Popular Inc (BPOP) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2011 Popular Incorporated earnings conference call. My name is Jonathan and I am your operator for today.

At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session after the prepared remarks. (Operator Instructions) As a reminder, this conference call is being recorded for replay purposes.

I would now like to Hand call off to Mr. Enrique Martel, Manager of Corporate Communications. You may proceed, sir.

Good afternoon 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 other members of our management team.

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, our financial quarterly release, and supplements. You may find today's press release and our SEC filings on our web page, which you can visit by going to www.popular.com.

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

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

For the second quarter, we reported net income of $111 million, compared with net income of $10 million in the first quarter and a loss of $44 million in the second quarter of 2010. Second-quarter profit was mainly driven by higher net interest income and an extraordinary tax benefit of $60 million, which were partially offset by a higher loan loss provision related to the non-covered loan portfolio.

This is our second consecutive profitable quarter, and we continue producing strong and consistent levels of revenues. While the level of credit costs remains elevated, we continue to make progress.

The most telling sign is our top-line revenues, which remain steady despite the economic challenges we face in our markets. Net interest income increased by $31 million to $375 million when compared with the previous quarter, and our net interest margin remains well above 4%.

We drew down the reserve for non-covered loan losses for the fourth consecutive quarter, albeit at a reduced pace. Loan loss provision of $144 million includes $49 million related to the Westernbank covered assets, which represented higher recognized credit losses in certain pools of loans. Keep in mind that an amount equal to 80% of the provision related to these covered loans flows back through non-interest income due to the FDIC loss-share agreement.

Excluding covered loans, held-in-portfolio nonperformers increased by $17 million. While we would like to see this number down every quarter, we are encouraged by the fact that NPL inflows in our commercial and construction loan portfolios at Banco Popular de Puerto Rico have declined in the last two quarters.

The FDIC-assisted transaction has been instrumental in broadening and supporting our revenue streams amid the sluggish economic environment. Each quarter we review expected losses and cash flows from the covered loans, and results have consistently been positive. While quarterly variations in the loan loss provision related to Westernbank may occur, the performance of the covered loans continues to exceed our expectations.

We continue to seek additional opportunities to raise our top-line revenue. During the second quarter we completed our second purchase of high-quality Puerto Rico mortgages in the last six months, adding an additional $282 million in mortgages to our loan book. The purchased mortgages, including the $236 million we acquired in the first quarter, have an average FICO of 718 and a loan-to-value of 81%.

As I said in the first quarter, the overarching theme here is that we have the machinery to add these assets with very little marginal cost from an operational point of view. So if potential asset purchases make sense, we are going to go ahead and do them.

On a smaller scale, we acquired certain assets and liabilities from the local retail branch of Wells Fargo Advisors, which should strengthen our retail brokerage business. This transaction was closed in July, right after the end of second quarter, and should be immediately accretive.

The tax agreement was the main significant event that had an impact on second-quarter results, though a number of significant items in the previous quarter widened the difference in pre-tax income. So if you please turn to slide 3 we'll review some of these items.

We reached an agreement in June with the Puerto Rico Treasury Department that reduced the tax expense we had recognized in previous quarters. The tax deductions related to certain loan charge-offs, recorded in the years 2009 and 2010, will be deferred until the years 2013 through 2016.

As a result, we made a payment of $89 million to the Puerto Rico Treasury and recorded a tax benefit of $54 million for the recovery of the tax benefits we were then able to recognize under GAAP. We also recorded a tax benefit of $6 million related to tax-exempt income for the first quarter of 2011.

The difference in non-interest income between the first and second quarter was largely widened by two events in the first quarter. In Q1 we recorded a $17 million net gain from the sale of our processing business in the Dominican Republic; and changes in the local tax code led to $14 million equity pickup from our 49% interest in EVERTEC. As you see on the slide, first-quarter results also included an impairment related to the Venezuela processing operations and a penalty for the extinguishment of high-cost debt, among other events.

Jorge will expand on the financial results shortly, but first turn to the next slide for an overview of the Puerto Rico economy during the last three months. The economy in Puerto Rico has seen some improvement. The recently implemented tax reform has led to higher government revenues, while retail sales increased 4% during the first two months of the year compared with the same two-month period a year ago. Job growth continues to be a challenge, and the unemployment rate on the island is still very high.

There were three developments in the second quarter that merit mention. The government awarded the first public-private partnership to a consortium last June, effectively monetizing the future toll stream of a highway strip in the northern part of the island for the next 40 years, in a deal valued at $1.4 billion. The administration also sold $304 million in general obligation bonds last June to fund infrastructure projects, among them the completion of the remaining expansion of a highway that runs on the northeastern coast, road improvements, and municipal projects.

Thirdly, the government extended the housing incentive law until October 31. Originally enacted with a sunset of June 30, the broad package of incentives has been a catalyst for mortgage originations.

As recently reported by the Puerto Rico secretary of housing, during the first 10 months of the incentives home sales totaled 12,491, of which 3,076 were new homes. New units sold in this period were 91% higher than in the previous year.

The second quarter was particularly strong for our Puerto Rico mortgage operations. Mortgage originations at Banco Popular reached $367 million in the second quarter, an increase of 18% when compared with the previous quarter and 40% when compared with the same quarter a year ago. The economy is certainly not where we would like to see it, but there is increasing evidence that it may be bottoming out.

We will reiterate, however, what we have said in previous calls. There are still structural challenges, such as the dependence on oil for fuel, that still need to be worked out. But there is certainly less uncertainty clouding the local economy.

With that, let me now turn it over to Jorge for a more detailed explanation of the financial results.

Thank you, Richard. Let's move to slide 5 for an overview of our consolidated financial results for the second quarter. The three big moving parts in the quarter were the tax benefit, the increase in net interest income, and the increase in the provision.

On top of the tax agreement reached, we also benefited from a lower tax rate that was introduced when the Puerto Rico tax reform was enacted at the beginning of the year. The effective tax rate for Banco Popular de Puerto Rico for 2011 is estimated at 22%.

Actual and expected increases in cash flow from covered loans, higher interest income from mortgages, and lower liabilities costs drove net interest income higher in the second quarter, increasing $31 million to $375 million when compared with the first quarter. Our net interest margin rose from 4.15% in the previous quarter to 4.48%.

Reducing funding costs has been a major initiative of the Corporation this past year. Our average cost of funds has fallen over the last 12 months by 47 basis points to 1.9%, while our average yield on loans and leases has increased by 41 basis points to 6.73%.

The high-cost debt we prepaid in previous quarters helped the margin in Q2. But a major drive behind the improvement was a reduction in our cost of deposits.

We have continued to make progress in repricing our Puerto Rico deposits and deposit costs. As a result, our interest expense on deposits declined by $6 million or 8% in linked quarters. We will continue to take advantage of opportunities to further reduce deposit costs, primarily in our Puerto Rico business.

The provision expense increased by $69 million, with $33 million of the increase related to covered loans. The main point I would like to make about our covered loans is that they are performing better than initially expected.

Our regular second-quarter loan review found that overall expected credit losses declined versus the previous estimates. A minority of the pools of covered loans did show increases from expected losses; and the loan loss provision was increased to reflect this. However, on an aggregate basis, actual and expected cash flows from covered loans increased, and the benefit will be recognized in future periods through higher loan yields.

The FDIC loss share income this quarter amounted to $39 million, an increase of nearly $23 million when compared with the previous quarter. Despite the rise in loss share income, consolidated non-interest income fell by $40 million to $124 million.

The decrease was principally the result of various special non-interest income items in quarter one, and a $13 million negative adjustment in the valuation of disbursements on the unfunded commitments of construction and commercial loans held for sale.

Expenses were up by $7 million in the second quarter when compared with the first. However, if we exclude the impact of the significant items in the first quarter, expenses increased by $24 million, mainly due to higher FDIC assessment.

Please turn to slide 6 for an overview of our Puerto Rico business. Gross revenues in Puerto Rico amounted to $439 million in the first quarter, up $22 million from the previous quarter.

Net income amounted to $140 million for the quarter, compared with a profit of $4 million in the previous quarter. Excluding the tax benefit mentioned before, the Puerto Rico business earned $80 million in the second quarter.

Net interest income increased by $30 million to $325 million. The margin in the Puerto Rico business improved to 5.19% from 4.78% in the first quarter. Operating expenses increased by $17 million to $217 million mainly because of FDIC assessments. The loan loss provision, excluding covered loans, rose by $19 million to $71 million in the second quarter driven by a rise in commercial nonperforming loans.

As an update on the Puerto Rico construction loan sale, there are currently several buyers interested in the commercial and construction loans held for sale, which are reviewing loan information and conducting due diligence work. We will actively pursue those deals that make sense for the Corporation.

Let's turn to slide 7 for a closer look at the performance of the covered loans. There are several takeaways from the performance of the covered loans portfolio.

The discount amortization from the revolving loans is running off, netting only $9 million. And the equity appreciation instrument issued to the FDIC, which expired without further exercise, produced only a gain of almost $600,000 compared to a gain of $7.7 million in the previous quarter.

The two main revenue drivers in the covered portfolio are the interest on the non-revolving covered loans and loss share income. Both came higher this quarter.

The interest on non-revolving covered loans increased by $29 million to $107 million. The FDIC loss share income increased by $23 million to $39 million, while the provision amounted to $49 million, a $33 million hike over the previous quarter. The latter two are intertwined, as any change in provision is offset 80% by the loss share income.

Each quarter we revaluate our loss estimates. The provision recognized this quarter is related to a minority of the pools of loans that make up the covered loans and is recognized immediately, whereas increases in the estimated cash flows are prospective, to be reflected through interest income in future periods. Looking at it through a wider scope, the opportunity for us lies in securing viable, long-term relationships and meeting the financial needs of these new clients.

Please turn to slide 8 for an overview of our U.S. bank. The US bank basically broke even in the quarter as we continued to work hard to improve financial performance.

Gross revenues were steady at $94 million for the quarter, compared with $92 million in the previous one. The margin expanded slightly by 4 basis points to 3.64%.

The bank provisioned $25 million for loan losses, compared to $8 million in the previous quarter. The increase was caused by the first-quarter event in which the bank recaptured $14 million after the price for the sale of the non-conventional mortgage portfolio came in higher than expected. Excluding the impact of the loan sale in the first quarter, the provision increased by only $3 million.

Excluding loans held for sale, nonperforming loans fell in the quarter by $23 million, mainly in the construction portfolio. Expenses increased by $4 million primarily due to variances in OREO expenses between quarters.

We will roll out the Popular Community Bank rebranding program in August to California and Florida regions. As you know, the program seeks to appeal to a broader base of clients.

Please turn to Slide 9 to review credit performance and the allowance for the second quarter. Nonperforming loans, excluding loans held for sale, increased by $17 million, due largely to a $30 million increase in Puerto Rico commercial loans.

As mentioned earlier, credit metrics in the US continues to improve for the most part, with nonperforming loans falling by $23 million. Nonperforming loans in our held-for-sale portfolios declined by $65 million, mainly due to payments received from construction loans in the held-for-sale portfolios in Puerto Rico.

Mortgage nonperforming loans in Puerto Rico, the primary driver of increases in previous quarters, rose by $10 million, which is lower than increases in recent quarters. Puerto Rico mortgage chargeoffs remain low at less than 1% for the quarter.

We have boosted our mortgage collection and loss-mitigation efforts to closely monitor the performance of restructured loans. As of the second quarter, 75% of restructured mortgages in Puerto Rico were still performing at the one-year mark.

Nonperforming loan inflows in commercials and construction loans in Puerto Rico fell again this quarter, down $16 million when compared with the first quarter. Inflows in these two portfolios have declined during the first six months of the year, when compared to the previous six months. As we pointed out in the last webcast, the ability to maintain this trend depends on future economic stability.

The reduction in nonperforming loan inflows in Puerto Rico was offset by a $17 million increase in the US. The increase in the US was primarily attributable to one large relationship that went into nonperforming status during the quarter.

Excluding covered loans, net chargeoffs for the Corporation fell $6 million on a linked-quarter basis to $133 million, mainly due to construction recoveries in Puerto Rico and declines in consumer losses in both Puerto Rico and the US. The reserve for loan losses for non-covered loans declined by $38 million from the previous quarter, which was at a slower pace than in Q1, this being our fourth consecutive quarter in which we have been able to draw down the allowance. Excluding covered loans, the allowance -- the loan loss ratio stood at 3.34% for June versus 3.52% in the first quarter.

Now, by turning to slide 10, we will briefly review our capital ratios. Our capital, which started the year at robust levels, continues to rise due to our return to profitability.

We already exceed full phased-in Basel III requirements and are well positioned for a challenging economic environment as well as heightened regulatory expectations for capital. A slight decline in regulatory capital ratios was driven by the deferred tax asset generated by the tax benefit, a portion of which is disallowed for regulatory capital ratios.

For Tier 1 common capital, we exceeded the Basel III requirement by approximately $1.1 billion, or over 400 basis points. For the other measures, the margin over the requirements were even greater. Since we are expecting balance sheet growth to be modest over the next few quarters, capital ratios should continue to rise.

Now, I would like to turn over the call to Richard for some final comments.

Thank you, Jorge. If you please turn to the last slide, I'll wrap it up by reviewing the key takeaways from this quarter and key issues to focus on in the coming months.

The consistent production of gross revenues amid the headwinds is reassuring heading into the second half of 2011. We have a unique franchise in Puerto Rico and a bank in the US focused on growing its community banking business under improved credit conditions.

The rise in NPLs in the quarter reflects a still sluggish economy in Puerto Rico. Yet there are encouraging signs, such as new public investments and the six-month decrease in NPL inflows, which suggest the cycle here could be bottoming out, albeit we remain cautious. The performance of our covered loan portfolio continues to exceed expectations and has elevated our revenue-generating capacity at a time of limited loan demand.

We will continue to manage credit costs and pursue transactions for our held-for-sale portfolios. We are also seeking opportunities to broaden our business through asset acquisitions that can be absorbed by our existing business platforms without undue added risk.

Above all is our return to sustained profitability. It lessens problems and creates opportunities.

We had a good first half in 2011, and we are working hard to finish the year even stronger. We thank you for your attention, and I would like to now open up the call now for questions.

(Operator Instructions) Joe Gladue, B. Riley.

Good afternoon. Congratulations.

Joe, thank you.

A question or two on the net interest margin. Notice that the yield on mortgage loans was up a good bit from the first quarter. Just wondering; is some of that due to some of the purchased loans, or are the loans you are originating coming in at higher yields, or what?

No, exactly what you said. The improvement is due to the new loans coming in that we acquired, the little over $500 million that we acquired in the first half of the year. Those came in at a nice yield and bumped up the portfolio.

Okay. On the funding side, you did have decrease in the deposit costs. Can you just touch on the competitive environment? Are I guess other banks in Puerto Rico following your lead? Or is the general competitive level getting more rational?

You know, rational is always in the eye of the beholder. We still think there is somewhat of a disconnect between the prices being paid for deposits vis-a-vis LIBOR. And we think there is still a room for improvement in loan pricing.

But all us free-market types hate competition, I guess. But it's gotten better than certainly a year ago, but we think there is still room for improvement.

Okay. I will just ask one more. How much in the way of loans repurchased under recourse agreements? Was that a significant amount in the second quarter? And what is the trend there?

I don't have that number on me. We can dig it up for you, Joe, but I don't think it has been significant, no. It was not really significant during this quarter.

Okay. All right, thank you.

Ken Zerbe, Morgan Stanley.

Great, thanks. I guess just to follow up on the funding cost question, is there any way you can quantify how much further you think that your overall funding costs might decline over the next year or so? I understand it's sort of a general question to ask, but just trying to get a sense of magnitude.

Well, I guess when we look at overall costs, I think we have a very low base. But when we look on the margin generating additional deposits, we are still somewhere around 30 to 35 basis points north of LIBOR -- or the brokered loan rate -- brokered CD rate. So we think there is some improvement we could see there as the market continues to exercise a little more disciplined [book].

But that is the only metric we really use. We look at cost on the margin vis-a-vis what comparable broker CD rates would be.

Okay. Then the other question, your commercial and mortgage nonperformers have been trending up for the last couple quarters. Obviously the concern is that with those continuing to trend up it could result in incremental losses or higher provision expense.

What can we on our side of the table look at, or how do we get comfort that the trend doesn't continue to go up? Provision expense follows.

I think, well obviously, the overall level of nonperformers. But I think it is more relevant perhaps to look at the trend and look at the inflows of C&I loans, and broken out by both the US and Puerto Rico. There we do begin to feel a little more easy about it.

All right, thanks.

So it is the inflows number that we are looking at.

Okay.

Brett Scheiner, FBR.

Hey, guys. Nice to see the internal capital generation. Just a couple quick questions. One, with the firm now squarely in profitability and you are showing excess capital in excess of TARP under Basel III, can you talk about timing of even a potential TARP repayment?

Okay; I will take that. It is true. We have now, as we were anticipating, are through two quarters of profitability. And that is definitely the first step.

But we do not have right now a specific plan for any TARP repayment. It is probably premature to engage in that.

But having said that I want to tell you that we are continuously looking our capital and different ways of enhancing our capital structure, including the repayment of any of the trust preferred securities or any other securities that are the composition of capital in order to enhance it. So this is -- it's a live situation that we are continually overviewing.

Okay. Then do you have the accretable yield balance at the end of the quarter?

Pardon me?

Your total accretable yield balance at the end of the quarter.

The total accretable?

Yes; because if you look at the yield on loans, the yield on the covered loans goes up and therefore your FDIC asset is accreting at a much slower rate.

I am saying do you have the total aggregate balance? I can follow up with you off-line.

The total aggregate balance of --? You are talking about the accretable yield during the second quarter on covered assets?

Yes.

I think we have it. It should be there. Yes; it is in the presentation.

In the level and yield part of the press release, or --

(inaudible - microphone inaccessible)

The yield on the covered loans went up to 9.91% in the quarter.

Okay. I will follow up with you guys off-line. I was looking for the number in aggregate, but we can talk about that. Thanks again.

Sure. If it's a dollar amount it was in page 8 of the presentation; it's our total interest income from covered assets. It was $94 million during the quarter.

(Operator Instructions) Derek Hewett, KBW.

Good morning, gentlemen. A follow-up question to the accretable yield. What was the net interest income contribution from Westernbank for the quarter?

Well, it is difficult to say. We are not showing that.

If you estimate -- you have the revenue sources that we have shown; but then if you estimate a cost of funds based on the FDIC note and any excess of the FDIC notes that it is funding, covered assets, at short-term rates of 0.25 to 0.5 point, it is probably around $20 million cost estimated. You know, these are with a wide brush, but around $20 million of interest costs for the quarter.

Yes, but he wants the net yield. Right? The net interest yield you want?

No, just the net interest income.

Okay.

It would be -- what? It would be the $100 million versus the $20 million cost, or --?

Interest income, then assume -- to the page that we show on page 7, you put out some cost of funds which is roughly around $20 million; and then estimate expenses that has already been reduced through synergies throughout the year. And it could be estimated anywhere between $20 million, $25 million. And again, these are very rough estimates.

You've got the gross number there though. It is roughly 107, 106 in gross income per quarter. You have got to take some interest expense off that and some operating expense off that.

So it is certainly north of $60 million for the quarter.

Yes, and apply some tax rate of 30% to that.

Okay, so $60 million pretax and then whatever that is after an effective tax rate of roughly 30%? I recall you guys mentioning that it was roughly a $40 million contribution last quarter, so --

That's about right.

It hasn't changed much.

Okay, great. Then what is your guys' outlook for the US mainland franchise going forward? I know last quarter you thought that you might be in the red for BPNA, and then you made -- essentially you broke even. Are you expecting a loss in the third quarter? Or do you think you will remain either breakeven to maybe slightly profitable going forward?

We have Carlos Vazquez here, so we will put him on the spot and I will be taking notes. But --

We are still working through our delevering and our cleaning up our historical discontinued business portfolio. So we will continue to be challenged to show a profit for the year. But we are giving it a try and heading that way.

Okay. Great. Thank you very much.

Joe Gladue, B. Riley.

Just wondering if you could give us an idea of what was going on with early-stage delinquencies, loans 30 to 89 days? Is that improving any?

We have a credit risk management on the line, [Vanessa Rodriguez]. So, Vanessa, you want to tackle that one?

Yes, in US region it's --

Vanessa, please speak up, please.

Yes, in US region the delinquencies in the early stage are continuing to show improvement. In Puerto Rico, some of the portfolios, consumer portfolios, aren't doing as well. We have to -- we are cautious with commercial loans that delinquencies are still a little bit high.

Okay, thank you.

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Thanks. Sure. So just -- you mention that you are still looking at trying to sell the Puerto Rico construction loans. Is there any risk -- or maybe not even a risk. But can you just talk about the process you're going to go through to determine if there's any incremental marks that you are going to have to take or write down on that portfolio?

Do you need to see where the bids are before you write it down? Or do you -- I guess, yes, what are we looking at on that?

Thank you for that, Ken. If I may, let me correct because I saw a note you wrote earlier today; and you mentioned that we had increased our loan marks there. That is not the case.

What that refers to -- that amount referred to was advances we have made on loans that we put in held-for-sale. So if we advance an amount we have to write down the amount we advance once the loan has already been put in held-for-sale.

That is what that number referred to. It is not that we increased the mark.

Now once you have put a loan in held-for-sale, you must every quarter do an analysis of the loans and make sure your marks are where they should be. We did that this quarter, and we found no difference. So we are comfortable with our loan marks.

We are talking to some groups of people. We have given them the list. They have been looking at it. Some have done some on-site inspections, and hopefully we will see something that makes sense and we will move ahead.

So on the advances it is a dollar-for-dollar writedown?

Well, if you say mark them down to $0.48 and you advance $1.00, you have to write down $0.52 of that dollar.

Got it. Okay.

It's irrespective of the fact of whether -- you made the advance, you think you will get it all back. You have to write it down at the value of the loan mark.

How much is there potential advances that is currently outstanding that you could be losing money on? Meaning that do you have -- is it another $100 million of potential advances that could be made?

Again, it depends on when we get these loans off the books. The judgments you make on whether you are going to get this money back or not before you make the -- most of these are construction and development loans, and you will make that decision before you make the loan.

There is some commitment outstanding that we have to respect, but it is not a significant number. It's probably on the order of what?

$15 million, $20 million.

$15 million, $20 million.

Okay, great.

Okay. That clear it up?

Yes, it does. Thank you.

With no further questions in queue I would like to turn the call back to Mr. Richard Carrion, Chairman and CEO, for closing remarks.

Again, thank you very much for joining the call. We hope we have cleared up again a little noise in the quarter with this tax thing, which we think is favorable and we decided to go ahead with it. And we look forward to communicating with you in the near future.

Ladies and gentlemen, thank you for your participation in today's call. The presentation has ended. You may now disconnect. Have a good day.