Popular Inc (BPOP) 2022 Q3 法說會逐字稿

Welcome to today's Popular, Inc. Q3 2022 Earnings Call. My name is Juan, and I'll be coordinating your call today. (Operator Instructions)

I'm now going to hand over to Paul Cardillo, Investor Relations Officer at Popular, Inc. To begin, please go ahead.

Good morning, and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our COO, Javier Ferrer; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano. They will review our third quarter results and then answer your questions. Other members of our management will be available during the Q&A session.

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 risk 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. You may find today's press release and our SEC filings on our web page at popular.com.

I will now turn the call over to our CEO, Ignacio Alvarez.

Good morning, and thank you for joining the call. Our results for the quarter were solid and reflect the strength of economic activity in our markets. Our diversified sources of revenue and prudent risk management. In the third quarter, we achieved net income of $422 million or $196 million, excluding the impact of the Evertec transactions. At the beginning of the quarter, we closed a previously announced agreement with Evertec to acquire key customer-facing channels and to extend important commercial agreements.

This transaction is already allowing us to accelerate our ongoing digital and business transformation, as we focus on the changing needs and expectations of our clients and enhancing the omnichannel experience that we provide. Please turn to Slide 3.

Our quarterly net income, excluding the impact of the Evertec transaction was $16 million lower than the second quarter. Third quarter results were characterized by positive variances in net interest income and fee income, offset by higher provision for credit losses and operating expenses.

The adjusted results for the quarter do not include any equity pickup from our prior investment in Evertec. During the quarter, loan growth was strong and broad-based, both geographically and across all loan segments. Total loan balances grew by $1.2 billion. Commercial loan growth in Puerto Rico was particularly healthy during the period.

Our net interest margin improved in the quarter; however, we have begun to see a higher cost of deposits, particularly in our Puerto Rico public deposit portfolio and a Popular Bank. Credit quality trends remained favorable during the period. NPLs decreased in the quarter and NCOs are significantly below pre-pandemic levels. In the third quarter, we continued to return capital to our shareholders. In July, we completed the previously announced $400 million accelerated share repurchase program.

Also, upon completion of the sale of our Evertec shares in August, we entered to an additional $231 million ASR which we expect to complete before the end of the year. In light of the rapid increase in interest rates year-to-date as well as the uncertain outlook for interest rates going forward, in October, we transferred $6.5 billion in intermediate-term U.S. Treasury from available to sale to held-to-maturity. This reduces the impact of OCI on tangible capital from future interest rate fluctuations.

These securities had an accumulated pretax loss of $873 million. Please turn to Slide 4. Our customer base in Puerto Rico grew by approximately 8,000 in the third quarter to reach 1.97 million unique customers. Adoption of digital channels among our retail customers continues to be strong.

Active users on our Mi Banco platform exceeded 1.1 million or 56% of our customer base. Additionally, we continue to capture nearly 2/3 of our deposits through digital channels. This trend remains significantly higher than pre-pandemic levels and well above our island peers. Commercial loan growth was strong. Commercial loan balances at BPPR and Popular Bank increased by $489 million and $332 million, respectively.

Auto loan and lease balances at BPPR increased by $97 million or 2% versus the second quarter. The dollar value of credit and debit card sales of our customers remained stable during the quarter and were 1% above the third quarter in 2021.

As on the mainland, mortgage originations in Puerto Rico have been impacted by rising rates and limited inventory of available properties. The dollar value of mortgage originations at BPPR decreased by 36% compared to the third quarter of last year. In September, Puerto Rico and Florida were impacted by hurricanes Fiona and Ian, respectively.

Hurricane Fiona caused a complete blackout on the island and considerable damages to certain sectors in the Southwest region. While the impact to our operation was not material, some customers concentrated in flood-prone communities were significantly impacted by the disaster. Hurricane Ian did not have a significant impact on our operations.

We have offered various forms of assistance to our customers in both regions. This includes waiving late payment fees on certain products and waiving the ATM withdrawal fees for using ATMs outside of our network. Additionally, we have offered a moratorium to eligible borrowers impacted by the storms.

We are still evaluating the impact of hurricane Fiona and Ian. However, given the low level of assistance requests received to date, the effect on credit risk should not be significant. That said, we will continue to work with our customers that were impacted by these events.

Please turn to Slide 5 for an update on the current macro environment in Puerto Rico. The local economy continued to perform well during the third quarter. Business activity has remained solid; however, certain metrics suggested economic trends in Puerto Rico, while still positive, may be moderating somewhat. The Puerto Rico Economic Activity Index for August, which is the most recently released data, is 1.5% higher than August 2021 and continues to exceed pre-pandemic levels.

We remain encouraged by solid employment levels. In September, total nonfarm employment in Puerto Rico increased slightly from its level in June. The August 2022 employment rate of 5.8% is the lowest ever. New auto sales decreased by 11% in the third quarter compared to the same period in 2021, but remained above pre-pandemic levels. The auto industry was disrupted in September by hurricane Fiona, and continues to be affected by supply chain-related product shortages.

Despite these challenges, there continues to be robust demand for cars in Puerto Rico. The tourism and hospitality sector continues to be a source of strength for the local economy, as Puerto Rico is a popular destination for mainland residents.

Airport traffic has remained robust. Year-to-date through September, total passenger traffic has increased by 8% compared to 2021. Hotel demand has also remained strong. Occupancy rates are up 10% year-to-date and the average daily room rate continues to compare favorably to historical levels.

In short, we are pleased with our results for the third quarter, particularly with strong loan growth. We are mindful of the global economic uncertainty and market volatility, but remain optimistic about the future of Puerto Rico, our primary market, and our ability to manage through any potential challenges that may lie ahead. I'll now turn the call over to Carlos for more details on our financial results.

Thank you, Ignacio. Good morning. Please turn to Slide 6. As usual, additional information is provided in the appendix to the slide deck. Today's earnings press release details variances from the second quarter. Net income for the quarter was $422 million. Early in Q3, we completed the previously announced agreement with Evertec. In August, the corporation completed the sale of its remaining 7.1 million shares of Evertec common stock. These transactions resulted in an aggregate after-tax gain of $227 million.

Excluding these Evertec transactions, Q3 net income would have been $196 million. Net interest income for the third quarter was $580 million, an increase of $46 million from Q2. The variance was driven by higher yield on investment securities as well as higher income from loan growth at both banks. This was somewhat offset by higher interest expense on deposits resulting from increased interest rates, mainly from Puerto Rico government deposits and to a lesser extent, Popular Bank.

Noninterest income increased by $269 million to $426 million. Excluding the $558 million pretax gain from the Evertec transactions, noninterest income for the quarter was $168 million. The remaining $11 million variance in noninterest income during the quarter resulted from an increase of $9.2 million due to the reversal of a contingent consideration related to the purchase price adjustments for last year's acquisition of our U.S. Equipment Finance business.

During the quarter, we also took a charge of $9 million for goodwill impairment on the transaction, eliminating the benefit of this reversal. We also recorded an increase in other service fees due to higher insurance fees and higher merchant acquiring fees, the latter related to the revenue sharing agreement with Evertec. These were partially offset by a reduction in mortgage banking income due to the runoff of the servicing portfolio and higher losses on closed derivative positions.

And lower deposit service charges, primarily due to the corporation's initiative, to eliminate or modify account overdraft fees. We expect noninterest income to be approximately $150 million in Q2. The reduction from our $155 million to $160 million run rate is partly due to 3 factors that would also have an effect on our 2023 run rate.

First, reduced earnings from our portfolio of investments held under the equity method related to the sale of our ownership stake in Evertec. Second, lower deposit service charges stemming from the elimination of account overdraft fees, the modification of related policies and higher earnings credit rate on corporate cash management services.

Lastly, in August, we decided to retain in portfolio FHA-insured mortgage originations rather than sell them as we have done in the past. As a result, our mortgage gain on sale fees will be lower, but our tax exempt interest income will be higher. In our January webcast, we'll provide updated 2023 guidance for quarterly noninterest income.

The provision for credit losses for the third quarter was $40 million compared to $9 million in the second quarter. Total operating expenses were $476 million in the quarter, an increase of $70 million from Q2. This included $17 million in expenses tied to the transaction with Evertec and the previously mentioned $9 million goodwill impairment charge related to last year's acquisition of our U.S. Equipment Finance business. Personnel costs were $25 million higher mostly as a result of the previously discussed market and merit salary adjustments that were effective in July.

This was a concerted effort to enhance our ability to attract and retain talent. Credit endeavor card processing expenses increased by $3 million due to lower card network incentives and OREO income decreased by $5 million due to lower gain on sale of properties. Excluding the impact of the Evertec expenses and the goodwill impairment charge, expenses in Q3 would have been approximately $450 million versus our prior guidance of $445 million.

In Q4, we expect expenses of $450 million. We anticipate that expenses in 2023 will be higher than our quarterly run rate driven by continuing increases in personnel, technology, digital transformation, consulting and compliance costs.

Our effective tax rate for the quarter was 14% compared to 23% in the second quarter. This decrease was mainly a result of the Evertec transactions, which are subject to a preferential tax rate. The full year 2022 effective tax rate guidance remains unchanged at 17% to 20%. Please turn to Slide 7.

Net interest income on a taxable equivalent basis was $647 million, $51 million higher than in the second quarter. Net interest margin increased by 23 basis points to 3.32% in Q3. On a taxable equivalent basis, NIM was 3.71%, an increased 26 basis points. The increase is driven by a higher interest rate environment, improved asset mix, a 25 basis point increase in loan yields and the lag in repricing of government deposits.

Excluding Puerto Rico public deposits, deposit balances declined by $900 million in the quarter, mainly from deposits managed through (inaudible). As of the end of the third quarter, other deposits were roughly $17.5 billion, an increase of $400 million from Q2. However, in the first week in October, the Puerto Rico government transferred approximately $1.4 billion from the bank to fund pension obligations as part of the plan of adjustment.

Currently, Puerto Rico public deposits at BPPR, totaled approximately $15.8 billion. We expect public deposits will end 2022 between $13 billion and $15 billion, slightly higher than our previous range. Our ending loan balances increased by $1.2 billion or 4% compared to Q2 and are up $2.3 billion or 8% year-to-date. All loan segments were higher in the quarter with commercial loan growth being particularly strong.

During the quarter, we shifted $3.4 billion of liquidity from Fed funds to T-Bills that currently provide a higher tax effective yield. We are encouraged by the demand for credit at BPPR and PB. We will continue to take advantage of opportunities to extend and improve the use and yield of our assisted liquidity.

Please turn to Slide 8. Year-to-date, our retail and commercial deposit franchise in Puerto Rico has continued to track below its historical data, but these deposits now represent a lower portion of total deposits compared to the last rate cycle. As we discussed last quarter, given the rapid shift to higher short-term interest rates, going forward, the cost of public sector deposits, which accounts for approximately 27% of our total deposits will now move in tandem with market rates, albeit with a quarter lag.

For the fourth quarter, we expect the cost of public deposits to be 150 basis points higher. As a result of the increased in public sector deposit cost, we expect our reported margin to decrease in Q4 before resuming a positive trend in 2023. Our interest rates in security will be relatively neutral to rising rate scenarios in the coming quarters.

The majority of the increased deposit cost is driven by public deposits in Puerto Rico and to a lesser extent, Popular Bank and commercial excess cash accounts at BPPR. We will continue to actively manage commercial deposit costs, taking into consideration the total relationship with the client.

Please turn to Slide 9. We have seen a decrease in fair value of the investment portfolio that is temporary. Our investment portfolio is basically comprised of treasury and agency mortgage-backed securities, which carry minimal credit risk. The bond portfolio has an average duration of approximately 3.2 years.

As the positions roll down the yield curve, their face value will convert to par and the mark will go down to 0. Given the rapid increase in interest rates year-to-date as well as the uncertain outlook for interest rates going forward, in October, we transferred $6.5 billion of U.S. treasuries in the 4- to 6-year maturity range from available for sale to held to maturity, thereby reducing the forward-looking impact of AOCI on tangible book value.

This action reduced AOCI exposure to interest rates by about 1/3. At the time of the transfer, these positions had recorded in AOCI a pretax unrealized loss of $873 million, which will effectively be amortized back into capital through the remaining life of the transfer positions at a rate of approximately $40 million per quarter to 2026, then tapering off until final maturity.

The yield on transfer securities remain the same and no losses recognized as a result of this move. This transfer does not have a material effect on our liquidity. We continue to maintain a large available-for-sale portfolio in short-term treasury and cash at the Fed. While the changes in the amount of unrealized gains and losses in AOCI have an impact on the corporation's tangible capital ratios as well as those of the wholly owned banking subsidiaries, they do not impact regulatory capital ratios.

Please turn to Slide 10. Our return on tangible equity was 31.9% in the quarter, benefiting from the gain in the Evertec transactions. Regulatory capital levels remain strong. Our common equity Tier 1 ratio in Q3 was 16%, down 35 basis points from Q2. In July, we completed the previously announced $400 million ASR. In total, we repurchased 5.1 million shares at an average purchase price of $78.94.

In August, we entered into another ASR agreement to repurchase an aggregate of $231 million of Popular's common stock. The full impact is already reflected in our capital balance. The combined effect of the ASRs during the year increased our EPS in Q3 by $0.41 per share. Annual book value at quarter end was $38.69 per share, a 16% decrease, driven mostly by higher accumulated unrealized loss on debt securities available for sale of $782 million, a result of higher interest rates and the impact of the ASR and the dividends during the quarter.

These were partially offset by the quarterly net income. Given the uncertainty in markets, including the volatility in interest rates, which impact our tangible capital levels, we have decided to temporarily delay additional stock repurchase activity beyond the current ASR. We will maintain the current level of dividends and plan to revisit future capital actions in the second half of 2023, once we have more certainty around the outlook for interest rates and the economy.

As a result, we do not intend to announce new capital actions in our January webcast. Our perspective on capital return has not changed, anchored in our strong regulatory capital ratios. Over time, we expect our regulatory capital ratios to move towards the levels of our mainland peers plus a buffer to account for our geographic concentration in Puerto Rico. With that, I'll turn the call over to Lidio.

Thank you, Carlos, and good morning. Overall, Popular continues to exhibit stable credit quality trends with low levels of net charge-offs and increasing nonperforming loans. We continue to closely monitor changes in borrowing performance and the macroeconomic environment, given potential economic headwinds, rising interest rates and geopolitical uncertainty.

However, we believe that the improvement in the risk profile of the corporation's loan portfolio positions Popular to operate successfully on the more difficult economic conditions. The impact of hurricanes Fiona and Ian is still being evaluated, but given the hurricane's limited impact in the markets we do business and the low levels of assistance requests received to date, the effect on credit risk should not be significant. Turning to Slide #11. Nonperforming assets decreased by $23 million to $547 million this quarter, driven by an NPL decrease of $25 million.

The decrease in NPLs was mainly in Puerto Rico, driven by lower mortgage NPLs by $32 million and lower commercial NPLs by $9 million, in part offset by higher auto NPLs by $6 million. The increase in auto NPLs was due in part to hurricane Fiona as we stopped collection activity during the last 2 weeks of the quarter.

In the U.S., NPLs increased by $10 million mainly due to an $11 million health care relationship that was placed in nonaccrual status during the quarter. Compared to the second quarter, NPL inflows, excluding consumer loans, increased by $6 million driven by the U.S. health care relationship previously mentioned, offset in part by lower mortgage inflows in Puerto Rico.

At the end of the quarter, the ratio NPLs to total loans held in portfolio was 1.4% compared to 1.6% in the previous quarter. Turning to Slide #12. Net charge-offs amounted to $18 million or an annualized 24 basis points of average loans held in portfolio compared to $6 million or 8 basis points in the prior quarter.

The results for the quarter were impacted by a $5 million charge-off of a pharmaceutical manufacturing relationship and by the lack of collection activities in Puerto Rico during the last 2 weeks of September. The corporation allowance for credit losses increased by $21 million or 3.1% to $703 million, driven by higher loan volumes, changes in credit quality and an $8 million specific reserve recorded for the previously mentioned health care commercial NPL inflow.

The ratio of allowance for credit losses to loans held in portfolio remained flat at 2.23%. The ratio of allowance for credit losses to NPLs held in portfolio was 155% compared to 143% in the prior quarter. The provision for credit losses was an expense of $40 million compared to $10 million in the previous quarter, reflecting the changes in allowance for credit losses and the net charge-off activity. In Puerto Rico, the provision for credit losses was $29 million compared to $9 million in the prior quarter, while in the U.S., the provision was $11 million compared to $1 million.

Please turn to Slide #13. As discussed in prior webcasts, we leverage Moody's Analytics for the U.S. and Puerto Rico economic forecast. Notwithstanding persistent high inflation, increase in interest rate, supply chain constraints and general uncertainty, Moody's analytics near-term baseline outlook remains for the U.S. economy to continue recession-free. Our framework assigns the highest probability to the baseline scenario, followed closely by the more pessimistic recession scenario, S3.

The quarter-over-quarter change in the ACL was driven by loan portfolio growth and increases in specific reserves offset in part by continued strength in Puerto Rico employment forecast and changes to the period Popular utilizers to revert its macroeconomic forecast to historical levels.

To summarize, our loan portfolio continued to achieve strong credit quality metrics in the third quarter with low net charge-offs and decreasing nonperforming loans. We remain attempted to the above environment but believe that improvements over time in the risk profile of the corporation's loan portfolio positions Popular to operate successfully under more difficult economic conditions.

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

Thank you, Lidio and Carlos, for your updates. Our results for the quarter and year-to-date have been strong, driven by solid earnings, robust loan growth, stable credit quality and continued customer growth. We are aware of potential challenges stemming from inflation, higher interest rates and market volatility. We remain optimistic about opportunities in Puerto Rico, our main market.

Consumer activity continues at healthy levels and recovery funds from previous events are expected to provide additional stimulus. With strong fundamentals, proven management and diversified sources of revenue, we are well positioned to leverage these opportunities and address any potential challenges that may arise. In addition to our financial results, I'm extremely proud about our team's response in the wake of hurricane Fiona. Thanks to their agility and resolve, we mobilized quickly to assist communities in need, serve our customers despite operational challenges and support impacted employees. Our colleagues performance in such event evidences our unwavering commitment to all the important stakeholders we serve. We are now ready to answer your questions.

(Operator Instructions) Our first question today comes from Alex Twerdahl from Piper Sandler.

First, I wanted to ask about your comments on the delaying of the capital actions until the second half of '23. Just curious if the whole exercise that you go through with the Fed that I think was supposed to take place around this time, if that -- if the whole exercise gets delayed by 6 months or if you're ongoing that right now, and kind of have to go through the plans and then you just won't announce anything until the second half of next year.

Yes. No. The normal process we go through with the Fed is completed. We have completed our stress test, everything else that I saw the biggest part of that process. So that is done. It is convenient when we talk about capital actions close to finishing these discussions because it's a fresh stress test.

So I think this is a reasonable chance if we talk to them about it in the second quarter that allows us to refresh it or like that, but maybe not, you never know. The 1 we completed already might be good enough. But we respond normally to update requests from the Fed is it -- will be no different.

Okay. And then just as it relates to the timing of the transfer from AFS to HTM, is that correlated to completing the stress test? And you think about TCE, historically, it hasn't really mattered and maybe it still doesn't given the amount of regulatory capital you have. But I'm just wondering if there's kind of a floor that either you have internally or that the Fed has suggested upon you that we should be aware of?

No. It is not covered at all. It was a separate decision, as we're working through it to get implemented. We ended up implementing what we did, which was at the beginning of the fourth quarter. It's not probably whatsoever, and we have not received any comments from the Fed on capital whatsoever.

Okay. And then, Carlos, I was just wondering if you could clarify the guidance on expenses. I think you said $450 million for the fourth quarter and then 2023 should be higher than the quarterly run rate. Is that the average quarterly run rate for '22 that it should be higher then? Is it the back 2 quarters? How does the profit sharing whether we get it or not factor into that guidance, just so we're all on the same page and there's no big surprises in the second half of next year?

Now what I said is higher than our current run rate. So it's not the average quality for the year, but our current run rate, Alex.

Okay. So the average starting point should be around 450, you're going up from there and then a profit sharing comes in the second half of next year, then that will be added on to that current run rate?

Yes. I mean, profit sharing, as you know, we have to outperform our budget for that to kick in. So that normally doesn't happen until the latter part of the year. The only difference this year is that it was reasonably clear we were going to outperform earlier in the year, and that's why we spoke about it in the second quarter that typically in the fourth. But again, it is a program that is intended to share outperformance. So we always hope we get there because that means everybody is doing better, including our shareholders. But that is not part of the bucket, no.

Our next question today is from Timur Braziler from Wells Fargo.

My first question is around net interest margin, maybe for Carlos, in your commentary that will decline in the fourth quarter and then should trend higher in '23. How should we be thinking about the government deposits repricing post the last rate hike? Is it going to be the same 90-day lag, so 1 quarter out, that book kind of stabilizes? Or just given the larger balances there and the more turnover, it might take a couple more quarters. It just seems like is going to be hard for NIM to outperform while that book catches up?

I mean it's not exactly 90 days. So it's pretty close to 90 days. As you can see from our commentary for the next quarter, the increase in Fed rate in the third quarter was 150. So that's what we expect the increase in government deposit costs to go up next quarter.

So conceptually, if the increase in the fourth quarter is 125, then that will carry over to the first quarter of next year and so on and so forth. And the lag did benefit this quarter? We have talked about the lag helping as rates start to go up, but then as long as the rate of increases is constant, it will just catch up 1 quarter later.

Okay. The 1 quarter following the last rate hike that should kind of flush to the system. Got it. And then that $17.5 billion in public funds, is that an average number? Or is that end of period?

That's end of period. And again, as of now, the number is -- sorry, $15.8 billion. So it's already down from the end of quarter number.

Okay. And maybe you can provide us kind of a low point and a high point for the quarter. And I'm just wondering if the increased government activity and kind of growth from here translates to a larger growing balance within those accounts? Or you still have good visibility that those balances are ultimately going to come down?

Yes. I don't have the peak and the low balance for the quarter. But again, our best estimate right now given the information we have from the government. and again keep in mind that the government is not 1 entity. We have over 200 accounts that make us the government deposit balances.

So sometimes it is hard for them to have visibility. But our best guess right now continues to be -- that will end of the year advances between $13 billion and $15 billion. What has changed from that range is that last quarter, we had a range of $11 billion to $15 billion, and we just don't think the lower range is going to happen anymore. We haven't increased the upper part of the range. But our estimate is still that it's going to be somewhere between $13 billion and $15 billion.

Okay. And then maybe 1 for Lidio. Can you provide any additional color on the U.S. health care loan that went nonperforming during the quarter?

It is, I mean, not systemic. I mean it's just 1 case of a customer that had some financial difficulty, but not at all systemic of the overall health of our portfolio.

Okay. That's helpful. And then just -- it looks like broader credit landscape is starting to normalize somewhat. We're seeing consumer charge-offs kind of go higher. Are we entering a period of normalizing asset quality?

And then I guess, in that kind of context, should we be assuming a similar level of provisioning, as we do enter that period of normalization? Or I guess, is there additional room to kind of take down allowance even as we're staring at a recession on the mainland?

I would say, I mean, there's such a thing as a good provision. I think this was the case this quarter because a lot of it was driven by growth, not necessarily the credit environment. I think it's too early to tell me. We still have impact of Fiona in terms of some of the numbers. So you have a little bit of a higher charge-off because of Fiona, a little bit of a higher NPLs because of Fiona. So we still feel that we are -- the credit picture is very strong, very good. And the numbers for the third quarter were very, very, very good for the organization.

Our next question comes from Brett Rabatin from Hovde Group.

Wanted to go back to the capital action question. And if I understand correctly your commentary, the Fed did not tell you to wait and -- my question specifically is, let's say, the bond market changes and we have some sort of different environment than we presently do that would change our -- your tangible book from here, maybe earlier than the second quarter. Could that alter your decision process? I mean I look at the adjusted tangible book here at $76 -- over $76 and your stock immediately dropped to $71 after you mentioned the change in the capital plan. Any color around that?

Well, this is Ignacio. I want to make absolutely clear that this decision was not related to the Fed. It was not requested by the Fed. This was a decision made by us. We felt -- thought it was prudent given the environment and also taking into account that opposed to other banks that have actually paused buybacks, we're still buying back our shares to the ASR as we speak.

So -- it had nothing to do with that. We wanted to give you a timetable because that's what we think is a reasonable time to expect and that's what we're thinking. We're going to look at -- the world changes dramatically. There's nothing written stone that we couldn't revisit that earlier.

Okay. Fair enough. And then around the margin commentary, there's maybe a little more complicated relationship for figuring out the margin than some banks with the government deposits so to speak. Can we maybe take it a different direction and just think about total NII dollars?

And as I look at it, it kind of seems like you're absolute dollars of NII could decline somewhere between $30 million and $40 million linked quarter. Do you think that's a fair way to think about the fourth quarter levels? Or would you point me to a different number?

Well, that will depend on what you're penciling in for loan growth and what rates you're putting in for the new loan production, Brett, the NII, right? But the calculation on the increased cost, it shouldn't be very complicated, is whatever balance you have or you expect to have in government deposits plus 150 basis points from where they are today. So if that number comes out to be an additional $40 million, then that sort of number is.

Okay. Fair enough. And then maybe 1 last one. I think thematically, the banks in Puerto Rico and BPOP specifically have a big advantage to a lot of the mainland banks. Obviously, the government deposits are more price sensitive. But generally speaking, your deposit betas, as you even illustrating your slide deck or much lower than the Mainland and that would presumably continue to be at least the case going forward.

But just wanted to maybe step back and just think about the balance sheet in '23, the loan growth. Do things change from here from how you're running the balance sheet? Or will you continue to have the same sort of path?

No. I mean it's -- we've seen very good loan growth this year, maybe a little bit better than we expected. It definitely sooner than we expected. You remember, we were guiding to the net loan growth wouldn't happen until the second of the year, and it actually started happening in the very first quarter of the year.

So loan growth has performed maybe a little better than we expected. We have done on the balance sheet exactly what you would expect us to do when that happens with our reducing investment portfolio and redeploy it to loans. That's our -- the perfect thing for us that we would like to do more.

We are still very positive on loan growth for the rest of this year and next year. So I hope we can do more of that as next year comes along. Now -- so directionally, if what I just said pans out, what you should see in the balance sheet is a continued gradual reduction in investment securities okay? and our investment portfolio should start to gravitate to more normal levels.

If you look historical for Popular, our investment portfolio has represented something in the high 20% of our total asset as opposed to 50% of total assets. So I would hope that we can start the path in that direction next year. We definitely rather have loans and relationships than investment interest rates if we can have.

Our next question today comes from Kelly Motta from KBW.

I just wanted to circle back on that slide you gave on deposit betas. I found it really helpful. Just wanted a point of clarification when you give the historical betas for the nonpublic funds, whether that is an interest-bearing deposit beta or total deposit beta? And how you expect those to -- there's an argument to be made that deposit beta to be higher than what we've seen historically, given what we're seeing with the mainland banks. So just wondering what you guys expect for kind of the core deposit beta run rate?

Okay. What we have here is -- on the chart is historical betas for the last rate cycle increase, Kelly. So it is historical. As was mentioned earlier in the call, our historical betas have been lower than they typically are for peer banks of ours in the states, and that continues to be true this year.

What is different, of course, is the mix. We have a lot more government deposits now than we had in the last rate hike cycle. On your question on whether they will remain the same? So far, we're tracking well. There is a lot of discussion from very well-informed analysts that they expect betas in this cycle to end up accelerating or being a bit higher than they were last time, simply because of our reaction to the rapid raise of the rate of -- increases in rates being so quick.

I think there is some merit to the discussion. We haven't seen it yet, but of course, we won't see it until the cycle is over. So at this point in time, we are performing well within historical trends. And if at the end of the day, the whole market ends up in higher betas, we would hope that at least in our Puerto Rico Bank will still remain below the market business.

Okay. That's helpful. And then with your margin guidance for margin to contract sequentially in 4Q. Does that factor in the public deposit guidance you gave of those coming down. And what would happen to your margin if for whatever reason those ended up hanging in similar to the current amount that they are now?

Yes. Well, if you put together a couple of our comments, the first comment that we expect the balances in public deposits to end up between $13 billion and $15 billion for year-end. So that sort of implies that we expect the balances to be sort of around where they are now. So that commentary incorporates maybe some reduction in balances, but not a huge reduction in balances.

It does not incorporate an increase in balances that what were to happen. And the commentary on margin does include the expectation of increase of 150 basis points in cost of those deposits, yes.

(Operator Instructions) Our next question today is from Gerard Cassidy from RBC.

This is Thomas Leddy calling on behalf of Gerard. Circling back to loan growth, another strong quarter. Have you guys seen any new entrants into the market for lending, perhaps from mainland banks that weren't as active there maybe a year ago? I mean, I know you guys always compete with them, but maybe any changes that you can speak to?

No, not really. We haven't seen any new entrants. I think you may see some of it down the road for some of these big infrastructure projects that haven't been done yet. But in the bread-and-butter commercial loan, we have not seen any new entrants or significantly high levels of competition from non-U.S. banks.

Okay. And you mentioned in your presentation, an increase in auto loan NCOs in the quarter. And with the acquisition a few years back of the Wells auto portfolio, you guys are obviously a bigger auto lender on the island. Are you in Puerto Rico seeing the use car price inflation that we've seen in the states? And then can you share with us your outlook for credit quality in that space as we head into next year?

We have seen an increase in used price, the same as you have seen in the mainland in Puerto Rico. So that is -- and we see it through the lower or high realization in regards that we repossess and sell. We -- I mean our outlook -- I mean, we continue to be performed much better than we had prior to the pandemic with lower early delinquency, lower NPLs and lower charge-offs across most of our portfolio, but also in the auto loan portfolio.

I mean we still feel like given the level of liquidity of our client base, the spectra economic activity in Puerto Rico that continued to perform well on a going-forward basis.

Our next question today is a follow-up from Brett Rabatin from Hovde Group.

I was going to ask about auto, but you just addressed that. So maybe just 1 follow-up around the pipeline as you guys see, I mean, loan growth continued to be better than expected. And I've been looking at the economic data and it's -- holding in there pretty good. Is the pipeline, with Carlos, is it actually improving relative to maybe the past quarter? Or what would you say about the loan pipeline relative to where it was earlier in the year?

This is Ignacio, but I would say that it's about the same. We've had good loan demand starting in the second quarter. Obviously, I've said this before, some of our corporate business especially is lumpy. So you're never sure it's going to form 1 quarter or the other. But I still see good loan demand across sectors in Puerto Rico.

And every quarter, you may get a bigger loan or a smaller loan that changes the balance and also sometimes the payoffs can come in heavy in 1 quarter, lighter in the other. But in terms of loan demand, we're seeing it steady. I mean, I have not seen any decrease in for loan demand so far.

Okay. And then maybe 1 last one, if I could, just around -- you talked about the Puerto Rico environment. And it would seem like this would be a good opportunity for what has happened with Fiona to really -- for LUMA, it's really kind of improve a lot of things in its operation, but I've not heard good things. Any thoughts around LUMA and just what you guys are hearing or seeing from a ground level in Puerto Rico around electricity production and how that might possibly improve in the next year?

I don't know if the next year is the cycle, I would say. But I think if there's ever a similar lining to something like Fiona, it is that. And I think the federal government has especially noticed that the recovery efforts from Maria were much too slow and they've created a task force to work on energy. There's a lot more emphasis. I think there's a lot more -- people understand that really we have to pick up the pace.

And recently, FEMA announced that not necessarily tied to electric situation, but that they were going to upfront 25% of the cost of a project. The normal FEMA works like an insurance company where they reimburse you. And part of the problem in certain jurisdictions like ours, which could be CAT TRAP. It's hard to come up with 25%. So I think we're going to see is a lot more focus. LUMA is under a lot of pressure to perform. And I think the federal government is under a lot of pressure also to show progress in this front. So I think the pace will accelerate.

Our next question is a follow-up from Timur Braziler from Wells Fargo.

Just 2 more questions for me...

We can't hear you, Timur.

Is that better? Can you hear me?

It's a lot better. Thank you.

Sorry, yes. So 2 quick follow-ups for me. Maybe starting on the fee income guidance of around 150. That's a pretty large step down from this quarter. I'm just wondering, is that majority coming from gain on sale? And then as far as the revenue sharing component that started hitting this quarter, is that the full quarter's impact? And kind of what does that run rate look like for the Evertec revenue share?

Yes. Well, the -- this quarter, it has a couple of unusual things in that number. The $9 million connected to our U.S. Equipment Finance company is in that number. So the 168 is not exactly run rate. So -- if you adjust for that, we're back to the run rate we're always referring to 155 to 160.

The 150, we're talking about here, there's a couple of differences. First of all, it's 1 that is pretty clear what's happening. We don't have an equity pickup from Evertec anymore, and that was about $6 million to $7 million a year -- a quarter, sorry.

So that affects that number. And then the other factors I mentioned will affect the number as well moving forward. So I'll just disagree with the statement, it's a big change because the number -- when you take a neutral of things happening in the number for this quarter out, this quarter was pretty much in line with prior guidance.

Okay. No, that's a fair statement. And then just last for me, on the goodwill impairment for Q2. I guess what drove that an acquisition hasn't been on your books for that long. Maybe just some color on what drove that impairment?

Yes. It's -- your typical goodwill exercise, the acquisition was not exactly meeting the budget that we thought they would and that leads to an adjustment in the goodwill. To some extent, luckily, we have structured the deal in such a way that there was a lot of contingent payments linked to that performance.

So those contingent payments went away as well. So at the end of the day, the effect of those 2 things canceled out and didn't have an effect on the performance for the quarter. So it was just a matter that they are a bit slower than we expected to meet their targets. It luckily has picked up lately. So we hope they'll make up some of that ground.

Our next question today is from Alex Twerdahl from Piper Sandler.

Just a quick follow-up question on the loan growth. I was wondering if you could give us some color on the granularity of the commercial loan growth that you saw both in Puerto Rico and in the mainland, if there's any really big chunky loans in there?

Yes. In Puerto Rico, we had some -- we had 1 large loan in the hospitality sector. Other than that, I think it's pretty much typical stuff. So I think the only thing that I would say that in both markets (inaudible) we did have a large loan in Puerto Rico in the hospitality segment.

You have any line of sight on the -- sorry. .

I would say that's a sector that it's performing very well, and there's a lot of interest, both on island and off island in that sector right now.

Yes. Do you have any line of sight on any other big chunky loans like that, that could be potentially coming on over the next several quarters?

Not perhaps that size, but we have some nice loan prospects we're following up on that 1 is probably bigger than normal, what I just mentioned. But we have some nice ones in the pipeline, but I want to be honest, probably a little bit bigger than we normally do.

Okay. And then just -- I'm sorry if I missed this, but the Slide 8, that has the complexion of retail versus commercial versus sector deposits. Can you give us the distribution of the noninterest-bearing relative to those various sectors?

We don't have that here. We'll have to work on that. We don't have broken up exactly that way. As you can see from our financials, we typically break up deposits by product as opposed to by segment. So we'll come up with the information, but we don't have...

Okay. Is there any one of those -- I mean would it be fair to say that public sector deposits don't have very much interest-bearing?

No, both (inaudible).

They're all interest-bearing. Okay. And then the commercial and the retail, if you -- I mean if you really guessing, would it be a rough equal split?

I don't know. I don't want to give you a number off the top of my head, Alex. The best we can do is obviously, what you have on Slide or Page 8 gives you the melded beta of the interest-bearing and noninterest-bearing. So -- but we'll look into it to see if we can address your question.

There are no further questions at this time. I would now hand you back over to Ignacio Alvarez for closing remarks. .

Thanks again for joining us and for your questions. and we look forward to updating you on our progress in our January call. Have a nice day.

That concludes today's Popular, Inc. Q3 2022 earnings call. You may now disconnect your lines.