Popular Inc (BPOP) 2018 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Popular, Inc. Q2 2018 Earnings Conference Call. (Operator Instructions) Please also note today's event is being recorded.

At this time, I'll turn the call over to the Investor Relations Officer at Popular, Inc., Brett Scheiner.

Good morning, and thank you for joining us on today's call. Today, I'm joined by our CEO, Ignacio Alvarez; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano. They will review our second quarter results and then answer your questions. They'll 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 risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release and are detailed in our SEC filings, our financial quarterly release and supplement.

You may find today's press release and our SEC filings on our web page at popular.com.

I'll now turn the call over to Mr. Ignacio Alvarez.

Good morning, and thank you for joining the call. We are very pleased with the results for the second quarter. In addition to us achieving a successful termination of our FDIC loss-share agreement, we produced excellent financial results. These results were primarily driven by strong top line revenue growth in our Puerto Rico franchise, where the economy continues to recover from the impact of Hurricane Maria. Debit and credit card activity after the storm was severely impacted by power and telecom service interruption. However, for the second quarter, the dollar volume of our clients' transactions exceeded the second quarter 2017 by 17% reflected in higher fee income.

Similar to last quarter, consumer loan origination was approximately 96% of our second quarter 2017 pre-hurricane level. The trends are encouraging with credit demand in some sectors like auto and personal loan continuing to grow at a faster recovery compared to others such as mortgage. New car sales in Puerto Rico for 2018 through June are up 20% from the same period last year, while our auto loan production is up 29%.

Cement sales showed continued strength up 24% year-to-date over 2017. On the commercial side, we expect additional lending opportunity to arise as the economy continues to recover. The recovery of the Puerto Rico economy following this storm has been very encouraging. However, the sustainability increased -- and pace of this recovery will be heavily dependent on the magnitude and timing of federal recovery and private insurance fund flowing into the island.

Insurance companies continue to make advances, and the pace while slower than many would like, has yielded over $3 billion out of an amount estimated by the Puerto Rico oversight board to exceed $8 billion. Regarding federal fund, approximately $6 billion has been dispersed in emergency relief assistance to individuals, public corporation and municipality. The Puerto Rico fiscal board anticipate an additional $8 billion of federal and insurance fund to be dispersed in the next 12 months and over $50 billion of federal recovery funds in the next 6 years. This inflow will have a stimulative impact on the economy. The effect will be tempered somewhat by the government austerity contained within the recently approved fiscal plan. The plan contains a number of budgetary and structural reforms designed to improve fiscal stability on the island. The successful execution of this plan will require discipline and increased cooperation between the oversight board and the local government. Recently released passenger data from the San Juan Airport reflects that the net number of people who left the island from September to March is approximately 124,000, significantly lower than the figure that we provided in the first quarter. This is mostly due to the return of 71,000 people in the first 3 months of 2018. These statistics are consistent with recent publicized data regarding Puerto Rico cell phone usage by geography.

In line with these figures at the end of June, employment has stabilized down only 2.2% or 19,000 jobs at September. We expect additional hospitality jobs to bolster these figures once larger tourist hotels reopen later in the year and in the first quarter of 2019. Notwithstanding the impact of the hurricane and the declining population, our deposit and number of customers have continued to increase. Looking beyond the immediate stimulative impact of the recovery process, the island's long-term economic prospects will depend on the decisions regarding Puerto Rico's ability and the implementation of required structural reforms.

We should take the unique opportunity provided by this short-term stimulus to implement those structural reforms that are essential to achieving long-term sustainable growth. I'd like to address the highlights of the second quarter. But before I do, I am pleased to report that this morning we announced our intention to execute $125 million common stock repurchase.

Please turn to Slide 3. In the second quarter, Popular reported a net income of $280 million. Excluding the impact of the termination of our FDIC loss-share agreement, adjusted net income was $121 million compared to last quarter's net income of $91 million. While much of the discussion in the last few quarters had centered on the hurricanes, we continued to execute on our growth strategies.

We grew commercial loans in our U.S. business by 4%, increased our total deposit base by over $2 billion in our combined market, and we received regulatory approval to purchase $1.8 billion of auto loans in Puerto Rico. Our capital levels remained strong with Tier 1 capital and Tier 1 common ratios at 17.5% at quarter end. Regarding credit quality, during the quarter, we saw a normalization of the activity following the hurricane and the related moratorium. Total nonperforming assets of $785 million were up slightly from $779 million last quarter. Nonperforming loans increased to $643 million from $607 million as a result of 3 commercial loans. 2 of which are in Puerto Rico and 1 in the mainland U.S.

Nonperforming loans were 2.6% of loans compared to 2.5% last quarter. Our second quarter sales of OREO exceeded pre-hurricane levels. Lidio will explain these results later in the call. The key takeaways from this quarter's results were strong revenue growth in our Puerto Rico operation with client activity and fee income now exceeding pre-hurricane levels in most lines.

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

Thank you, Ignacio, and good morning. Slide 4 presents our results for the second quarter. Additional information is provided on Slide 5 and the appendix to the deck. Today's earnings press release detailed variances in the first quarter driven by higher net interest income, higher fee income and our lower loan-loss provision, offsetting part by higher operating expenses. Net interest income for the second quarter was $414 million, up $21 million from the first quarter on higher volumes and rates on loans and investments.

Our net interest margin was 3.81% down 8 basis points from last quarter. The reduction in margin continues to be driven mostly by asset mix as the largest increase in balances was concentrated in our lower-yielding investment portfolio. Our overall loan yields were up 12 basis points. The cost of our interest-bearing deposits was up 4 basis points to 61 basis points, mostly due to higher volume of Puerto Rico deposits and higher deposit costs in the U.S.

During the quarter, we terminated our FDIC loss-share agreements related to the 2010 purchase of Westernbank, which resulted in a benefit of $159 million. Given this termination, we are now presenting the $1.7 billion Westernbank loan portfolio broken up into the applicable loan categories. Activity from these loans will no longer reflect an FDIC loss-share income or expense.

On February 14, we announced the agreement to purchase $1.8 billion of consumer auto and auto-related commercial loans in Puerto Rico from Wells Fargo. We continue to expect this acquisition to contribute approximately $34 million of net income for the first 12 months after the closing. Additional information is available in the 8-K we filed in connection with the announcement of this transaction. We are still targeting to close the transaction on August 1.

Excluding the reliable acquisition, for 2018, we anticipate slight growth in overall loan balances with continued growth in the U.S. and stable balances in Puerto Rico. Our U.S. operations commercial portfolio grew 4% in the second quarter. For the second quarter, net interest income, excluding FDIC loss-share activity, increased by $11 million. We saw fee income improve across nearly all categories other than mortgage banking. Our Puerto Rico mortgage business originated $169 million of loans in the second quarter, up from $145 million in the first quarter. Despite this improvement, originations seem to be leveling off at a pace below pre-storm levels.

Total operating expenses for the quarter were $338 million, including an $8 million impact of costs related to the FDIC termination. Excluding this impact, operating expenses were up $8 million from last quarter. This was due mostly to higher professional fees and increased credit -- card-related activity, including interchange, processing and reward programs. Excluding the impact of the Reliable acquisition and the expenses related to the FDIC loss-share termination, for the full year 2018, we expect operating expenses to average $331 million per quarter on slightly higher personnel and technology cost as well as higher professional fees. For the full year 2018, we expect our tax rate to be approximately 22%, incorporating the effects of U.S. tax reform. Please remember that the U.S. tax reform only affects Popular's U.S.-based income.

Please turn to Slide 6. We continue to have strong capital levels relative to peer banks as well as with respect to well-capitalized regulatory requirements. Tangible book value in the quarter was $44.78, up $2.17 from last quarter as book value contributions from the FDIC transaction and our operating earnings were slightly offset by the payment through our quarterly common stock dividend and rate-driven unrealized losses in our securities portfolio. Our Common Equity Tier 1 ratio was 17.5%, up 70 basis points on the quarter.

Regarding our capital actions, as Ignacio mentioned, we intend to execute $125 million stock repurchase as our regulatory discussions have been completed. As mentioned in the past, we'll continue to pursue our target of a double-digit return on tangible equity, while keeping capital levels are appropriate for Popular's risk profile.

With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. In Puerto Rico, we are seeing normalization in our credit quality metrics after Hurricane Maria. Generally, these results are within or par from the assumptions used to create our hurricane reserve in the third quarter of last year.

In consumer lending, early delinquencies, our nonperforming loans are near or below pre-storm levels. Consumer charge-offs have been somewhat volatile post hurricane impacted by the payment moratorium and the temporary suspension of collection activity. The consumer net charge-off ratio for the second quarter of 2018 was 2.88% comparable to the second quarter of last year at 2.81%. In the mortgage portfolio, total delinquency is near the pre-hurricane level, but there has been a shift from early delinquency to nonperforming loans. As of the end of the second quarter, mortgage NPLs stood at $273 million, an increase of $66 million compared to the year-ago period prior to the storm. However, 30 to 89-days delinquencies have decreased by approximately $60 million during the same time frame.

Mortgage charge-offs were relatively high during the moratorium when -- with the interruption of collection activity, the number of loans subject to credit loss increased. However, for the second quarter of 2018, mortgage net charge-off were below pre-hurricane levels.

In commercial lending, overall credit metrics during the quarter remained stable and near pre-storm levels, despite higher quarter-over-quarter NPL influence. The increase in NPL influence was driven by 2 customers in Puerto Rico with an aggregate loan amount of $46 million. Net charge-off in the second quarter are below pre-hurricane levels. In the U.S. we recorded our provision for loan losses of $9.8 million and charge-offs $10.4 million related to our taxi medallion portfolio, impacting the U.S. credit metrics for the quarter.

The construction loan portfolio also experienced an NPL increase driven by a single borrower. Excluding these, asset quality in the U.S. remained strong.

Please turn to Slide #7. At quarter-end, our outstanding direct exposure to the Puerto Rico government, municipalities and other instrumentalities is $481 million flat from the prior quarter. At the end of the quarter, we had no direct exposure to the Puerto Rico central government or its public corporations. Our municipality exposure consists mainly of senior priority loans to a select group of municipalities whose revenues are largely independent of the central government. In most cases, the good faith credit, our limited taxing power of each municipality is pledged to a repayment of the loans.

Our municipal borrowers typically make 2 payments annually: interest on principal on July 1, interest on January 1. In the interim period, prior to the next payment, property taxes for mortgage, residential and commercial properties are collected in escrow by the servicing banks and remitted to a central collection agent for the municipalities. Accordingly on July 1, we received the scheduled principal payments of $23 million from municipal borrowers.

Our top exposures are to 4 large municipalities in the San Juan Metro area: Carolina, where the airport and several major tourist hotels are located; San Juan, the capital of Puerto Rico; Maunabo, the municipality with the highest per capita income; and Bayamón, the second-most populous municipalities. These municipalities comprise 74% of our total exposure.

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 associate programs in the U.S.

Turning to Slide #8 to discuss credit metrics for the quarter. As discussed in introduction, credit quality metrics in Puerto Rico continue to normalize after Hurricane Maria. Nonperforming assets increased by $6 million to $785 million this quarter, driven by a nonperforming loan increase of $36 million offset in part by an order decrease of $26 million. The increase in NPLs was driven by higher U.S. construction NPLs of $18 million and Puerto Rico mortgage NPLs of $15 million. The U.S. construction NPL increase was driven by a single borrower. We do not expect a loss given the collateral underlying the loan. At the end of the second quarter, the ratio of NPLs to total loans held in portfolio increased slightly to 2.6% from 2.5% in the prior quarter. The decreasing OREO was mainly in Puerto Rico, driven by the combined effect of the resumption and acceleration of sales efforts and lower inflows due to the suspension of our flowchart activity as a result of Hurricane Maria.

Please turn to Slide 9 to discuss NPL inflows. Compared to the previous quarter, inflows of NPL held in portfolio increased by $51 million, mainly driven by higher inflows in the Puerto Rico commercial portfolio of $39 million due to 2 relationship totaling $46 million, coupled with higher inflows in the U.S. construction portfolio prompted by the previously mentioned borrower. Puerto Rico mortgage inflows remained stable.

Turning to Slide #10. Net charge-off amounted to $58 million or annualized 95 basis points of average loans held in portfolio compared to $53 million or 90 basis points in the first quarter of the year. The increase of $5 million for the prior quarter was mainly driven by higher Puerto Rico commercial net charge-off, mostly related to loans we served in the prior quarter. In the U.S., net charge-off increased by $2 million related to the taxi medallion portfolio. The corporation allowance for loan losses increased by $36 million from $607 million to $643 million, mainly driven by increase of $33 million in Puerto Rico due to the reclassification of the allowance from loans previously classified as corporate.

The provision for loan losses decreased to $60 million from $69 million in the prior quarter or the provision for Puerto Rico decreasing by $12 million, which includes a downward adjustment of $9 million to the reserves associated with the Hurricane Maria. The provision for the U.S. increased by $3 million driven by the taxi portfolio. At the end of the second quarter, our taxi medallion portfolio had an unpaid principal balance of $222 million. Net of reserves, the carrying value of this portfolio is $56 million or approximately 25% of its unpaid principal balance, representing less than 1% of our total portfolio. 95% of the taxi portfolio is in New York City with an average current loan value of $162,000 per medallion. Excluding the impact of the U.S. taxi medallion portfolio, the U.S. operation continue to reflect strong growth and favorable credit quality metrics.

To summarize, credit metrics in Puerto Rico continue to show signs of recovery after the effects caused by Hurricanes Maria and Irma. Second quarter results reflect a normalization of credit quality with lower charge-off and stable delinquency compared to pre-storm levels. We continue to monitor credit quality and macroeconomic trends but are encouraged by recent figures.

As I mentioned in the beginning, the credit results are within or better from the assumptions used to create our hurricane reserves in the third quarter of last year.

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

Thank you, Lidio and Carlos for your update. Please turn to Slide 11. Our second quarter results reflect strong margins, higher net interest income and fee income growth combined with relatively stable credit metrics. There are many factors that are driving value for our shareholders: strong earnings, robust capital and executing on opportunities in our market. Our franchise in Puerto Rico continues to demonstrate its strength. It has proven its value in a wide variety of scenarios, many of them extremely difficult. Looking ahead, there are many moving parts, but we have no doubt that we will manage challenges and seize opportunities to deliver solid results. We look forward to closing the acquisition of Wells Fargo's auto loan business in Puerto Rico in the third quarter, which will contribute favorably to our earnings in the second half of the year. We are also encouraged by the growth in our U.S. business and a strong pipeline. This year in October, we will celebrate our 125th anniversary. We are proud of our history and even more excited about our future. While we are monitoring macroeconomic trends, we are focused on the future ready to take advantage of the opportunity that lie ahead. We look forward to updating you on our progress. Thank you for your time, and we are now ready to answer your questions.

(Operator Instructions) Our first question today comes from Alex Twerdahl from Sandler O'Neill.

First off, I was wondering if you could share with us, what the pro forma Tier 1 common equity ratio will be after the Wells deal closes on August 1?

The Common Equity Tier 1 will drop by about 140 basis points.

Okay. And then as we -- obviously great to see the buyback announcement this morning, very widely expected. But as we kind of think about the timing of announcements and capital return in the future, are we -- now that DFAST is no longer really a concern, are we still limited to kind of one announcement per year? Or do you think it can be more of a fluid thing going forward?

Yes. We've been sort of in a January cycle for the last couple of years, except this year, obviously, because of the effect of the storm. What we are trying to make sure -- we could conclude discussions this year in the summer, and we are trying to get back on cycle, if we can, while we do not have to publish our stress test anymore. We will conclude it shortly, and we will start discussions again with our regulators after we do that. We are still hoping that again we can sort of get back on schedule and those discussions can be concluded by early next year, but time will tell. We're obviously hoping that there is no hurricane this year too.

As we're all hoping for that. And then just in terms of the execution of the buyback. Last year, you did an accelerated share repurchase. Is that the plan, again, this year? Or do you think you'll do it in the open market?

We concluded our discussions, literally, like 3 hours ago. So we haven't even started to work on the execution yet. So nothing to comment on that yet.

Our next question comes from Brett Rabatin from Piper Jaffray.

I wanted to first ask just thinking about the deposit generation you had this quarter. Can you talk about maybe how much of that was related to inflows on sort of the insurance monies and whatnot, maybe some HUD money and then just also wanted to get some commentary, if possible around kind of managing the margin from here, and if you'll just stay really liquid or if you'll start to use more of that possibly for depending on the margin so to speak?

I'll let Carlos come on a little bit later. This is Ignacio, Brett. I think we have -- our deposit growth has been mostly from the private sector and public deposits. We haven't seen a large inflow of the insurance ones yet directly through insurance companies and the HUD money, really the HUD money is going to begin in August. So we haven't really seen, if you're talking about the community development block grants, that's going to begin in August. So out of these, some of the insurance money runs through our clients when they collect. But I don't think that really explains the increase. I think it's mostly just the growth on our retail, commercial, private clients and the public deposits. And in the margin, I mean, we're going to be spending a good (inaudible) liquidity soon on...

On the margin, we are hoping to redeploy about $2 billion of cash shortly in the next weeks to much higher-yielding auto-related loans, so that'll use some of it. As far as the rest of the additional liquidity, it's that -- we've been saying for a couple of years that we expect government deposits to have hit top and start going down, and we've been wrong for a couple of years. So we will continue to monitor that and be a little bit conservative on how we really deploy that, but there will be a couple of billion dollars of less cash sitting around, hopefully, in the next few days.

Okay. And then if you look at auto sales here the past few months, they've been really strong. Do you have any visibility of that into maybe the current quarter? And then just -- is that something that you're capitalizing on in terms of -- you mentioned you expect flat balances in the PR loan portfolio. Just is there any mix-shift change in that? Or can you talk about maybe any incremental opportunities in the auto space?

Well, I mean, beyond the Reliable transaction...

Other than $2 billion additional.

As you saw, our loan production, as we mentioned in the prepared remarks, we are up almost 30%, 29% for the quarter. So the market continues strong. We continue to see new loan auto sales go up. The statistics that you see are new car sales, it's impossible to measure used car sales, but they are also strong in Puerto Rico right now.

Okay. And then just lastly the mortgage NPL inflows were down just a little bit linked-quarter. Do you have any visibility into just kind of post the moratorium? I know there are 3 different options for people who were looking to catch up or make payments that hadn't. Can you talk maybe if what you're seeing suggest that those could continue to decline or any thoughts around the mortgage NPL inflows kind of post the moratorium and visibility into that number?

I think as we -- as stated before, and we also discussed in the prepared remarks, when you look at the total delinquency, the reality is that, we're flat when compared to pre-storm levels. However, the mix had shift from early delinquency to late delinquency, we are increasing NPLs of about $66 million and they can commit and decrease early delinquency of $60 million. Some of it is driven by the moratorium and execution of -- in the most cases (inaudible) is not being enough to bring all of our clients' current. And now we're working through those clients in which the (inaudible) was not sufficient to work through in terms of bringing them current. I expect that those will continue to normalize in the third and fourth quarter of this year.

Our next question comes from Arren Cyganovich from Citi.

Just want to follow up on the deposit growth. I think it's 7% quarter-over-quarter, 17% year-over-year. You mentioned that it's not really insurance or government aid. I'm just surprised by those numbers if it doesn't include a decent portion. Just help me understand that.

No, it does include public deposits, yes. The public deposits, in fact, they're up quite a bit in the second quarter. What I'm saying is the insurance -- we don't -- I don't attribute a lot of that to the insurance fund, not yet anyway.

But keep in mind as well that our actual number of clients has gone up as well. So we actually have more clients too, both in the retail and in the commercial space.

Great, okay. And then I think you put some number or expectation around insurance claims on the island in your prepared remarks. Could you repeat those numbers?

That's actually provided by the fiscal oversight board and they're estimating $8 billion, from private insurance and things. But $8 billion have been paid to date.

Excellent. And then also touching on yet a couple of commercial NPL inflows for the quarter. Yet the reserves were actually somewhat lower or does just previously reserved for part of the original hurricane reserve, I'm trying to get -- understanding around the movements there.

I think as we also in our prepared remarks, the levels that we're seeing in terms of NPLs charge-offs are within or better than the assumptions we use when we built-up the reserve during the third quarter of last year. So it was included in those.

Okay. So now it's specific, but previously it was included in more of a broader...

Broader sense, yes.

Our next question comes from Gerard Cassidy from RBC Capital Markets.

This is actually Steve Duong in for Gerard. Just going back to on capital, you guys just announced this buyback $125 million, and that's about 25% in your earnings and you have a dividend of another 25% So you're around 50%. And you have this -- the Well's acquisition coming in, which would take about another 140 basis points, I think. So what is the run rate CET1 level that you guys want to reach? When would you want to reach that? And how do you plan on doing that?

The level that we want to reach is lower than where it is. When we were going to reach it? We're unclear. And how to do that is we're going have to do all of the above. We will have to, hopefully, continue our path to follow the trend of our peers as far as the level of distribution they are making of earnings. We are going in the right path. We are following our peers, although, we're not quite a peer level obviously. We will continue to look at capital deployment opportunities, like the Reliable transaction we are hoping to close in the next few days. If there are any assets that are available we will continue to look at those. But in the bottom line, we're going to have to do all of the above to help our capital levels move lower. And in the meantime, we are blessed with making a lot of money, which doesn't go, if there was that goal, but it's actually a good context in which we try to achieve.

Always a good problem to have. And then so just to follow up on that then. So far this year, we've been seeing more accommodation from regulators for the CCAR banks. Are you guys getting a similar posture with your discussions with your regulators?

We got an answer. I don't know -- we're not, obviously, distributing capital at the level they are yet. And obviously, that reflects I think the regulators' continuing concern about Puerto Rico, especially, after the storm. But we continue to try to close the gap little by little.

Our next question comes from Ken Zerbe from Morgan Stanley.

I guess, just in terms of -- you mentioned that you're going to deploy a lot of this $2 billion of extra funds or cash, I guess, into higher-yielding assets like the auto portfolio. But could you just help us understand sort of the need for liquidity and -- because I'm just thinking about the additional disbursements that are coming due and presumably you're going to have more public funds money coming in, but deploying it into longer-duration assets versus keeping it in cash and how do you think about the need for liquidity versus like money coming out from deposit outflows?

Well, we're obviously a very liquid bank right now. If you add up our cash and investment portfolios and you look historically, it's a bit higher than it has been historically. So if you look at our historical trend, that will tell you as far where we would like to be as far as the portion of our assets, our investments and cash that had been fairly steady in the past. It's a bit higher now. So it is situational. We do have a lot of cash right now that bumps that up. If we get -- if we can reach to a conclusion that a significant amount of the additional cash we received will be around for a while, then it will be redeployed into higher-yielding investments. We'll keep in mind that our investment portfolio is very conservative. As you know, we only have agencies and treasuries within the portfolio, there is no municipals, there's no corporate, nothing like that. So our debt portfolio is actually quite conservative. So we -- and the best way to redeploy the cash will be if we can -- if as part of the recovery in Puerto Rico loan growth goes up, then that will be the best use of the cash because those are the best yielding asset always.

It sounds like the presumption those that was -- of the $2-ish billion of additional deposits that came in. If you're going to redeploy it, presumably, you would expect all that to stay?

No. We don't know how much of that is going to stay. So the presumption is that it's here, but we don't know how much it's going to say. If we can reasonably conclude that a portion of that will stay, then it will be redeployed.

I think to answer your question, we're not concerned I mean, we could have a significant reduction in deposits and the $2 billion outlay would not be an issue. So we have plenty of space, plenty of liquidity. So we -- it's a dividend reduction in our deposits would not effect.

Got you. Understood. And sorry if you covered this in your prior comments. Just in terms of the -- have you seen acceleration in loan growth? I mean, do you anticipate or seeing signs that loan growth could actually pick up more particularly on the island, given some of the rebuilding?

I think as we've seen -- we've seen the consumer come back in a sense that with the exception of mortgage loan, obviously, auto loans are way up. We're starting to see credit card and personal loan activity pick up. In commercial loan growth, it's been slower, but anecdotally our loan officers are telling us we're getting a lot of inquiries, a lot of proposals are coming in. So we do anticipate that as the recovery progresses and more money actually flows into the island, because keep in mind, a lot of the money you hear about has been approved and assigned, but has not been dispersed. For example, the HUD almost -- HUD has approved almost $20 billion for Puerto Rico and original $1.5 billion assignment followed by $18 billion, not a penny of that has been expanded yet. We do expect as that money flows in to economy, the loan growth will -- demand for loan growth will pick up. And we're -- anecdotally we're hearing a lot of customers coming in floating proposals, but we haven't seen the disbursement of any of those loans yet.

There's a lot of discussions going on, Ken. But we prefer to discuss book loans than proposed loans. And those are -- yet to occur.

Our next question comes from Scott Valentin from Compass Point.

Just with regard to the 2 Puerto Rico borrowers, the 2 commercial borrowers. Were they in the same industry by chance or is it just isolated?

No, there were not in the same industry.

And then in terms of noninterest income, you guys had a very strong quarter there. Is that kind of a good rate to use going forward as a baseline?

Well, yes, we don't give forward-looking projections, but there was nothing unusual in those numbers. They represent the economic activity that's picked up. So that's how I'd answer that question.

Okay. And then just going back to your comment on the average expense -- noninterest expense for the quarter. I think you said $331 million on average quarterly expense for the year, excluding the FDIC and the Reliable transaction, is that correct?

Correct.

Our next question comes from Joe Gladue from Merion Capital Group.

I guess, I'm going to follow up on that expense side a little bit on the last question. Just, I guess, first off, let me just ask about the increase in employees during the quarter. The press release said a lot of it was summer internships programs, but also some loan modification support. Just trying to, I guess, get an idea of how much of that might be the longer-term loans support kind of people?

Well, as you said, it's broken up into 3 categories. In the summer intern, we made a philosophical decision that we wanted to help young people in Puerto Rico gaining employment experience, we thought that was very important. So we made a commitment to increase that amount dramatically. The other is, we've had to staff up, I mean the loan moratorium following the hurricane has created a tremendous demand. Remember a lot of the business in Puerto Rico is actually walk-in, people walk in to our offices and that has been -- has put a bit of a strain on our existing resources. The other area we grew was the retail sector, and again, we've been growing clients, we've been increasing transaction. So that's the kind of growth that we felt we needed in terms of maintaining our customer service.

Okay. Just wondering, if -- again, in the aftermath of the hurricane or just in the normal course of business, any thoughts on more cost reductions, whether its branch closures or rationalization or anything along those lines?

We are -- as those -- as a result of the hurricane, I think, we ended up ultimately closing 2 or 3 branches. And mostly because they suffered severe damage and it wasn't really worth repairing them. We're constantly looking at our branch network and -- but while I say that and we're always looking for cost savings, while I say that, we believe that our branch network has been a big strategic benefit for us as one of the reasons why even with the economy that we've had in Puerto Rico and the decline in population, we continued to increase clients and continued to increase our deposits. While we will obviously be looking for cost aids, we're going to be very careful about not adversely impacting that strategic advantage we think is very important to us.

Our next question comes from Glen Manna from Keefe, Bruyette & Woods.

Carlos, I don't know if this is just rounding what -- you've been saying deploying $2 billion of liquidity for the Reliable transaction. I think there was $1.84 billion of loans when that deal was announced. With all of the activity in the auto sector, can we assume that balances have increased there at Reliable?

It is rounding. What's a couple of hundred million between friends? So just rounding the $1 billion number. We are not changing -- we have not changed our disclosure in the deal.

Okay. And on the government deposits, which have really increased over the past 2 years of public sector since the government defaulted on the debt, are there any events that we could see in the Puerto Rican government that would precede a drain-off in those deposits, like agreement with certain class of bondholders or something like that?

I think you just hit the nail on the head. I mean, the government has been able to build up a lot of liquidity because it's not paying its debt. As part of any debt restructuring deal, they're going to have to start paying the debt whether they make a down payment on that or not or they fund reserve fund on that we would know. But obviously, at some point, the government will have to begin to pay its debt. Now remember the COFINA money is in a separate, it's -- not in our deposit. It's in the Bank of New York in a separate escrow account, that's not with us. But once the government cuts the deal, they'll have to start paying interest on the debt. So that's what's going to cause it to go down.

Our next question comes from Brett Rabatin as a follow-up from Piper Jaffray.

I guess I should have asked it differently earlier. So just going back to the deposit question, the public or the government deposits, I believe, last quarter were $6.9 billion in total and that have grown a little bit over the past year. Do you have any idea what that number was at the end of 2Q?

Around $7.5 billion.

$7.5 billion.

Okay. And then also just wanted to ask on the U.S. growth that you guys had in the quarter. Could you maybe give us a little more color around that? Was it more in Florida or New York and then just commercial. What kind of stuff you're doing?

It was definitely commercial. I mean, the book of business we're originating hasn't changed much. We are trying to build up the mortgage -- the retail mortgage business slowly, but the loans were definitely commercial real estate, most of the loans. I think I don't have the exact breakdown between New York and Florida, but it's followed historical patterns, it hasn't shifted dramatically.

Okay. And then just lastly, there has been a lot of noise lately about PREPA. And I was just curious for your viewpoint on what's going on there? And what kind of challenges that may imply for the recovery in Puerto Rico?

Well, I'd start by saying, obviously, the reform of the electrical system in Puerto Rico is key for the future economic recovery, it's key for our ability to withstand hurricanes in the future. So probably, I would put it as one of the top priorities of the things you have to address. Obviously, PREPA is facing a myriad of the kind of operational, administrative, every type of challenge that you can foresee. In recent days, there was, basically, the corporate governance there, the system that was set up basically collapsed. They had to name a new executive director, but the one thing is that, that I get some optimism from is there seems to be a pretty firm consensus across government and private that -- and the private industry that PREPA has to be privatized. So that consensus is there and I think that's the key for the long-term solutions of the problem. I think it will be very difficult, quite impossible to reform as long as it stays with government agencies. So and I think there's broad consensus that, that has to be done, obviously, it's going to be a complex process. It'll take longer than we want it to take, and it has to be done correctly for us to get the full benefit of such a process.

Our next question comes from Brock Vandervliet from UBS.

I was wondering if you had any incremental color on that U.S. construction credit. What the -- any -- that the situation was there? Any more information you have on that would be great.

Commercial property in New York and basically one of the issues is a disagreement among the partners, which has resulted in some construction delays and overrides. But we think that we're very well collateralized there and don't expect that overall. So probably, it was internal discussions within the partnerships and basically that's why we haven't put it on nonperforming. Lidio, do you want to add anything to that?

No.

Our next question is a follow-up from Alex Twerdahl from Sandler O'Neill.

I just wanted to ask for a little bit more clarification on the capital return discussion. If we define capital return in 2018 as $227 million between the buyback and the dividend together, you talk about the payout as a percentage of earnings and kind of wanted to get closer to where some of your peers are over time. How should we think about the earnings piece of that for you guys? Is it stated earnings for 2017? Is it the last 4 quarters? Is it core earnings. Obviously, there is a lot of moving parts that have caused a pretty big difference between what we might call core earnings and stated earnings? And obviously, the increased reserve from the hurricane and things like that. How should we be thinking about that ratio as it is today so we can kind of get a better sense for where it's going to be moving from here?

Well, we can come up with an answer. I think the most important question is, how the fed thinks about it and that is that we're not necessarily sure we know the answer to it. But I think the bottom line is that we have some room to hopefully keep improving our distribution. It doesn't matter whether we use backward-looking earnings or forward-looking earnings. We are running behind our peer banks and therefore, hopefully, we have a little bit of runway to continue to improve that part of our capital management.

But I think it's safe to say the fed usually looks backwards, that's the way they usually look at it.

Okay. And then just one other question. As we talk about earnings today, we obviously draw a lot of comparisons to kind of post and pre-hurricane. And there's still a pretty sizable reserve that's "hurricane" related. How much time has to pass from the hurricane -- from taking that -- from the end of the moratoriums, et cetera, before we're not really talking about the post-hurricane reserve? I mean, if you think about that reserve and maybe it's somewhere in the ballpark of $100 million. Correct me if I'm wrong, when would that be able to flow back through earnings?

I think it's difficult to answer in terms of when we'll make the determination there. There is no need for reserves associated with the storm. I think as we have said, we expect normalization in the coming quarters. Just to correct you, the hurricane reserve is down to about $75 million more or less. Some of it has been picked up in the regular allowance, while other has been released over the last 3 quarters.

Okay. So this is not like a 1 year since the end of the moratorium or any sort of the milestone that would be sort of the dropoff of that point or any sort of -- anything along those lines?

There's nobody aligned. It is very subjective.

(Operator Instructions) Our next question comes from Bob Napoli from William Blair.

You had mentioned, I think at the offset fee income part of the drive and the growth of the fee income is spending -- consumer spending. I thought you had given out a number at the front of the call that I may have missed. But what is the growth in spending in Puerto Rico? How is that trend versus last quarter? And is there a significant difference between consumer and commercial?

As we've said in the prepared remarks, we basically stated that the dollar value of our clients' transaction exceeded the same quarter of 2017 by 17%. In terms of transaction-wise, it was 4%, but dollar amount was 17%. That's credit and debit together.

Okay. And that's an acceleration from the first quarter?

Slightly higher.

Slightly higher than the first quarter. The first quarter, we had transactions up by 3% and dollar amount up by 14%.

And do you have a feel for how much of that growth is driven by the economic activity responding to the hurricane?

No, it's purely anecdotal. I think people are -- after the hurricane hit and everybody was very concerned. I think Puerto Rico has rebounded faster than most people thought. So I think consumer confidence is up. I think people are probably more stable about their employment prospects now with the economy is picking up. Some people have got insurance money, they spent that. I think it's a combination of different factors.

And then do you know -- well, I think one of the concerns was that the out-migration would accelerate once school was out for the summer, but you are saying that you've not -- you've seen a deceleration in out-migration or?

Our data is through March.

Our data is through March and our data is (inaudible) San Juan airport number. Definitely, I can say that the worst predictions about out-migration have not yet come to bear. Obviously, the school hasn't started yet, so we don't know what that impact is going to be. But I think that the worst possible outcome that people were talking about and following the hurricane have not come true. More people came back than I think most people expected. Still a lot of people left Puerto Rico, but we're not trying to undercut.

And ladies and gentlemen at this time, I'm showing no additional questions. We'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.