Popular Inc (BPOP) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2010 Popular Inc. earnings conference call. My name is Erica and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions). I would now like to open the presentation over to your host for today's call, Mr. Enrique Martel, Manager of Investor Relations. Please proceed.

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 fourth-quarter results and then answer your questions. They will be joined in the Q&A session by the President of BPNA, Carlos Vazquez; our Chief Risk Officer, Amilcar Jordan; our General Counsel, Ignacio Alvarez, 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. You may find today's press release and our SEC filings on our web page that you can visit by going to www.popular.com. And now I would like to turn it over to Mr. Carrion.

Good morning and thank you for joining the call. Please turn to the second slide.

For the fourth quarter, we reported a loss of $227 million, compared with a $494 million profit in the third quarter and a loss of $213 million in the fourth quarter of 2009. For the year, we reported net income of $137 million, compared with a loss of $574 million in 2009. As you may recall, the third quarter included a net gain of $531 million from the sale of a majority interest in EVERTEC. There is plenty of noise in these numbers, so we are going to try to clear things up for you as much as possible.

The fourth-quarter loss was mainly driven by the provision expense, which was magnified in this quarter by additional charges incurred in the reclassification of approximately $1 billion in loans held for sale.

Other financial drivers in the quarter included the following -- a $34.5 million charge to settle rep and warranty liabilities and an increase in indemnity reserves for loans sold with recourse. We have lower fee income due to the sale of a majority interest in EVERTEC and we have some one-time expenses related to prepayment of high-cost borrowings and the securities class action suits which we settled.

As Jorge will discuss in more detail, the provision expense amounted to $355 million, of which $176 million was related to the reclassification. Excluding the additional provision related to this reclassification, the provision fell by $36 million to approximately $178 million.

As we announced on Monday, we signed a letter of intent to sell approximately $500 million in construction and CRE loans of Banco Popular de Puerto Rico, the majority of which are non-performing. After increasing our capital by $1.7 [million] (sic - see press release) during the previous two quarters, we are committed to further strengthening our balance sheet by reducing credit risk. The credit actions that we took in the fourth quarter lowered nonperforming held-in-portfolio loans by $772 million and provide clarity to our exposure to the construction sector in Puerto Rico.

Aside from the significant reduction in non-performing which is our first objective here, we see two benefits from the sale of this portfolio. First, the prospective buyer is an experienced property manager who has more flexibility to manage this portfolio and who is in a better position to market these properties within and outside of Puerto Rico, in addition to coming in with substantial capital. Secondly, it'll free up resources that we can reallocate to other areas.

We continue to be very satisfied with the FDIC-assisted transaction that we closed last April. The transaction is performing better than expected. And eight months into it, losses from the covered loans are less than we originally estimated.

As we have more information available now than when we made the limited due diligence that we did in April, this is reflected in the revaluation presented this quarter of the estimated losses from the Westernbank portfolio. And the main takeaways are that estimated cumulative losses are substantially less than expected -- about $1.1 billion. Accordingly, the market value of the loans reflected in our books has increased and the estimated value of the FDIC indemnity asset has decreased.

As I said previously, this transaction opened Banco Popular's entire platform of product and services to close to 140,000 new customers who did not have a relationship with Popular at the time of acquisition. In a time of weak demand, the widening of our client base is of great strategic importance to us.

Net interest income remained stable at $355 million despite the weakness in our main market. Continual reduction in the cost of funding helped offset the negative effect brought about by the reduction in loan balances. The two banks paid down approximately $975 million in high-cost borrowings in the quarter.

Gross revenues at Banco Popular de Puerto Rico amounted to $411 million in the quarter, slightly down from $429 million in the third quarter. In the US, gross revenues amounted to $87 million, in line with the previous quarter.

The continuous recession in Puerto Rico makes loan growth a challenge; the one exception is our mortgage business on the island. Government housing incentives that were enacted in September helped drive a 42% linked-quarter increase in our origination of purchase transactions to $214 million in the fourth quarter. We feel, nonetheless, that the absorption of this new housing on the island will take a little bit of time to sort out.

During the quarter we also agreed to settle five lawsuits with no material cost to the Corporation. And this is part of our general strategy to resolve legacy issues and focus on the future.

If you move to the next slide, we can see that the economy in Puerto Rico is still weak, though with somewhat less strain. Coming off significant declines in jobs and fixed investment in 2009, 2010 started off with large spending cuts and layoffs in the public sector and turmoil in the banking industry that ended, as all of you know, with the consolidation of three commercial banks. The pace of job losses decreased in 2010 but total employment still finished the year down 3%.

The spending cuts have allowed the government to regain its footing. It reduced its structural deficit to an estimated 12% of recurring revenues, down from 43% the previous year, and now it is implementing a tax reform to ease the burden on consumers and local businesses, as it looks to diversify the island's energy mix and generate investments in resources through public-private partnerships and the remaining American Recovery and Reconstruction Act funds. Along with a 15% unemployment rate, the rising price of crude is expected to maintain pressure on consumers.

Bottom line here is that the economy still faces headwinds, although signs of stabilization such as the fiscal progress and the US economic recovery are encouraging.

Let me now turn it over to Jorge so he can tackle some of the details in the financial summary.

Thank you Richard. Good morning. Please let's move to slide four to give an overview of our financial results for the fourth quarter.

The quarterly results were primarily affected by the non-recurring, credit-related items. The reclassification of approximately $600 million in construction and CRE loans in Banco Popular de Puerto Rico and $395 million in non-conventional mortgages of Banco Popular North America triggered a one-time provision charge of $176 million to cover losses incurred in the transfer to loans held for sale. Excluding these actions, the provision for the fourth quarter decreased by $36 million to $179 million.

The reduction in earning assets continues to apply pressure. Nevertheless, net interest income stayed flat versus the third quarter at $354 million as the reduction in earning assets was offset by a $12 million decrease in interest expense. For the year, net interest income increased by $194 million to $1.3 billion mainly due to the acquired covered loans from the FDIC and lower interest expense.

We used proceeds from the FDIC-assisted transaction and cash flow generated from our investment portfolio to pay down the FDIC note by $796 million in the quarter. At year end, the FDIC note, which we issued to finance our acquisition, amounted to $2.5 billion, down from the original $5.7 billion. Operating expenses were driven down $26 million on a linked-quarter basis largely because of lower personnel costs related to the majority sale of EVERTEC and transaction costs incurred in the third quarter.

Our main challenge in 2011 is offsetting the decline of earning assets. Despite the difficult economic situation in Puerto Rico, we feel that we should be reaching operating profitability for the Corporation as a whole during the year.

Let's turn now to slide five for a closer look at the reclassification of our high-risk portfolios. Most of the loans transferred to held-for-sale were based in Puerto Rico, where non-performing loans at Banco Popular de Puerto Rico decreased by approximately $[551] million in our held-for-sale portfolios.

The bulk of the reduction in non-performing loans came from non-covered Puerto Rico construction held-for-investment portfolio, which after the classification now carries a balance of approximately $168 million. We expect to close the sale during the first quarter. The sale price was 47% of the unpaid principal balance.

We will also own 25% of the equity of the joint venture, finance 50% of the purchase price and cover certain related costs, as we mentioned in the press release.

In the US, non-performing loans in our mortgage portfolio fell by $164 million after the reclassification of the non-conventional mortgages. As we mentioned in the press release, we are also pursuing the sale of the reclassified non-conventional mortgage portfolio.

Total losses for the quarter are higher in part due to the reclassification mentioned earlier and also because we charged off previously reserved impaired amounts of collateral-dependent loans under FASB 114.

There were $210 million in charges -- in charge-offs specifically related to this change. This change in loss recognition for impaired loans is mainly a timing issue that is consistent with regulatory guidelines in the current economic conditions. These charge-offs had no impact on the results since the impaired amounts were reserved in prior periods.

If we now turn to slide six -- as mentioned earlier, in the fourth quarter we re-estimated the loss expected from Westernbank's portfolio. We are pleased to report that expected cumulative loss declined by over $1 billion, which led to an increase in the market value of the loans of $939 million. Due to the lower losses expected from the Western portfolio, the valuation of the indemnity asset was reduced by $985 million. Goodwill was reduced by $19 million to $87 million.

The net financial impact of these changes will be positive. Although the increase in the value of the loans was offset by a decrease in the value of the indemnity asset, the loan portfolio is a higher yielding of the two, and the net impact should be an increase in interest income which more than offsets the decline in other income.

Given the materiality of the revisions, we recasted the financial results we reported in the second and third quarters to reflect the revised estimate of the related Westernbank portfolio.

The large adjustments in expected losses reflect the fact that we undertook the original due diligence review of the loan portfolio with limited information within a short period of time. In the absence of more robust information, we adopted conservative assumptions as we prepared our bid in April.

We are capitalizing on opportunities to convert many of these new customers as possible into long-term Popular customers. The loan portfolio represents a great opportunity to strengthen even more our franchise as we work together with our new customers, establishing more long-term relationships.

We can now move to slide 7 to review the results of the Puerto Rico business.

Puerto Rico lost $[26] million (sic - see slide 7) in the quarter due mainly to the provision expense, which included $55 million related to the loan reclassification. Excluding the loan reclassification in the fourth quarter, the provision expense decreased by $40 million.

Net interest income amounted to $303 million compared with $306 million in the third quarter and $268 million in the fourth quarter of 2009. Gross revenues in the fourth quarter were fairly flat when compared with the previous quarters.

As mentioned earlier, during the quarter we continued deploying the excess liquidity at the Puerto Rico bank by repaying $796 million of the FDIC note.

The US bank fourth-quarter highlights, which are featured in slide eight, were the credit actions taken by management in the non-conventional mortgage portfolio and a $22 million increase in operating expenses. The increase in operating expenses was driven by a $6 million OREO write-down related to the loan-portfolio reclassification -- also was a $12 million penalty for prepaying high-cost Federal Home Loan Bank advances, which will benefit our cost of funds going forward.

Net interest income of $78 million was in line with quarterly averages for the year. The provision expense related to the reclassification of $396 million was offset by favorable credit trends in consumer loans and lower specific reserves.

Excluding extraordinary items charge-offs were relatively flat on a linked-quarter basis, and non-performing held-in-portfolio loans fell by $221 million to $460 million, nearly half of what we had at this time last year.

With considerable work done in the legacy portfolios and the restructuring of its operations behind, Banco Popular North America is increasingly expanding its community-banking reach. It reemerged late in the year with the addition of a surcharge-free ATM network, new consumer products and a reengagement in the small and middle markets, all of which will help offset the reduction in assets.

As we see in slide nine, though non-performing loans for the Corporation remain at elevated levels, we have moved past the peak of our credit issues. Excluding loans held for sale, non-performing loans decreased from 10.59% to 7.59%. Delinquencies came down across the board except in our Puerto Rico mortgage portfolio, where non-performing loans continued their upward trend, though at a smaller pace than in the third quarter. However, we continue to experience relatively small losses in this portfolio. Charge-offs in the Puerto Rico mortgage portfolio remain manageable at 86 basis points.

The $451 million drawdown in the reserves was driven by the two loan portfolio reclassifications and the FAS 114 write-down. Excluding these events, the allowance for loan losses declined $87 million. Reserve for loans stood at 3.83%.

In 2010, we successfully completed our capital plan. We raised $1.1 billion through a secondary offering and an additional $531 million through the sale of a majority interest in EVERTEC. The $1.6 billion in common equity gives the Corporation a robust capital base to meet Basel Three requirements.

And with that, I would like to turn it over to Richard for a recap and final comments.

Thanks, Jorge. If you please turn to the last slide, I'll wrap it up by reviewing the key takeaways from this quarter.

First, we took a big step in managing our most troubling portfolio by signing that LOI to sell $500 million in construction loans, which were a major source of losses and uncertainty that took up a considerable amount of time and resources from our management team. We are doing a similar derisking of our balance sheet in the US with our non-conventional mortgage portfolio.

Secondly, we want to maintain the momentum that gave us so many results this past year, but with a different mindset. We are rewiring our business lines, which have spent a large portion of their time in workout and remediation, to start lending again, as we reinforce our service culture to ensure that the lending process works as efficiently as possible.

Banco Popular de Puerto Rico has an undisputed advantage in the scope of its distribution channels. We must make certain that we provide superior service and reach efficiencies that reflect our current size and business mix. In the US, we are satisfied with the continued progress in the development of our core businesses within our footprint and the management of our legacy assets. We will closely analyze the results of our Illinois rebranding pilot program to decide on a regional rollout, and we'll continue to look at ways to improve the balance sheet.

Most of the business in Puerto Rico, where we expect loan demand to remain sluggish as businesses remain cautious and individuals continue to rebuild their finances -- as the largest bank on the island, we are well aware of our impact on the local economy and are actively promoting economic and business opportunities through sound lending.

We entered 2011 in a much better position and with great momentum to take advantage of the gradual improvement in economic conditions. We accomplished everything we set out to do in 2010, and we are working relentlessly to ensure that we achieve profitability in 2011.

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

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Thanks. On the other $500 million of loans that you moved into held-for-sale but that is not part of the -- I guess the joint venture -- are you currently in discussion with anyone in order to sell that? And I guess I am asking, what gives you confidence that you may be able to get rid of the entire $1 billion of held-for-sale by the end of the first quarter? Thanks.

Yes, we are in discussions with a couple of people. They have given us preliminary bids. They are finalizing and firming up those bids. And we expect to announce something in the first quarter -- announce final closing in the first quarter.

Okay.

So there are active discussions now in progress.

Good. Okay. And then the other question I had was, how should we be thinking about provision expense or reserve levels going forward, now that you have substantially cleaned up a lot of the -- a lot of your sort of problem loans?

Clearly that is the objective here, is to relieve some of the pressure going forward and refocus our efforts. So we would expect the provision to go down. We're being cautious as we do that. But I think it's a safe assumption that provision expense will continue to go down.

And on a net basis, would you expect reserve release, just meaning provisions less than charge-offs going forward?

There should be some reserve release in the 2011 time period, yes.

Okay, thank you.

Brett Scheiner, FBR Capital Markets

Hi, guys. Just quickly, other OpEx in the quarter -- $218 million. Can you talk about what contributed to that number? Also some color on Rio expense and the unfunded lending commitment reserve?

Can you repeat that -- other what?

The other operating expenses in the quarter -- $218 million. Can you talk about the components there?

I think a bit of that came down with obviously with the EVERTEC sale -- is I think the biggest thing. On the negative side, we had some of these -- we had the settlements and some of these charges to settle some outstanding issues, not only lawsuits but also some loans and some new purchase commitments there.

And can you give the size of the unfunded commitment reserve increase in the quarter?

Yes it was $21 million.

$21 million, okay. And then also looking at core provision, almost irrelevant of charge-offs now that you have moved this large slug of loans into HFS -- it looks like you'd be profitable on a run-rate basis in first quarter. Can you talk about that versus -- profitability versus additional loan workout?

You know, we're not going to break it down by quarter. We certainly expect the year to be profitable. We are very committed to having a profitable year. We will be releasing the provision as we see conditions improve. But certainly, the provision is going to be the main driver here. We still think we have another lever in operating expenses. And we think we can continue to work those down.

Obviously, if we get a little tailwind from the economy, that would be gravy. But right now the main levers will be what happens to the provision expense and how we can continue working on the operating expenses.

And then one last question -- can you give NPA inflows versus last quarter for both banks?

Sure. Let me turn that one over to Amilcar and --

Okay, NPA levels for both banks (technical difficulty) by geographic region, they went down, excluding the held-for-sale transaction, by $550 million in the case of Puerto Rico; and in the case of the US, they went down by $220 million. That is after considering the transfer to the held-for-sale of the loans I mentioned before.

Can you disclose what the new inflows to nonaccrual status were?

We would provide that information in the 10-K report. I guess this is a slowdown in terms of the inflow of new cases into NPL. But we would provide a breakdown in the 10-K report.

And based on the transaction, there will be additional disclosure on the total remaining balance of accretable yields with the restatement?

Yes.

Okay, thanks very much.

Adam Barkstrom, Sterne Agee.

Good morning. Can you hear me? Are you guys there? Okay. Jorge, could you just sort of -- you walked through the Westernbank transaction -- or not transaction, the reclassification. Could you maybe spend a couple more minutes on that, and kind of walk through what the potential effects would be on future income levels from that?

Okay. If we tried to go and give an accounting explanation I think, you know, that I would probably fail in communicating that. And even if I was successful, you probably would fail in understanding it.

So let me give you the essence of what has happened here. This portfolio, when it was originally analyzed, we estimated X amount of losses, over $4 billion. And it was certainly due -- because we had very little time to do an adequate due diligence. Now after a few months, you know, we have been taking a look, a different look, meeting with customers, we feel more comfortable. And we feel that the losses, similar losses, are going to be less; are going to be about $1 billion lower.

So when that happens, you have to determine whether it was because of something that took place after the [growth spurt] or something that was there at the beginning but you just didn't have enough information. And we're going to take one. We're going -- we're adjusting, going back and adjusting day one, because it's something that was present at that time. So this is why all the work that had to be done -- and in part, the reason for the delay of our announcing numbers -- that we have been recasting. It's recasting the second and the third quarters, as if all this had taken place in acquisition date.

It is like a restatement. But it is called recasting. But it takes the work of a restatement. In essence, loans are increased by -- and I'm going to be rounding off numbers. It is going to be with a very wide brush. Loans are worth $1 billion more. But since now we're going to be losing less, we have to adjust the indemnity asset, because we will be receiving 80% of those lower losses. We will not be receiving that from the FDIC.

So the $1 billion gets automatically cut by $800 million and now you have a net benefit of $200 million. Now that $200 million is benefit for the institution that will be earned throughout the life of the loan in addition to what we had before. But there is a clawback provision in the guaranteed agreement with the FDIC -- that if the expected losses are lower than what they had originally determined, then they are entitled to about 50% benefit from that recovery. So you also feed that into the model and you come up with numbers that will determine new accretable yields.

But in essence, you're going to have the $1 billion that gets reduced to $200 million. FDIC gets 50% of that, or $100 million. So the Corporation will now stand to benefit in around $100 million during the life of the duration of this portfolio.

Let's assume that the portfolio last for four years. So you're going to have $25 million of increasing revenues annually for the next four years before taxes. So, roughly, roughly, you're talking of an improvement from before that could be around $10 million to $20 million.

Gotcha. That was very helpful. Thank you.

Any idea -- this is kind of -- you probably don't, but I'm sure you guys have thought about it and looked at it. But you've got this big sale of the nonperformers. One of the things that you've talked about is, you're going to free up resources. Any idea on how to quantify that? I mean, are there any cost saves that you could quantify from not having to manage those problem assets? Or is it just too many moving parts to frame that?

Adam, there's a lot of moving parts here. We'll probably have a better handle on it in the next few months. But without a doubt you have a lot of people tied up in the construction, in the management of that construction portfolio. In addition to that, you have a lot of legal fees, you have appraisal fees. You have a whole lot of stuff. And you have a whole bunch of collection people. These construction loans tend to be a lot tougher to work out. Some you have to do some advances. You've got to finish projects, all of that stuff. So I think there will be considerable resources freed up here.

The thing is, what do we do with those resources? We would like to start trying to build portfolios again. But they're clearly going to be a mixture of cost saves and re-purposing those guys to doing other stuff.

Right, okay. And then maybe if you could put some color around the reps and warranties charge that you took? That's something I believe -- I know we talked about that. But it's kind of something -- a new item in the press release. And I just wonder how you're thinking about that for 2011?

I think that should -- the reps and warranties one should not come back in 2011 in any meaningful way. This was two things. One was related to the PFH issue in the US where there was a limit. And we just signed an agreement with the purchaser that for an amount -- and that would eliminate any future reps and warrants. And the other was E-LOAN, buyers of -- a large buyer of the E-LOAN that had also wanted to close off the reps and warranties issue.

So I think between the two of those there is around $14 million in the quarter and then the rest was that $20-plus million that we built up in reserves for repurchases of Puerto Rico mortgage loans.

So, Richard, if I understand you right, you basically closed off PFH and E-LOAN, is that correct?

You know, in substance, yes. There could be something in E-LOAN going forward. But this was a large buyer. So we think that is substantially closed off and the portfolio has been behaving better. As you know, that is a business that they were winding down. And we haven't made loans there since '08, so yes, we think that was moving off.

And it's just one more real quick. Jorge, if you could talk about -- I know you guys mentioned it, but the FAS 114 of $210 million in specific reserves, why did that hit this quarter? What is sort of the thinking there? Please, if you could give us some additional color there? And should we expect to see any of that kind of activity going forward? And then also, if you could talk about your corporate tax rate going forward.

Okay. On the 114, this accounting rule has a very good purpose. It's that in the event that loans are becoming impaired, but because of the nature of the loan, there are -- there is a possibility that it may come back performing -- so you want to give yourself some time before you charge it off. And that is why you establish a reserve against the estimated losses, but you do not charge off the loan, and you give yourself some time.

Right now we're giving ourselves a year to do this. And in the past you know that seemed to be working out fine. But here, given that most of these loans are construction loans, and given that these are collateralized by real estate, and the value of real estate has been consistently going down in the last couple of years -- so it has become academic. And therefore we're just shortening the period in which we charge off.

As I mentioned, it is not going to impact the P&L because the reserves had already been built under the 114; it is just the timing in which we charged it off, that now we're going to be looking at charging off within the quarter in which the 114 reserve is established.

Adam, I think with the moving of these portfolios into the available-for-sale, I don't think it's -- it really becomes academic as Jorge said. And to just put a little point on it, I think the regulators really wanted us to do this a little quicker than we were doing it. And we were fine with it.

Gotcha. And then the tax rate?

I would not annualize this [charged-off month] by any stretch of the imagination.

I understand. Then, Jorge, could you put some color around the tax rate going forward?

Yes. There was a tax reform that was approved. And now it is good, because it will reduce our tax liability to 30% versus the current 40%. And so, definitely, that is a plus going forward.

But we have to cross one bridge -- it's that for tax purposes in Puerto Rico we had been losing money so we had been building a deferred tax asset. And that deferred tax asset had been built at the old rate or the 40% rate. So now that the rate is 30%, we will have to make that adjustment of 10% on that estimated -- what, how much? We're looking at a number (multiple speakers)

-- we're looking at that but it's in the order of $75 million. But we're looking at the final version of the law and the rate to see what we can do there.

And we're still active in conversations with the regulatory authorities to see how this can be mitigated. But it's a plus over the long run, no doubt.

Last thing -- I'll jump off, I'm sorry I'm taking a long time. Can you give us the FTE margin?

We don't have that yet. (multiple speakers) no, no.

General -- margin was better during the quarter. I think you have it in the press release, Adam.

Yes, we just wanted the tax adjustment.

The tax benefit right now given the position we are -- so take it as the same as the FTE, because there is going to be no tax benefit.

Okay, thank you guys.

Joe Gladue, B. Riley.

Hi. I guess even if you don't have the inflow number, just wondering -- I'm still trying to -- with all of the ins and outs in the nonperformers -- just trying to get an idea of trends going forward. Can you just give us some color on, maybe, what is happening with trends in delinquencies? Where you expect the nonperformers to go in the next quarter, too?

Right now, as you can see in the numbers, we have been experiencing an increase in terms of nonperformers in the mortgage portfolio in Puerto Rico. And the reason for that is, basically -- one is that the loans that we are repurchasing under the recourse agreement, and the other one is a relatively high level of delinquency in the mortgage portfolio in Puerto Rico.

Aside from that, the other portfolios are showing relatively -- levels of stabilization in terms of nonperformers. Certainly with the transaction or the transfer of the construction loans to held-for-sale, which was the largest increase that we have particularly in 2009 and a portion of last year too, we don't foresee that significant influence in terms of [NPS]. However, we will continue to monitor some portfolios like the CRE portfolio, both in Puerto Rico and the States. And the mortgage portfolio also in Puerto Rico because [in the States] with the transaction on the non-conventional mortgage portfolio, delinquency should also be going down, going forward.

Okay, alright. And I guess, just wondering if you could give us an update on how the competitive environment is looking post-consolidation in Puerto Rico, in terms of deposit pricing and just general levels of competition?

It is still competitive, Joe. We're seeing some activity on the deposit side. But in general, I think we've been successful in lowering our funding costs. We still see a bit of aggressiveness, strangely enough, on the loan side. But again, we have also managed to expand margins. So it's rationalizing a bit, but there's still competitors out there. And they all want to increase share.

Alright, thank you.

Derek Hewett, KBW.

Good morning. A quick question about the cost of borrowings. It looks like it went up on a linked-quarter basis from 3.57% to 3.94%. Any color in terms of what is going on there?

Probably I think it's the result of math, because we are certainly -- we're rolling debt at lower rates. Maybe we had something large maturing, that it was a very low rate during the quarter. We're speculating here. We're trying to -- Richard Barrios is trying to get the answer to that. But it is counterintuitive, yes. No reason why that should be going up unless it's that we had a large [block] liability at relatively low rates that came due.

Okay, great. And then also, on the US deferred tax asset, I realized that that is 100% reserved for. But I guess given the trends that you guys are seeing as we head into 2011, 2012, has your thought process changed in terms of being able to at least reverse a little bit of that back?

We'll tackle that. Let's first finish up the other one, because I think Richard wants to add something.

This is Richard Barrios. One possible explanation, Derek, is the velocity with which we've been prepaying the FDIC note. And the FDIC note has a premium that was recognized on the date of issuance. And as we have been accelerating the repayments of note, we have been needing to amortize the premium, which is impacting, distorting, the cost of funds.

Regarding the DTA, as you correctly mentioned, the US DTA was completely written off. Obviously we're doing everything possible to accelerate the return to profitability in the States, and try to get that back. That is clearly an objective. We don't have a handle of when that is going to take place. But that is uppermost in our minds when we look at the US operations.

Okay, great. Thank you very much.

Robert Schwartzberg, Compass Point.

Good morning. I had a question about the financing of the sale of the nonperforming loans. I understand you provided 50% of the financing. Did the buyer borrow any money on their own? Or come up with any equity out of pocket? Can you tell me a little bit more about the transactions?

Well, first of all, we don't have -- the transaction is not done yet. We have an LOI to do the transaction. Under that LOI, we would finance 50% of the purchase price, and the other 50% would be capital, which they would put up -- of which 25% of which would be capital that we put on -- in the transaction. That is the -- but they are putting up real cash. Without a doubt, they are coming up with real cash.

Yes, it's not coming from loans, or -- no. They are coming in with cash. We'll receive cash in the exchange of selling those assets to the entity.

And will you be putting in cash? Or just retaining an interest in the joint venture?

Well, it would be the net. But in essence, at first we sell all the assets. And we get cash. And then we put cash back. So it's a cash investment.

Okay, but they're not getting any other debt on their own on these assets?

No, no. That's their own problem. How they get the money is their own responsibility.

Okay.

But I mean, we have dealt -- we know who the -- we know them well. They are backed by a substantial fund. And I don't think it's going to get over-levered. On the contrary, we see this as greatly improving the position here.

And the US assets, how close would you say they are to some form of Letter of Intent?

I will let Carlos take that if he is here.

We have been working on this transaction for a couple of months now. And it will be fair to assume that it will be completed in the first quarter.

Okay. If I could ask one related question, because you had addressed the deferred tax asset in the United States, and that you're working very diligently to try to realize that. Can you refresh my thinking on what kind of income you would need to achieve in the United States before you would look at reducing the allowance on that asset?

As you know, these things, I don't want to say it is like magic but --

That's why I'm asking you.

It is moderately gray. Look, it's roughly $1.2 billion that has been fully reserved. I think what you have to show [is the ability] to generate earnings. And to the extent that you can show an ability to generate earnings that will absorb that in the 17, 18 years that are left in that DTA -- to that degree, they will help you relieve some of that reserves. But you have to make a convincing case that going forward you are going to be able to make the money.

Okay. And one other item, could you also -- I apologize, I'm travelling. Could you refresh my understanding of the extraordinary expenses in the United States operation? It looks like those ticked up. Some of that was for paying off -- debt prepayment penalties. Is that correct?

There was a debt prepayment penalty of some Federal Home Loan Bank advances that we paid off. You had the OREO related to these loans that we reclassified. And you had the two things that we mentioned earlier regarding E-LOAN and PFH.

Those were in the United States?

Those in the US, yes.

Okay. And how much were those?

Those two added up to roughly 14. [E-LOAN and] PFH, the OREO I think was about [6], and the prepayment was 12.

Thank you very much.

Ken Zerbe, Morgan Stanley.

I just wanted to follow-up on -- in terms of EVERTEC, how is that being reflected in the income statement, both in fourth quarter and going forward? Because I guess I was expecting both income and expenses to drop because of that. But it looks like it might be embedded in the results?

You are right. I will let Jorge tackle that one. It is both -- but it is both on the income and expense side.

Yes, as you know, we sold the company at the end of last quarter. So in the fourth quarter, you know, the [basis] is not reflected there. We continue to have some expenses and some revenues related to it, because we do have an interest in it.

But before the transaction, EVERTEC would contribute approximately $60 million a year to corporate earnings. So you're talking of around $15 million a quarter. And that is no longer there. So now we have an investment. And the benefit that we will receive would be as that investment grows and yields fruit. So basically, that is how you should be looking at this going forward -- that from a $15 million a quarter net contribution, that was sold and we received value for it. That is why the price -- the sales price was high. And that is part of our capital.

But now we will depend on the yield from this investment that we have -- that we owned 48% in EVERTEC. And as you can imagine, the nature of the new entity is one that wants to grow the business. It was a heavy leveraged transaction. So the interest expense is very high. So they are publishing public statements, because there are a public company and they have securities out there in the market, public securities in the market. But they're not going to be making -- probably not expecting to make much money for the next few quarters as they continue to build the business and reinvest a lot of their money back into the business (multiple speakers).

Understood. But from a modeling perspective, you're going to record all the expenses in your expense line. Your portion, sorry, your portion of expenses in the expense line -- your portion of the revenues in your fee line.

I will let Ileana address that. Now it really gets complicated.

Bear in mind that half their business comes from us. So that is the tricky part. Let's let Ileana give you a follow-up.

An estimate -- although the net will be like zero, [there's no activity] costs, at the end of the day you would have elimination of other income and other expenses. It could be 16, or around $16 million a quarter. Because you have an [inter-companies] that you own 50% and that you need to eliminate by whatever is yours. But in mind of EVERTEC, we have 50% business, in addition to having 49. (multiple speakers) it's going to be zero but in two different line items.

Okay, so you're not going to get any benefit near-term from EVERTEC.

Unless there's equity [recovered on that].

We don't see it because they're just running the company with a lot of debt.

Okay, alright, thank you.

Bret Scheiner, FBR Capital Markets.

I know you're close to an LOI and there's nothing formal. But just a quick follow-up. Do you know what the LTV of the new note on the sale of loans would be to the revalued collateral?

Well, you know, if you take it that they are basically putting up some capital, and if you take it that they are -- the capital is 50% of the purchase price, right?

Right.

And they've just revalued to 47% of unpaid principal balances. We are feeling a lot more comfortable with the LTV and with the fact that we have a lot of capital behind them now.

Certainly you're in a better position. But I'm just trying to get a handle on additional declines in collateral values, and at what point the equity would start to take a hit, and at what point the note would start to take a hit.

The equity takes a hit first. This is Ignacio Alvarez. Obviously, all the -- the way the structure -- the way the venture is structured is that all the cash flows go first to pay the operating expenses of the venture, but after that it goes to pay the loan before anything goes to the partner. So the equity is at risk first.

(multiple speakers) We can follow-up off-line. Just one other question, what is the assumed coupon on the financing note?

Right now we are in a LOI. But right now we've been talking about around 300 basis points over LIBOR.

And that will be a floater?

Yes.

Okay, thanks very much guys.

We have no further questions at this time. I would now like to turn the call back over to management for any closing remarks.

Well, first of all, thank you all for being here on the call. We realize there is still a lot of noise in these numbers. We will try to provide a lot more clarity in the 10-K that is coming out in about three weeks. Again, we would like to tell you that there's going to be no more noise in these quarters, but we're just going to do whatever it takes. Really, we are committed to continuing to knock down the pins. And we are very committed to making money this year. So have no doubt as to that. So I look forward to talking to you in the next few weeks. Thank you.

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