Popular Inc (BPOP) 2015 Q2 法說會逐字稿

Good morning and welcome to the Popular, Inc. second-quarter 2015 earnings conference call. (Operator Instructions). Please also note today's event is being recorded.

I would now like to turn the conference over to Brett Scheiner, Head of Investor Relations. Please go ahead, sir.

Good morning. Thank you for joining us on today's call. 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 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 would like to first address the highlights and key events of the second quarter, then I will present an update on the assets, deposits and other businesses we acquired in the Doral 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 on credit trends and metrics.

Please turn to the second slide. In the second quarter, Popular earned adjusted net income of $90 million, flat to last quarter and up $4 million from last year's second quarter. We continue to generate strong revenues with capital levels well above peer averages. Tangible book value was $41.75, up from $36.33 last quarter due mostly to this quarters partial reversal of the allowance against our US deferred tax assets reflecting the improved profitability and outlook of our US operation.

Our net interest margin of 4.54% decreased slightly from last quarter's 4.57% as the full quarter's contribution from our acquired Doral asset was partially offset by higher levels of liquidity. Please note, however, that net interest income increased $19 million sequentially. Our spread remained strong relative to peers with our Puerto Rico net interest margin of 4.92%.

Total NPAs this quarter of $806 million including covered loans, were down $129 million from last quarter's $935 million. NPL inflows decreased $31 million when compared to the previous quarter driven by lower mortgage and commercial inflows in Puerto Rico. Non-covered NPLs were $576 million or 2.6% of noncovered loans, down $89 million from last quarter.

Our net charge-offs excluding write-downs were $46 million or 89 basis points, up slightly from last quarter's $36 million or 72 basis points on higher commercial charge-offs and below trend results last quarter.

This quarter we completed the majority of our previously announced plans to consolidate our Illinois and Central Florida operations center, transferring most of these support functions to Puerto Rico and New York. These actions have simplified our operations providing an opportunity for capital relief and improving the return on capital for our US regions.

At quarter end, available holding company liquidity stood at approximately $234 million. Our liquidity position provides in excess of two years debt service coverage with no maturity until 2019.

In addition, the market value of our remaining stake in EVERTEC is approximately $224 million and significantly exceeds our [position's] current book value of $29 million. As investors we will continue to participate in a proportionate share of the Company's income while our investments also represent an additional source of capital flexibility and potential holding company liquidity.

As we discussed last quarter, we filed our Dodd-Frank stress test at the end of March, the strong results of which we made public in June. In addition, we filed our capital plan in April. We remain confident in our capital plan submission and expect to update you during the third quarter.

In February, Popular acquired approximately $1.7 billion in loans and assumed $2.2 billion in deposits from the FDIC as receiver for Doral Bank. So far the acquired loan portfolios have performed as expected and this quarter our Puerto Rico mortgage origination shows increased volumes partly as the result of Doral's exit from the market. We have also seen strong commercial production in the US operations aided in part by the addition of Doral's New York-based commercial origination team.

As noted last quarter, Popular's bid to purchase approximately $5 billion of GSE mortgage servicing rights was also affected by the FDIC and these transactions have now been completed. Popular's total Puerto Rico MSR portfolio now stands at $20 [million].

In May, we also purchased Doral Insurance Agency's portfolio for $17 million. These transactions represented an efficient deployment of capital with meaningful earnings accretion and the end market expansion that provided significant cost savings opportunities.

Please turn to slide three.

Before I turn it over to Carlos, let me comment on the Puerto Rico economy which has been in the news quite a bit lately. The government of Puerto Rico continues to face multiple fiscal challenges in the coming weeks and months. In order to address the challenges, the government formed a working group tasked with creating a five-year fiscal stability plan and starting discussions over debt renegotiations. The government has also proposed the creation of a financial control board. As detailed plans emerge we will continue to assist in every way we can to enhance the execution of the plan.

We hope that the political leadership will arrive at solutions that will achieve fiscal balance and more importantly, put the economy back on a growth track. We will do everything in our power to support this result.

However, as a result of the work done in the last few years, we shift the risk profile of our credit portfolio, enhance operations, increase profitability and grow our capital we are prepared to manage through a variety of potential scenarios.

Regarding our exposure to the Puerto Rico government, our underwriting process, the structure and the size of our 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 to municipalities not publicly traded securities of the central government. Our direct exposure is down $266 million from the previous quarter and down $104 million compared to last year's second quarter as some balances were paid down through the first half of the year. However, we will continue to selectively participate in funding the Puerto Rico government's capital needs where we feel the risk reward is in our favor.

As will be described in further detail later by Lidio, there have been some changes in our Puerto Rico public sector exposure other than usual repayments in advance. We have agreed to sell the majority of our PREPA exposure at a price close to what we had reserved it down two quarters ago. As a result, we have moved the loans to held for sale and written it down accordingly by $30 million. We have also recognized an OTTI charge of $14 million on some of the publicly traded securities of our small Puerto Rico government bond portfolio. We continue to monitor events in this portfolio closely and will make future adjustments if they are warranted.

We have operated in a weak economy for the past nine years. Despite that, the strong revenues generated by our Puerto Rico Bank have produced positive earnings in each of those years. We are confident that our strong market position, significant liquidity, excess capital levels and internal capital generation will continue to be key to our future performance.

Please turn to slide four as our CFO, Carlos Vazquez, discusses our financial results in further detail.

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

The second-quarter's earnings were impacted by a full quarter's worth of revenue from our Doral acquisition offset partly by higher expenses related to the wrap up of the commercial LSA. Today's earnings press release details variances from the first quarter, the largest being higher net interest and noninterest income offset by higher loan-loss provision and operating expense.

On an adjusted basis, net interest income for the second quarter was $363 million, up $19 million from the first quarter. As the quarter included three full months of spread income from the acquired Doral assets compared to one month last quarter. With the restructuring of Popular's US operation largely behind us, we are pleased to have achieved organic growth of 9% in US commercial loans this quarter excluding Doral. This healthy growth follows last quarter's 6% increase in US commercial loans. Despite the US-based growth, our outlook on overall loan balances remains unchanged. Going forward, we are hopeful that we can maintain flat loan balances through the end of 2015.

In Puerto Rico, we have offset limited organic growth with selective loan portfolio purchases over the last few years. We will continue to pursue this acquisition strategy if attractive transactions become available. The average deals of our $2.4 billion covered loan portfolio increased to 9.4% from 9.1% last quarter. This increase is due to ongoing loan resolutions, repayments and the quarterly recast of the portfolio's expected cash flows. Our interest-bearing deposit costs fell 3 basis points from the prior quarter to 50 basis points.

Noninterest income excluding FDIC loss share activity increased by $25 million compared to last quarter. This was mostly the result of higher service fees, higher income from our mortgage business and higher income from our equity investment. These positive variances were offset by markdowns on the small trading portfolio at our broker-dealer.

Popular's Puerto Rico mortgage business originated 399 million loans in the second quarter, up from 340 million last quarter partially due to Doral's exit from the market.

Total operating expenses for the quarter were up $31 million to $322 million. This increase was mainly driven by $10 million of higher loan resolution expenses, many linked to the expiration in this quarter of the loss share portion of the commercial LSA. $5 million of elevated personnel costs related to annual employee stock-based compensation were also recognized during the quarter.

Our non-GAAP results details on Doral's transaction related expenses that we have adjusted for in the last two quarters. In addition to those adjustments, we are also incurring other expenses that are not adjusted as we operate two platforms prior to the full integration of Doral's banking systems during the third quarter. These increased expenses are concentrated in the professional fees and equipment line item.

Given these slightly elevated expenses, we expect quarterly operating expenses to average approximately $305 million for the second half of 2015. While this figure is up from last quarter's estimate, better than expected performance from the Doral transaction offsets the majority of this increase.

As Richard mentioned, given the more stable earnings stream and outlook for our restructured US business, we have recovered $545 million of our US EPA. This recapture will require our GAAP results to incorporate an effective tax rate of approximately 44% on our US earnings beginning in the first quarter of 2016. For the remainder of 2015 results, we will continue to use a 0% marginal tax rate for our US business.

Our adjusted tax rate for the quarter was 19% mostly due to a larger proportion of contributions to our earnings from our US Bank. Given our revenue mix expectations for the rest of the year, we estimate a tax rate at the low end of a 20% to 29% range. Our 2016 expectation incorporating the full US tax rate will move up to the high end of that range.

Doral related transaction [tests] incurred in the second quarter were $13 million. We expect an additional $5 million of such costs to be incurred in the third quarter. We also expensed $6 million of (inaudible) restructuring cost this quarter and expect to significantly reduce restructuring expenses moving forward.

Please turn to slide number five. The loss share portion of the commercial LSA expired at the end of the second quarter. On slide five, we provide an overview of the losses expected to be realized and collected from the FDIC to the closeout period of the commercial loss share agreement. Our total $393 million receivable from the FDIC includes $85 million related to the single-family mortgage loss share agreement which expires in five years. The remaining $308 million includes $79 million of first-quarter losses already collected from the FDIC during July and $88 million expected to be billed for second-quarter loss.

In addition, $141 million of reimbursable losses remain in dispute. While we currently expect to collect the remaining balance, any amount remaining in the loss share assets not collected from the FDIC will be charged off.

Please turn to the next slide. We continue to enjoy strong cash flow levels relative to Mainland and Puerto Rico peers as well as with respect to well capitalized regulatory requirements. Our Common Equity Tier 1 ratio was down 14 basis points to 15.6% as our positive earnings were offset by the higher risk-weighted assets resulting from the reclassification of $1.5 billion of the Westernbank portfolio to noncovered.

Our Tier 1 ratio decreased 51 basis points to 15.6% for the same reason. As mentioned earlier, the DTA reversal has a minimal effect on our regulatory capital. All of Popular's capital ratios remain robust and well above regulatory requirements as reflected by the results of our Dodd-Frank stress test made public last month which Lidio will cover later. It is our goal to maintain strong capital levels that are appropriate to Popular's risk profile as we continue to work towards 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. While operating in a challenging economic environment, we are pleased to report that asset quality continued to improve during the second quarter as nonperforming assets, nonperforming loans and NPL inflows improved over the previous quarter. This quarter's net charge-off of $46 million or 89 basis points while up from last quarter are in line with our trends in 2014.

In addition to improve credit metrics and strong capital levels, we continue to feel confident with our exposures and risk profile.

Please turn to slide seven. This slide compares and contrasts Popular's current portfolio mix to the mix prior to the financial crisis. The key message is that changes in our portfolio composition, coupled with changes in underwriting parameters have led to a lower risk profile and better credit performance.

In the US, we no longer have a subprime consumer and mortgage business. Our US bank is now a community and niche lender with a much lower risk profile.

In Puerto Rico, our commercial and construction exposure excluding loans reclassified to noncovered during the second quarter has decreased from 65% of our total loan book to 38%. Construction lending has decreased 94% and now stands at $77 million.

On the bottom of the slide, we also segment the commercial portfolio and include net charge-off distribution by segment since 2008. The important message from the table is our commercial mix has significantly improved by reducing exposure to asset classes with historically high losses.

In the retail portfolio, mortgage exposures are now 65% up from 45% in 2007. In addition to a markedly improved risk profile, our recently published disclosure, Dodd-Frank stress test provide us with additional comfort. The stress test released in June incorporates a severely adverse scenario for Puerto Rico in which the unemployment rate sits at 20.4% and economic activity, measured by [GMP], decreases by 6.3% during the first calendar year.

Under such a scenario, we forecast over 10 percentage points of loan losses in the nine-quarter period and reflect a 3.3% impact to our Tier 1 common equity ratio over that time maintaining a meaningful cushion in excess of well capitalized (inaudible) at all times.

As Richard covered on slide three, our current outstanding direct exposure to the Puerto Rico government municipality and other intrumentality, is $673 million, a decrease of $140 million from the previous quarter. The decrease is mainly due to the full pay off of $100 million in tax revenue anticipation notes and $20 million previously (inaudible) coupled with a $30 million write-down in our PREPA relationship.

As we have discussed in the past, most of Popular's direct Puerto Rico government exposure is in the form of municipal loans and not securities. Having said that, we do have a small portfolio of Puerto Rico government securities with a par value of $44 million which is reported equally with the corresponding and realized gains and losses reflected in OCI. This portfolio is subject to (inaudible) review where we evaluate if any of the reported changes in value are other than temporary.

During the second quarter, we recognized an OTTI charge of $14 million on the portion of this portfolio. We will continue to evaluate all of these securities in the normal course of business.

We believe our total exposure to the central government and public corporations is [marginal] representing only 4.6% of total Tier 1 capital. Our municipality exposure is mostly a diversified portfolio of senior priority loans with a select group of municipalities whose revenues are independent of the central government. As discussed in previous earnings calls, we also have indirect lending facilities in which the government acts as the 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.

In addition to this exposure to the Puerto Rico government, we also have commercial credit where a significant portion of the client's ability to service their debt comes from revenue devised from government sources and consumer credits where borrowers are employed by the Puerto Rico government and related agencies. We have segmented our commercial portfolio exposure into multiple risk categories based on the dependence of government revenue and (inaudible) of government services in which our clients are involved.

We have also stressed our entire consumer portfolio assuming a representative proportion of our clients are government employees. We continue to analyze and monitor these higher risk [tools] who at this time we feel confident that our exposures are both appropriately sized with our risk tolerance and are manageable given our earnings power and strong capital base.

Please turn to the next slide to discuss credit metrics for the quarter. In addition to the underlying improvement in our credit metrics this quarter, the reclassification of the commercial portion of our covered loan portfolio impacted some of our credit metrics. Going forward, only the $600 million of single-family loans covered under their respective LSAs through 2020 will be presented as covered in our financial statements.

Nonperforming assets including covered loans increased by $120 million to $106 million driven by a decrease of $104 million primarily associated with the transfer to held for sale of our PREPA relationship and a decrease of $66 million primarily from the sale of covered commercial properties. These decreases were offset in part by an increase of $42 million in NPLs held for sale due to PREPA.

Please turn to slide nine for a summary of trends and NPL inflows. On a linked quarter basis, NPL inflows excluding consumer loans and NPL inflows classified from covered loans decreased by $31 million mainly driven by lower commercial and mortgage inflows in Puerto Rico of $11 million and $22 million respectively. Mortgage inflows in the first quarter included $17 million from Doral. Please turn to the next slide to discuss net charge-offs provisions and allowance for loan loss.

Net charge-offs excluding write-downs of $30 million from PREPA amounted to $46 million or an annualized [89] basis points of average loans held in a portfolio compared to $36 million or 72 basis points in the previous quarter. The increase was primarily driven by higher commercial and construction net charge-offs in Puerto Rico as the prior quarter reflected a lower loss including higher recoveries. This increase was partially offset by a $5 million recovery associated with the sale of a portfolio previously charged off credit cards and auto loans in Puerto Rico.

In the US charge-offs amounted to $1.3 million compared to recoveries of $882,000 in the previous quarter driven by lower recoveries in the (inaudible) portfolio. This quarter's $60 million noncovered provision while up from last quarter reversed it back to the trend from previous quarter prior to the first quarter 2016.

The corporation's allowance for loan losses decreased slightly by $3 million from the previous quarter driven by the above-mentioned $30 million write-down in Puerto Rico. The ratio of allowance for loan losses to loans held in portfolio stood at 2.3% compared to 2.5% in the previous quarter. Excluding the reclassification of the commercial portion of our covered loan portfolio, this ratio will remain flat. The ratio of allowance for loan losses to nonperforming loans improved to 89% from 78% in the previous quarter.

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

Thank you, Lidio. 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 in Puerto Rico and yields reasonable returns while the leading market position of our Puerto Rico franchise allows us to earn above average margins.

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

We are driving shareholder value as we remain focused on creating revenue opportunities while effectively managing credit, our capital and our overhead cost. We have started the year with continued stability in both revenue and credit metrics and are encouraged by the organic growth in the first half of the year from 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 in our main market. 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 certainly aware that Puerto Rico has been very much in the press lately and we are monitoring events closely. Given the fiscal and economic challenges we face on the island, we will focus our attention on understanding the situation and its potential risk while acting to minimize their impact.

Nonetheless, we will continue to seek opportunities in the current environment. While the Puerto Rico economy has been soft, in the past 12 months we have with the approval of our regulators, repaid close to $1 billion in TARP, had two credit MOUs listed, restructured our US balance sheet and back office, and purchased $1.7 billion of loans in the Doral transaction. 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 profit.

But Popular 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 operations 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.

With that, I would like to open the call to questions. Thank you.

(Operator Instructions). Brian Klock, Keefe, Bruyette, Woods.

Good morning, gentlemen. So I guess my first question is really about the capital plan and I guess probably what kind of color you can give to what timing or what expectations you might have of getting some sort of feedback from the Fed on your capital plan. It just seems like from an outsider's perspective you look at your deep edge results and with the Puerto Rico franchise you've got a strong core earnings power pretax pre-provision earnings to observe a lot of those losses if you have the purchase accounting marks and other things to absorb some of the losses.

I look at the credit quality today, look at the -- even with everything in the news with Puerto Rico, there is the NPL formations are pretty low today and they keep going down. So it kind of feels like with the level of capital you have got, the core pretax pre-provision earnings power in Puerto Rico, it seems like there could be an opportunity to ask for a buyback with your capital plan. Maybe can just let us know what your thoughts are and if there is any way to know when you could find out an answer on your capital plan this year?

First of all, we agree 100% with your position and we would like to send you down to DC. You seem to know. At any rate, look, we submitted it in April. They are kind of looking at it, they will let us know when they are done, we think that will happen this quarter, specifically sometime in September and there is not much we can do. It is their clock and they determine when they respond. We agree with everything that you said.

Okay, that is fair enough. A quick follow-up. On the PREPA exposure, I guess can you maybe kind of give us your thoughts on your decision to move into held for sale? Does that mean you actually do have something that is a signed contract or it has just been moved?

We do have something, it is awaiting, it needs to get approved by our brethren, the loan syndicate. The lawyers are doing their thing and we just made the decision that we would rather be out of it. We are less than 10% of that syndicate and less than 1% of PREPA's debt so we just prefer to be out of it. So as you saw we wrote it down by 40% last December. We had written it down pretty close to that I think -- we had written it down by 38 and change and so we did the full write-off this quarter.

And then just quickly on that one too and I will get back in the queue, so was there an indication there then -- it seems like there's a lot of things and deadlines for around September and September 15 that would almost seem to be positive so I was wondering why the decision to sell ahead of that?

Well, you know, we would rather have it out of nonperforming frankly. And yes, I hope they sort things out by September. We are not playing a meaningful part in any of those discussion so we put rather have an earning asset.

Fair enough. Thanks for your time.

Higher is higher and we've got some money on the table.

Okay, thanks for your time. I appreciate it.

Alex Twerdahl, Sandler O'Neill.

Good morning, guys. Just want to ask a little bit more about the DFAST process and your assumptions in this severely adverse scenario. Would you have had any sort of government default or government austerity built into that severely adverse scenario given that the situation on the island is kind of -- I mean even with the government's comments three weeks ago it is really kind of largely unchanged from what it has been for the last two years and we kind of knew what the governments liquidity was like etc., etc. So would you have included any sort of austerity or government default or anything like that in the DFAST plan?

As we discussed today and we made public a couple of weeks ago, our scenario for Puerto Rico incorporates a very severe scenario which the unemployment growth speaks around 20.4% and economic activity goes down to 6.3% in the first calendar year scenario as you can imagine there will be lot of -- affected in the island potentially including a government shutdown.

Okay, thank you for that. And then just to extend upon Bryant's question on the capital plan. You filed it in April, obviously a lot has changed in terms of mentality on the island and from investors and probably assuming regulators as well over the past couple of weeks. Would there be any need to file or to update a capital plan following the governors' comments a couple of weeks ago either at the request of the regulators or on your own volition?

No, not really in the sense that as we have mentioned I think our stress test scenario will be severely adverse or much worse than what we expect would happen in case of a partial shutdown.

Okay, great.

The results are well within what is the severely adverse scenario.

Okay, great. And then just my final. Of the municipal exposure on the island, do you have specific reserves associated with those exposures and would you be willing to share with us what those were or if they have changed since the end of March?

No, not on the municipal exposures we don't have any specific reserves. In fact bear in mind municipalities have three different sources of revenues which are independent of the central government with the property tax, the municipal license tax and 1% of the sales tax. So we feel much better about those exposures.

Okay, great. Thanks for taking my questions.

Ken Zerbe, Morgan Stanley.

First question, just on the DT recovery, if I heard you right, I think you heard you say that you are going to have a zero tax rate in the US for the rest of the year but I guess I was under the impression that when you get the DTA back, you actually start booking at a 35% tax rate. What is the difference?

I will let (inaudible) handle that but this is one of those wonderful rules that the accountants have set up. Go ahead.

This is Jorge Garcia. The reversal of the DTA is considered a discrete event and therefore you measure it for 2016 forward, the impact on 2015 is just blended to the effective rate for the remainder of the year, that is why you won't see a spike in the effective tax rate in 2015 but we would expect it in 2016.

Got it. I will build it in, that is totally fine. And then just on the [SAC], the commercial loss share that has expired so it looks like it expired at the end of the quarter, probably didn't see any -- presumably any impact from the expiration in the quarter itself but when you look ahead to the third quarter like from a margin perspective, anything else -- actually margin in particular -- but what will change going forward because of this?

Two things. One is we did have an additional $10 million hit there in the last -- in this quarter to adjust the IA. Technically the LSA does not end now because it has a three-year clawback provision for any recovery so technically the commercial LSA is not over. We don't expect any meaningful impact on NIM in the sense that the loans will continue to yield. The impact on NIM is that as the loan starts to run off, that it will be impacted. It is an asset value that will diminish over time but we don't expect any meaningful impact on NIM over the next few quarters.

Got it. And just on NIM broadly speaking, is the 454 kind of a decent run rate to assume going into the third quarter or maybe you could write any kind of NIM guidance?

We haven't in the past and are going to start now.

Our NIM is pretty strong and particularly in our Puerto Rico operations. You have seen it fluctuate 2, 3 basis points over the last couple of quarters. We don't see anything very meaningful there.

Okay, great. That helps. Thank you.

Jeff (inaudible), Candlewood.

Thanks for taking my questions. I was just wondering if you could go into a little bit more detail or give the background for the release of the valuation allowance this quarter just given the economic headwinds, the fiscal reality on the island, why do you think now is the time to make that release?

I will let Carlos take it but bear in mind, this in our US operation, not Puerto Rico and this is mostly driven by the accountants. We are not really -- it is an accounting thing for us. We are not getting any cash. Our regulatory capital is not affected so this is more accounting rules than anything else. But I will let Carlos add some more color. Be gentle on him, it is his first day.

Again, we look at the present profitability and the outlook for continued profitability for our US business. We make a judgment on whether that will allow us to reverse some of the allowance against the DTA so calculations attached to it and then reverse it accordingly. As Richard mentioned, this is mostly an accounting decision as opposed to a business decision and something that we are prepared to review on an ongoing basis.

I just want to confirm that the Puerto Rico is an area that does not impact the US taxable income or tax structure and they are really separated. They are two division that are individual to the geography.

Okay, thank you for that. And then as it relates to just the Puerto Rican direct government exposure, I know you have answered some questions on that but can you just give us -- can you clarify whether on the chart in the presentation, are those exposures listed at face value, market value or some other metric? I guess can you give us the average mark on the Puerto Rican exposures?

On the securities, I think it is roughly 20% is the mark from our book value.

The securities under there (multiple speakers) essential government securities are at market.

They are at market. Then the only other mark there is on that loan which is a $75 million loan. We took a 40% hit on it so that at least 45 so that is net of our mark.

The municipalities, securities are mainly at book value.

At book value, which if I heard correctly are on par.

They are mostly long term and the carrying cost -- (multiple speakers)

I'm sorry, I couldn't hear, that is at par on the municipalities?

The central government securities are at market value and the municipalities, securities are at basically cost basis, amortized cost basis. They are held to maturity accounting requirement.

Okay, thank you for that. Appreciate the time.

(Operator Instructions). Taylor Brodarick, Guggenheim.

Great, thanks. I think everybody has covered most of mine. Carlos, quickly, would you just say again the tax guidance? I didn't catch that at the beginning.

Would be happy to do that. Let me flip through my pages here. It is going to be for the rest of this year, the low-end of 20% to 29% and for 2016, the high-end of that range.

Perfect. Thank you. And I guess just looking at business activity, have you found that your capital position and just your relative strength compared to your competitors is I guess attracting significantly more customers than maybe in the past? Is there more of a dislocation occurring since the Governor's comments couple of weeks ago?

We haven't seen any unusual movements really. Deposits have been strong but we haven't seen any unusual movements one way or the other. Government deposits are higher than they were at the beginning of the year end as I said deposits in general have been strong but nothing very unusual.

Okay, great. Thank you for your comments on the capital plan. Appreciate it.

Brian Klock, Keefe, Bruyette, Woods.

Thanks, gentlemen. I just wanted to follow up on an earlier question that was asked about the municipal exposure. So when I look at slide three, the $430 million which is most of your municipal exposure is in the form of loans which if I remember correctly, these are not mark to market, right -- they --

They are trade loans to 10 municipalities in fact.

Can you remind us -- because I think you guys from what you have talked about before, you guys have managed the operating accounts for a lot of these municipalities and I think you have probably the stronger municipalities that you went to. Just maybe just a little color on those municipalities?

Definitely not random walk down the municipality table. We do look at the municipalities, we have had relationships with them for a long time. There are 78 municipalities in Puerto Rico. We lend to 10 of them and we look at their statements, how will they are managed and the normal things we would look at in a good relationships but we specifically have their operating accounts as well.

And in some ways, actually you have more information than what you get from some of your commercial customers having these loans in the municipalities, is that right?

Yes, we feel very comfortable with that, absolutely.

Okay. Thanks for your time, guys.

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

Just one other question here, I wanted to ask Carlos, is there any change in your P&L or any expected change in the coming quarters as the island switches towards the VAT tax and also is that business to business taxes implemented?

No. Do we have any --

There will be a general increase in our operating expenses on our quarterly basis. It is not a significant amount.

It is doesn't seem to be major.

So that would be included in the guidance for expenses, the $305 million per quarter going forward?

Yes, it is in there.

Great. Thank you.

(Operator Instructions). Jeff (inaudible), Candlewood.

Thanks. I was just wondering if you could give a little bit more color on the deposit side of things, how much of your deposits are related to government entities or municipalities? And as a side question, given the recent regulation aimed at driving more of those deposits towards the GDB, Government Development Bank, are you seeing an impact to your deposits there?

Again, most of these deposits are in operating income but we don't think -- we provide services that we don't think that other banks, certainly the government bank would provide to them. The municipalities are excluded from those rules that are aiming to drive those deposits back. They are mostly operating accounts, very little in the way of the (inaudible). So we feel -- it behaves, as I said, they are higher than they were at the end of last year. We haven't felt any impact from that.

Great, thank you very much.

(Operator Instructions). Seeing no further questions, this concludes the second quarter Popular, Inc. conference call. You may disconnect your lines at this time and have a wonderful day.

Thank you.