Popular Inc (BPOP) 2017 Q1 法說會逐字稿

Good morning, and welcome to the Popular Inc. First Quarter 2017 Earnings Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the call over to Investor Relations officer at Popular Inc., Brett Scheiner. Please go ahead.

Good morning, and thank you for joining us on today's call. Today, I'm joined by our Chairman and CEO, Richard Carrión; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano, who will review our first quarter results and then answer your question. They will be joined in the Q&A session by other members of our management team.

Before we start, I would like to remind you that on today's call, we may make forward-looking statements that are based on management's current expectations and are subject to risk and uncertainty. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings release and are detailed in our SEC filings, our financial quarterly release and supplements. You may find today's press release and our SEC filings on our web page at popular.com.

I will now turn the call over to Mr. Richard Carrión.

Good morning, and thank you for joining the call. I'd like to address the highlights and key events of the first quarter, then I will present an update on our business and our thoughts regarding the fiscal and economic situation in Puerto Rico. Carlos will comment on the quarter's financial results, and Lidio will provide an update of credit trends and metrics.

Before we delve into our financial results for the quarter, I'd like to make some comments regarding the announcement we made this morning about changes in our leadership structure.

Effective July 1, I will assume the position of Executive Chairman of the Board of Directors of Popular; Ignacio Alvarez, who has been President and Chief Operating Officer since 2014, will become the new CEO and a member of the Board of Directors of the Corporation.

At 26 years as CEO and with Popular in a strong position, the time is right to begin a transition in our leadership structure. I'm ready, Ignacio is ready and the organization is ready for both of us to assume new roles.

As Executive Chairman, I will continue to work with Popular, collaborating with Ignacio on strategic matters, including mergers and acquisitions, innovation and technology, social responsibility initiatives and government and client relations. As President and COO, Ignacio has demonstrated his strength as a leader, delivering positive results in our Puerto Rico business despite challenging conditions and overseeing the repositioning of our operations in the United States, all while showing a deep understanding of our organization's culture and earning the respect of employees at all levels. He has proven he has the skills, the experience and the vision to lead this organization.

Leading Popular has been the greatest privilege of my life. I am very proud of everything that we have accomplished. I feel fortunate to be able to continue contributing from a new position, and I have absolute confidence that under Ignacio's leadership, Popular will continue to achieve great success.

So let's move on to discuss the results of a very strong quarter. Please turn to Slide #2.

In the first quarter, Popular reported net income of $93 million, up from both last quarter's $4 million reported loss and last quarter's adjusted net income of $89 million. We continued to generate strong revenues with capital levels well above peer averages.

Tangible book value was $43.84, up from $43.12 last quarter.

Our net interest income was up $7 million from the prior quarter.

Our net interest margin at 4.08% increased from last quarter's 4.02% as a result of higher yields on earning assets, a slightly larger asset base and lower funding costs. Our spreads remain strong relative to peers' with our Puerto Rico net interest margin of 4.46%.

We're encouraged by the trends in our U.S. business, particularly the continued strong commercial loan production.

Total NPAs this quarter of $795 million, including covered loans, were up $21 million on higher NPLs in Puerto Rico. Noncovered NPLs were $576 million or 2.5% of noncovered loans, up $18 million from last quarter mainly due to a single commercial relationship in Puerto Rico. NPL inflows, excluding consumer loans, increased by $22 million.

Our net charge-offs were $36 million or 63 basis points of loans compared to $56 million or 1% last quarter. The market value of our stake in EVERTEC is approximately $185 million and significantly exceeds our position's current book value of $42 million.

As investors, we will continue to participate in our proportionate share of the company's income, while our investment also represents an additional source of capital flexibility and potential holding company liquidity.

As evidence of the progress we have made in the past few years, we increased our quarterly common dividend from $0.15 to $0.25. And during the quarter, we also completed a common stock repurchase of $75 million, purchasing 1.5 million -- 1.85 million shares at $40.60 per share.

Please turn to Slide #3. Before I turn it over to Carlos, let me comment on our Puerto Rico government exposures and the Puerto Rico fiscal situation.

Our direct outstanding exposure to the Puerto Rico government is $516 million, down $13 million from the previous quarter. Nearly all of our direct Puerto Rico government exposure is to municipalities, not to central government or its public corporations. We derive comfort from our underwriting process, the structure and the size of this exposure relative to our capital base.

We will continue to monitor developments in this portfolio closely and make future adjustments as needed while selectively participating in funding the Puerto Rico government's capital needs where we feel the risk-reward is appropriate.

Regarding the Puerto Rico government's fiscal challenges, last year federal legislation created a fiscal oversight board for the island and established a legal framework and path towards an orderly debt restructuring. Earlier this year, the Government of Puerto Rico presented a 10-year fiscal plan, which was approved by the board.

Over time, we believe the board and restructuring framework will result in increased fiscal discipline and facilitate a transition toward a manageable debt load. However, given current imbalances, the plan includes the reduction of government spending, which, in the short term, could negatively impact economic activity on the island.

We see some near-term opportunities to offset potential government cuts stemming from improved business and consumer confidence, energy infrastructure development and, hopefully, a paydown of balances owed to suppliers by the Puerto Rico government.

With the board having named an executive director, the most pressing charge is managing the fiscal rebalancing and debt restructuring process. In the interim, at the end of April, the Government of Puerto Rico will submit their budget proposal for the July 1 fiscal year for the board for review.

On May 1, the stay on bondholder litigation under PROMESA will expire. To the extent a negotiated settlement cannot be reached with creditors in the next few days, it is likely that PROMESA's Title III restructuring provision will be invoked. In sum, we believe this legislation and the actions that will follow, albeit painful, are a step in the right direction to restore the fiscal health of the Puerto Rico government and, ultimately, the Puerto Rico economy.

So we do not plan for meaningful economic growth on the island in the near term. We're hopeful over time for the prospect of a manageable debt load, balanced government budget and renewed economic growth.

As the largest financial institution on the island, we will continue to seek to be a source of information, support and advice, particularly on the economic growth front. This is the most critical element in the long run.

Please turn to Slide #4 as our CFO, Carlos Vázquez, discusses our financial results in further detail.

Thank you, Richard, and good morning. Slide 4 presents our GAAP financial results for the first quarter. The prior quarter's adjusted net income can be found on Slide 5, and additional information is provided in the Appendix.

Today's earnings press release details variances from the fourth quarter, driven by higher net interest income and lower operating expenses. Last quarter's reported results were meaningfully impacted by the resolution of the FDIC arbitration. Net interest income for the first quarter was $362 million, up $7 million from the fourth quarter mostly due to higher revenues resulting from a higher volume of loans and investment securities and a higher net interest margin. Our NIM was up 4.08%, up from 4.02% last quarter mostly due to higher asset yields and lower funding cost.

The average yield on our $1.8 billion Westernbank loan portfolio decreased slightly to 8.53% from 8.56% last quarter. Run-off in this portfolio has slowed considerably in recent years. Over time, we expect the yield on this book to decline as a result of prepayments and loan resolutions.

The cost of our interest-bearing deposits was down 2 basis points to 56 basis points.

We continue to deliver organic commercial loan growth in our U.S. operation with growth of 4% in the first quarter. For 2017, we anticipate slight growth in overall loan balances with the U.S. growth more than compensating for Westernbank run-off and limited growth in Puerto Rico.

On the island, we have offset limited organic growth with selective loan portfolio purchases in the last few years. We will continue to pursue this acquisition strategy if attractive transactions become available.

Along those lines, after review of our portfolio and experience to date, we've resumed the purchase of personal loans from Lending Club, acquiring $42 million in this quarter. Credit performance in this portfolio continues to be in line with our initial expectations.

Noninterest income, excluding FDIC loss-share activity, decreased by $6 million compared to last quarter due to the annual recognition on -- of contingent insurance commissions in the fourth quarter, offset in part by higher income from equity method investments.

Excluding last quarter's impact of the FDIC arbitration, FDIC loss-share expense increased by $5 million mainly due to the impact of the quarterly fair value adjustment on our true-up payment obligation.

Our Puerto Rico mortgage business originated $226 million of loans in the first quarter, down from $243 million last quarter.

Total operating expenses for the quarter were $311 million, down $10 million on lower legal expenses, lower IT fees and lower business promotion expense, partially offset by an $8 million write-down related to a discontinued software project.

For the remainder of 2017, we continue to expect average quarterly operating expenses of approximately $320 million as expense categories, such as technology, business promotion and professional services, will have a higher impact later in the year.

Our effective tax rate for the first quarter was 26%. Through the end of 2017, we expect our quarterly tax rate to average between 25% and 27%.

Please turn to Slide #6.

We continue to enjoy strong capital levels relative to mainland and Puerto Rico peers as well as with respect to well-capitalized regulatory requirements. Our Tier 1 common equity ratio declined slightly from 16.5% to 16.3%, reflecting the exclusion from capital of an additional part of our Puerto Rico DTA, as required by existing capital regulations.

As Richard mentioned, we have increased our quarterly common stock dividend to $0.25 per share and completed a 75 million common stock repurchase program. We are pleased to have been able to increase our capital return and payout ratio given our strong capital base.

While being cognizant of the challenging environment in our local market, we will pursue additional opportunities to actively manage our capital, including additional dividends, share repurchases, M&A and asset acquisitions. It continues to be our goal to maintain strong capital levels that are appropriate for Popular's risk profile as we work towards our target of a double-digit return on tangible equity.

With that, I will turn the call over to Lidio.

Thank you, Carlos, and good morning. Despite the continued challenging economic and fiscal conditions in our main market, Puerto Rico, overall asset quality remains stable during the quarter. In Puerto Rico, we experienced a decrease in net charge-offs, an increasing NPL, an improved to NPLs, the last 2 driven by a single commercial relationship of $25 million.

In the U.S., we experienced strong loan growth and stable credit quality metrics. Given the macroeconomic and fiscal conditions in Puerto Rico, we remain vigilant to changes in credit quality trends.

As Richard covered on Slide #3, our current outstanding direct exposure to the Puerto Rico government, municipalities and other instrumentalities is $516 million, decreasing by $13 million from the prior quarter. Our direct exposure to the central government and public corporations is minimal, representing only 40 basis points of total Tier 1 capital.

Our municipality exposure consists mainly of senior parity loans to a select group of municipalities whose revenues are independent of the central government. In most cases, the good faith, credit and unlimited taxing power of each municipality is flushed to the repayment of the loans.

Our top 4 exposures are to Carolina, where the airport and several major tourist hotels are located; San Juan, the capital Puerto Rico; Guaynabo, the municipality with the highest per capita income; and Bayamón, the second most populous municipality. These municipalities comprise 77% of our total exposure.

As discussed by Richard, the oversight board certified an amended fiscal plan for Puerto Rico last month. Among other things, the fiscal plan provides for reductions of general fund subsidies to Puerto Rico municipalities.

Such subsidies constitute a material portion of the operating revenues of certain smaller municipalities though only represent 7% of revenues for the larger municipalities that make up the majority of our portfolio. We also have indirect lending facilities in which the government acts as a guarantor.

The largest such exposure is in the form of residential mortgage loans to individual borrowers in which the government provides a guarantee similar to FHA programs in the U.S.

Turn to Slide #7 to discuss credit metrics for the quarter.

Nonperforming assets, including covered loans, increased by $21 million from $774 million in the previous quarter to $795 million this quarter. The increase in nonperforming assets was mainly driven by an increase of $18 million in nonperforming loans. At the end of the quarter, the ratio of nonperforming assets to total assets stood at 2%, flat from the previous quarter.

Nonperforming loans in Puerto Rico increased by $16 million mainly due to the previously mentioned $25 million single commercial relationship. Excluding this relationship, NPLs decreased by $9 million due to improvements in the rest of the commercial portfolio.

In the U.S., nonperforming loans increased by $2 million mainly due to increases in the consumer portfolio. At the end of the quarter, the ratio of NPLs to total loans remained flat from the previous quarter at 2.5%.

Please turn to Slide #8 for a summary of trends in NPL inflows.

On a linked-quarter basis, NPL inflows, excluding consumer loan, increased by $22 million, mostly in Puerto Rico. The increase in Puerto Rico was mainly driven by the previously mentioned $25 million single-commercial relationship. Excluding this relationship, inflows-to-NPLs decreased by $3 million quarter-over-quarter.

In the U.S., NPL inflows were flat at $6 million.

Turning to Slide #9. Net charge-offs for the quarter amounted to $36 million or annualized 63 basis points of average loans held in portfolio compared to $56 million or 100 basis points in the prior quarter.

The decrease of $20 million in net charge-offs was mainly driven by decreases in Puerto Rico of $7.4 million in mortgages, $6.6 million in commercial and $6.2 million in consumer loans.

The U.S. net charge-off remained stable at $2.7 million compared to $2.8 million in the prior quarter. The provision represented 118% of net charge-offs compared to 72% (sic) [ 73% ] in the previous quarter, driven by increase in the allowance with the taxi medallion portfolio in the U.S. region.

At the end of the first quarter, our taxi medallion portfolio had unpaid principal balance of $237 million. Net of reserves, the current value of this portfolio is $137 million or approximately 58% of its unpaid principal balance, representing less than 1% of our total loan portfolio. 92% of the portfolio is in New York City with an average covered loan value of $384,000 per medallion.

The corporation allowance for loan losses increased to $570 million, up $6 million from the previous quarter, driven primarily by higher reserve for the U.S. taxi medallion portfolio. In Puerto Rico, the allowance for -- the allowance was flat quarter-over-quarter.

The ratio of the allowance for loan losses to loans held in portfolio remained flat at 2.3% quarter-over-quarter. The ratio of the allowance for loan losses to NPLs remained stable at 90% compared to 92% in the previous quarter.

To summarize, despite challenging economic conditions in our main market, our credit metrics for the first quarter of the year remains stable. The continued improvement of our credit -- in our credit risk profile is the result of the steps we have taken to derisk our loan portfolio by reducing exposures to high-risk asset classes and improvements in our credit underwriting criteria. Given uncertainties in our main market, we remain attentive to changes in credit quality trends.

With that, I would like to turn the call over to Richard for his concluding remarks. Thank you.

Thank you, Lidio. And please turn to Slide 10. Before we open the lines to questions, let me conclude today's remarks by reviewing the actions we've been taking to drive shareholder value.

Our healthy revenue generation and our leading market position in Puerto Rico allow us to earn above-average margins. We're encouraged by the progress in our U.S. operations and by the strength of our Puerto Rico franchise.

In spite of the difficult macro environment, we continue to see stability in our main credit quality indicators while remaining attentive to fiscal and economic trends. This improved credit profile, together with our strong capital levels, create a solid foundation for our strategy. We also benefit from our EVERTEC ownership and our stake in Banco BHD Léon, the second largest bank in the Dominican Republic.

In the past 2 years, we have purchased $2 million of assets in the Doral transaction, reinstated and increased our common stock dividend and completed a common stock buyback. Given the fiscal and economic challenges we face on the island, we are focused on the current situation while continuing to make long-term investments in new business initiatives.

The actions taken by the oversight board and the new administration in the coming months will be a defining moment for Puerto Rico's future. We remain confident that Puerto Rico will emerge from the current challenges with a more vibrant and diversified economy, and we will do everything in our power to ensure this output.

Although our company is intrinsically linked to Puerto Rico, Popular's is also a story of a solid organization that has navigated through a complex environment and has emerged as a stronger, better capitalized and more diversified institution. We look forward to reporting on our progress in the next few months.

Now with that, I'd like to open the call for questions.

(Operator Instructions) The first question comes from Gerard Cassidy with RBC.

Can you guys share with us, when you look at the return of capital that you've given shareholders over the last 2 years, when you made your proposals to the New York Fed, did you -- or did they tell you that they had to get it approved out in Washington? Or was it entirely a New York Fed decision?

I think everything gets approved out in Washington these days, Gerard.

Okay. No, no, I agree. And hopefully, there's change coming where that may work in your benefit, if that's the case, going forward or maybe returning more capital.

I haven't gotten that memo yet, I think, but...

And the second question. Richard, you talked about some of the near-term challenges that the island's economy may face due to the fiscal situation. Do you think that could have a near-term impact on credit quality, though you've managed it very effectively? It's been stable on the island. But could that have some sort of negative impact?

Well, I don't think -- depending on what you call near term. But we don't think any of this will flow through until maybe, at the very earliest, late third quarter perhaps but not until early next year. We do -- we'll see the budget in its entirety next week, but we do suspect there's going to be -- according to the 10-year plan, there's going to be a significant reduction in some of the government expenditures, and that will naturally have an impact.

Although as we mentioned, we do see some near-term opportunities. There will be some outsourcing. There will be some privatizations. And that, hopefully, will start putting capital back into the economy.

Great. And then just finally, you guys have always given us good detail on the municipal exposure, that it's obviously separate then from the government exposure. When you guys look at it -- I know you mentioned -- I think Lidio mentioned that the subsidies are -- may drop even though it's not material to the larger municipalities. When you look at the total number, can you give us what the top 3 or 4 municipalities represent of that total number?

Top 3.

San Juan...

Our top 4 municipalities is 77% of our total exposure. Is that what you asked, Gerard?

Yes. Yes. No, that's good. Yes. And then just finally on that, if you use the fiscal situation and what's going on in the economy as a comparison, are any of them -- are any of those large municipalities in as dire shape as the total fiscal situation?

No, not at all.

Okay, good. Appreciate it. Richard, congratulations on the retirement.

Thank you. One -- I'm going to hang around, though. It feels so good to be around.

Okay. Well, I'm glad to hear that, too, then.

All right. Good, thank you.

Our next question comes from Brett Rabatin with Piper Jaffray.

I wanted to first ask on the $25 million credit. Was that directly weighted to the new budget? Or can you give us maybe any flavor on the industry? Any...

Usually, we don't give that type of detail, but it's not related to the government.

Okay.

It has no relation to the government.

Direct relation to the government.

Okay. And then on the expense guidance of $320 million, so does that line item, professional fees, move back higher from here? Or can you give us any color around the increase going forward from 1Q levels?

Yes, Brett, the -- as you know, we tend to not go to granular line by line because each line tends to be volatile. That is why when we gave you the guidance of $320 million, we go to it on the aggregate debt level. But what's driving the number is that there are some seasonality and some timing differences on this quarter's expense level. So to some expenses, that actually will happen, they just didn't happen this quarter, and they touch a bunch of different lines, technology, professional fees, a number of different expense levels. So it is more a matter of timing, and we want to make sure that, that is understood.

Okay. Fair enough. And then on the increase in deposits, can you give us any more color around the $1.7 billion retail versus government deposits? And is -- are those sticky numbers? Does the earning asset base kind of stay at the first quarter levels?

Yes, the -- now, we'll provide more details on our deposits on the Q, but -- and the call report. But the -- all lines of deposits went up, Brett, Client deposits, government deposits. So all -- the performance of every line of deposit business was positive. With regards to your other question of the stickiness of deposits, government deposits in particular, time will tell. We obviously are -- have a significant amount of those and exactly how those will behave, I presume will in part depend on the budget that Richard mentioned -- we'll see next week, and a number of other things. So time will tell.

Our next question comes from Scott Valentin with Compass Point.

With regard Lending Club, I noticed you guys -- you mentioned you restarted the relationship. Just wondering, do you see that growing further going forward? I think back in early '16, you acquired, I think, $80 million a quarter roughly, I think that's 1Q '16. Just wondering if you see the relationship ramping back up to that level.

I think, I mean, at this point in time, we purchased some more. When we discontinued the program, we got -- we had a couple hundred million outstanding, I think, at the time. And overall, we're probably going to gravitate around 2.5. To some extent, we're just replenishing run-off. It's probably going to be in that ballpark. It will depend on how quickly and who'll repay and how quickly they'll repay.

Okay. So the goal is about $250 million running?

Yes, that's probably where it's going to end up, yes.

Okay, okay. And then just on the securities portfolio, pretty significant growth this quarter. Just wondering if that reflects -- obviously, deposit growth was there, but just wondering if that reflects maybe a lack of opportunity or lack of loan demand that you see or if it's you guys being somewhat conservative. And then just in terms of duration and maybe what you guys invested in during the quarter.

Well, I think it's a little of all of the above, but the...

Yes. I mean, the -- you'll recall in the last quarter call we had explained that some of the things that had affected our margins for the prior 3 quarters were the fact that cash was building up and we have been very cautious in putting that cash to work. But part of what you've seen in the investment portfolio is just that we actually to put some of that cash to work. So -- and some of that -- The characteristics of our investments have not changed materially. They continue to be high-quality treasuries or agencies. To a large extent, we have nothing else in there. And the average life is about...

Duration is around 3.4 years.

Duration of about 3.4 years.

Okay, all right. And then just one final question. Because no good deed goes unpunished, congratulations again. The buyback done. Just wondering, when you guys said that...

I have no idea what you might want to ask now.

So just wondering, as you look forward, is the time frame kind of similar, you think, to what it was last year in terms of submission and getting the results back and then finally making an announcement?

Yes, pretty much. In all probability, yes.

Our next question is from Alex Twerdahl with Sandler O'Neill.

I'm just wondering, Richard, with your new role specifically mentioning a particular emphasis on mergers and acquisitions, if any of the criteria for M&A has changed or will change. As you kind of look at various opportunities, are you still thinking New York and Florida primarily? Or is there anything that maybe now should be included as well?

Well, we're focused on those 2 markets as well as earning assets that make sense to us that would either add a team and a new business line. Something that would increase our earning assets or decrease our funding cost is really what we're focused on.

Okay. So you won't be looking to acquire stakes in banks like the BHD Léon or something like that, that's kind of totally out at that point?

We've talked about topping up our stake there to 20%, but we have no specific plans on that one, though.

Okay. And then just to circle back to the discussion about the cash levels on the balance sheet at almost $4 billion now. I mean, is -- how much of that is really directly tied to the government and sort of the uncertainty of what your budget is going to look like over the next couple quarters and what might fall out pretty immediately versus how much you actually feel like you need to have in cash and potentially that you could go to work at over the next quarters?

As I mentioned, it's a bit of all of the above. If anything, we're going to err on the side of caution in terms of liquidity because there is uncertainty regarding how those balances could behave in the next few months. But they're mostly operating accounts, so we are keeping a very close tab. It's just some major events are about to unfold in the next few weeks. So we'll, again, err on the side of caution. Any -- aside from that, there's just few places where we can deploy the money where we'd like to. Loan demand is not as good as we'd like locally, so we're seeing a lot of that in the space.

Okay. And then just my final question. Carlos, I think you mentioned the expense guidance at around -- an average of about $320 million per quarter. Does that include the first quarter? So maybe we're going to be running a little bit above $320 million for the next couple of quarters?

That is for the next 3 quarters.

(Operator Instructions) Our next question comes from Joe Gladue with Merion Capital Group.

I think I just have one question left. I'm just wondering if you could give us a rundown of what you're seeing in regards to deposit rates in your -- the various markets you operate in.

Well, I think locally, we've managed to hold the line so far. We've seen a little pressure in the U.S. operation but not much on to -- we'll see how the next few months. But right now, it's not a concern on either market, less so in the U.S. but it's not been a concern.

This concludes our question-and-answer session and also our conference. Thank you for attending today's presentation. You may now disconnect.