Popular Inc (BPOP) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Popular Inc. earnings conference call. My name is Shaquana and I will be your coordinator for today. At this time, all lines are on a muted line. We will facilitate a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I will now like to turn the call over to your host for today, Mr. Enrique Martel, Manager of Investor Relations. Please proceed, sir.

Good morning, and thank you for joining us on today's call. Our Chairman and CEO, Richard Carrion, and our CFO, Jorge Junquera, will review our second-quarter results and then answer your questions. They will be joined in the Q&A session by our Chief Risk Officer, Amilcar Jordan; our Controller, Ileana Gonzalez; and our Treasurer, Richard Barrios.

Before we start, I would like to remind you that in today's call, we may make forward-looking statements, which 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, and financial quarterly release and supplements, which are included as exhibits. You may find today's press release and our SEC filings in our web page, which you can visit by going to www.popular.com/investors.

I will now turn the call over to our Chairman and CEO, Mr. Richard Carrion.

Good morning. Before we begin, I want to mention that this quarterly webcast call is a step towards expanding our communications with shareholders and market participants, as we provide periodic updates on our strategy and the business conditions in our markets in Puerto Rico and the US Mainland.

Let's first turn to slide two to cover the quarter's highlights. The second quarter featured a number of key events that further strengthened our capital base and advanced our business strategy in Puerto Rico. First, we completed a stock offering of $1.15 billion in new capital, which helped pave the way for the FDIC-assisted transaction of Westernbank

Secondly, the Westernbank transaction presented us with a great opportunity to substantially grow our earning assets in a weak economy, by adding a significant amount of loans with an FDIC loan loss protection, as well as to demonstrate our capacity to manage a difficult credit scenario in Puerto Rico, helping lead an economic recovery on the Island. The transaction increased our loan book on the Island to $19 billion, and it also involved a base of 240,000 clients, 140,000 of which did not currently have a relationship with Popular.

We've been very focused as a management team to make this conversion as seamless as possible, realizing the planned cost synergies while being sensitive to the customers and the community of Mayaguez, where the Bank was headquartered and where most of the reductions in force will take place. The integration of Westernbank's operation is proceeding according to plan and should be substantially completed by the end of the third quarter.

Thirdly, we agreed to sell a 51% interest in EVERTEC, including the Bank's merchant processing business to Apollo Management through the establishment of a joint venture. This new joint venture is valued at approximately $900 million and is expected to result in a net gain after taxes of roughly $600 million, which will further boost capital and complete our capital plan.

We are extremely satisfied with this transaction because it creates value in the short-term while allowing us, through our 49% ownership, to benefit from the long-term growth prospects of this Company under the new partnership with Apollo. We expect to close the transaction in the third quarter and this, as well, is on target. So while we're still operating in a difficult credit scenario, we strongly believe these three transactions have positioned Popular to benefit from a turn in the credit cycle and deliver significant shareholder value.

Regarding our financial results, today, we reported a loss of $55.8 million or $0.29 per share, which was mainly driven by our provision expense of $202 million. I should clear up an item here. When we issued shares on April 13, the market price was $3.50 and the shares were issued at $3. This difference of $0.50 per share times the 383 million shares we issued, or $191 million, the accountants have determined, in their wisdom, is a deemed dividend, and deducted the same from retained earnings and added it to paid in surplus.

So the capital accounts remain the same. If you take the $55.8 million loss and divide it by the approximately 853,010,208 shares that were average outstanding, you get a loss of somewhere between $0.06 and $0.07 a share, $0.0654 a share. So I wanted to clear that up. I'm sure Jorge will expand on this in a bit.

Moving on to slide number three, I would like to start discussing the strength of the financial services franchise in Puerto Rico, which is certainly the jewel of the Company. We have a combination of businesses that have leading positions in the market and these have been strengthened by our recent actions.

Banco Popular de Puerto Rico, which was founded in 1893, ended the second quarter with roughly $32 billion in assets. With $20 billion in deposits, it is by far the leader in market share, and the Bank enjoys a considerable source of funding stability and margin potential. Banco Popular is also the leading commercial and consumer lender in our home market.

The strength of our Puerto Rico business was boosted by the Westernbank asset acquisition. It added approximately $8.4 billion in loans, with a low level of credit risk, which is accretive from day one. The acquisition has put our deposit and lending franchises even further ahead of the competition, and will position us to benefit from the consolidation of the market and the stabilization of the credit environment on the Island.

In the US, we have our community banking franchise, Banco Popular North America. In recent years, most of our efforts have been directed towards returning the operation to profitability as quickly as possible. We have significantly downsized our operations, divesting those lines of business which did not fit within our risk return guidelines, and are working on repositioning the Bank in the markets we serve.

Technology has always been an important part of the business and the valuation of the EVERTEC joint ventures suggests we've been able to deliver substantial value in the financial technology space. We'll continue to have a vested interest through our 49% ownership in the future success of EVERTEC, and we're pleased to have Apollo Management as our partner. They share our enthusiasm and our commitment to grow the business.

As you can see on slide four, the Puerto Rico economic environment is still challenging. Historically, unemployment in Puerto Rico has hovered above 10%, but now it remains stubbornly high at close to 17%, the highest it's been during the recession. Among the primary headwinds are a construction industry that is at a standstill and the fiscal tightening by the Commonwealth government, coupled with a continued deleveraging by a very weak financial sector. Hopefully, this last factor will diminish with the recent consolidation of the three institutions.

The government has made progress in reaching fiscal balance, and it recently approved a 2011 budget with projected deficit of $1 billion. This is in line with the multi-year plan to reach fiscal balance by 2013. Although it continues to work towards closing the gap, we do not believe that further substantial cuts, such as those which shocked the economy in 2009, will be required to reach its fiscal targets.

Several major projects are moving forward in areas such as energy and road infrastructure. These are to be structured as public/private partnerships and are expected to boost the economy as they are awarded and they come online. There are also various hotel projects coming onstream.

Another positive development is the last installment of the [Ara funds], of which $2.9 billion or 41% has been disbursed to date. So even though the Puerto Rican economy is still vulnerable, the government has made substantial progress in addressing the budget deficit while the banking sector has been substantially recapitalized.

With that, I'd like to turn the presentation over to Jorge.

Thank you, Richard. Good morning.

Popular's loss of $56 million in the second quarter is $29 million less than the $85 million loss in the first quarter. The $0.29 earnings per share loss was primarily driven by the difference between the price of the converted common stock at $3 and the closing price of $3.50 on April 13, as Richard mentioned before, this [deemed] dividend.

The difference of $0.50 multiplied by the 383 million shares issued was deducted from retained earnings, reducing earnings per share, and transferred into additional paid in capital. So, the capital was not impacted at all. Removing the accounting impact of the shares conversion, our second-quarter earnings per share would have been a loss of $0.07 per share.

Our net interest income was $279 million and it gained 4% over the previous quarter, while our margin was 3.21% as compared to 3.44% for the reduction of 23 basis points in quarter one.

The change in our margin was driven primarily by the excess liquidity available from the common stock issuance and the repayment of loans, which is temporarily invested in money markets with the Federal Reserve, and also, due to the FDIC loss-share identification asset of $3.3 billion, which is considered a non-interest earning asset. We estimate that this effect had an impact of around 8 basis points in the reduction of the net interest margin.

I would like to comment on the impact of the Westernbank transaction on net interest income. After applying FASB 141 to Westernbank's loan portfolio, loans were marked down substantially and an FDIC indemnity asset was created. This asset is, in substance, the present value of the guaranteed portion of expected loan losses. It totaled $3.3 billion as of June 30.

In prospective periods, the return of the markdown loan portfolio flows through net interest income; but the FDIC indemnity will generate a return, which will be recognized on other income. So, in summary, the returns related to the Westernbank's loan assets acquired will be recognized through both net interest income and other income.

Non-interest income amounted to $215.9 million compared to $157.9 million in the first quarter. The increase was mostly due to $24.4 million reduction in the estimated fair value of the equity appreciation instrument issued to the FDIC, given the decrease in the price of our stock. Also, the increase in non-interest income was due to $23.3 million recognized for the two-month's accretion of the FDIC loss-share indemnification asset.

Operating expenses in the second quarter amounted to $328 million compared with $281 million in the first quarter. The main variations were Westernbank's related expenses, which accounted for 43% of the increase. The rest of the increase was related to higher personnel costs, higher professional fees, and higher write-downs on OREO's.

In slide six, we have an overview of the Puerto Rico business. In the second quarter, Puerto Rico earned $26 million in net income and $232 million in net interest income. The provision in the second quarter equates to a run rate of approximately 2.89% of the loan portfolio, which continues to be very high, even though it is off the levels that we saw in the previous year. We still remain cautious in our outlook for Puerto Rico, given that we have a large proportion of the balance sheet exposed to the Island and the economic environment should continue to be quite challenging, at least for the short to the intermediate term.

Puerto Rico's net interest margin decreased by 41 basis points to 3.69 from 4.10 during the first quarter. The reason for the narrowing of the margin are the same that we mentioned for the reduction of the consolidated margin. Despite the challenging environment, we believe our Puerto Rico franchise is far the strongest competitor in the Island, with a capacity to generate amounts of topline revenues. We believe that as credit conditions normalize, our results in Puerto Rico business should benefit substantially.

On slide 10, I would like to give an overview of Westernbank's acquisition for those in the Islands who may not have had the opportunity to learn about it before. The main benefit of the transaction, as Richard mentioned, is that it added $9 billion in low risk assets to Popular's balance sheet at a time when loan demand in Puerto Rico is very weak. With this transaction, we acquired $8.7 billion in loans and OREO, and $2.4 billion in deposits at 45 branches.

The loss-sharing agreement with the FDIC protects Popular from 80% of loan losses on virtually the entire portfolio. As disclosed in our 8-K we filed last Friday, loans were marked down as per FASB 141 by $4.29 billion to $4.26 billion, a markdown of 50%. A loss indemnification asset was recognized for $3.3 billion.

As a result of these marks and other adjustments, we recognized a $106 million goodwill, which is a little over 1% of the assets acquired. Most of Westernbank's deposits have been retained. Of the $2.39 billion assumed, we had $2.28 billion outstanding as of July 16, 2010. As Richard mentioned, the integration is flowing according to plan and Westernbank's businesses already contributed $0.03 per share during the second quarter.

In slide eight, we would like to talk about the US business, which lost $58 million in the second quarter compared to a loss of $104 million in the first quarter. The results were driven primarily by a provision of $80 million, representing 4% of loans on an annualized basis. Even though the level of provisioning and charge-offs this year are off the 2009 peak, they remain at elevated levels. These losses are related to several legacy portfolios, including HELOCs, construction, and mortgage loans, which were generated near the peak of the cycle.

In the US, we continue to focus on reaching profitability. We have completed the restructure of our US business and consolidated our branch network from 140 branches to 97, while shutting down all wholesale businesses. As we communicated before, we are concentrating on branch-based banking that generates traditional lending opportunities, deposits and fee income, similar to our model in Puerto Rico.

Our US restructuring efforts has led to a reduction in assets since 2005 by approximately 54% to $9.9 billion and the level of staffing by 71% to 1,387. As in the first quarter, delinquency trends in the US, particularly the HELOC portfolio, generally improved during the second quarter. However, we still see the US economy as fragile and we expect the US business to remain under pressure.

Turning to slide nine, we can see that our legacy loan portfolio has been declining consistently since last year, reflecting weak economic environments in our markets. However, the FDIC-assisted transaction we closed in April added $4.3 billion in loans to our books after the accounting marks. Non-performing loans rose sharply in 2009, but have leveled off this year, while the charge-off rate has also declined. The FDIC indemnity related to the Western transaction provides substantial credit protection. In addition, we have a $1.3 billion loan loss reserve, which is unchanged from the previous quarter.

Despite the improving credit metrics, weak loan demand remains a challenge. Our loans and portfolios, including Westernbank's, decreased by $612 million, of which $404 million came from the US business, mostly reductions in commercial real estate loans and construction, and about $208 million from Puerto Rico. On the Island, however, mortgage originations increased by nearly $100 million in the second quarter.

On slide 10, we continue with more information regarding credit quality measures, including Westernbank acquisition. Net charge-offs fell by $22 million in the linked quarters, as you can see on the slide. All portfolios suffered fewer losses except construction, where charge-offs increased by $2 million. Excluding Westernbank's non-performing loans, increased by only $16 million or less than 1% when compared to the first quarter, mostly driven by mortgage delinquencies.

To get some perspective on non-performing loan increases, in the second quarter of 2009, non-performing loans increased 41% or by $574 million from the first quarter of 2009. In the first six months of 2010, non-performing loans increased 18% or $352 million, when compared with the same period in 2009. However, in the first half of 2009, non-performing had increased -- same period in 2009 -- excuse me -- however, in the first half of 2009, non-performings had increased 114% or by $1.1 billion when compared to the first half of 2008.

So, second-quarter figures do suggest credit stabilization, but we still want to wait two or more quarters before we call it a trend. The caveat here is housing values in Puerto Rico. The excess housing inventory needs to be moved and we expect pressure on home values as a result.

Moving on to slide 11, in this slide, we show actual June 30 capital levels together with pro forma numbers, assuming the sale of EVERTEC. As of quarter-end, total capital was 13.86%; Tier 1, 12.56%; and Tier 1 common was 9.22%. The sale of EVERTEC will raise the risk-based ratios by approximately 2 percentage points, resulting in pro forma total capital of [60.14] as of June 30; Tier 1 of 14.85, and Tier 1 common of 11.52.

The recently passed Dodd-Frank banking bill has a provision to effectively phase out the use of trust preferred securities as Tier 1 capital throughout a five-year period. As of June 30, we had $859 million in trust, which accounted for 21% of Tier 1 capital. However, only $427 million of our Trups are subject to the phase-out, as the remainder was issued to the US Treasury is exempt from the provision.

I would now like to turn it over to Richard for a recap and final comments.

Thank you, Jorge. There are several key takeaways regarding where we are at the end of the second quarter. First, we have completed our capital and liquidity plan. Given the series of actions we have shared, we now have a strong balance sheet to weather the cycle and take advantage of opportunities.

The acquisition of Westernbank through the FDIC-assisted transaction gives us the asset we need to accelerate our return to profitability. It provides a substantial amount of low-risk earning assets, and provides a buffer during the current environment in which loan demand has been weak. We are focused on completing a seamless transition and fully realizing all of the transaction's benefits.

There are still some turbulent waters we have to navigate, namely the credit environment and the profitability of our operations in the US. As I discussed in the beginning, the economic backdrop in our home market continues to be difficult. We are ensuring we have our most capable resources focused on minimizing losses in our loan book, and that we obtain the greatest benefit from the Westernbank portfolio. While this will not be easy, I am confident we have the best credit talent in the market dedicated to the task.

The US business has been a source of substantial difficulties during the past few years and we have worked very hard to restructure that business. We are still dealing with the fallout from various lazy portfolios, but are making progress in reaching our goal. We will keep taking the necessary measures to take the business back to profitability in the shortest time possible. I am confident Popular is in a much stronger position and we will remain intensely focused in the areas we have discussed.

We thank you for your attention and I would like now to open up the call for questions.

(Operator Instructions). Amanda Larson, Raymond James.

What are your current plans in the US? Are you still looking to sell some branches or whole franchises? If so, will this be a new focus, as certain big events are finally behind us?

Well, right now, I think we have completed most of the restructuring, Amanda. We have shut down close to 50 branches -- we've shut down 40 and sold a few. So we're down to slightly under 100 branches; I think 97 is the count. So I think that restructuring is done.

We still continue to work through some of the loan portfolios, notably the nonconventional mortgage and the HELOC. There are no major strategic moves right now, but we recognize that longer-term, that is the main strategic question that we face. Right now, our focus is returning the operation to profitability.

Alright. Have you done any balance sheet restructuring subsequent to the FDIC deal to manage the actual liquidity? And will this liquidity continue to be a drag on the margin? And how should we think about the margin going forward?

Well, obviously, you had -- until the transaction settled, you had a bunch of liquidity. And as things have steady-stated, I'll let Jorge elaborate, but we are looking at a few opportunities to reduce, and over the next couple of weeks, we should have something more definite. But we do think there's plenty of opportunities to pay down some expensive debt, both at the holding company and at the bank level.

Yes, throughout this very difficult period, we have been very sensitive to liquidity. So we have maintained ample liquidity at the banking institutions. That's -- we've been very fortunate to have been able to weather the storm without any problems there.

Our problems, as you are all aware, were centered in the holding company liquidity. And now with the issuance of the capital raise, over $1 billion came in the form of cash, and the soon-to-be-closed sale of EVERTEC, that we will see an additional $600 million in cash. Now we can say that we have completed our capital and liquidity plans. But this is leaving us with a lot of cash at a moment with a very -- with historical low interest rates. So it's something that we have to move to maximize the benefit of that.

So, as Richard mentioned, we are looking at different alternatives. We're also seeing our loan demand that has been -- it's very slow, so we're probably going to be looking more at the liability side and try to identify expensive debt, both at the level of the banking subsidiaries and at the level of the holding company, and I will try to negotiate repayment of some of that expensive debt.

We have already engaged in some conversations, and we feel comfortable that we will be able to make some announcements during this current quarter of some effective improvements in the margin, as a result of repayment of expensive debt.

Okay. Very good. I have another question. How are you thinking about capital longer-term? Are you targeting a specific TCE ratio? And where do you want to be as a business before you pay back TARP?

On the first part, we're looking at ratios that are around 200 basis points above the minimum levels to be well-capitalized. We're using that as a guidelines in our conversations, so with a different [FOREX], we saw that those are reasonable levels. So as a guideline, we'll be looking at maintaining at least around 200 basis points above well-capitalized levels. We are aware that this numbers are probably going to be going up, so we want to make sure that they're there when that happens.

Regarding TARP, it is something that, of course, we have on our radar. It is not something that we have spent too much time up to now, since we had other more important issues as a capital raise and the sale of EVERTEC, and the -- now integration of Western. But we believe that definitely we will be in a position to repay TARP before the rate jumps to the higher level, to the 9%. And this will come from earnings, future earnings. As you know, right now, the Company is losing money, so we have to turn that corner from earnings, and potentially from going to the capital markets and raising senior debt to repay the TARP.

[Adam Bartrey], Sterne, Agee.

I think it's Barkstrom.

Yes, thank you. Alright, a couple of things. And not to get too nitty-gritty, but just to kind of go through, if we could, some of the potential nonrecurring items. I understand the first one -- I think that one's pretty straightforward; but going into the income statement, I was wondering if you could shed some color on the, I guess, the fair value adjustment, that $24 million. To me, that looks like that's not recurring.

That's correct.

And then, Jorge, if you could talk about the FDIC loss-share indemnification asset. How do we think about that? Is that a nonrecurring? I mean, it sounds like that might be -- we might continue to see that one. And (multiple speakers) -- just go ahead.

Yes, the (multiple speakers) -- this is Richard, Adam, and I'll get -- I'll let Jorge chime in if I screw up. But the equity appreciation instrument re-values -- that is the piece we gave to the FDIC as part of the transaction.

They have -- in essence, they get $50 million times the difference between $3.42 -- any increase in the price of shares above $3.42. When that was valued originally, I think it was valued at $70 million based on the share price at that moment, and right now it's come down. And that difference -- again, the accountants, in their wisdom, have determined flows through the income statement. So that's the roughly $24 million that you see there. So regarding the (multiple speakers) --

So, Richard -- (multiple speakers) let me ask you question on that. So let me just -- so let's just say next quarter that the value kind of switches. That would then be an expense. So let's say the value goes and that number should be $50 million instead of $24 million, we would see something in the expense line to the effect of $10 million. Is that fair?

Correct. It will go up and down, depending on the value of the stock and how it's valued. At the end of one year from April 30 of 2011, we'll know the real value. But in the meantime, it will bounce up and down, depending on where the stock is in relation to $3.42 and do the appropriate Black-Scholes on that.

The other, the FDIC indemnification asset, that should definitely be recurring and that will continue to accrete over time. That is, as Jorge explains, that is essentially the present value of the cash flows of the payments we get for any losses that are incurred. Again, at the end of the period, of the five-year period, that should balance out to zero. It's something that you adjust with the value of the loan. If we have losses, you take it from the FDIC indemnification asset.

So that should accrete at a smaller rate than the funds. I think we have it at 4.2, more or less. (multiple speakers) But it will come in as other income, Adam, which is an important point, and not as interest income. That will come in as other income.

Got you. So, Richard, how do we think about that line item kind of going forward? I mean, is it kind of a street bond? (multiple speakers) Go ahead.

Well, it will obviously depend on the balance, but eventually pays down. It should reach zero at the end of the five-year period. So you'll see the balance and you'll see the accretion. I guess I think about it as one -- together with the loans, and what is that yielding? The problem is you'll get it as other income and you won't get it as interest income. So we'll have to make -- you have to make some kind of adjustment to figure out the impact on margin. Okay?

Okay. And then if you could also speak to -- I know there's some commentary in the press release, but maybe give us a little color, too, because the tax line, you've got a tax payment there where losses should be generating a benefit. So there's some noise there, obviously, in the tax line and how do we think about that kind of going forward?

Okay. This one's really hairy, Adam, so I'm going to let Ileana tackle it.

Mainly, you have to understand that in our case, we have the US operations and Puerto Rico operations. So though it's true that we are having a loss, part of it is related to the US operations and we have a full valuation allowance in our DTA. So we will continue paying taxes in Puerto Rico while we're making money. And you would have that negative impact, tax with a consolidated debt loss for the quarter.

We're not allowed to consolidate our return with the US income, is the gist of it, Adam.

Right. They are separate returns.

They're separate returns.

There's a little noise last quarter. We had a refund from -- in the payout returns, so that's [$15 million] that you have to add back. But we will continue paying taxes and the benefit of the income tax, the exempt income is less now because we're making less money.

Okay. And if I can ask one more, then I'll jump off and let the next person on. Hey, looking specifically at your non-performing assets, and they were pretty level linked quarter -- levels of the last quarter's balances -- but there were some movement in some of the categories. And it looks like commercial and construction was down linked quarter. I was wondering if you could talk about that.

And then looking at the mortgage book, that was actually up linked quarter and it looked like, I guess, not surprisingly, the lion's share of that was from the Puerto Rico Bank.

Right.

And I wonder if you could talk about the loss content in the BPPR piece versus the BPNA piece.

Okay, absolutely. You're right, the -- overall, the NPLs stayed relatively flat. I think linked quarter was $16 million. The bulk of the increase or most of the increase was in mortgage loans in Puerto Rico, and we've had commercial and construction come down primarily in the States.

In Puerto Rico, you have typically very high delinquencies in mortgages and we must say they have been trending higher. However, traditionally, the losses on these portfolios are a lot smaller than you see in the US -- well under 1% has been our experience. And that is what we are figuring as well. There's a lot of reinstatement in mortgages that go delinquent.

Okay, great. Thank you.

So the bulk of that increase is mortgages going over 90-days delinquent.

Okay, thank you.

Joe Gladue, B. Riley.

I assume you are related to Joe Gladue?

Yes, we're pretty close. I wanted to ask a little bit more about the net interest margin and, I guess, noticed one thing -- it looks like the yield on mortgage loans declined pretty substantially from first-quarter to second-quarter, about 38 basis points. Just wondering was that related to interest reversals on loans going nonaccrual or what was driving that?

Yes, two things -- primarily, what you just said -- the interest reversals on non-accruing loan and there was also an adjustment for TDRs in the nonconventional mortgage portfolio in the US. So that's the main difference in that interest in mortgages going down. You should get it -- you should see it come back up in the next quarter, hopefully.

Okay. And just wondering if you have what the -- trying to tease out what the impact of all the financing and the acquisitions were -- just wondering if you had what the net interest margin was for the month of June?

Well, we do have the net interest margin with and without the Westernbank. I do want to comment here that there are some apples and oranges questions that you have to bear in mind. The yield on the cost -- the net interest margin coming in from the Westernbank acquisition will be lower, but bear in mind that that margin will not have a loan loss provision attached to it as a general nature. So it should really be looked at as a net interest margin, post- a loan loss provision.

While it will show up partly in the net interest margin, we also have the FDIC indemnification asset, which is coming in as other income. And that also muddies the picture.

In this quarter, we had a lot of excess liquidity, if you will, which is a phrase a couple of years ago I never thought would be coming out of my mouth. But we had a lot of excess liquidity in this quarter and that's certainly impacted it. But we think margins are in good shape and well-positioned to move up as the market rationalizes.

Jorge, you want to add anything to that?

No, I agree. I think that you should look at the two of them together and try to come up with a margin that it's -- it should be comparable to ours, after you take into consideration that this is like a risk-free spread. So it's -- and in today's environment of such high level of provisioning, it is actually better than our margin after provision, of course. So it was positive, as I mentioned. It already contributed to the earnings during the first -- during this quarter.

Okay. And I guess with the residential mortgages being they, I guess, contributing the most to asset quality deterioration in the quarter, just could you just give us a little bit of, I guess, color on the housing market, home inventories in Puerto Rico and absorption rates, if you have any color on those?

The mortgages -- the situation in Puerto Rico continues to be fragile because of the high level of inventories and the absorption rates. As we have talked before, for the first six months of 2010, the absorption rate has come down to around 3,000 units annualized. And we have an inventory that it's coming there and coming to market by the end of the year, which will be roughly around 20,000 units.

So by doing a simple computation, you have like six years or seven years of inventory, and it's high. We are moving very closely with the developers and trying to be, again, creative in coming out with different schemes that will try to develop some demand.

But inevitably, the biggest lever here is the value of homes and that's why we are anticipating that that's going to have to give some ground in order to induce some demand. But it's very fragile. And it is probably our biggest concern and uncertainty going forward, as we have been mentioning now for some time.

Okay, thanks. I'll step back and let somebody else.

[Brett Schriver], [FRB] Capital.

It's Brett Scheiner from FBR. Hope all's good. A few quick questions. The impact of accretable yield from Western on the margin going forward, can you talk about that, the timing? I know you disclosed in the 8-K the size.

Yes. Right now you see through the net interest income, it's yielding around 6%. That's a number that is accreting. Obviously, we will need to review that every quarter to determine the cash flows, and if it improves, we will definitely increase the yield. But we will need some time to review that number. Right now it's accreting at 6.03% (inaudible).

Okay, great. That's helpful. Can you quantify the impact of REO and OpEx in the quarter?

Pardon me, of what?

The foreclosure expense in the quarter -- do you have that available?

OREO expense. Not offhand, Brett.

Not offhand, yes. We can dig it up.

We can dig it up.

We did have some adjustments in OREO in other operating expenses of some real property. I think it amounted to around $10 million.

That was part of the reason of the increase (multiple speakers) after doing that.

That is part of the reason we increased on the other operating expenses.

The total amount, we have to get it.

But the increase is $10 million.

Okay. And then just one last question on workout. Some of the construction projects, I know, on the Island have had low rate, 99 LTV, single-family swaps mortgages for the large C&D loans to sort of get a bit more granular exposure. Can you talk about Popular's participation there and if you're seeing that elsewhere on the Island, and if that's helping with workout?

Yes, we definitely have been participating in that. As you know, you buy down that rate and you charge it to the commercial side. So that on the books, you have a market rate on the mortgage. So the difference is put on the commercial side.

Yes, we have participated in that. We plan to continue participating in that and try to get whatever other creative things we can do to help move the inventory. We said in the past, we prefer to have 100 mortgage loans earning interest than an non-earning construction loan.

Certainly, certainly. Okay, thank you so much. Take care.

Bain Slack, KBW.

I guess to get back onto the net interest margin, Jorge, I think you had -- and I apologize, I don't think I heard the whole piece about the opportunities maybe to pre-pay some debt at the holding company level, which may have some accretion to the margin. I guess I wanted to dig a little deeper into that. And do you have an overview of the, I guess, of the debt outstanding, and the schedules and rates, of what they're at right now?

Okay. As you know, the total debt at the holding company has been reduced to about [$575 million]. We have three tranches -- one coming due at the end of 2011; then another block coming in at the beginning of 2012; then the balance at the end of 2012.

We are in touch with the holders of that debt. They are all Puerto Rico investors. We are discussing the possibility of repaying at least a half of that. And it's probably something that is going to take place. Some of that debt now it's yielding 10% higher. And we should be able to negotiate somewhere where there is an arbitrage for the two parts. So we will not just be present valuing that future interest expense, but there's probably going to be a net benefit to us for prepaying it.

Then at the bank levels, there are some others. There's some for the home loan bank borrowings out there and some other short-term debt that could be negotiated. And also, we could -- we also could entertain the FDIC note, which as you know, we have -- we elected the fixed-rate option for five years at 2.5%.

And the market has shifted. At that time, when we made the selection, we had determined that the duration of the note would have been around 1.7 years. And this was more or less the same of choosing the floating or the fixed. But now with the new interest rate projections where interest rates are going to be kept substantially low, it will probably be that there could be an opportunity there. So it's something that we will also be looking at.

Okay. And on the deposit side, I guess, given the consolidation, what opportunities do you see within the cost of deposits to be able to bring that down, say, in the next -- say, in the second half of this year?

Yes, we are -- once we consolidate systems, they all -- then they will be treated as regular deposits from Banco Popular and we will be paying the same rate. So we should expect that the average cost of the deposits that we assume from Western will be coming down to the Banco Popular levels during the next three to nine months.

Okay, great. And on the legacy loan portfolio, I'm assuming, as we'd talked over the past couple of years, there's been the ability to re-price, I guess, some of your existing portfolio upwards. What is -- I guess, as you look in your own book, what's left there, essentially, to re-price? And how are you treating those? Are you bringing them up to certain floors? I guess I'm just trying to figure out what's maybe left there over the next, say, three to -- two to three quarters.

Yes. Well, this has been a long process and we knew that this was not going to happen overnight. This is something that we started a couple of years ago, trying to begin to charge what portfolio risks that we were assuming. But we were still -- having to compete with a lot of rationality from some very strong competitors.

Now with the consolidation, it does present itself an opportunity to improve those margins and we're in that process. It's a slow process, because the customers, they have been maintained with very low rates for many years. So it's delicate; it's a delicate situation. But we continue to move forward trying to increase the spread on loans on a one-on-one basis.

A lot of effort is going to have to be dedicated to the loans that are being brought in from Westernbank because a lot of the customers that were lured to them was because of very competitive pricing. So they are now for a big change -- now that they're under our umbrella. So, again, short-term, a slow process, but over the intermediate term, we should reap great benefits from a higher yield on loans and lower cost of funding in the Island.

Okay. And just last question, kind of turn into credit a little bit. I saw mention here of some positive trends, especially I think in the -- I think you guys mentioned in the HELOC portfolios in the US. And I was just kind of wondering, I guess, with regard to that particular category, what you guys feel like the sustainability of that is. And maybe taking a step back and asking a broader question is, what are the trends that you all are seeing in the early-stage delinquencies, the 30 to 89 past due or the credit watch list?

Okay, I'll let -- Amilcar Jordan will answer that question.

Yes, we -- well, we have noticed improvements in the 30 days and 90 days past due. That has been a trend that we have seen in the last two to three quarters. So it has been sustained so far.

Also, the rate of loss charge-offs has been very stable at this point. We've got to keep in mind that the portfolio that has been receiving the heavy charge-offs in the last couple of years; so the remaining portfolio is actually a portfolio that is already improving and showing a better performance than the one that we had a couple of years ago.

Okay. So that looks to -- so this experience that we're seeing doesn't look to be seasonal or anything; it looks like it maybe pretty consistent going forward, do you think?

That should be our position at this point, yes.

Okay. Great. Well, thanks, guys.

(Operator Instructions). [Hinenga Delmudez, Bankbish].

How do you plan to deal with the DTA valuation allowance and its effect on Tier 1 capital? Could you comment on whether you are evaluating transactions to try to recover some of these DTA valuation allowance?

Well, we have a full allowance, so there is no impact currently on Tier 1 capital for the US. The only impact is on the Puerto Rico DTA, where they only allow the first year of the deferred tax. We are looking -- obviously, the best thing we can do for the DTA is to start making money in the US and take advantage of that. We have a -- how many years, 20 --?

18 more.

Yes, about 18 more years to take advantage of that DTA, which has been completely written off. It's a little more difficult to do any kind of deal which will realize that, because there's some fairly large constraints on what the purchaser could take advantage of. But it is something that we are continuously evaluating and seeing how we can minimize the tax exposure that we have. And taking advantage of an asset that's essentially been written down to zero.

Okay. And regarding the non-treasury tax trust preferred, are you planning to call some of those early with the excess liquidity you have at the parent company given the Dodd-Frank's bill?

No, that won't start impacting us until about two years from now and we have not looked at that. We don't think, given where regulators' heads are at this point, we don't think until we have started making money again, we don't think that's a viable option. So we have not looked at it.

So you say that two years from now, the trust preferred will no longer be part of Tier 1 capital?

It will start -- I forget the schedule, but it starts (multiple speakers) phase-out of five years, 2012. It won't start until 2012, yes.

Well, if you can recapture some of that DTA valuation allowance for the US to restore some of your Tier 1 capital, that would be very attractive, would it not?

Absolutely, yes. Of course.

And one last question. How does the departure of David Chafey -- has affected management?

You know, we move forward. It's unfortunate. As we said at the time, we worked together for over 30 years. We've had 29 good years and one year that wasn't so good. So, most of the time it was very positive. We've moved on.

Okay, thank you so much.

At this time, there are no further questions. I would now like to turn the call over to management for closing remarks.

Again, thank you very much. This is the first time we do this. We'll try to make it a little smoother next time, but we appreciate the number of people that called in.

This is a quarter that was somewhat noisy with a lot of these accounting adjustments (multiple speakers); but it was -- but I think we're feeling a lot more comfortable with the position of the Company vis-a-vis one year ago or even three months ago. We definitely have completed the capital plan.

We have some transactions that we think are going to be very favorable. The Westernbank transaction is certainly going to be accretive and has proven to be from day one. And once we get the EVERTEC thing, we think we will continue to move forward. We're encouraged by some trends on the credit side; although, as Jorge said, we remain very cautious until we see a few more quarters of that. And hopefully, the economy will continue to get stronger.

So, again, thank you very much for joining us. And we'll be sure to keep you posted of our progress.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.