Popular Inc (BPOP) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second-quarter 2013 Popular earnings conference call. My name is Philip and I will be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Brett Scheiner, head of Investor Relations. Please proceed, sir.

Good afternoon and thank you for joining us on today's call. I am honored to be here and eager to get started.

Today I am joined by our Chairman and CEO, Richard Carrion; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano, who 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 on today's call we may make forward-looking statements that are based on management's current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release and are detailed in our SEC filings, our financial quarterly release, and supplements. You may find today's press release and our SEC filings on our Web page, which you may visit by going to www.popular.com.

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

Good afternoon and thank you all for joining the call. I'd like to first address the highlights and key events of the quarter, and then discuss our progress in priority areas. Carlos will then go into greater detail on the quarter's financial results, and Lidio will provide an overview of credit trends and metrics.

Please turn to the second slide. Popular reported $328 million in net income for the second quarter. To say there is a little noise in these numbers would be the understatement of the century.

There are three large pieces affecting our results, two of which we previously announced and we will discuss in greater detail. These are the EVERTEC IPO and the sale of residential NPLs.

To this we add the impact of changes in the Puerto Rico tax code, and we come up with an adjusted net income figure of $68 million in a quarter that reflects our two greatest sources of strength -- revenue-generating capacity and capital levels.

Our margin of 4.46% remained strong relative to peers, while our robust capital position allowed us to aggressively address the level of non-performing loans, which we have reduced by 42% in the second quarter. After completing two bulk sales in the first two quarters, we have now reduced NPLs by more than $800 million in the first half of 2013.

The sale of mortgage NPLs this quarter marked the end of major loan portfolio derisking transactions. However, we will continue our workout efforts through individual resolution of problem credits and continue to actively manage our portfolios within enhanced risk-management structures.

The underlying credit trends continue to move in the right direction. Excluding the bulk sale, NPLs reached their lowest level since 2006, and net chargeoffs decreased to their lowest level in five years. In addition, inflows were essentially flat compared to the previous quarter.

We head into the second half of the year with an NPL-to-loan ratio, excluding covered loans, below 3%. Including the effect of the NPL sale and the EVERTEC IPO, we ended the quarter with strong capital levels.

Our Tier 1 common equity ratio reached 13.1% and exceeded the 5% CCAR target requirement by $1.9 billion. Our tangible book value per share at quarter end was $33.38, up from $31.21 last quarter.

Please turn to slide 3. Last quarter we provided color on the initial public offering of EVERTEC. To recap, this was a very successful transaction.

The deal was upsized due to strong demand, as Popular sold 8.8 million shares and recorded an after-tax gain of $157 million. Today EVERTEC's market cap exceeds $1.9 billion.

From a balance sheet perspective, we received approximately $270 million of cash from the transaction, including $92 million from the repayment of EVERTEC debt. The gain from this sale and related transactions increased Tier 1 common equity by 67 basis points.

Popular retained a 32.4% stake in the company following the IPO, with a current market value of $631 million and a book value of $64 million. Including the benefit of a 4% tax rate on all gains related to this investment, as we mentioned last quarter, the market value of the remaining shares exceeds the book value by more than $500 million after-tax, based on yesterday's closing price.

Let me add that EVERTEC continues to be an important business partner to Popular. Our remaining stake in the company is one of many valuable assets on our balance sheet.

As investors, we will continue to participate in a proportionate share of the company's income. We expect to remain a significant shareholder in the company and believe this investment will continue to yield a healthy return.

Please turn to slide 4. During the second quarter, Banco Popular sold nonperforming residential mortgage loans with a book value of $435 million and an unpaid principal balance of $511 million. The loans were sold to an unaffiliated financial group for cash, with no financing or additional recourse to Popular.

The sale price of $244 million, or 47.75% of UPB, resulted in a $107 million after-tax loss. The transaction reduced total NPLs excluding covered loans to $614 million, with the NPL-to-loans ratio of 2.85% and the total NPA-to-asset ratio of 2.71% now nearing pre-crisis levels.

Coupled with our three prior bulk loan sales, these workout efforts have dramatically accelerated the timing of achieving sustainable levels of nonperforming loans and loan loss provisioning. On a core basis, we are near the 1% loan loss provision to noncovered loan ratio we targeted as normalized earlier this year at our 2013 Investor Day. We also expect non-personnel credit-related cost savings from the two bulk sales completed this year of approximately $5 million to $6 million per quarter based on pre-sale expense levels.

One last significant event during the quarter involved a number of actions taken by the Puerto Rican government. We believe these fiscal measures and the approved $9.4 billion budget stabilized the island's credit outlook.

The government of Puerto Rico has made long-term oriented decisions on pension plan reform, strengthening tax revenues, and executing on initiatives such as the public-private partnership that led to the sale of the island's major international airport. These steps advance the agenda to improve the fiscal standing of the Commonwealth and should help pave the way for an eventual economic recovery.

As part of these fiscal measures, Puerto Rico corporate tax rates have been raised from 30% back to the 39% level in effect prior to 2011. While necessary to address the difficult fiscal situation, we recognize that these measures may decelerate the pace at which the Puerto Rico economy improves. Though we cannot be certain of the magnitude of these effects, we have been able to make significant improvements in Popular's business, despite the soft macro environment on the island.

As you turn to slide 5, we highlight the key areas of focus for senior management and our shareholders alike. With the completion of four bulk NPA sales since 2011, we are encouraged by our return to pre-crisis credit quality metrics.

We expect to continue derisking our Puerto Rico and US portfolios though aggressive internal resolution of problem loans. Notably, quarterly NPL inflows have been reduced by 80% in four years from a peak of nearly $1 billion to $187 million in the second quarter.

We continue discussions with our regulators regarding the exit from TARP. Healthy levels of excess capital and material improvements to our loan portfolio's credit profile continue to strengthen the Company's position for the most shareholder-friendly exit from TARP. At this point in time, however, we do not have a specific time frame of when a TARP exit could take place.

Our capital building and credit derisking efforts continue to strengthen and expand Popular's position as the leading financial institution in Puerto Rico. These accomplishments contribute to closing the gap between our current earnings power and our targeted normalized earnings potential.

Please turn to slide 6 as our CFO will discuss our financial results in further detail. Carlos?

Thank you, Richard, and good afternoon. With the NPL sale, EVERTEC IPO, and Puerto Rico tax reform, this quarter had many moving parts. On slide 6 we present a financial summary excluding the impact of these events. Please note this data is reconciled to GAAP figures in the appendix to the slide deck, with supporting information disclosed in today's earnings press release.

While the impact of recent events is significant, our underlying performance is driven by -- number one, stability in net interest income; and two, improving credit trends.

Net interest income for the second quarter was $354 million, up $8 million from Q1, mostly due to the impact of the Q1 mortgage purchases in both Puerto Rico and the US. Our Puerto Rico mortgage business originated $439 million in Q2, up from $397 million in the same quarter last year and $82 million higher than in Q1 of this year.

We continue to work on reducing our funding costs. Puerto Rico deposit costs fell 4 basis points on a linked-quarter basis to 64 basis points. This marks our 17th consecutive quarterly deposit cost decrease in Puerto Rico. While a few alternatives remain to potentially achieve incremental savings, many of the opportunities to lower costs have already been captured.

Noninterest income was up slightly on higher deposit service charges and other service fees, offset by a lower net gain on the sale of mortgage securitizations. The average yield in our $3.2 billion covered loan portfolio increased to 8.6% from 8.31% last quarter due to greater projected cash flows.

While the covered loan loss provision is up $8 million over the last quarter, keep in mind that 80% of this expense is absorbed by the FDIC loss-sharing agreement. This offset, in addition to the FDIC's 80% reimbursement of the expenses related to our covered loan portfolio, was a primary driver of the $23 million positive variance in the FDIC loss-share income line. Table O in the press release provides greater detail on our covered loan portfolio.

One of the largest drivers of this quarter's reported financial performance was the provision for noncovered loans, which was elevated due to the charge resulting from the sale of NPLs. Excluding that $169 million impact, the provision was down slightly from last quarter on improving chargeoffs. Lidio will expand on the credit results in a moment.

Personnel costs were down slightly when compared to last quarter, although other operating expenses were up $12 million due to the previously disclosed FDIC insurance benefit of $11 million recorded in Q1. Excluding this variance, core operating expenses were flat.

We continue to experience elevated credit-related operating expenses reflected in our OREO and professional service fee lines, though we have made progress in bringing these expenses down. With the bulk loan sales behind us, we expect to see the $5 million to $6 million expense benefits mentioned by Richard to phase in during the next two quarters.

We want to bring your attention to a change in the way we present our transactions with EVERTEC on our income statement. Prior to the second quarter, Popular reclassified its proportional share of the intercompany transactions with EVERTEC from their respective revenue and expense categories, and presented the net amount as an adjustment to equity pick-up, as part of other operating income. This quarter, Popular discontinued these reclassifications after the EVERTEC IPO.

While there is no effect on pre-tax or after-tax income, this change increases our total operating expenses by approximately $18 million from historical run rates, with an equal offsetting increase to various revenue components. It is reflected for all periods presented.

Please turn to slide 7. As Richard alluded to earlier, the Puerto Rican government has undertaken a number of initiatives to stabilize public finances. The most relevant measure for Popular is an increase in the Puerto Rico corporate income tax rate from 30% to 39%, reverting to the rate in effect in 2011.

In addition, the Company will see slightly higher expenses due to a new tax on top-line revenue of approximately 0.5%. We currently estimate Popular's effective tax rate will be 35%, although we are obviously working to manage that rate down over time.

As a result of this tax rate increase and according to GAAP accounting, the Company's Puerto Rico deferred tax asset has been revalued, reflecting a non-cash benefit of $216 million in this quarter. This increase has no impact on Popular's regulatory capital levels, but is included in this quarter's results and reported book value.

Please turn to slide number 8. We continue to enjoy strong capital levels relative to mainland and Puerto Rico peers as well as with respect to well-capitalized regulatory requirements. Our common equity Tier 1 ratio stands at 13.1% and represents an excess of $1.9 billion over the CCAR target requirement of 5%.

While the NPL sale modestly reduced our excess capital, this was more than offset by the EVERTEC IPO and our core earnings. We expect our capital levels to continue to exceed well-capitalized requirements under the recently revised Basel III guidelines.

We remain focused on continuing to increase our strategic and financial flexibility while maintaining strong capital levels. That, together with stable credit metrics, strengthens our position to exit from TARP.

With that, I will turn the call over to Lidio.

Thank you, Carlos. Please turn to slide number 9.

Before discussing the credit metrics for the quarter I think it is useful, given the bulk sales we have completed, to compare current credit indicators with the ratios we had prior to the start of the financial crisis in late 2007. The bulk sales have driven the reduction of our NPA, NPL, and net charge-off ratios to levels prior to the financial crisis.

The NPA ratio of 2.7% in this quarter is slightly above the 2.4% ratio we averaged for the third quarter of 2007. The current noncovered NPL ratio of 2.9% is slightly below the pre-crisis level of 3.1% for the third quarter of 2007. Excluding the effect of the NPL sales, the net charge-off ratio of 1.47% in this quarter is 8 basis points above the 1.39% charge-off ratio for the third quarter of 2007.

As discussed by Richard, the sale of mortgage NPLs this quarter marked the end of major loan portfolio derisking transactions. It is important to note that, coupled with the accelerated improvement seen through the completion of NPA sales, we continue to see positive trends that are being driven by stabilizing credit conditions, internal workouts, and resolutions of problem credits.

The underlying credit performance continued to move in the right direction. Excluding the bulk sale, NPLs were stable. Total NPL inflows remained at the record low levels for this credit cycle reached during the first quarter of 2013.

Nonperforming loans decreased by $437 million or 42% from the first quarter of 2013, and are down 74% from the peak levels in the third quarter of 2010. This reduction was driven by the impact of the sale of mortgage NPLs.

Excluding the sale, the slight decrease in NPLs was driven by improvements in the US, offset in part by some deterioration in Puerto Rico. In the US, better performance in the commercial portfolio led NPLs to a sequential decrease of $18 million or 9%.

This quarter marks the 14th consecutive quarterly decrease in nonperforming loans in the US. We head into the second half of the year with NPLs in the US below $200 million for the first time since 2007.

Excluding the impact of the sale, the $16 million increase in Puerto Rico NPLs was mainly caused by the classification of two significant borrowing relationships into nonaccrual status during this quarter. These loans amounted to a combined $25 million.

The aforementioned sale of NPLs drove the nearly $0.5 billion decrease in NPAs, which are down $427 million or 30% from the first quarter of 2013 and 62% from peak levels in the third quarter of 2010. We ended the second quarter with an NPA ratio of 2.7%, the lowest level since the third quarter of 2008.

Please turn to slide 10 to review inflow trends. NPL inflows excluding consumer loans increased slightly by $3 million this quarter compared to the record low for this credit cycle reached last quarter. This difference was mainly due to an increase in the Puerto Rico commercial portfolio offset in part by a decrease in Puerto Rico mortgage NPLs.

The increase in Puerto Rico commercial NPL inflow is mainly driven by the two previously mentioned significant borrowing relationships. Since peaking in the third quarter of 2011, NPL inflows have decreased approximately $294 million or 61%, driven by improvements in Puerto Rico mortgage, Puerto Rico commercial, and US commercial.

Commercial NPL inflows in the US for the second quarter remained at the record low level reached during the first quarter of 2013. Mortgage NPL inflows reached a new low for this credit cycle totaling $106 million, an improvement of $9 million compared to the previous quarter. This is driven by Puerto Rico.

Before discussing the provision, allowance, and related ratios, I would like to briefly discuss enhancements implemented during the quarter to our allowance methodology. Please turn to the next slide.

We are always looking to improve and build upon all our procedures and practices. Our allowance methodology is based on a combination of short-term and long-term indicators, coupled with an emerging risk component that incorporates current market conditions that could cause estimated credit loss to differ from historical levels.

During the second quarter of 2013, we made two main enhancements to the methodology. First, we changed the configuration of homogeneous pools to include risk rating as a component in the segmentation. And second, we recalibrated and enhanced the framework used to account for current changes in market conditions.

The changes implemented resulted in a slight net increase of $12 million in the allowance for loan losses -- an increase of $23 million in Puerto Rico and a decrease of $11 million in the US.

Having discussed our allowance methodology, let us turn to the next slide to discuss the allowance, provision, and related ratios. The $279 million in net charge-offs recorded in the second quarter included a $200 million write-down from the NPL bulk sale. Excluding the impact of the NPL sales, noncovered net charge-offs decreased slightly by $2 million from the first quarter to $79 million.

The annualized net charge-off ratio of 1.47% is at the lowest level since 2008 and, as discussed earlier, in line with pre-crisis levels, reflecting improvement across both regions. In Puerto Rico, the net charge-off ratio was 1.55% while in the US the ratio was 1.24%. Both are record levels for this cycle.

The $18 million noncovered linked-quarter increase in the provision for loan losses was driven by higher write-downs from the bulk sales in the first two quarters. Excluding the impact of the sales, the provision for the second quarter decreased by $2 million to $55 million, reflecting general improvements in credit quality in both regions.

For the quarter, the provision to net charge-off ratio remained relatively flat at 80%. In Puerto Rico, excluding the effect of the sale, the provision to net charge-off ratio was 99%, while in the US changes to the allowance methodology led to a release of reserves and therefore a negative provision for the quarter.

The coverage ratio reached a new high for the cycle at 86% due to the effect of the sale. In Puerto Rico the coverage ratio stands at 95%, while the US coverage ratio stands at 70%.

To summarize, the completed bulk sales are transformative transactions that have significantly strengthened our balance sheet and improved asset quality. Excluding the effects of the sale, we continue to show steady improvements, with NPLs, NPAs, and net charge-offs reaching their low points in this credit cycle, and are back to pre-crisis levels. And finally, the coverage ratios for Puerto Rico and the US are at the highest point in this cycle.

With that, I turn the presentation to Richard for his concluding remarks.

Thank you, Lidio. Please turn to slide 13. Before we open the lines to questions, let me conclude today's remarks by reviewing the actions we're taking to drive shareholder value.

The leading market position of our unique Puerto Rico franchise is allowing us to sustain above-average margins. Our covered portfolio continues to produce better-than-expected results.

We are operating with both greater speed and efficiency in addressing NPLs, as demonstrated by the continuing improvement in the credit quality of our portfolios in both the US and Puerto Rico on top of the improvements resulting from the residential NPL sale. With the major NPA transactions now behind us, Popular's credit metrics are close to pre-crisis historical levels.

In summary, we are driving value for our shareholders with the significant portfolio derisking transactions which we have completed and our ongoing efforts to build capital. We have robust capital under existing Basel I capital requirements, which we expect to continue under the proposed Basel III rules. On these merits, we are moving toward the exit from TARP in the most shareholder-friendly fashion.

We continue to see additional value stories in our EVERTEC ownership; our stake in BHD, the second largest bank in the Dominican Republic; and in determining the best path to value creation for our US operations. We look forward to reporting to you on our continuing progress.

With that, let me open the call for questions.

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Thanks. I guess my first question, just in terms of TARP, you made a comment earlier at the beginning of the call that there really was no change or you had no update on the timing of TARP repayment. But I would have thought that the two big NPA sales would have materially improved the likelihood of a TARP repayment somewhat sooner rather than later.

Are we wrong in that assumption? I thought that we would be a little bit closer to getting out of TARP at this point.

Well, I think you are right, we are certainly closer. But as you can imagine this is an ongoing dialog we have with the regulatory authorities as to when is the right moment. And it is not exactly a symmetrical conversation there.

But I think we are making good progress. Our aim is to get out as quickly as possible, but to get out in the best way for our shareholders. So we will continue fighting that battle.

Okay. I guess next question just in terms of EVERTEC, I think you mentioned there was a -- your expenses increased -- I forget how much it was, in the high teens I believe. But then you made a comment that there was a corresponding increase in the revenue line.

But I thought -- I guess EVERTEC is profitable at this point. Can you maybe tell us what the net positive benefit of EVERTEC was in the quarter? That would be helpful. Thanks.

Okay. I will let Carlos take that. That was an accounting change, so it really doesn't change the net income line. We are expecting the EVERTEC to report earnings in a few days, so you will have some information there. Go ahead, Carlos.

I think your question naturally tends to -- refers a lot more to the EVERTEC income as opposed to the accounting changes, if I heard you right.

Yes, correct. Yes.

We report our proportionate share of EVERTEC income in our results, and that is included in other income. But we will not comment on the exact magnitude of that number, because that is material nonpublic information until EVERTEC reports their results.

So our proportionate share of other income is included in our results. The actual number, you can back it out when they report in a few days.

Understood. So in a few days at least, we can call back or whatever and get the exact numbers afterwards. Okay, perfect. Then just a last question. What was that?

It is 32.4% of whatever their income.

Understood, perfect. Then just the last question on the tax rate. With the increase in the Puerto Rican tax rate, the 35% that you mentioned, was that essentially the number for the entire organization? Or is that just for the BPPR earnings?

No, that is for the entire organization. As Carlos mentioned, obviously, we will be working to bring that down over time. But at first blush, that is what it comes out to be.

Okay. Thank you very much.

Alex Twerdahl, Sandler O'Neill.

Hey, guys. Good afternoon. Just a couple questions here. First, could you quantify the amount of cash that you had at the Holding Company at the end of the quarter, and also cash that you had at the Bank level that could potentially be dividended up to the Holding Company?

Sure. We will tell you the Holding Company figure, Carlos, is what? 400?

Yes, it is just north of $400 million.

Okay.

At the Bank level I guess we could dividend up. But that is -- again subject to negotiation.

The Bank level can change pretty quickly if we just change deposit rates.

Okay. Can you help me understand also the math behind that tax benefit? I saw in the Q that you had the DTA in Puerto Rico at about $622 million at the end of the first quarter. How does that translate to that $216 million tax benefit number, just the math behind that?

You basically have the tax benefit, which you were dividing by a 30% rate. You now divide by the 39% rate, and you gross it up that way.

If you will recall, a couple of years ago when rates were lowered, it was the other way around. We took a hit.

So I guess we get whipsawed by GAAP and these fiscal policy changes. But it is really a fairly mathematic -- arithmetical, just dividing by the different rate.

Okay. Then that normalized earnings projection that you gave at the end of -- or I guess during your Investor Day. That was a 25% tax rate. Is that correct?

That was -- yes.

I believe it was. I will have to check on that. Okay?

Okay, and then just one last question. What was the level of accruing TDRs at 6/30?

The total TDRs -- this is Lidio. The total TDRs at the end of the second quarter was $195 million. That is down by $154 million from the first quarter. A lot of it was driven by the sale.

And accruing TDRs at about 80%, 81% of the TDRs are on accruing status today.

Okay, thank you.

Todd Hagerman, Sterne Agee.

Richard, I just wanted to follow up on your comments regarding EVERTEC and the interest in retaining a significant share of the company, which is certainly understandable. What I was curious about is, obviously EVERTEC is a component of the eventual TARP repayment, presumably. And now that you're 32.4%, is it something -- should we think about a benchmark in terms of ownership that may be in excess or around 25%?

And how should we think about monetizing that unrealized gain that you refer to? I am just trying to get a sense of how you are thinking about that residual investment and the different dynamics that you are thinking about in terms of exiting the regulatory orders in TARP and so forth.

That is a fair question, Todd, and I will be a little vague in the sense that -- yes, we do want to maintain an investment in EVERTEC. Hopefully that investment will be north of 20%.

But this is a moving part that -- probably when we get down to brass tacks in TARP it is entirely possible that we monetize and sell down to a different level. So without a doubt, that is one of the arrows in our quiver.

We do want to maintain a long-term ownership stake in EVERTEC, but we will see how the conversation goes.

That is very helpful. Then if I could just -- a question for Lidio. In terms of the credit metrics, excluding the impact of the sale this quarter, as you mention, inflows are relatively flat. You had a couple large credits on the commercial side that came in.

What I am curious about is, if we step back prior to the bulk sales and the progress the Company was making on the credit side, we have a different dynamic today in terms of the economy in Puerto Rico being relatively stable, if you will. So what I am curious about is your outlook for that residual portfolio.

As you talked about, it has now shifted towards a workout strategy as opposed to any material loan sale. So I am trying to think about, with a stabilizing economy and switching gears to workout, how should we think about the pace of improvement going forward, based on what you see today and the level of classified asset and so forth?

The level of NPAs that we will have or NPLs that we will have in Puerto Rico is significantly lower than the ones that we had a year ago. So certainly that is going to have an impact.

When I look at our portfolio, I tend to look at it this way. When I look at the commercial exposure, most of our clients are now used to operating only low-growth environment. And those who have been successful after 5 or 6 years of recession will continue to be successful as we continue to move forward.

We made -- early in the cycle we made a lot of adjustments to our retail exposures, and those have -- the numbers and the credit metrics for those portfolios have actually improved through the recession. Our short-term expectation, if nothing significantly changes, is for them to continue to behave in the same manner.

Okay. But again, as I think about the stabilization, granted, is it more -- and if I think back to the asset sales typically in the first quarter with the commercial construction focus, is that something that you are more optimistic about now relative to the mortgage?

Or how do you think about the two portfolios at this stage relative to a no-growth economy? Where do you see the potential upside post the sales right now, given where we are with the economy?

In Puerto Rico or the US or both? Because I think it is a different story.

I am more focused on Puerto Rico for the most part. But I am just trying to tell that -- or understand that, knowing that there has been some incremental improvement in the lower end of the housing market, whereas on the commercial side it is definitely more problematic. So I am just wondering at this stage of the game where you see the momentum in terms of further reductions from a workout standpoint.

I mean, I will say -- I will reiterate what I said. Our commercial exposure after 6 years of recession I think that people have been able to operate, and the people that continue to -- our commercial exposures are now stronger names. And therefore, my expectation, if things remain the same, is for the portfolio to behave as it has behaved, with steady improvements on a quarter-to-quarter basis. Not sure if I have answered your question.

No, that's helpful. I appreciate that.

Then just lastly, Richard, just a bigger-picture question on the economy. With the passage of the budget and how -- the differentiation between the corporate side versus the consumer, do you have any early impressions in terms of talking with various customers, particularly in terms of small business in particular? How they are thinking about the residual impact on them, and how it may affect their opportunities or a rebound going forward.

Well, look, they're obviously not happy. Nobody is happy with the tax increase. And we can argue about how that whole reform should have been done.

But as Lidio mentioned, these guys if they are still around, they have been hanging out tough for 5, 6 years, so they are used to operating in this environment. They will adjust.

Obviously there could be some flow back into lower income for them. But in general I think they will adjust.

Okay, great. Thanks very much for taking my questions.

One commentary with regards to the earlier question. The tax rate that was embedded in the presentation that we -- earlier in the year at Investor Day was 22%.

(Operator Instructions) Taylor Brodarick, Guggenheim Securities.

Actually all my questions have been answered. Thank you very much.

Ken Zerbe, Morgan Stanley.

Thanks, I guess a follow-up. So actually the follow-up question I have was on expenses. Now given the inclusion of EVERTEC in the expense line and the revenue line, when we think about your previous guidance or for a normalized expense number of roughly $1.1 billion, how does that change going forward? What is the new normalized earnings number?

Well, you can do it either way. But you would have to adjust the expense number up by roughly $18 million a quarter, and you will have to adjust your revenue number up by the same amount.

Okay. Because there was also I think a $10 million increase in your FDIC deposit insurance cost this quarter, which presumably if we multiplied that out it would be another $40 million. I just want to make sure that there is no -- that either that reverses, or --

No, we discussed that in the first quarter. The first quarter benefited from a credit on the FDIC assessment of $11 million. That is not -- something that does not happen on an ongoing basis.

Got it. Okay.

The second quarter is the better number to use going forward.

Understood, okay. And sorry to harp on the tax issue; you mentioned just now that it was 22% before. Now it is 35%. If I do my math correctly essentially are you saying that your pre-tax earnings are now going down by roughly 12 percentage points versus where we expected them to previously, just simply based on this tax change?

No.

That is a big number. I just want to make sure that we are right with that.

It is a valid question. What we said was that the tax rate that was embedded in the normalized example we use in our Investor Day was 22%. Then we said that our current estimate of what the tax rate will become, given the changes as we understand them now, is closer to 35%.

Now, we actively try to address our tax expense, but most of the regulations of the new tax laws in Puerto Rico are just coming out now. So at this point in time it is not clear to us how we could address the new effective rate; but we are hoping that we can actually do things to lower it.

I see. Okay, thank you.

(Operator Instructions) Dan Bandi, Integrity Asset Management.

Hey, just a follow-up on one of your earlier comments. You guys had mentioned regarding TARP exit and talking to the regulators that I think you said something like it is not always a symmetrical conversation or something like that. I am just curious.

Have you guys floated ideas that either isn't getting a response or is being shot down? Or is there something in particular they are pushing you to do that you don't want to do? Can you give any more color on that?

Well, it was moderately sarcastic; but it is like arguing about the strike, what can I tell you? We do have this ongoing conversation. They are -- they take their time before they want to release us from a few things here.

So I just think it is going to be an ongoing dialog till we are happy with the result of the conversation. But yes, there is an ongoing dialog and they are naturally a little more conservative than probably we would like them to be.

Is it fair to say then that you have floated plans to them that perhaps they did not like up to this point?

Well, we really can't discuss what the conversations have been.

Okay.

Okay?

No, that's fair enough. Thanks a lot. I appreciate it.

Ladies and gentlemen, this concludes the question-and-answer portion as well as today's conference. Thank you all for your participation and you may now disconnect. Have a good day.

Thank you.