this last chart to analyze what has been happening within the breakdown of Mexican exports because it is not only the auto sector, it is also all other industries that have been increasing in a significant way. First of all, that chart that you see there, I really hope that was S&P 500 or something else. But now it is now in all exports in Mexico, a very significant trend. We analyzed some structural shifts. The most important ones were in the 90s NAFTA in 5 or 6 years ago when there was this trade war between the U.S. and China, and we think that nearshoring will be an additional structural shift, because although Mexico knows how to tackle the situation and it is not new for Mexico, it is not only about cost efficiency, but it's also about managing risks, geopolitical risks logistics risks. That's why we also hear terms like French shoring, ally shoring. And I think Mexico has also a very good things to consider there. The other thing is that look at what has been happening in terms of market share. These are the exports of China, Canada and Mexico in terms of vehicles to the U.S. Mexico is this orange area. In the last 5, 10 years, this market share has increased in a significant way. And given the investments that I just presented to you minutes ago, I think that this trend can continue in years ahead. And last one, let me just go into also other sectors that have been important, because it is not only autos, but also computers, monitors, projectors, appliances surgical instruments, electric equipment, all of them with a very positive trend at least in the last 5 or 10 years. So this is telling you that Mexico is not only specialized in autos, but also has been using economies of scale in several regions in order to also increase the exports of these types of goods. So all in all, I think that the story is appealing. I think that this will be a story that will allow Mexico to keep on growing. And thank you very much for your attention. I invite you to visit our new research website in which you can observe all our research notes, interactive dashboards in terms of trade dynamics in Mexico and several other things that I think will be of your interest. All the information is in Spanish and English. So I'm sure this will help you to analyze what has been happening in Mexico. Thank you very much. And I'll give the word to Rafael Arana, thank you.

Thank you, Alejandro. At Banorte, the last 5 years, we have devoted ourselves to really try to go deep into the artificial intelligent piece and also not just artificial intelligence, machine learning, all that is robotics and things like that to improve our process and guarantee the service to our clients. As you know, 5 years ago, we started with IBM, Watson to try to develop that capabilities for Banorte. We know for the second consecutive year, IBM was recognized on the Gartner 2023 as the best enterprise conversational platform. and Avatar that you will meet here in a minute was instrumental to get -- to receive that recognition. By the way, we have named her Maya. And I will stop here because she likes to present herself. So I will let you with Maya. [Presentation]

Well, Maya is going to present with me, but thanks, Maya. My name is Armando Rodal, I'm the head of the wholesale bank. As we have seen from Alejandro's presentation, the nearshoring opportunity is real, it's already here. It can be as large as we allow it to be. In the next video, you will see how the client-centric model used to serve our wholesale clients, especially our corporate and large enterprise position us very well to take advantage of this opportunity. Together with Salesforce and Medallia, we have developed a powerful engine to maximize value of our clients for listening to their needs directly from them, centralizing our clients and deal information, but using AI tools to build account plans and identify the next best product or next best offers. This client-centric model has brought impressive results. If I increase, can you show the -- okay. Thanks. We have increased 17% on a compound basis rate or not loan revenues, which in is doubling this revenue source in the last 5 years. We are confident that the outstanding results that we have been able to deliver in the past in terms of growth, client development and asset quality represents a solid foundation for the opportunities that we have ahead. Please join me to watch this video. [Presentation]

Well, following we present a video that shows how data analytics and AI are used to help our customers to improve their financial decision-making process. Through our solution, Banorte confirms its leadership in transactional banking services. Please? [Presentation]

Thank you, Armando. With our business model and financial solutions, we are clearly ready to face the challenges of today and tomorrow. [Presentation]

Join me to learn about one of these digital experiences. [Presentation]

Incredible, isn't it. Banorte has convenient solutions to match our clients' day-to-day needs. Now I want you to meet Louise, who experienced one of our unique journeys. [Presentation]

We're pleased to be part of our customers' saving goals without missing the personal touch. Next, let me show you how we create value for our customers when combining the advantages of human interaction with technology to improve our processes. [Presentation]

Now I invite you to see one of the experiences at the branch. [Presentation]

We have worked hard to transform branch experiences that our customers love in a very short time. We are always available when they need us. [Presentation]

It's amazing what we can achieve for banking and financial inclusion in all the communities, right? Definitely, the path forward continues, focusing with investment in the development of new solutions for individuals and get into B2B spaces. Now we can say that developing our capabilities, we have become a digital bank with branches and a bank in minutes. Next, we will hear about our risk models with Gerardo Salazar, Managing Director of Risk and Credit.

Well, thank you very much, Maya. And just to welcome you very warmly. I'm delighted to show how our risk management team does in Banorte. It's -- you're very welcome to see risk the way we do and the way we manage it. I'm going to cover an agenda that consists of 11 points, but do not worry, we will try to be short, quick and precise in covering these 11 points. The agenda mainly consists of the following, the following has to do in the first 3 points regarding risk management by the analysis, the processes and the approaches that we take in doing so. Section #4 is going to be about the Mexican banking sector regulation, which has for the recent events that just happened 5 very important features to be mentioned. In Section #5, we will give some numbers, but also what we do within risk management. We're going to talk about Banorte's risk status as of today. In Section #6 and 7, we will provide 2 very important reasons why our risk management metrics have been so good for the recent years. We're going to talk about the asset liability committee role in doing risk management, also the inventory and importance of our internal risk models, which we consider ourselves leaders within the banking sector. In Point #8, you can see that we are going to analyze the COVID impact of risk handling. We're going to try to go back and remember that event that is almost officially closed, as you know. But in view of the fact that, that represents for us the genesis of hyper-personalization and this is very important to understand the current strategy. One big question is going to be addressed in Section #9. Section #9 has to do with if this credit and financial risk metrics are sustainable or not. The short answer is yes, but we're going to provide reasons, fundamentals and some color regarding the metrics of liquidity, solvency and credit risk quality. In Section #10, we're going to talk about risk culture and risk mitigation strategy. And obviously, we're going to close this part of the presentation at Banorte Day, just with some closing remarks in which we will guide you through 6 principles of risk management within Banorte and also we are going to share some thoughts with you. So regarding the Section #1, what we do. The risk management analysis that we do has to do with the permanent assessment or quantification of potential losses. We do all the time. So those losses can be both expected and respected, but they have an impact on the P&L and also they have an impact on capital. So we don't stop there. We don't just write a report and just deliver it. We will take actions given Banorte's targets and given Banorte's risk capacity, risk tolerance and risk appetite. I will emphasize that. Risk tolerance in Banorte is below risk appetite in minorities below risk tolerance and that in turn is below risk capacity. All the time, for every risk factor, you will see that, yes, we do have the resources, and we do have the talent to undertake more risk, but we don't. The Board is very precise defining and approving the risk appetite that we work within that area. Section #2, risk management processes. And this is a role to be worked in 5 steps. Step #1 is risk identification. Step #2 is risk measurement, evaluation and analysis. Step #3 is risk prioritization. Step #4 is risk treatment, and step #5 is risk control and monitoring. We have a process which reviews these steps permanently. Talking about Section #3, risk approaches within in Banorte met some treatment of each risk factor. Each risk factor has to be or avoided or every risk should be present some retention. Between these 2 extremes of risk avoidance and risk retentions, we do risk reduction and also risk sharing, transferring risk to third parties. You will see that Banorte talking about an example of risk avoidance, we do not -- or we are cypto currency agnostic, for example. We do not do anything within crypto. And with risk retention, you just take on the risk we are comfortable with. So all the time, you -- each and every risk factor will receive this kind of treatment regarding our approach to risk. Section #4, the Mexican banking system has 5 main features that are worth mentioning as of today. And the first one being that Mexico is basically 3 compliant. So we have minimum liquidity metrics like the net stable funding ratio of 100% and also the liquidity coverage ratio of a minimum 100%. The second feature is that we do annually stress testings that have to be compliant, not just with our internal policies and standards, but also with what the CNBV and Mexican regulators have to be approved. Those stress tests are of paramount importance for approving, for example, dividend payments and to just evaluate if we have enough capital to operate. The third feature of the Mexican banking system has to do that with the estimation of expected losses. Expected losses regarding the credit risk factors are estimated daily for the securities portfolio, either for the held to maturity portfolio and also for the available-for-sale securities portfolio. Feature #4, local regulation includes different capital buffers. In the case of Banorte, we have a SIFI buffer systemically important financial institution buffer of 90 basis points. But also we have a capital conservation buffer of 250 basis points. You add up those together is 340 basis points, obviously. But wait, the end is not there. As a fifth feature, I have to mention that we are on track as a system of banks to comply by December 2025 with TLAC, the total loss absorption capacity, and that also requires a buffer. In the case of Banorte, the TLAC buffer is 6.5% that is 650 basis points. All in all, if you add up these 3 buffers, we have 990 basis points in total, which is remarkable for the Mexican macrosystem as a whole, but also in the case in Banorte, which we have to apply those numbers. So what is Banorte risk status? In Section #5, we can mention just 4 aspects as a starting point. And the first 1 is that we have a remarkable capital generation. Internally, we have a system of supply and demand of capital, and we manage it all the time. So from the supply side of internal capital, you will see that the 2 main drivers are obviously net income generation. And the second driver is capital optimization, which results always in a surplus of capital just by managing capital with our internal models. In the other side of capital, internally speaking, there is the demand side. The 2 main drivers of internal capital demand are growth, obviously. And the second very important driver is dividend payments. So this interaction between supply and demand results in a capital surplus. We have a remarkable capital generation that has been seen all these years. You can review the numbers in that regard. The second aspect that is worth mentioning as a starting point for the risk status of Banorte has to be -- has to do with the specific capital buffer that we use, which amounts to 100 basis points. Those 100 basis points are used as a cushion in regard to market volatility of our securities portfolio. That is a buffer self-inflicted if I may say so. It's voluntary. So you will see that, that reflects certain prudency in managing our securities portfolio that is much less than the loan portfolio, but it does present risk, obviously, market risk and credit risk. So if you were talking about this securities portfolio, if you were theoretically to mark-to-market the held-to-maturity portfolio the impact on capital will not be material. It will be just 59 basis points. So we can work through that possibility, although there is no regulation that is telling us to do so. But in the case, we were to recognize mark-to-market valuation in the held-to-maturity portfolio, the impact is just 59 basis points. Our third aspect of Banorte status regarding risk is a solid and automized core deposit base. And this is very important to understand liquidity later on in this part of the presentation. If we take a look at core deposits, you will see that 65% of core deposits are retail. They come from the retail market and almost 60%, 59.x percent are FDIC insured that is EPA insured. But wait, I have to mention this other element. The other element, which is important and comes from the wholesale banking part of the bank is the 32% of deposits have cash management services from our transactional banking unit. So those deposits are also very stable. So if you make some numbers regarding those indicators, you will see that we have a very automized and a very stable base on core deposits, which is very important for us. The 4 aspect of these risk status that I want to share with you has to do with the prudent and active interest rate risk measurement and management. And this is very important. I will tell you and give you some numbers when we try to answer that question if those current risk natures are sustainable or not, I will tell you the numbers, the precise numbers. But I will tell you, as of now, that is risk -- interest rate risk management is managed with maturity transformation of a very modest scope. This is very important for us, and you will see in 1 minute what I'm talking about. So the numbers are the following. You see that the capital deficit ratio closed last year in 22.9% and the minimum regulatory ratios, integrating core equity Tier 1 plus Tier 2 and what is the total Tier 1 is just 13% a little above that because what you see here is that we have, since December 2022, some chunk of capital added because of TLAC we have from 2022 to 2025 to get those 650 basis points I was telling you about a minute ago. So we are fully loaded tech TLAC compliant since day 1. Healthy liquidity or some of the audit metrics, and that has to do with the loan-to-deposit ratio that has averaged 99% in the last years. But as of now, the loan-to-deposit ratio, you can see it is 103%. Liquidity coverage ratio is 155%. So high-quality liquid assets have an excess of 55% of our net outflows in a 30-day horizon. Our deposit base is very diversified. I will call your attention to 2 arrows. These 2 arrows will just emphasize the fact that we do not have a dependence on money market operations to explain the behavior of total bank deposits. What we have is the core deposits explaining almost all the possible and probable behavior of total loan deposits. So we don't have any dependence or relevant dependence on the wholesale market for funding the activities of the bank. Loan portfolio has 3 or 4 main variables that describe the state it has. So robust loan structures, variable rate loan hedges, conservative risk taking and internal models reserves and capital allocations are of paramount importance. You will see that our loan portfolio has very low cost of risk and also a very good coverage ratio. Coverage ratio stood out at 179% by the end of last year. And in the other part, the cost of risk was 1.36% by the end of last year. It has remained stable in 1.4%. If we take some detail and begin to analyze the loan book, you will see that from 2019 to 2022, the loan growth was 21% with a 60 basis point credit risk quality improvement. NPL went down by that amount, 60 basis points below. So if we just make visible to 2 large parts of the loan portfolio, you will see that the wholesale portfolio grew 15% with a 10 basis points quality improvement whereas the retail portfolio grew 27% with a change or credit risk improvement of 120 basis points. We can take a look at -- a big dive in the wholesale loan portfolio. And you will see that for the commercial or large enterprise loan book, we grew 35%, for the corporate banking, the loans grew 13%, and for government, they decreased very slightly, 1%. But in any case, corporate banking presented a credit risk quality improvement of 150 basis points and credit risk quality in the government part of the loan book cannot be better. It is just 0.00%. If we talk about the retail loan portfolio, you will see that the principal parts are mortgage loans with a 33% loan growth with a 30 basis points improvement in NPL. Payroll loans presents 10% improvement and 3% growth, 10% for credit cards with a 300% improvement and auto loans with 150 basis point improvement in quality with a growth of 19%. One of the stories we like to tell internally is the performance of the SME loan portfolio. The SME loan portfolio has presented a 17% loan growth but with a 550 basis points quality improvement regarding credit risk, which is very, very impressive. So you can see with these numbers, that there is no trade-off between risk quality and loan growth. So we don't have to sacrifice loan quality trying to grow our loan book, which is important. Although these metrics are relevant. If you do some quick benchmarking, you will see that Banorte is the best in the business regarding NPL ratio. We are the lowest NPL ratio there is, we are second best in adjusted NPL ratio terms. And also, we are above in reserve coverage ratio, as you can see on the graph below the screen. There is a multidimensional answer to this good performance regarding risk metrics, but 2 of those answers stand out. The first one is the ALCO's role. The asset liability committee role in trying to achieve the metrics you just saw could be explained in structural mandate, follow-up and active management. If I were to invite you to this cell, which is [ Grupo de Capital ] or the ALCO, you will be invited each and every week of the year. You will participate in the approval of very relevant decisions like minimum capital, minimum liquidity buffers, either by regulation or self-imposed by ourselves or discuss decisions as dividend payment, for example. And this is -- this ALCO is multidisciplinary, and that's -- that enriches the options and the decisions that we have whenever we made decisions inside that cell. Follow-up, it's very important for us, and we do lots of follow-ups. Follow-up is important because basically of 2 things. Everyone in the organization owns a risk or several risks. And everyone in the organization is accountable for the performance of those risks. So if you look at any part or any corner of the organization, there is a clear understanding of accountability and risk ownership. The third part that describes the activities within the ALCO has to do with active management, more of a preventive than corrective approach to risk whenever that's possible because we don't have the full solution that we control everything. But in any case, we try to be preventive most of the time. The second possible answer to this very good performance regarding risk has to do with the inventory and importance of internal risk models. We're going to begin with credit risk models. As you can see, between models and sub-models in the retail credit risk, you have 120 models. All in all, they are internal, internal. So some of the things it's for origination purposes or for reserve purposes. I don't know -- I won't go to the whole list, but you can see that in that side, we have 120 models. In the other side, the wholesale bank, we have 28 models, and they come or they go for economic capital and stress testing, for example, and so forth. What is the importance of this inventory of risk models. You can see that they back decisions like portfolio profitability, asset quality, solvency and also sustainable growth. They take a big part and they are a big part of those kinds of decisions. The credit risk models obviously are state-of-the-art. They provide us with optimal reserves and capital risk estimation. They are forward-looking and also they provide us with the possibility to do stress test simulations and timely identification to take corrective and preventive action. This inventory also extends the financial risk models in the banking book. Just we have 13 models in the traded book 55 models, and they provide some elements, which are very important for us. One of the most important is liquidity optimization and capital optimization that have -- has a very positive contribution to those indicators you see at the right-hand side of the screen. Remembering quickly the COVID-19, you will see and you have seen that the cost of risk has remained stable in 1.4% because of risk in 2020 was 2.8% throughout COVID. And also, you have -- you can see the NPL ratio performance closing last year in 1.1%. Why are we talking about this? Because when we backed our customers, which were around 630,000 in the retail side of the market and in the wholesale side of the market, there were 735 customers. We saw the possibility of taking advantage of managing the crisis after apparently was receiving. We learned 3 lessons here: Lesson number one has to do with the termination and agility in decision-making that created a very good sense of customer loyalty. That was a net gain for Banorte. And lesson number two has to do with that we leverage our analytical capabilities to begin offering personalized payment plans that gave continuity to initial programs. But perhaps one of the most valuable lessons that we learned is the third one at the right-hand side of the screen, which we learned the skills developed during the pandemic to allow the analytics, risk and product teams, among others, to extrapolate the lessons and launch a strategy of hyper personalization. That was very important because we took on a deeply granular segmentation strategy to provide custom-made solutions in the retail side of the bank. That doesn't happen very often in this kind of business. So the Section #9 has to do with a very important question, which is our current risk metrics sustainable or not. We're going to talk about first liquidity. If I tell you what is happening within liquidity, you already heard that deposits are automized and stable. But also, we have to trust that we have created throughout the years, the franchise value proposition that we enjoy today, and that it's an investment we keep on doing. Where do you look or how do you measure that franchise value? That's market power because the rate that we pay on our deposits is it grows less speedy or more slowly that the reference rate by the market. You can see that we have not lost deposits in that regard. Technically speaking, we have and we enjoy very low price elasticity of core deposits. So we have deposits that are not sensitive enough to interest rate movements. So that is explained mainly by the kind of expenses and investments we have made throughout the years. We have spent in salaries, branches, marketing, brand positioning, technology, to create value-added services that retain those deposits that make those deposits less sensible to interest rate movements. So price elasticity of core deposits is a reality and that creates franchise value. But when these kind of expenses are exercised year-over-year, you can also see that those expenses are noninterest rate sensitive, which is very important as of today. Liquidity gets connected with interest rate management, and I have to talk a bit about that because if you look at our balance sheet, you could cut in 2 slices the balance sheet. The first slice has to do with a fixed interest rate. The fixed interest rate, you will see that liabilities duration exceeds asset duration, which doesn't permit you to play the maturity transformation game. So you will see that incredibly enough, we are over hedged we have around MXN 57 billion of potential loan origination at fixed rates under the current environment. So the fixed interest rate doesn't present our risk for the bank regarding just managing the gap. So the deposit gap deposits are in excess of loan in terms of duration. In the second slice of the balance sheet, you will see the other regime, variable interest rates. If you look and analyze the variable interest rates, you will see that there, we do play the maturity transformation, the maturity transformation game. So liabilities have a higher duration than deposits. And if liabilities have a higher duration than deposits, we play the yield curve, which if it is positively sloped, it will give us some interest income. But wait, what we have here is a very important thing to recognize. That excess of asset liability over -- asset duration over liability duration is less than a year. So it is very modest. It is very short. That gap is very short and also is very conservative and very prudent. Talking about solvency real quickly, I would say that if we were to deplete. The -- if we were to deplete the capital adequacy ratio all the way from 22.9% to 10.5%, we will need the equivalent of 14 COVID crisis. So what I'm talking about here is that the cost of risk through the pandemic was MXN 7.2 billion. MXN 5 billion, I remember, were general provisions and MXN 2.2 billion were write-offs. So MXN 7.2 billion was the cost of risk of going through the pandemic. So if we were to prove by a stress test, the solvency that we enjoy, the capital adequacy ratio of 22.9% can go all the way down to 10.5%, if we withstand 14x the COVID crisis. So you can attest to that. And also, I would like to share with you another stress test regarding solvency. We were not to replace AT1s. And if we were to pay a 50% dividend, we will still be TLAC compliant, which is very important. So is solvency sustainable? I think, yes. Is liquidity is sustainable? I think, the same answer, yes. The third front in order to answer this very important question is credit. Cost of risk, as I said, was -- at the end of this -- of last year 1.4%. It was 2.8%, if you recall, by 2020 in the COVID crisis. The maximum cost of risk that Banorte has encountered was 4.1% on December 2009. So we have ample room to maneuver even if we multiply cost of risk by 3x. But because of our historic standards, we will be online and flexible enough to maneuver. So talking about risk culture and risk mitigation, there is an interaction between these two. And obviously, the 3 main principles, which is important to do so are risk ownership, effective communication and teamwork. We work in sales. I won't go into detail regarding that. So the risk culture that we have is promotes data-driven decisions, and they also play a big part on the decision-making process. Finally, our closing remarks consist on 6 comments. Our risk culture goes by these 6 very important principles: One, we all consider ourselves risk managers; two, we played the recent anticipation game like we did in the COVID crisis. We even get earlier than public policy regarding the COVID crisis; third, we use a prospective vision; four, we allow for multidisciplinary participation; five, we act on a high level of communication and continuous training; and six, we embrace innovation. Well, to share a thought in this part of the presentation of Banorte Day, what we consider us at Banorte as a financial intermediaries that buy and sell, sell and buy money. We sell and buy securities, we sell and buy data and information, we sell and buy trust, and obviously, as you have seen up to now, we sell and buy customer center experiences. But above all these, first and foremost what we sell and what we buy is risk. Risk is priority number one that is set by our Board, set by our institutional shareholders, set by our own culture, and we are very conscious of selling and buying risk. After that, we can do a lot of things, all right? So many types of risk. Thank you very much. I'll leave you now with Rafa Arana. He will tell you -- will talk about the position and regulation of AT1 notes.

Gerardo, thank you very much.

Thank you.

I will move now to the AT1 situation in Banorte. As you know, Banorte historically has had, I would say, an important number of capital notes on the balance sheet, not just the AT1s, but basically, the Tier 2 on the Basel II and then we move to Basel III. And basically, we start using the AT1s. Let me just give you a glimpse about how is the evolution of the notes in Banorte. This shows you what has been the average through the years about the situation of the capital notes. The Basel II and the Basel III, and you see the average, obviously, is around 30%. You should ask, and I'm sure you're saying why Banorte is doing this? Remember that Banorte is the result of many acquisitions. And every time Banorte acquires an institution, the assets go in front of the liabilities. We always get a lot more assets than liabilities. And if we get liabilities, usually, those liabilities are pretty expensive because are very high cost market funds. So for us, this has been basically the dynamics of growth for Banorte. As you see, once we start building up the liability side, we start reducing the capital notes. But the capital notes for the AT1s have been very efficient for us. Remember that we are not a global bank. So we need to have midterm funding available for us to compete in the dollar market and we have been extremely successful doing that, as you can see in this. This graph shows you how's been the evolution of how Banorte has really been gaining market share in the dollar book. You see to the right, what's the position against our peers in the 2 years, U.S. to dollar on the dollar book loan growth. You see that we are growing 47%. We are becoming one of the key players in the dollar book in Mexico. That's the way we also compete by managing those capital notes on that part. There's also some concerns about what's the regulation about the capital notes and what's the position that Banorte has considering what would be the, let's say, a stressed position that we can get in trouble with the capital notes. You can see first in the graph that is in the middle that in order to -- for us to go down to the 5.1 number that is shown on that part, Banorte needs to go to a loss process of $4.4 billion to reach that number. That's the size of the losses. On the cancel -- on the interest cancellation process, there have to be related to the core Tier 1 or the Tier capital ratio or the capital adequacy ratio. And each of those shows you what would be the size of the loss that you have to incur in order to either trigger interest cancellation process or really problems with the core Tier 1. On the core Tier 1, to move from 15.1 to 7.9, that is the minimum regulatory, it's going to take you $3.2 billion to reach that number. On the Tier 1 capital ratio, it's going to take you $5.7 billion and on the capital adequacy ratio, it's going to take you $5 billion on that part. On the end of the screen, you can see the regulation that rules the AT1s. The first one is the Article 64 that basically what it says is that AT1s have seniority over the equity, okay? But you have to take that into consideration when you link the Article 122, okay? I'm talking about judicial liquidation of the entity. On the Article 122, the regulator says that it cannot only act, and this is critical, only act in the case of capital deterioration. It doesn't show the liquidity part, okay? Only in the case of capitalization problem, and then he can defer or cancel the interest and principal prior to the resolution of the bank. But there's another caveat here, and it goes on the end of the page. If you get government support -- money from the government, then by law, you can go into the liquidation process. And then the AT1s get canceled, okay? If you get money from the government once you get it into the judicial liquidation process. So that's the position that we have with the AT1s. That's why we have built our capital base the way we build our capital base. And another very important piece is that you have to remember that Banorte is a financial group, 2/3 of the assets of financial group are really assets that are not linked to the credit risk positions. It can be linked to valuation, but not a credit risk. That's the insurance company, the annuities company, the pension company that are net providers of dividends and capital to the group. So in an extreme case, you have entities that can provide you capital surplus in a continuous basis for the bank. Okay, let me give you another view about how this process works in Mexico. In Mexico, you have really 3 steps before you get into the process of initial liquidation process. Banorte, as you can see, is what we consider Capital 1 -- Class 1 bank because we cover every single requirement by the regulator. We are well above that. As Gerardo just mentioned to you, we are fully complying with TLAC on day 1, okay? And on Class 1 bank, you see that basically, the capital buffer of 90 basis points, that is included by the systemic risk capacity of the bank is already included in all of those. So if you start moving from Class 1 to Class 2 to Class 3, and you get into Class 4 and Class 5 that once you really start getting to the initial process of liquidation or really integration from the authorities, you need to really go through many steps before that. okay? And I will show you in a minute, what's all the requirements that you got when you move from Class 1 to Class 2, Class 3, Class 4. So this can happen on 1 day. It is a very, very detailed, and I would say, kind of a long process to go into those steps on that part. And I can -- I will show you that in a minute. These are the different steps and actions that you need to take and corrective measures in order to move from Class 1 at Banorte is, then if you go start to moving to Class 2, you have to go into the more corrective measures, you have to submit a capital plan to the regulator. And you have to disclose that you are in that position. On day 1, you have to disclose that, okay? Then you move to Class 3 that you keep on building up the capital plan, but then you start paying dividends, you stop paying dividends, buybacks any investments that could hurt the capital position of the bank really cancel any increase in the salaries of -- and bonuses for the top management, okay? And then you move into Class 4 and Class 5 that [indiscernible] at that point in time, you almost enter in a potential liquidation process. But this is a long process on that part. And it's fully disclosed to the market on day 1. So this is the way the Mexican market works. This is how the potential corrective measures and write-offs of the AT1s could happen in Mexico. So it's a very long process on that part. And remember, what is said on the law only because of capital deterioration process, you can enter into this part on this. And also that in the first article, you see that Tier 1s are senior to equity on that part until you get into the liquidation process. okay? And the other part that is critical is that if you receive money from the government because you are in a judicial process or liquidation process, then in that moment, the AT1s get erased on that part. But that's the only case on that part. But what is important is to understand that how you can reach into the AT1s and I will also like to give you another point about the AT1s. Some people say, well, the AT1s are maybe expensive on that part because of the characteristics of the notes. But it's important to remember that in Banorte, we have 2 type of investors, the fixed one, fixed rate, the bondholders and the equity holders. And we have to manage both in the right way. So we always keep our capital core Tier 1, we have said that from 12 to 12.5 is where we stay on the capital ratio, on our core Tier 1 on that part. Because at that number, we feel very confident that we could manage any risk regarding the market or regarding any issues that we could have with credit or whatever. And we understand that T1s are affecting the capital, okay? We pay the interest using the capital of the bank. And the equity holders, sometimes they say, well, but you are using part of my capital, yes, but we are returning 24%, 25% on that equity. And by the way, yesterday, just the CNBV finally produced the January numbers, and we reached at the bank level, 29.6 return on equity for January. So we are putting in very good use the money that we use on the equity side to produce returns close to the 30% equity for the shareholders on that part. So with this, I just finish my presentation about the AT1s. I hope I conveyed to you how do we manage the T1s and why we use the T1s. We're in a very good position in the market. We manage risk pretty well, as you have seen. We have solvency, liquidity metrics all the time in that part. And we have a bank with very, very high returns on that part. So now we go and walk to the -- to a break, then we will convey in 15 minutes, okay? There's just one more. As you know; Maya is always present. So she wants to say goodbye on to you, okay?

It has been a pleasure to be your guide today. Remember, I'm permanently evolving and learning from humans, expanding my knowledge and available anytime and anywhere I'm needed. Next, we will have a 15-minute break. I hope to interact with you soon.