Popular Inc (BPOP) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2011 Popular earnings conference call. My name is Keisha, and I will be your operator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to hand the conference over to Mr. Enrique Martel, Manager of Corporate Communications. Please proceed.

Good morning and thank you for joining us on today's call. Our Chairman and CEO, Richard Carrion; our CFO, Jorge Junquera; and our CRO, Lidio Soriano, will review our fourth-quarter and year-end 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 that are based on management's current expectations and subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth in 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 webpage, which you may visit by going to www.popular.com.

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

Good morning and thank you for joining the call. There are three things we would like to accomplish today -- review our fourth-quarter and annual results, analyze the latest credit trends in our portfolios, and present an outlook for 2012. I will first go over the financial highlights and give general views of our results before I turn the call over to Jorge and Lidio. I will then come back to conclude our presentation.

So please turn to the second slide.

This year marked a turnaround year for Popular. The $151 million profit for 2011 marks the first year of operational earnings since 2006.

For the year, gross revenues remain strong, amounting to $1.9 billion, while the provision expense fell by $436 million. A substantial push to bring our cost of deposits down and greater interest income from our covered portfolio helped maintain a strong interest margin of 4.34% for the year.

For the quarter, we reported net income of $3 million in our fourth consecutive profitable quarter compared with net income of $27.5 million in the third quarter of 2011. Gross revenues amounted to $494 million for the quarter compared with $492 million in the third quarter.

The linked-quarter decline in profit was primarily driven by a $16 million expense triggered by the implementation of a voluntary employee retirement program, which we expect to generate $15 million in annualized savings.

The fourth quarter reflected improved credit trends. The net charge-off ratio decreased, and commercial and construction NPL inflows in Puerto Rico fell by $111 million from the third quarter.

As a result, the provision expense for noncovered loans fell by $27 million to $124 million.

The effective management of liabilities drove the cost of Puerto Rico deposits to below 1% to help maintain the strong 4.97% margin in our main franchise, in line with the previous quarter.

The US bank turned to a marginal loss in the fourth quarter on higher provision but finished the year with a $30 million profit. That compares with a $340 million loss for the previous year. While still a ways to go, the financial turnaround of our US bank had expanded our options to increase our return on capital.

We set four objectives at the beginning of 2011 -- mitigate the decline in earning assets amid the economic headwinds in Puerto Rico, increase efficiency, derisk our balance sheet by way of loan losses, loan sales and loss mitigation, and accelerate the performance of our US operations. We think we made great strides in all areas.

Our held in portfolio loan book in Puerto Rico increased by $350 million as $648 million in loan purchases more than offset the decline in our covered loan portfolio. We are seeking similar opportunities to take place in 2012.

While we were able to substantially reduce credit costs in Puerto Rico during 2011, these remain elevated, and this is the one area where we anticipate the most improvement in 2012. We believe most of the economic contraction in our main market has already taken place, and we are well positioned for improved results in 2012.

We have seen growth in the consumer lending sectors with declining delinquencies and losses, and we are seeing an increase in the business appetite of our corporate clients.

Before I turn the call over to Jorge, I want to briefly talk about TARP, which has generated a fair amount of inquiries as of late.

We understand these concerns about the possibility of Popular repaying TARP in a manner that is not in the best interest of shareholders. I would like to reiterate that we don't have a current plan to repay TARP, we are not obligated to fully or partially repay it, and any repayment of TARP will be done in a manner that protects shareholder value and will be subject to regulatory approval.

When we did our exchange offer in August of 2009, we realized an accounting gain because we were required to mark-to-market the new TruPS securities that were issued to the US Treasury in exchange for the TARP preferred stock. This accounting gain is being amortized using the effective yield method over a 30-year period and has a current balance of $466 million. The interest expense on the TARP capital is fixed at a little north of 16% of the accreting book value. In other words, the interest expense on TARP has two components -- the 5% coupon which we paid to the Treasury which amounts on the $935 million legal balance and the discount accretion.

In 2011 interest expense on the TARP capital was approximately $73 million, of which $47 million represents the cash payment made to the US Treasury and $26 million is the accretion. While the step-up in rate schedule for December 2013 would increase our cash payment, interest expense would not be impacted because of the concomitant reduction in the discount.

The key takeaway here regarding TARP is that it will be repaid when feasible under conditions that make sense for the shareholders, and the potential step-up in the rate will not be a significant consideration in making this decision.

So, with that, let me turn the call over to Jorge.

Thank you, Richard. Good morning to all. By turning to slide three, you can see the financial summary of the quarter.

As Richard mentioned earlier, our fourth-quarter results reflected continuing strong revenue levels, offset by still elevated credit costs. We ended the year with strong capital and should benefit in 2012 from an anticipated decline in credit costs. We did better in 2011 than the previous year, and 2012 should be better.

Richard touched much of the major items, so let's move to slide for to discuss the specific variances.

Excluding the one-time cost of the retirement window and the lower gain on sale of securities, the quarterly variance in pretax net income was $9 million. On the right side, you have the variances that add up to the $9 million difference.

We had two events that drove down net interest income by $25 million. First, the yield on the covered loan portfolio declined by slightly over 1 percentage point, coupled with a decline in average balances of $156 million. This reduced interest income by $17 million in the quarter.

Net interest income was boosted in quarter three by the favorable resolution of some loans and the run-off of revolving credit lines, which had been benefiting our margin for several quarters. As we have mentioned before, the covered loan portfolio is an asset that is running off, and the income from this portfolio should continue to trend down moderately in 2012.

The other item that reduced net interest income by $8 million was the reversal of interest income on insured FHA and VA mortgages that are more than 18 months past due. Starting this quarter, we will no longer recognize interest income once it hits 18 months past due.

The amount reversed in the quarter covered the entire portfolio of insured mortgages. So the quarterly impact going forward should be substantially less than the $8 million.

Offsetting the drop in net interest income was the $23 million increase in loss share income that principally resulted from the increase in the loan loss provision of the covered loan portfolio. The increase in this provision is generally 80% covered by the FDIC. This pushed non-interest income higher in the quarter to $149 million.

The provision for our noncovered portfolio in Puerto Rico fell $43 million as a result of lower level of losses in our commercial portfolio and lower delinquencies in our consumer portfolio. Also, during quarter three we booked an adjustment of $13 million as a result of the reclassification of commercial and construction loans to held for sale related to the loan sale during the quarter.

The provision for covered loans rose $30 million, primarily related to two credit relationships, of which $11 million were charged off with respect to one relationship.

In the US business, provision increased by $16 million as a result of a lower release of reserves. We drew down our reserves in the fourth quarter at a slower pace than in previous periods due to slower trends of improvement in credit metrics.

We had a one-time $16 million charge caused by the voluntary employee retirement window, which accounted for over half of the $28 million (see press release) increase in operating expenses.

In December, 369 employees voluntarily signed up for the window that will generate an estimated $15 million savings going forward. We are losing some good experience resources, but we have in place robust plans and a deep bench that will permit us to adapt the organization to be more efficient without impacting effectiveness.

Most of the other half of the increase in expenses was primarily caused by year-end business promotion campaigns and by costs associated with the re-branding of the US bank in California and Florida and OREO expenses. We expect lower operating expenses going forward with a reduced headcount, the consolidation of branches and lower credit management costs such as legal and collection expenses.

Please turn to slide five for an overview of our capital levels.

As you can see on this slide, we continue to strengthen our capital levels that are well above regulatory requirements. We are continuously reviewing our capital structure with the objective to ensuring we maintain adequate capital for potentially stressful environments, while we maximize its return.

You already heard Richard discuss TARP, but let me underscore the main points. We have no current plans to repay, we are not obligated to repay, and we will do so only when it makes sense to our shareholders.

With that, now let me turn it over to Lidio. Thank you.

Thank you, Jorge, and good morning to all. Before we review the credit metrics for the quarter, let me make three general observations that sum up the credit performance of our portfolio heading into 2012.

First, in the US we continue to enjoy the benefits of the de-risking strategies initiated in 2008. US construction exposure is down to $150 million, which is down 55% from the balance we had at the end of 2010, and 83% from its peak of $858 million. Nonperforming loans continue to decline, though as expected, the change in the rate of improvement has begun to level off and, as a result, our reserve releases have slowed down. This led to a higher provision expense in the fourth quarter.

Second, all of our portfolios in Puerto Rico, except for the mortgage portfolio, show better credit quality with both early delinquency and NPLs decreasing. The increase in mortgage NPLs was driven by repurchases from our mortgage recourse portfolio. These are mostly legacy securitizations into Fannie Mae pools. In early 2009, we stopped the practice of securitizing with recourse. These loans are from old vintages with an average seasoning of seven years and average loan size of $102,000.

Once we repurchased the loan, we put them through our loss mitigation program, which, as of December 2011, 70% of all modified loans are still performing one year after modification.

Notwithstanding the increase in Puerto Rico mortgage NPLs, charge-offs continue to be low. Our exposure in these portfolios are both contained and manageable.

Third, we concluded the review of all loans above $1 million in our Puerto Rico commercial portfolio, which we initiated in the third quarter.

Our review was risk-based with riskier credits analyzed first. As a result, the third quarter of this year shows significant increases in commercial NPLs, charge-offs and provision for loan loss expenses. During the fourth quarter, inflows into commercial and construction NPLs decreased 52% to $101 million, the lowest inflow of NPLs in the last two years.

On slide six, you can see the principle credit metrics of the Corporation. Total loans remained relatively unchanged on a linked-quarter basis. Slight growth in Puerto Rico was offset by decreases in the legacy portfolios in the US. We expect the decline to continue in the US commercial and construction portfolios until originations begin to outpace runoffs by the end of the year.

Year over year noncovered NPAs decreased $232 million or 10%, driven by sales of nonperforming loans, offset in part by an increase in mortgage NPLs in Puerto Rico.

Noncovered net charge-offs were at the lowest level of the year at $126 million, a decline of $9 million versus the third quarter. The linked-quarter decrease in net charge-offs was mainly driven by lower losses in the Puerto Rico commercial portfolio.

In Puerto Rico, our charge-off ratio fell to 2.14%, the lowest in the year. In the US, the slight increase for the quarter in charge-offs was driven by two large loan relationships.

For the year, net charge-offs in the US fell by $269 million to 3.28%. The decline in the ratio of noncovered provision to net charge-offs off was driven by improved credit indicators in Puerto Rico. Given the still difficult economic environment in Puerto Rico, we continue to build reserves, but at a lower rate due to the aforementioned improvement in the credit trends during the fourth quarter.

Provision to net charge-offs in Puerto Rico was 113% compared to 146% in the third quarter. In the US, we continue to release reserves but at a lower rate. Provision to net charge-offs in the US amounted to 75% compared to 43% in the third quarter.

Our allowance to loans remained flat. To understand our coverage ratio, it is important to highlight that approximately 50% of our NPLs are subject to specific analysis, most of it concentrated in mortgage TDRs and commercial, including construction.

Based on the fact that most of our impaired loans are collateral dependent, we require updated appraisals or current evaluations to establish reserves and charge-offs.

Please turn to slide seven for a review of our credit quality by portfolio.

Looking first at the top right-hand corner, you see that noncovered NPLs were relatively flat with an increase of $6 million, driven by an increase in the Puerto Rico mortgage portfolio.

Equally important in terms of our mortgage portfolio is the graph in the bottom right-hand corner, which shows stability in losses. The level of losses in the Puerto Rico mortgage portfolio remains under 1% at 46 basis points for the quarter.

Commercial NPLs held steady during the fourth quarter with an increase in US caused by one large relationship, which was partly offset by a decrease in Puerto Rico where commercial NPLs dropped by $21 million.

Puerto Rico commercial NPL inflows declined by 53% to $93 million, which marks the lowest level in the last two years. As discussed earlier, the conclusion of the portfolio review was the major driver.

The credit quality of our construction portfolio continues to improve. Exposure is down 13% or $46 million on a linked-quarter basis, mostly in the US. Construction NPLs are down 31% or $59 million, mostly driven by sales of units from existing projects, discounted payoffs negotiated with borrowers, foreclosures and transfers to held-for-sale. Net losses in construction increased from $4 million to $8 million driven by lower recoveries.

Finally, our consumer portfolio continued to be the best performing portfolio with strong credit quality.

Before I turn the presentation back to Richard, let me do a quick recap and provide a brief outlook.

My three initial observations were, first, that the US continues to show progress in credit quality, although at a lower rate. Second, all portfolios in Puerto Rico, except for mortgage, shows better credit quality. Based on the characteristics of our mortgage portfolio, we feel comfortable with this risk. And third, the conclusion of our commercial review helped us identify risks, providing additional comforts which should lead to improvement in the credit quality of our Puerto Rico commercial portfolio.

Lastly, our expectations for 2012 are that credit trends in the US will continue to improve though at a slower pace than before.

Having finished a thorough review of our commercial portfolio in Puerto Rico and based on a stable economic outlook, we are optimistic about the credit outlook in our main market.

For a recap and outlook of 2012, I will now turn the presentation over to Richard.

Thank you.

Thank you, Lidio. Please turn to slide eight.

In summary, 2011 was a turnaround year where we boosted our margins, reduced our credit costs and turned our first operational profit since 2006. We have executed several important transactions during the last two years that have strengthened our financial position. Operationally, we are a much smaller organization than we were a few years ago, and we are focused on our core community banking business.

We have progressed in our turnaround in 2011, and 2012 will be about building on that. We expect the Puerto Rico economy to remain flat, the US economy to grow moderately and our credit trends to continue improving.

Given that, we expect net income for the Company in 2012 to range between $185 million and $200 million, a significant rise over our operating 2011 results. The biggest driver in 2012 will be an expected decrease in provision expense.

So, with that, I would like to open the call for questions.

(Operator Instructions). Joe Gladue, B. Riley.

I wanted to start off with a few questions on credit quality. I would just like to dig into the commercial credit review a little bit. Clearly you had a decrease in inflows to commercial credits from third quarter to fourth quarter. I am just wondering how to look at that going forward. Do you think that the lower level is sustainable, or was there some sort of -- with the amount of that done in the third quarter, was some of the inflows pulled into the third quarter and maybe we see a bounce back after this quarter?

I will let Lidio take that one.

I think a lot of it is also dependent upon the economic outlook. So I mean certainly in the third quarter there was a bit of a catchup in terms of NPLs and credit quality from our commercial portfolio.

So under normal situation, I will say that the expectation will be something along the average of what you saw during the year. Based on the prospect of our economic outlook, there might be a potential for decreases in inflows on a going forward basis.

Okay. And I'm just wondering if you could touch on where 30 to 89 day delinquencies were and accruing TDRs?

30 to 89? I don't have the numbers in front of me, but some of the levels that we have in terms of early delinquencies are actually improved over the last two years. That should be the case heading into the fourth quarter as we finish the fourth quarter. In terms of accruing TDR, the number is approximately $300 million.

Okay. And let me ask one more question and I will step aside. Just looking at the deposit flows, it looks like there was some increased usage of brokered deposits. I'm just wondering what your thoughts are on the outlook going forward in terms of generating more core deposits as opposed to brokered.

Okay. The only reason for the increase at the year-end of our brokered CDs was to -- that we were very eager to pay off the FDIC note that was carrying at 2.5 percentage point cost. So we completed the payment of the FDIC note, and we went out then to raise some brokered CDs. We are expecting the brokered CD balance to go down substantially during that 2012. So you saw a peak at the end of the year.

Okay. And, of course, while I'm on the subject of deposits, let me ask about the outlook for further reductions in deposit costs.

Okay. Yes, we will continue to work at it. We have been very successful throughout the last two years, and there is still some more room to go. Probably there is from 15 to 25 basis points additional reduction to be achieved, and we have a lot of maturing CDs in the next few months. So this should work out, but there is still some more room.

Ken Zerbe, Morgan Stanley.

The first question, Richard, your comments on TARP, I guess I was interested to hear that you are talking about sort of post-2013 in your discussion about when or the ultimate effect on the net income statement. My question is, is your comments an indication that TARP repayment in 2014 or later is actually now an option for Popular?

Well, all I want to say is, first of all, we will do it when it makes sense to do it and that the 2013 date is not going to affect the calculus too much. Because the way we are -- we have accounted for this, the interest expense is really not going to be affected when that rate kicks up to 9%.

Love to do it before 2013 if it makes sense, love to do it whenever -- I would love to do it this afternoon, but not issuing stock at this level. So that I just wanted to make that very clear, that we will do it when it makes sense and not the trigger of 2013 is not a date. So don't read into that that we are going to do it post-2013. We will do it whenever it makes sense.

Okay. And then the other question I had, just on the net interest margin, obviously a big decline in the covered loan interest income. I guess part one is I assume that is there is no offsets to that decline of $17 million. That falls directly to the bottom line?

And then the other part of the question is, is there any other sharp declines in covered interest income that we should expect over the next 12, 18 months?

I think in general the decline in income is going to come as the portfolio runs off. It is really up to us to replace those loans and turn those covered loans into permanent customers. So this is not going to go to zero. It will be up to us to turn those loans into permanent customers.

Regarding the first question, there is no offset to that. I mean it was just the third quarter probably was a little higher than it needed to be because of the accounting considerations that Jorge mentioned.

And just adding to that, going forward we should expect to see relatively much more stability than what we experienced during 2011. So this -- hopefully it will become something that it can be modeled a little easier than what has been the experience in the past. There were a lot of moving parts in 2011 that should not repeat in 2012. So it should be smoother.

Michael Sarcone, Sandler O'Neill.

My first question, in your 2012 net income guidance, the presentation says, driven primarily by lower provision expense. Is it possible, maybe can you quantify that and also quantify some of the other moving parts like NIM expectation and your operating expenses?

Look, we struggle a lot over doing this guidance, and our intent really is not to go line by line on the guidance but just tell you the number that we are looking for.

In general, I think we were driven to do this because we know there has been a lot of noise in our quarterlies of late, and it is very difficult to model the results. So we did want to tell you what we are committed to doing in 2012, and we don't really want to go line by line.

As you know, if you look at the provision for this year, it was down substantially by $436 million. Part of that was what we did in the fourth quarter of 2010 with the movement to held for sale. But we think we will get most of the improvement out of the provision, but that is about as far as we want to go on this one.

Got it. So it is just more to say that you see directional improvement?

Right.

And then the second question, you have around $216 million of NPLs held for sale, and then the presentation you guys say completed NPA asset sales and PR in US. Are you still looking to complete more loan sales, or is that more opportunistic?

Yes, they are held for sale, and we will do it when the right opportunity comes along. We are comfortable with the level where they are marked at, so we will continue to execute the loan sales when we think it makes sense.

Brett Scheiner, FBR.

A couple of quick questions. There is a big swing in the quarter in AOCI, which hurt book value. Can you give some color on that? I assume it is about movements in the bond portfolio.

I think that has to do with the change in the discount rate of the pension plan.

Okay. Okay. And then also covered NPLs, doing some quick math, it looks like they went from $11 million or $12 million last quarter to $95 million in the quarter. Can you just talk about the covered book and credit quality there, cash flow expectations, accretable yield, etc.?

I think the accretable yield is around 7%. I think that change had to do with a couple of large loans that we are dealing with, and there were some charge-offs there and some movement into NPL.

As you know, we have to do a recasting every quarter of what our losses are, and we have seen those consistently improved over the past year.

Derek Hewett, KBW.

Do you guys have the amount of classified commercial loans, or at least directionally could you say if went up or down during the quarter?

I don't have the number in front of us, classified commercial loans. I think directionally having finalized most of our review in the third quarter in which we downgraded a lot of our relationships in the fourth quarter, that was not as prevalent.

So the number has stayed relatively flat compared to the numbers that we had at the end of the third quarter.

Okay. Great. And then regarding the non-interest expense, currently you guys are on a run rate of $296 million or so, and I believe last quarter you mentioned that you were going to implement cost savings of $25 million. Now this $15 million of annual cost saves for the reduction in employee expenses, is that part of that $25 million?

Yes. You know, I would, of course, not look at the fourth quarter as representative of a number going forward. I would tend to look more at the third quarter, and that is when we talked about that we were going to look at the expenses and implement some cost savings. So I would look more at the third quarter in order to go forward.

Part of that will kick in in Q1, so the retirement date is (multiple speakers) January 31. So a part of that will begin to see the benefits in Q1, and there is also some branch consolidations that are in our plan as well.

(Operator Instructions). Joe Gladue, B. Riley.

I would just like to see if you can give us an update on the rebranding efforts in the mainland and I guess how we should think of expenses related to that effort going forward?

Well, Carlos Vazquez, who heads our US operation, is here with us, so I will let him have a speaking part here.

The rebranding is going well. It is achieving the goals we set out, which is for us to increase the amount of accounts we opened for new clients that are other than Hispanic clients, and we increased the average balances of the accounts we are opening for all segments that we serve.

As far as the expenses, they will continue to be similar as they were this year. We will be making a decision on the final part of our rebranding in the coming weeks for the New York region, and they should not be considerably different.

That concludes the Q&A session for today's call. Thank you all for your participation in today's conference. This concludes the presentation. You may now disconnect your lines. Have a great day.

Thank you, all. Bye-bye.