Popular Inc (BPOP) 2015 Q1 法說會逐字稿

Good morning and welcome to the Popular, Inc., first-quarter 2015 earnings conference call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to the Investor Relations officer of Popular, Inc., Brett Scheiner.

Good morning and thank you for joining us on today's call. Today I'm joined by our Chairman and CEO, Richard Carrion; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano, who will review our first-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 to 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 in today's earnings press release and are detailed in our SEC filings, our financial quarterly release, and supplement. You may find today's press release and our SEC filings on our webpage at Popular.com.

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

Good morning and thank you all for joining the call. I'd like to first address the highlights and key events of the first quarter, then I will present an update on the assets and deposits we acquired in the Doral Bank transaction and provide our thoughts regarding the fiscal and economic situation in Puerto Rico. Carlos will comment on the quarter's financial results, and Lidio will provide an update of credit trends and metrics.

With that, please turn to the second slide. In the first quarter, Popular earned adjusted net income of $90 million, up $13 million from last quarter and up $4 million from last year's first quarter. We continued to generate strong revenue with capital levels well above peer averages.

Tangible book value was $36.33, up from $35.89 last quarter. Our net interest margin of 4.57% decreased from last year's adjusted 4.70% on lower spread income from our covered portfolio. Our spreads remain strong relative to peers, with our Puerto Rico net interest margin at 5%.

Total NPAs this quarter of $935 million including covered loans were essentially flat from last quarter's $933 million. NPL inflows decreased $65 million when compared to the previous quarter, driven by last quarter's $75 million public sector borrower that entered nonaccrual status.

Noncovered NPLs were $665 million or 3.2% of noncovered loans, up $35 million from last quarter, with the majority of the increase related to the Doral failure and subsequent acquisition. Lidio will give you some more color on this.

Our net charge-offs were $36 million or 72 basis points, down from last quarter's $50 million or 104 basis points on lower commercial charge-offs in Puerto Rico.

During the second half of 2014, we completed the sales of our California and central Florida operations and made progress on our previously announced plans to consolidate our Rosemont, Illinois, and Orlando, Florida, operations centers, transferring most of these support functions to Puerto Rico and New York. These efforts are on track to be concluded in the second quarter. These actions have simplified our operations, providing an opportunity for capital release and improving the return on capital of our US region.

At quarter end, available Holding Company liquidity stood at approximately $219 million. Our liquidity position provides in excess of two years' debt service coverage, with no maturities until 2019.

In addition, the market value of our remaining stake in EVERTEC is approximately $248 million and significantly exceeds our position's current book value of $27 million. As investors, we will continue to participate in a proportionate share of the company's income, while our investment also represents an additional amount of capital flexibility and potential Holding Company liquidity.

Our repayment of TARP last summer better positioned us for more active capital management. At the end of March, we filed our Dodd-Frank stress test, the results of which will be made public in June. We've continued discussions with our regulators regarding our capital plan, which we expect to file this week; and we'll update you on those discussions in the third quarter.

Please turn to slide 3. Popular led a group which acquired most of the loans and assumed all of the non-brokered deposits from the FDIC as receiver for Doral Bank. As part of this transaction, Popular acquired approximately $1.7 billion in loans and assumed $2.2 billion in deposits.

The remaining assets and deposits that were part of the transaction were sold to co-bidders and closed concurrently with the primary transaction. Popular is servicing all portfolios until the different co-bidders complete their conversion, which should occur in the third quarter.

This transaction represents an efficient deployment of capital, with meaningful earnings accretion; and the in-market expansion provides significant cost-saving opportunities. In addition to strengthening our Puerto Rico franchise, the transaction grows our strategically important New York business through the addition of an attractive commercial platform.

As previously noted, Popular's bid to purchase approximately $5 billion of GSE mortgage servicing rights was accepted by the FDIC. We subsequently closed on $2.7 billion in Ginnie Mae MSRs; and final negotiations for the acquisition of the remaining $2.3 billion in GSE MSRs are ongoing.

We recorded an estimate of fair value as of March 31, with final valuations expected later in 2015. As such, we recognized preliminary goodwill of $43 million and a core deposit intangible of $24 million, in line with prior estimates.

Before I turn it over to Carlos, let me comment on the Puerto Rico economy, which has been getting quite a bit of ink lately. We've operated in a weak economy for most of the past eight years, and the strong revenues generated by our Puerto Rico bank have produced positive earnings in each of those years. We're confident that our strong market position, significant liquidity, excess capital levels, and internal capital generation will continue to be key to our future performance.

Over the next few weeks, comprehensive tax reform, the ongoing restructuring of the Puerto Rico Electric Power Authority, and the government budget will be the critical events impacting the fiscal and economic outlook. We hope that the political leadership will arrive at solutions that will achieve fiscal balance and put the economy back on a growth track, and we will do everything in our power to support this result. However, as we have done in the past, we are prepared to manage through other potential scenarios.

Regarding our exposure to the Puerto Rico government, our underwriting process and the size of that exposure relative to our capital base gives us comfort. Keep in mind that the majority of our direct Puerto Rico government exposure is in loans, not publicly traded securities. Our exposure is essentially flat from the previous quarter and down $131 million compared to last year's first quarter, as balances were paid down through 2014.

Last year, we placed one of our public-sector relationships with $75 million outstanding on nonaccrual status, and we believe we are adequately reserved for this exposure. We are monitoring developments in this portfolio closely.

We believe the risk/reward of our Puerto Rico government exposure is positive; and as such, we will continue to selectively participate in funding the Puerto Rico government's capital needs. Please turn to slide 4 as our CFO, Carlos Vazquez, discusses our financial results in further detail.

Thank you, Richard, and good morning. On slide 4 we present our adjusted financial summary for the first quarter. This quarterly data is reconciled to GAAP figures in the appendix to the slide deck.

As described in today's earnings press release, variances from the fourth quarter affected many lines on our income statement. The three largest variances were lower noncovered loan-loss provision, lower FDIC loss share expense, and lower operating expense. These were partially offset by higher covered loans and a higher income tax expense.

On an adjusted basis, net interest income for the first quarter was $343 million, down $2 million from the fourth quarter, as the benefit of one month's worth of income from Doral assets was offset by lower covered loan balances and a lower day count.

With the restructuring of Popular's US operations largely behind us, we are pleased to have achieved organic growth in excess of 6% in US commercial loans this quarter. Despite this growth, our outlook on overall loan balances remains unchanged. Going forward, we are hopeful that we can maintain flat noncovered loan balances till the end of 2015.

In Puerto Rico, limited organic growth has been offset by selected loan portfolio purchases over the last few years. We will continue to pursue this opportunistic asset acquisition strategy if attractive transactions become available.

The average yield on our $2.5 billion covered loan portfolio declined to 9.14% from 9.31% last quarter. This decline is due to ongoing long resolutions, repayment, and the quarterly recast of the portfolio's expected cash flow.

Our cost of interest-bearing deposits was flat to the prior quarter at 53 basis points. Noninterest income, excluding the FDIC loss share activity, decreased by $10 million compared to last quarter.

This was mostly the result of lower gains on sales of loans in the US, as our loan workout efforts there are nearly completed. This line item also affected by seasonally lower insurance revenue, offset by a lower recourse reserve expense.

Our Puerto Rico mortgage business originated $340 million of loans in Q1, up from $275 million last quarter, on market expansion and additional market share gains.

Total operating expenses for the quarter were down $19 million to $292 million. This decrease was mainly driven by elevated legal expenses in the fourth quarter that did not recur in this quarter, as well as lower tax-related expenses on the elimination of Puerto Rico's gross receipts tax.

Some of these benefits were partially offset by higher pension expenses and seasonally higher personnel costs. While subject to variability, we expect quarterly operating expenses, including the impact of the Doral transaction, to average approximately $300 million through 2015.

Our adjusted tax rate for the quarter was 28%, mostly due to a larger proportionate contribution to earnings from BPPR. While we expect our full-year tax rate to approximate this quarter's 28%, we remain hesitant to update this number until we have a better feel for Puerto Rico's upcoming tax reform.

Continued strong post-restructuring performance by Popular's US business, complemented by the additional income contributed by the acquired Doral assets, could impact the assessment of our US DTA and could eventually lead to a partial reversal of the US DTA allowance. While we do not know the timing of this potential event, we continue to make quarterly evaluations of that allowance.

With respect to the Doral transaction, we estimate the quarterly net income contribution going forward to be around $10 million. Doral-related transaction costs incurred in Q1 were $9 million. We expect an additional $15 million of Doral transaction-related costs to be incurred between the second and the third quarter.

The BPNA strategic realignment has right-sized our operations and adjusted the back office to appropriately service the bank's updated size and regional [preference]. Having also cleaned out the remaining letters of credit and high-cost liabilities, we are confident that our simplified and refocused US operations will provide capital [release] and improved returns. We expensed $11 million toward BPNA's restructuring costs in the first quarter and expect the majority of the remaining $12 million to be recognized in the second quarter.

Please turn to slide number 5. The commercial portion of our FDIC loss share agreement expires at the end of the second quarter of this year. On slide 5 we provide an overview of the losses expected to be realized and collected from the FDIC till the end of the loss share agreement.

With the activity outlined on the slide, we estimate that the $410 million loss share asset reported in the first quarter will result in $149 million in remaining losses to be claimed before the end of the LSA. This figure excludes the single-family mortgage portion of the loss share asset and its amortization, as this part of the loss share does not expire for an additional five years.

Our estimate incorporates recent payments from the FDIC, the commercial indemnity assets' remaining amortization, and expected payment on charge-offs taken in the first quarter of 2015 but billed for reimbursement in the second quarter. Additionally, we have excluded a $55 million claim that is under dispute with the FDIC, as disclosed in our most recent 10-K.

Losses can be realized through lower appraised value of collateral, discounted payouts, and asset sales. While we currently expect to collect the total remaining $149 million balance of the loss share asset, any amount remaining in the loss share asset not expected to be collected from the FDIC will be charged off.

Please turn to the next slide. We continue to enjoy strong capital levels relative to mainland and Puerto Rico peers as well as with respect to well-capitalized regulatory requirements. Under the Basel III rules which took effect on January 1 of this year, and including the impact of the Doral transaction, we saw a 7 basis point decrease on our Tier 1 common equity ratio to 15.8% and a 194 basis point decrease in our Tier 1 ratio to 16.2%. All of Popular's capital ratios remain robust and well above regulatory requirements.

As mentioned last quarter, we are in discussions with our regulators about the possibility of implementing a capital distribution strategy. At this time we cannot estimate when these discussions will conclude or what the outcome may be.

We seek to maintain strong capital levels appropriate for Popular's risk profile and will continue to work to our target of a double-digit return on tangible equity. With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. Despite Puerto Rico's challenging macroeconomic environment, we are pleased to report stable credit metrics for the Corporation, highlighted by strong asset quality in our US operation and stability in our Puerto Rico operations. The Doral Bank failure and asset acquisition impacted our credit quality results for the quarter.

Specifically, subsequent to acquisition, approximately $7 million of [taxable value] loans in our US operation entered NPL status. This increase is mainly driven by a single borrowing relationship that, based on our fair value exercise, was already discounted on our books.

In Puerto Rico, prior to its failure Doral serviced a residential mortgage portfolio of $150 million for Popular, on which it was committed to advance contractual payments irrespective of our delinquencies. In addition, Doral was required to repurchase or substitute delinquent mortgage loans.

Subsequent to Doral's failure, we are now reporting such loans based on their contractual delinquencies. As a result, mortgage NPLs in Puerto Rico increased by $17 million.

In Puerto Rico, excluding the previously mentioned Doral impact, our credit metrics reflect lower net charge-offs, lower NPL inflows, and stable NPLs. In the US, we continue to reflect strong credit performance with low NPLs, low net charge-offs, and stable NPL inflows.

Let us turn to slide number 7 to review the details. Nonperforming assets remained flat at $935 million, mainly driven by a decrease of $12 million in other real estate owned in the US, and a decrease of $17 million in covered other real estate owned in Puerto Rico, offset by an increase of $34 million in NPLs.

In the US, total NPLs held in portfolio increased by $8 million to $27 million from the previous quarter, driven by the previously mentioned Doral relationship. Excluding this, NPLs in the US were flat quarter-over-quarter.

In Puerto Rico, noncovered NPLs increased by $27 million during the quarter, mainly driven by higher mortgage and commercial NPLs of $25 million and $7 million, respectively. The mortgage NPL increase included the $17 million impact of loans previously serviced by Doral. Excluding Doral, NPLs in Puerto Rico were stable quarter-over-quarter.

Please turn to slide 8 for a summary of the trends in NPL inflows. On a linked-quarter basis, NPL inflows decreased by $65 million, mainly driven by the previously disclosed $75 million public-sector borrower in Puerto Rico that entered nonperforming status last year.

Excluding the impact of the public-sector borrower, NPL inflows in Puerto Rico increased by $5 million, mainly driven by increasing mortgage NPL inflows of $15 million, in part offset by a decrease of $10 million in commercial NPL inflows. The mortgage NPL inflows includes the one-time adjustment related to the addition of $17 million of loans previously serviced by Doral. Excluding this impact, mortgage NPL inflows decreased by $2 million.

In the US, NPL inflows increased by $6 million, driven by the previously mentioned Doral loans. Excluding this, NPL inflows in the US were flat.

Please turn to the next slide to discuss net charge-offs, provision, and allowance for loan losses. Net charge-offs amounted to $36 million or annualized 72 basis points of average loans held in portfolio, compared to $50 million or 104 basis points in the previous quarter. The decrease was primarily driven by the Puerto Rico region.

Net charge-offs were $37 million in Puerto Rico, a decrease of $16 million from the previous quarter. The decrease was principally driven by lower commercial net charge-offs of $9 million, lower construction net charge-offs of $3 million, and a lower mortgage net charge-off of $2 million.

In the US net charge-offs, excluding write-downs and recoveries related to bulk loan sales, amounted to recoveries of $886,000 compared to recoveries of $2.3 million in the previous quarter. The provision to net charge-off ratio was 83% compared to 99% in the fourth quarter of 2014, primarily driven by the Puerto Rico region. The decrease reflects lower net charge-off experience in Puerto Rico during the quarter.

The Corporation's allowance for loan losses decreased slightly by $3 million from the previous quarter, driven by Puerto Rico. The ratio of allowance for loan losses to loans held in portfolio stood at 2.5% in the first quarter, compared to 2.7% in the previous quarter, mainly driven by the Doral acquisition. The ratio of allowance for loan losses to nonperforming loans decreased slightly to 78% from 82% in the previous quarter.

The key takeaway in the quarter is that, despite Puerto Rico's challenging macroeconomic environment, our credit metrics were stable.

Please turn to slide 10 to discuss our exposure to public corporations and the Puerto Rico government. Our current direct exposure to the Puerto Rico government, municipalities, and other instrumentalities is $995 million, of which approximately $813 million is outstanding, flat to the previous quarter. Our largest direct exposures to the central government and public corporations are: a $100 million exposure to tax revenue anticipation notes, for which we received the first scheduled payment, $11 million, after the close of the quarter; and loans to the Aqua and Sewer Authority of $85 million and to the Electric Power Authority of $75 million.

During the quarter, we received payments of $15 million from the Aqua and Sewer Authority. We believe our total exposure to the central government and public corporation is manageable, representing only 8.6% of total Tier 1 capital.

Our municipality exposure is mostly a diversified portfolio of senior priority loans to a select group of municipalities, whose revenues are independent of the central government. In addition to this direct exposure to the government, we also have indirect lending facilities in which the government acts as a guarantor. The largest such exposure is in the form of residential mortgage loans to individual borrowers, in which the government provides a guarantee similar to FHA programs in the US.

With that, I would like to turn the call over to Richard for his concluding remarks. Thank you.

Thank you, Lidio, and please turn to slide 11. Before we open the lines to questions, let me conclude today's remarks by reviewing the actions we are taking to drive shareholder value. Our healthy revenue generation uniquely positions us to benefit from an eventual economic recovery and yields reasonable returns, while the leading market position of our Puerto Rico franchise continues to allow us to sustain above-average margins.

Notwithstanding ongoing instability in our main credit quality indicators in Puerto Rico, we remain attentive to fiscal and macroeconomic trends. Popular's credit risk profile is meaningfully different from the one with which we enter this credit cycle, which, together with our strong capital position, improves our outlook.

While the Puerto Rico economy has been soft, in the past nine months we have, with the approval of our regulators: repaid close to $1 billion in TARP; had two credit MOUs lifted; restructured our US balance sheet and back office; and purchased $2.3 billion of assets in the Doral transaction. We started the year with continued stability in both revenue and credit metrics and are encouraged by the growth prospects in our restructured US business.

Our acquisition of Doral assets and assumed deposits will further enhance our ability to grow earnings in an otherwise sluggish macro environment. We continue to benefit from our EVERTEC ownership; our stake in Banco BHD Leon, the second largest bank in the Dominican Republic; and the improved performance of our US operations. We are driving shareholder value as we remain focused on creating revenue opportunities while effectively managing credit, our capital, and our overhead costs.

To finish, our story is to a large extent linked to Puerto Rico, its economy, and its future. We are aware of that and remain committed to working to improve the island's prospects.

But Popular's is also a story of a solid organization that has navigated through a complex environment and has emerged as a stronger, better capitalized, and more diversified institution. We are encouraged by the progress we are seeing in our US operation and by the strength of our Puerto Rico franchise, which has been demonstrated in the past few years.

We look forward to reporting on our progress in the next few months. And with that, I would like to open the call for questions.

(Operator Instructions) Alex Twerdahl, Sandler O'Neill.

Hey, good morning, guys. First off, we heard on one of your competitors' calls that you've been slow to bring down deposit costs. Can you talk a little bit about how your funding costs on the islands have trended?

Yes, let me say a few things about that. You know, the fact is our funding cost, particularly when you factor in the impact of demand deposits, is slightly under 40 basis points. So that's pretty low, and it's been maybe half a basis point lower in the last quarter; but we think that's pretty low.

Secondly, we generally price to keep our clients happy and not our competitors. So that's what it is.

Okay, thanks. Then secondly, I was hoping maybe you could expand a little bit more on that possible realization of a portion of the DTA valuation allowance in North America. Can you talk about how that decision gets made? If it's your decision, your auditor's decisions, and whether or not there's any breaking point out there that we should be paying attention to? To whether or not it makes sense to get the tangible book value gain, or continue to recognize a 0% tax rate.

Okay, I will let Carlos handle that one.

Yes, it is a little bit of all of the above. It mostly depends on the continued performance of our US business, so that is the more -- the most important input into the process.

There is a bunch of then boxes that need to be checked on the accounting side, one way or the other, and we will continue to look at it every quarter, as I mentioned. Our accounting firm will have a view and an opinion on this as well, obviously. But the main driver is the continued performance of our US business and then all kinds of accounting rules that get triggered by that.

Can you give us a sense for what the core profitability in North America is following Doral?

We have a segment report on the -- on our deck, and you've seen the detail there. On the quarter, it was about $4 million; that only includes one month of Doral.

Of course, this is GAAP. We need to adjust it for the one-time event. What's the number? 17 what?

$17 million.

Yes.

On a non-GAAP basis for the quarter.

Yes, non-GAAP basis for the quarter in the US will be $17 million.

$17 million?

That's one month. There is still some noise in that, Alex, because there was only one month. And again, there's a number of one-time events there.

That number will get clearer when we report next quarter, obviously. We will have a full quarter and a lot of the noise will go away.

All right. That's very helpful. Then my final question is: what is the normalized run rate for that nonpersonnel credit-related cost that was $29 million in the quarter? If you look back into sort of 2005/2006 time period, where would that have run?

Yes, the problem with that number, Alex, is that, as you know, our OREO expenses are rather volatile. So I will have to go back and check the input into that; and we will get back to you on that. But the OREO volatility makes it hard to give you a comparable response to that number which was put out, whatever, a year or so ago.

Okay, great. Thank you very much.

Ken Zerbe, Morgan Stanley.

Thank you. Just a question on loan growth. Obviously I would expect average balances to take up a little next quarter, given the remnants of Doral. But when you look out over the next 12 months beyond next quarter, given the situation on the island, do you have any thoughts in terms of loan growth expectations?

What we've said is that we expect to remain flat, given the growth we are seeing in the US, making up for the runoff. And that's after adjusting for the Doral acquisition.

Got it. Understood. Okay. Then on the FDIC income in this quarter, if I add up all my numbers right, it looks like that the net increase in the FDIC income was up about $8.5 million, including, if I read that right, the reimbursed. The mirror accounting on the expenses was actually greater than the expenses incurred this quarter.

Is that just said all timing differences? And would you expect that to revert lower next quarter?

Yes, the mirror accounting on the expenses could have a timing difference as you can only bill them after incurring a charge on a loan. So you incur costs ahead of that; that's maybe the difference.

As far as going forward, it will depend on the expense activity during the quarter.

Okay. The last question for you. I know you guys have talked a lot about operating in kind of a crappy environment for the last eight years. Just given the downgrade that we saw from S&P, if the government is unable to come to a reasonable solution and it defaults on its obligations, not the direct exposure, but more from a loan perspective exposure, like -- obviously, you guys have probably given this a lot of thought. What would you expect to happen from the lending side? How would that affect your commercial customers?

Well, obviously, it would impact the whole macro environment as the effects percolate through the system and suppliers get affected. Hopefully it will not come to that, and some kind of resolution can be reached before we get there.

But we are prepared to deal with it. But it's part of the scenarios we've looked at in our stress tests.

Understood. All right. Thank you.

Jordan Hymowitz, Philadelphia Financial.

Yes, I was just wondering if the situation on the island overall would delay any regulatory decision that would enable you to return capital? Are they completely independent of each other because they are different bodies, or is one tied to the other?

Well, you know, far be it from me to try to get inside a regulator's mind. But obviously, they will be looking at the regulatory environment; they will be looking at the results of the stress test and how we handle that particular scenario in terms of what it does to our capital. So it's something that we'll probably start getting into those discussions in the next few weeks.

Okay. Thank you.

Adam Hurwich, Ulysses Management.

Hi, good morning. Just a follow-up on your comments regarding recognition of DTA in the US. That is a GAAP figure. Could you just give us how we should think about regulatory capital and the impact -- if at all -- the impact of the recognition of the DTA on regulatory capital?

It would be very small if any, in the sense that you can only use the one year of DTA. No, my controller is shaking his head -- and under Basel III. So it will be nil on the impact of regulatory capital.

Under Basel III, it's a one year or is it a 10%?

No, it's done. They take it out.

It's a different formula. That's the old formula. On Basel III, it's more complicated. We can go off-line and provide, but it's formula driven and it adds other components like MSRs, etc., into that analysis.

Okay; we'll get into that later. Thank you.

Yes, the important part, it will be limited or no impact to regulatory capital.

Thanks.

Taylor Brodarick, Guggenheim.

Great, thank you. Core efficiency obviously improved this past quarter, and it looked better the last few quarters. I guess post Doral and some of the strategic actions you've taken, do you have any sense of what other levers you could pull to improve it? Or do you feel like you are approaching an optimal efficiency with the franchise you have?

No, you can always do better. Carlos mentioned we are trying to get -- with the Doral trying to get to $300 million or below in terms of quarterly OpEx. And obviously it would improve if we start getting a little growth; that would improve if we can keep it at $300 million.

Okay.

The other thing that weighs heavily on that is that we continue to have high workout costs. We have still a significant workout portfolio that we are working our way through. So eventually that will hopefully start trickling down as well.

Great. I guess one more question. You said something about with the capital plan the announcement would not occur, correct, until 3Q? Until the next quarterly earnings call; is that correct?

Correct.

I mean it will occur whenever --

Whenever we get an answer we will (multiple speakers)

Right, yes, yes. But that's your expectation; got you. Okay, very good.

Exactly.

All right, great. Thank you very much.

(Operator Instructions) Showing no further questions, this will conclude today's call. Thank you for attending today's presentation. You may now disconnect.

Thank you.