Popular, Inc. (BPOP) Q1 2015 Earnings Report, Transcript and Summary

Good morning. And welcome to the Popular, Inc. First Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I'd now like to turn the conference over to the Investor Relations Officer at Popular, Inc., Brett Scheiner.

Good morning. And thank you for joining us on today's call. Today, I am joined by our Chairman and CEO, Richard Carrión; our CFO, Carlos Vázquez; 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, I would like to remind you that on today's call, we may make forward-looking statements that are based on management's current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release and are detailed in our SEC filings, our financial quarterly release and supplements. You may find today's press release and our SEC filings on our webpage at www.popular.com. I will now turn the call over to Mr. Richard Carrión. Richard Carrión: 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'll 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 result 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 continue to generate strong revenues with capital levels well above peer averages. Tangible book value was $36.33, up from $35.89 last quarter. Our net interest margin up 4.57% decreased from last year's adjusted 4.70%, a lower spread income from covered portfolio. Our spreads remain strong relative to peers with our Puerto Rico net interest margin at 5%. Total NPA this quarter up $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. Non-covered NPLs were $665 million or 3.2% of non-covered loans, up $35 million from last quarter with the majority of the increased 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, our 104 basis points, a lower commercial charge-offs in Puerto Rico. During the second half of 2014, we completed the sales of our California, Illinois and Central Florida operations and made progress on our previously announced plans to consolidate our Roseland, Illinois and Orlando, Florida operation center, transferring most of the 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 U.S. 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 positions 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 positions us for more active capital management. At the end of March, we filed our Dodd -Frank stress test, the result of which will made public in June. We've continued discussions with our regulators regarding our capital plan which we expect to file this week, and we will update you on those discussion in a third quarter. Please turn to Slide 3. Popular led a group which acquired most of the loans and assumed all of the non-broker deposit from the FDIC as receiver for Doral Bank. As part of this transaction, Popular acquired approximately $1.7 billion and assumed $2.2 billion in deposit. The remaining assets and deposits were part of the transaction were sold to co-bidders and closed concurrently with a primary transaction. Popular servicing all portfolios until the different co-bidders completes their conversion which should occur in the third quarter. This transaction represent an efficient deployment of capital with meaningful earnings accretion and the in market expansion provide significant cost saving opportunity. 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 GSC mortgage servicing rights was accepted by the FDIC, which subsequently closed on $2.7 billion in Ginnie Mae MSR and final negotiations for the acquisition of the remaining $2.3 billion GSE MSRs are ongoing. We recorded an estimate of fair value as of March 31 with final valuation expected later in 2015. As such we've recognized preliminary goodwill of $43 million and core deposit and tangible 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 revenue is 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 continuous 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 essential flat from the previous quarter and down $131 million compared to last year's fist quarter and balances were paid down for 2014. Last year, we placed one of our public sector relationships with $75 million outstanding on non-accrual status, and we believe we are adequately reserved for this exposure. We are monitoring development 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 capital needs. Please turn to Slide 4 as our CFO; Carlos Vázquez discusses our financial results in further detail. Carlos Vázquez: 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 detailed in today's earnings press release, variances from the fourth quarter affected many lines on our income statement. The three larger variances were lower, non-covered loan loss provision, lower FDIC loss share expense and lower operating expense. This was partially offset by higher covered loan provision 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 four quarter. As the benefit of one month's work of income from Doral asset was offset by lower covered loan balances and lowered day count. With restructuring of Popular's US operation largely behind us, we are pleased to have achieve organic growth in excess of 6% in US commercial loan this quarter. Despite this growth, our outlook and overall loan balances remain unchanged. Going forward, we are hopeful that we can maintain flat non-covered loan balances till the end of 2015. In Puerto Rico, limited organic growth has been offset by selective loan portfolio purchases over the last few quarters. We will continue to pursue this opportunistic asset acquisition if attractive transaction becomes 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 loan resolutions, repayments and quarterly recast of the portfolio's expected cash flows. Our cost of interest rate deposit was flat to a prior quarter at 53 basis points. Noninterest income excluding the FDIC loss share activity, decreased by $10 million from third to last quarter. This was mostly the result of lower gain to sales of loan in the US as our loan workout efforts there are nearly completed. This line item was 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 expense including the impact of Doral transaction to average approximately $300 million till 2015. Our adjusted tax rate for the quarter was 28%, mostly due to a larger proportion contribution to earnings from BPPR. While we expect our full year tax rate to approximate this quarter 28%, we remain hesitant to update this number until we have a better feel for Puerto Rico's upcoming tax reform. Continued strong first restructuring performance by Popular's US business, complimented by the additional income contributed by the acquired Doral assets could impact the assessment of our US DTA that could eventually lead to partial reversal of the US DTA allowance. While we do not know the timing of this potential event, we continue to make quarterly evaluation 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 to cost to be incurred between the second and the third quarter. The BPNA strategic realignment has right sized our operation and adjusted the back office to appropriately service the bank's updated size and regional presence. Having also cleaned out the remaining letter of credit and high cost liabilities, we are confident that our simplified and refocused US operations will provide capital relief and improved returns. We spent $11 million of BPNA's restructuring cost in the first quarter and expect the majority of the remaining $12 million to be recognized in the second quarter. Please turn to Slide 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 through 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 in corporate recent payments of the FDIC, the commercial indemnity assets remaining amortization and expected payment on charge-offs taken in the first quarter of 2015 were build for reinvestment 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 a 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 world capitalized regulatory requirement. Under the Basel III rule which took effect on January 1 of this year and including the impact of the Doral transaction, we saw a seven basis point decrease on Tier 1 common equity ratio to 15.8% and 194 basis points decrease in our Tier 1 ratio to 16.2%. All of Popular's capital ratio remains robust and well above regulatory requirement. As mentioned last quarter, we are in discussion with our regulator about the possibility of implementing capital distribution strategy. At this time, we cannot estimate when these discussions will conclude or what the outcome maybe. We seek to maintain strong capital levels appropriate for Popular's risk profile and we 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 result for the quarter. Specifically, subsequent to acquisition approximately $7 million of taxable value [ph] loan in US operation entered NPL status. This increase is mainly driven by a single borrowing relationship that based on our fair value exercise also ready discounted on our books. In Puerto Rico, prior to its failure, Doral serviced, a residential mortgage portfolio of $150 million for Popular, on which US committed to advance contractual payment in respected of borrower delinquencies. In addition, Doral was required repurchase or substitute delinquent mortgage loans. Subsequent to Doral's failure, we are now reporting such loans based on the contractual delinquencies. After result mortgage NPL 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 NPL. In the US, we continue to reflect strong credit performance with low NPLs, low net charge-off and stable NPL increase. Let's turn to Slide 7 to read the details. Non-performing assets remained flat at$935 million mainly driven by a decrease of $12 million in other real estate or in the US and a decrease of $17 million in covered or the real estate owned in Puerto Rico, offset by increase of $34 million in NPL. In the U.S., total NPLs held-in-portfolio increased by $8 million to $27million 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, non-covered NPL increased by $27 million during the quarter, mainly driven by higher mortgage and commercial NPL of $25 million and $7 million respectively. The mortgage NPL increase included $17 million impact of loan previously service by Doral. Excluding Doral, NPLs in Puerto Rico were stable quarter-over-quarter. Turn to Slide 9 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 borrowing for Puerto Rico that entered non-performing status last year. Excluding the impact of the public sector borrower NPL inflows in Puerto Rico increased by $5 million, mainly driven by increase in mortgage NPL inflows of $15 million, in part offset by a decrease of $10 million in commercial NPL inflows. The mortgage NPL inflows include 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 a next slide to discuss net charge-off provision add on for loan losses. Net charge-off amounted to $36 million, or analyzed on a two 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-off was $37 million Puerto Rico, a decrease of $16 million from the previous quarter. The decrease was principally driven by lower commercial net charge-off $9 million lower construction net charge-off of $3 million and lower mortgage net charge-off of $2 million. In the US, net charge-off excluding write-downs on recoveries related to bulk loan sales amounted to recovery of $886,000 compared to recoveries of $2.3 million in the previous quarter. The provision to net charge-off ratio was 82% compared to 99% in the first quarter of 2014, primarily driven by the Puerto Rico region. The decrease reflects lower net charge-off experienced 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 non-performing 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 instrumentalities is $995 million, of which approximately $813 million outstanding flat to the previous quarter. Our largest direct exposures for the central government and public corporations are $100 million exposure to tax revenue anticipation notes for which we receive the first schedule payment $11 million till the close of the quarter. And loans to authority of $85 million and to Electric Power Authority of $75 million. During the quarter we received payments of $15 million from the authority. We believe our total exposure to the central government and public corporation is manageable, representing only 8.6% of the total Tier 1 capital. Our municipality exposure is mostly a diversify portfolio of senior priority loans we select to group 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 U.S. With that, I would like to turn the call over to Richard for his concluding remark. Thank you. Richard Carrión: Thank you, Lidio. And please turn to Slide 11. Before we open the line to questions, let me conclude today's remark 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 continuous to allow us to sustain above average margins. Notwithstanding ongoing stability 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 entered 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 MO use lifted, restructured our US balance sheet and back office and purchased $2.3 billion of assets in the Doral transactions. We started the year with continuous stability in both revenue and credit metrics and are encouraged by the growth prospects in our restructured US business. Our acquisition of the Doral assets and assumed deposits will further enhance our ability to grow earnings in 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 U.S. operations. We are driving shareholder value as we remained 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 future. We are aware of that and remain committed to working to improve the island's prospects. 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 operation and by the strength of our Puerto Rico franchise which has been demonstrated in the past few years. So we look forward to reporting on our progress in the next few months. And with that I'd like to open the call for questions.

[Operator Instructions] And our first question will come from Alex Twerdahl of 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? Carlos Vázquez: Yes. Let me say a few things about that. The fact is our funding cost particularly when you factor in the impact of the main deposits is slightly under 40 basis points. So that's pretty low and it has been maybe half basis points 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. Richard Carrión: Okay, I'll let Carlos handle that one. Carlos Vázquez: Yes. It is a little bit of the above, it is also depend on the continuous performance of our US business. So that is of course is more -- the most important influence into the profit. There is some bunch of that -- boxes that need to be checked on the accounting side well or the other. And we will continue to look at every quarter as I mentioned are accounted for more high view and I opinion on this as well obviously but the main driver is the continuous performance of our US business and then all kinds of accounting role that get trigger by that.

Can you give us a sense for what the core profitability in North America is following Doral? Carlos Vázquez: No, we have segment report on the -- on our deck and we've seen the detailed there, on the quarter it was about $4 million that include one month of Doral core business GAAP, we need to adjust it for the one time event.

$17 million Carlos Vázquez: Non GAAP basis for the quarter, the US was -- will be $17 million. That's one month, there is still some noise in that Alex before it was only month and there is a number of one time event there. That number will get clear when we report next quarter obviously we have a full quarter and lot of noise will go away.\

All right. That's very helpful. Then my final question is, what is the normalized run rate for that non personnel 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? Carlos Vázquez: Yes. The problem with that number Alex is that I see no-- our OREO expenses are rather volatile. So I have to go back and check that input into that and I will get back to you on that, but the OREO volatile makes it hard to give you comparable response to that number which was whatever a year or so ago.

The next question comes from Ken Zerbe of 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 kind of thoughts in terms of loan growth expectations? Carlos Vázquez: What we said is that now we expect to remain flat given the growth we are seeing in the US making up for the run off and that too adjusting for the Doral acquisition.

Got it. Understood. Okay. Then on the FDIC income in this quarter looks, 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 might 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. Just last question for you. I know you guys talked a lot about operating in kind of crappie environment for the last eight years. If just given the downgrade that we saw from SMP, if the government is unable to come to a reasonable solution and it defaults on its obligation, 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? And how would that affect your commercial customers? Richard Carrión: Well, obviously it would impact the whole macro environment as the effects percolate through the system and suppliers get affected. We've hopefully it will not come to that and some kind of less solution can be reached before we get there. But we are prepared to deal with it but it is part of this scenario we've looked in our stress test.

The next question is from Jordan Hymowitz of 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? Richard Carrión: Well, far be more for me to try to get in Fed or 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 is something that we'll probably start to getting into those discussions in the next few weeks.

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

Under Basel III, it's a one year or is it a 10%? Richard Carrión: No, it is none. They take it off. Carlos Vázquez: That's all formula on Basel III, it is more complicated. Actually we can go offline and provide but it is formula driven. And it has other component like MSRs et cetera if you like. You get better --

Okay. We'll get into that later, thank you. Richard Carrión: Yes, the important part, it will be limited or no impact to regulatory capital.

Next, we have a question from Taylor Brodarick of Guggenheim Securities.

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? Richard Carrión: You can always do better, Carlos mentioned we are trying to get with the Doral, trying to get 300 or below in terms of quarterly OpEx. And obviously it would improve if we start getting a little growth that would improve we can keep it up the 300.

Okay. Carlos Vázquez: 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 sound about -- with the capital plan, the announcement would not occur correct until 3Q until the next quarterly earnings call, is that correct? Carlos Vázquez: Correct. Richard Carrión: Probably it will occur whenever we get an answer.

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

[Operator Instructions] And showing no further questions. This will conclude today's call. Thank you for attending today's presentation. You may now disconnect. Richard Carrión: Thank you.