ECONOMIC
Value

Financial strengths of Banorte

2014 was a year in which GFNorte demonstrated it financial strength to achieve positive figures, as shown in the next section, with information based on GFNorte’s consolidated financial statements.

Net Interest Income

In 2014, GFNorte’s net interest income increased 14% YoY (inter-annual) going from Ps 38.738 billion to Ps 44.096 billion, as a combined effect of the following:

1. A 13% increase in net interest income and portfolio origination fees; the latter grew by 11% YoY mainly due to growth in the Government, Corporate and Consumer portfolios.
2. Reduced funding costs due to growth in Core Deposits (+14%), mainly in Demand Deposits (+18%), giving rise along with other factors, to an (11%) decrease in interest expenses. The latter was also reduced by the 50 bp drop in the market benchmark rate in the past 12 months, as well as the August 2013 payment of Ixe’s Perpetual Subordinated Notes with a fixed annual rate of issued 9.75% in US dollars, cancellation of the loan service fee for GFNorte’s $800 million dollar syndicated loan paid on July 26^th, 2013 and the prepayment on April 21^st, 2014 of Preferential and Non-Convertible Subordinated Obligations in the amount of Ps 2.200 billion that were paying a rate of TIIE + 2.0%.
3. A 43% increase in loan placement fees
4. A 33% increase in the Insurance and Annuities companies’ margins.

Net interest income, excluding the Insurance and Annuities companies posted an accumulated annual increase of 12%, going from Ps 35.428 billion to Ps 39.680 billion.

The average net interest margin (NIM) was 4.7% in 2014, 24 bp higher than in the same period last year, due to growth in GFNorte’s performing assets in higher yield segments (the Consumer portfolio excluding Mortgages, represented 14.5% of Performing Loan portfolio at the close of 2014 vs. 13.6% at the close of 2013) as well as by a greater positive impact on investment valuations for the Annuities company.

NIM related to lending activity in 2014 was 8.2%, increasing by 39 bp while the NIM average, excluding the Insurance and Annuities companies, was 4.5%, 19 bp higher than in the previous year.

The NIM average adjusted for Credit Risks was 3.5%, an increase of 8 bp over 2013 due to growth in net interest income and a higher yielding portfolio mix offsetting the annual increase in provisions.

Provisions

Provisions charged to results totaled Ps 11.196 billion, 25% more than in 2013, mainly caused by higher requirements in the Business, SME, Payroll, Mortgage and credit card loan portfolios and the loan exposure to housing developers facing financial problems.

Non-Interest Income

Non-interest income totaled Ps 16.233 billion increasing 10% YoY due to increases of 15% in Service fees, 29% in Trading revenues and 1% in Other Operating Income (Expenses). This offset the (77%) decrease in revenues in real estate portfolio recoveries.

Non-Interest Expenses

The non-interest expenses amounted to Ps 29.232 billion, a 5% YoY increase (in line with Mexico’s annual inflation of 4.08%) mainly due to the strengthening of business areas and the operational infrastructure expansion, which was partially offset by decreases in other concepts. The Efficiency Ratio was 48.5%, (3.6 pp) lower YoY, due to the positive operating leverage achieved in the period.

Taxes

Income taxes totaled Ps 5.668 billion, 59% higher YoY. The current rate for taxes and accumulated Employee Profit Sharing was 29.8%, 7.0 pp higher compared to the 22.8% for the same period in 2013.

Net Income

Net income totaled Ps 15.228 billion in 2014, 13% higher compared to 2013, due to the positive operating leverage achieved, an annual growth of 13% in total income, as well as a reduced growth rate in operating expenses, effects that offset growth in loan costs and taxes; in addition to the decrease in minority interest as a result of buying out IFC’s participation in Banorte and Generali’s participation in the insurance and annuities companies. Together with Afore XXI Banorte and SOFOM, they have presented a favorable business dynamics.

ROE for 2014 was 13.2%, decreasing by 99 bp over the same period last year due to the dilution effect of the equity offering last year; while ROTE was 16.4%, decreasing 2.3 pp compared to that registered in 2013. On the other hand, ROA for 2014 was 1.5%, an increase of 5 bp over the same period of last year, due to growth in net income, as a result of a better mix and returns on assets. RAPR was 3.1% in 2014, increasing by 8 bp over 2013.

Performing loans increased 11%YoY, growing by Ps 46.769 billion to close at Ps 471.606 billion at the end of 2014, excluding the proprietary portfolio managed by the Recovery Bank. The Loan portfolio has recovered to shift to growth levels not seen since the end of 2012 due to the gradual economic recovery and maintaining a growth rate higher than the national economy’s. Corporate and business portfolios (included in the Commercial portfolio) continued to receive prepayments from customers (approximately Ps19 billion in 2014). However, during the last quarter, these began to be compensated by new loan originations in both segments, achieving annual growth

Past Due Loans

At the close of 2014, Past Due loans totaled Ps 14.294 billion, 5% higher compared to 2013, as a result of growth in past due loans of some Commercial (including SMEs), Payroll, Credit card, Mortgage and Car loans, which failed to be offset by the significant reduction in Corporate Past Due loans. The PDL Ratio was 2.9%, 17 bp lower than that registered in 2013 due to a lower PDL Ratios in the Corporate, Credit card and Payroll segments.

When excluding the Past Due loans of the three housing development companies in financial problems, the PDL Ratio would be 1.8%, 30 bp above the level registered one year ago.

At the end of 2014, total deposits for GFNorte totaled Ps 497.922 billion, an increase of Ps 54.181 billion or 12% YoY, driven mainly by efforts to promote Banorte–Ixe’s deposit products as well as the significant increase registered in account balances of some clients, especially in GovernmentBaning since the end of 2013. In the Banking Sector, core deposits totaled Ps 498.697 billion, which represented an increase of 12% YoY or Ps 54.549 billion pesos, comprised of increases of 18% in Demand Deposits, 5% in Retail Time Deposits and 4% in Money Market deposits.

Our credit ratings

One form of recognition of GFNorte’s financial strength is the credit rating that different agencies have determined

Risk Management

As a financial institution responsible for the ministration and increase of the patrimony belonging to our clients and their families, we are responsible to use strict risk management systems.

Our main banking risks are loan risk (individual and business), portfolio risk, of financial instruments, market risk, liquidity and balance risk, operational risk, annuities risk, technological risk, legal risk and sustainability risk. We also have insurance risk.

In the case of the Consumer, Housing and Commercial portfolios, Banorte applies regulations relating to loan ratings issued by the National Commission of Banking and Securities.

Since June 2001, Banorte has also applied an internal risk rating methodology (CIR Banorte) to Commercial loan portfolios which establish the rating of a debtor. In assessing the credit worthiness of debtors using the Banorte CIR, risk and payment experience was calculated in a specific and independent manner as follows:

Each of the risk factors is analysed through descriptive evaluation charts whose result indicates the rating of the debtor, which is approved to the degrees of risk established by the Commission.

Banorte’s integrated risk management unit (UAIR) is in charge of identifying, measuring, monitoring, limiting, controling, informing and disclosing the various types of risk to which the Bank is exposed, and is in charge of the Directorate-General for Risk Management (DGAR).

Social and environmental risk management system (SEMS)

As one of the most important steps to identify, manage and mitigate risks associated with our loan portfolio, as from the end of 2012, GFNorte has implemented a Social and Environmental Management System (SEMS), enabling the identification, categorization, assessment and monitoring of risks associated with loan portfolios for Corporate and Business Banking, Government Banking and Structured Finance.

This year we improved our analysis of socio-environmental risks, to analyze all registered loans.

The results of management in 2014 are summarized in the following table.

For 2015, we plan to optimize the system’s function by increasing its coverage and efficiency and reinforcing the process of continual improvement.

Similarly, an evaluation of loans based on the Equator Principles was carried out, an initiative of the International Finance Corporation (IFC) created in 2003 with the objective of ensuring that projects financed by the signatory organizations develop in an environmentally and socially responsible manner, reflecting sound environmental management practices.

During the year a total of 47 Equator Principal financings were authorized, of which 3 received an A classification, 4 received a B classification and 40 were classified as C. These financings were the subject of an in-depth analysis on social and environmental risks and the fulfillment of their obligations is being monitored.

Once an analysis is done, we can offer clients consultancy specializing in social and environmental matter, minimizing financial risk and offering an added value of knowledge in areas of opportunity for their projects.