Popular, Inc. (BPOP) Q4 2016 Earnings Report, Transcript and Summary

Good morning. And welcome to the Popular Fourth Quarter 2016 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note, that this event is being recorded. I would now like to turn the conference over to Investor Relations Officer, Brett Scheiner. Please go ahead.

Good morning. And 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 full year and fourth 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 popular.com. I will now turn the call over to Mr. Richard Carrion.

Good morning and thank you for joining the call. I'd like to address the highlights and key events of 2016 and the fourth quarter. Then I will present an update on our business and our thoughts regarding the fiscal and economic situation in Puerto Rico. Carlos will comment on the quarter's financial results and Lidio will provide and update of credit trends and metrics. Please turn to Slide number 2. This year included a number of key events in improving the performance and risk profile of our bank. We grew loans in our U.S. business by 17% completed a large bulk sale of NPAs related to our Westernbank transaction and sold our exposure to PREPA at a gain. These accomplishments come in concert with favorable financial results for the Company. For the full year 2016, we reported net income of $217 million which includes the effect of two adverse FDIC arbitration awards. Adjusted net income from continuing operations was $358 million, down from the prior year's $375 million, as our U.S. business did not benefit from the low-income tax rate and credit recoveries experienced in 2015. Our credit quality improved as total NPAs including covered loans of $774 million were down from $843 million at year end 2015. Non-covered NPLs decreased $44 million to $558 million. NPLs were 2.5% of non-covered loans compared to 2.7% last year. Our stable credit metrics as a result of aggressive loss mitigation efforts, resolutions, restructuring, NPL sales and an improved risk profile. Our Tier 1 capital and Tier 1 common ratios at year end were 16.5%. Turning to Slide 3, as you can see, we continued to improve our leading market position in Puerto Rico. Our Puerto Rico franchise is unique and has consistently grown its retail and commercial client. We currently serve close to 1.7 million customers, generating annual total transaction growth of 5%. Given our competitive positions, we continue to focus on strengthening the relationship and satisfaction of our clients while providing innovative solutions, as part of our digital transformation efforts. Approximately 700,000 of our clients are active online and 74% of these use mobile devices. In December 2016 close to 40% of our deposit transactions in Puerto Rico were processed through ATMs and mobile devices, a figure that has been increasing consistently up from 30% last year. In our U.S. business, we expanded our branch network to 51 locations, including two de novos and 6 relocations, yielding branch deposit growth of 12%. Our business profile positions us well for an eventual economic recovery on the Island and continues to provide meaningful earnings power in the area. Please turn to Slide4. In the fourth quarter, Popular reported a net loss of $4 million which includes the impact for the $94 million after-tax in FDIC related expenses in the quarter. Adjusted net income totaled $89 million, down $6 million from last quarter's adjusted results. We continue to generate strong revenues with capital levels well above peer averages. Tangible book value was $43.12, down from $44.86 last quarter, mostly related to the impact of writing rates on the valuation of the investment portfolio. Our net interest income was up $2 million from the prior quarter, our net interest of 4.02% declined from last quarter's 4.12% on increasing deposit cost in the U.S. in addition to changes in our asset mix, driven by investment securities replacing the run-off of higher yielding loans. Our spreads remain strong relative to peers with our Puerto Rico net interest margin of 4.39%. We're also encouraged by the trends in our U.S. business, particularly the continued strong commercial loan production. The market value of our stake in EVERTEC is approximately $207 million and significantly exceeds our position's current book value of $39 million, as investors we will continue to participate in a proportionate share of the Company's income while our investment also represents an additional source of capital flexibility and potential holding company liquidity. As evidence of the progress we have made in the past few years, we are pleased to report that our Board has approved an increase in our quarterly common dividend from $0.15 to $0.25 next quarter. The board also approved a $75 million common stock repurchase plan. Before I turn it over to Carlos, let me comment on our Puerto Rico Government exposure and the Puerto Rico fiscal situation. Our direct outstanding exposure to the Puerto Rico government is $529 million, up $5 million from the previous quarter. Nearly all of our direct Puerto Rico government exposure is in loans to municipalities, not publicly traded securities of the central government or it's wholly corporations. We derive comfort from our underwriting process, the structure, and the size of this exposure relative to our capital base. We will continue to monitor developments in this portfolio closely and make future adjustments as needed, while selectively participating in funding the Puerto Rico government's capital needs, where we feel the risk reward is appropriate. Regarding the Puerto Rico Government's fiscal challenges, this past June, federal legislation created a fiscal oversight board and established a legal framework and path towards an orderly debt restructuring. The board has been constituted and is working with the new administration to develop a five year fiscal plan for Puerto Rico. Over time, we believe the board and restructuring framework will result in increased fiscal discipline and facilitate a transition towards manageable debt load. However, given current imbalances, this will likely include a reduction of government spending which in the short term could negatively impact economic activity on the Island. We see some near term opportunities to offset potential government cuts, spending from improved business and consumer confidence, energy infrastructure development and hopefully a pay down of balances to suppliers by the Puerto Rico government. The Boards most pressing charge remains naming an Executive Director to manage the fiscal rebalancing and debt restructuring process. Beyond that selection, the Board's focus will likely shift to working the local administration to develop the fiscal 2018 Puerto Rico Government budget as well as more substantive discussion with bond holders. The ultimate success of the oversight board depends on the cooperation of groups that frequently have conflicting interest. Progress on these fronts will require patience particularly with the new Puerto Rico Governor and administration, inaugurated earlier this month and commercial board Executive Director yet to be named. In sum, we believe this legislation and the actions that will follow will be a painful step in the right direction to restore the fiscal health of the Puerto Rico government and ultimately the Puerto Rico economy. Though, we do not plan for meaningful economic growth on the island in the near term, we are hopeful over time for the prospect of a manageable debt load, balanced government budget and renewed economic growth. As the largest financial institution on the Island, we will continue to seek to be a source of information, support and advice particularly on the economic growth front. This is the most critical element in the long run. Please turn to Slide 6, as our CFO, Carlos Vazquez, discusses our financial results in further details.

Thank you, Richard and good morning. Slide 6 presents our GAAP financial results for the fourth quarter. Our calculation of adjusted net income can be found on Slide 7 and additional information is provided in the appendix. Today's earnings press release detailed variances in the third quarter with higher net interest income and lower operating expenses offset by lower non-interest income. FDIC loss share expense increased meaningfully due to the previously announced charge resulting from the FDIC arbitration. Net interest income for the fourth quarter was $355 million, up $2 million from the third quarter mostly due to higher revenue resulting from the higher volume of investor securities, partially offset by higher deposit balance and cost. Our margin was 4.02%, down from 4.12% last quarter due mostly to investment securities replacement higher yielding loans. The variances that have driven Popular's margin down over the last three quarters, namely increased level of government deposits, lower yields in the Westernbank book and lastly a shift in our asset mix to larger cash investment balances, should not be as impactful in coming quarters. These reduced affect together with the potential for higher rate should lead to stability in our margins. The average yield of our $1.8 billion Westernbank portfolio decreased to 8.56% from 8.65% last quarter. Over time, we expect this yield to decline as a result of repayment and loan resolutions. Somewhat lower expected quarterly run-offs in this portfolio would also contribute to margin stability moving forward. Excluding the yield reduction of Westernbank, we benefit from relatively stable loan yields in the rest of our portfolio. The cost of our interest bearing deposits was up 1 basis point to 58 basis points. We continue to deliver organic commercial loan growth in the U.S. operation with growth of 9% in the fourth quarter. As previously mentioned, for 2017, we anticipate slight growth in overall loan balances, with the U.S. growth more than compensating for Westernbank and limited growth in Puerto Rico. On the Island, we have offset limited organic growth through selective loan portfolio purchases over the last few years. We will continue to pursue this acquisition strategy, if attractive transactions become available. Non-interest income excluding FDIC loss share activity decreased by $8 million compared to last quarter, as we saw contingent insurance commissions were offset by last quarter's gain on the sale of our PREPA loans. Our Puerto Rico mortgage business originated $243 million of loans in the fourth quarter, up slightly from $237 million last quarter. Total operating expenses for the quarter were $321 million down $4 million on lower operational and fraud losses, partly offset by higher professional fees, business promotion and OREO expenses. Excluding last quarter's goodwill impairment charge, operating expenses were down by $1 million. In the coming quarters, we expect average operating expenses of approximately $320 million similar to this quarter. Our effective tax rate for the fourth quarter was 25%. Through the end of 2017, we expect our quarterly tax rate to average between 25% and 27%. As disclosed last month, we are disappointed with the unfavorable result of the arbitration with the FDIC. In addition to the unreimbursed losses considered in the arbitration, this quarter's $127 million charge includes a related adjustment and then through a publication out to the FDIC and we covered there have been parts of the net damages claims in the arbitration. As of this quarter, we have a $69 million FDIC receivable, $6 million of that amount represent reimbursable losses that are still in dispute, for the remaining balance of $63 million is related to single family mortgage loss share agreement which expires in June of 2020. As we have stated before, any amount of the loss share assets ultimately now collected from the FDIC will be charged off. Please turn to Slide number 8. We continue to enjoy strong capital levels relative to Mainland and Puerto Rico peers as well as with respect to well capitalized regulatory requirements. Our Tier1 common equity ratio was 16.5%, slightly lower than last quarter's 16.6%. As Richard mentioned, we have increased our quarterly common stock dividend to $0.25 per share and will implement a $75 million common stock repurchase program. We are pleased to have been able to increase our capital return and payout ratio, given our strong operations and capital base. While being cognizant of the challenging environment in our local market, we will pursue additional opportunities to actually manage our capital, including additional dividends, share repurchases, M&A and asset acquisition. It continues to be our goal to maintain a strong capital level that is appropriate for Popular's risk profile. As we work towards our target of double digit return on tangible equity. With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. Despite challenging economic and fiscal conditions in our main market, overall asset quality remains stable during the fourth quarter. In Puerto Rico, credit quality metrics reflect lower non-performing loans, lower non-performing assets, lower NPL inflows and increase in net charge-offs. In the U.S., credit metrics reflect strong portfolio growth, lower NPLs, lower NPL inflows and stable net charge-offs. As Richard covered on Slide number 5, our current outstanding, direct exposure to the Puerto Rico Government, municipalities and other instrumentalities is $529 million, increasing by $5 million from last quarter. Our total exposure to the central government and public corporations is minimal, representing only 40 basis point of total Tier 1 capital. Most of our direct Puerto Rico Government exposure is in the form of municipal loans and not securities. Our municipality exposure consists of senior priority loans to a select group of municipalities whose revenues are independent of the central government. This exposure is a carefully underwritten book of business with senior interest in the municipalities' identifiable revenues and cash flow. Our top four exposures are to Carolina where the airport and several major tourist hotels are located; San Juan, the capital of Puerto Rico where now the municipality with the highest per capita income and Bayamón, the second most Popular's municipality. These four municipalities comprise approximately 77% of our total municipality exposure and combined have operating surplus of approximately $30 million and debt service capacity in excess of 2 times. We also have indirect lending facilities in which the government acts as a guarantor. The largest 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. Turn to Slide number 9 to discuss credit metrics for the quarter. Non-performing assets including corporate loans decreased $31 million from $805 million in the previous quarter to $774 million this quarter, the decrease in non-performing assets was driven by a decrease of $21 million in non-performing loans and a decrease of $10 million in OREOs. At the end of the quarter, the ratio of non-performing assets to total assets stood at 2%, a slight improvement from the previous quarter. Non-performing loans in Puerto Rico decreased by $19 million, mainly due to a decrease of $13 million in the residential mortgage portfolio and a decrease of $7 million in the commercial loan portfolio. In the U.S., non-performing loans decreased by $3 million, mainly due to improvements in the residential mortgage portfolio. At December 31, 2016, the ratio of NPLs to total loans held in portfolio was 2.5% compared to 2.6% in the third quarter of 2016. Please turn to Slide number 10 for a summary of the trend in NPL inflows. On a linked-quarter basis, NPL inflows excluding consumer loans decreased by $10 million with improvement in both Puerto Rico and the U.S. In Puerto Rico, NPL inflows decreased by $7 million mainly due to a decrease of $11 million in the mortgage portfolio offset in part by an increase of $5 million in the commercial portfolio. In the U.S. NPL inflows decreased slightly by $2 million, mainly due to lower mortgage inflows. Turning to Slide number 11, net charge off for the quarter amounted to $56 million or annualized 100 basis points of average loans held in portfolio, compared to $35 million or 63 basis points in the prior quarter. The results for the third quarter included a $7 million recovery from the sale of previously charge-off consumer loan. Excluding this impact net charge-off increased by $14 million quarter-over-quarter, mainly due to an increase of $6 million in both the commercial and mortgage portfolios in Puerto Rico. The increase in the commercial net charge-off in Puerto Rico was mainly due to a single borrower specifically reserved for in prior quarters. The U.S. net charge off remains stable at $2.8 million compared to $2.2 million in the prior quarter. The allowance for losses decreased by $15 million for the previous quarter to $510 million, the decrease was due in part to the charge-off associated with the single borrow – commercial borrower previously reserved in Puerto Rico. The ratio of allowance for loan losses to loans held in portfolio stood at 2.2% in the fourth quarter 2016 compared to 2.3% in the prior quarter. The ratio of the allowance for loan losses to NPL held in portfolio or coverage ratio increased slightly to 91.5%, compared to 90.7% in the prior quarter. The provision for loan losses remains flat at $41 million on a linked-quarter basis. While the provision to net charge off decreased to 73% from 121% in the prior quarter. To summarize, despite challenging economic conditions in our main market, our credit metrics for the last quarter of the year remains stables. Our Puerto Rico region reflects the lower NPLs, lower NPAs, lower NPL inflows and an increase in net charge offs. While the U.S. region reflected lower NPLs, lower NPL inflows and stable net charge off. The continued improvement in our credit risk profile is the result that we update in risk our loan portfolio by reducing exposure to high-risk assets classes and improvement in our credit underwriting criteria. These markedly improved risk profiles combined with our strong stress test result give us comfort that we will continue to be a source of strength as Puerto Rico emerges from the current challenges. With that, I would like to turn the call over to Richard for his concluding remarks. Thank you.

Thank you, Lidio. And please turn to Slide 12. Before we open the lines to question, let me conclude today's remarks by reviewing the actions we've been taking to drive shareholder value. Our healthy revenue generation and our leading market position in Puerto Rico allow us to earn above average margins. We're encouraged by the progress in our U.S. operation and by the strength of our Puerto Rico franchise. In spite of the difficult macro environment, we continue to see stability in our main credit quality indicator, while remaining attentive to fiscal and economic trends. This improved credit profile together with our strong capital levels, creates a solid foundation for our strategy. We also benefit from our EVERTEC ownership and our stake in Banco BHD Leon, the second largest bank in the Dominican Republic. Given the fiscal and economic challenges we face on the Island, we're focused on the current situation, while continue to make long-term investment in new business initiatives. We've managed the Bank within this environment for the last 10 years completing several troubled loan sales, refocusing our loan books on lower loss content business line, raising approximately $2 billion of common equity and completing two in-market FDIC-assisted acquisitions, all while earning positive profits in our Puerto Rico business during the island's prolonged recession. In the past three years, we have repaid close to $1 billion in part; had two credits MOUs lifted, restructured our U.S. balance sheet and back office and purchased $2 billion of assets in the Doral transaction. In addition, we have reinstated and increased our common stock dividend and announced our common stock buyback. We will continue to seek additional growth opportunities in the current environment. The actions taken by the oversight board and the new administration in the coming months will be defining moment for Puerto Rico's future. We remain confident that Puerto Rico will emerge from the current challenges with the more vibrant and diversified economy and we will do everything in our power to ensure this outcome. Throughout its 123-year history, Popular has persevered through a number of challenges on the island. Although our company is intrinsically linked to Puerto Rico, 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 a more diversified institution. 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] Our first question comes from Brett Rabatin with Piper Jaffray. Please go ahead.

Hi everyone. Good morning. Wanted to first just go back to the comments around the macro backdrop and the discussion around potential I guess you would call austerity potentially having somewhat of an impact. Can you talk a little bit more about what you are seeing in that regard and what actions as you see it or potentially going to happen in the next few quarters?

Well, you know so far there has been some correspondence exchange between the Board and the governor outlining some targets regarding the budget and the five year plan that needs to be approved. You know the aggressive targets and there has been pushback from the administration. I think the board is meeting as we speak. We suspect over the next few weeks, they will push the stay and give them additional time to prepare the plan and Board will name an Executive Director. But the short answer is, we do expect a reduction in government expenditures over the next few months.

Okay, and then wanted to make sure I had here the growth in the U.S. Were there any loan purchases this quarter and then the realized rates were up, but the AOCI change, any thoughts on that?

The growth in the – there were no material purchases in the U.S. this quarter, so all the growth that you saw was organic. And AOCI, you want to take that?

Mainly in our mortgage back securities portfolio that's driven by market rate changes.

Our investment portfolio as you know is pretty conservative basically mortgage back, treasuries and agencies, and it's just a reflection of the change in market rate.

Okay, fair enough and just last, you could pull out some liquidity, you mentioned stability in the margin. Can you give us a little more maybe on what you did in the securities portfolio and what you might be doing with excess liquidity?

If you recall last quarter, we mentioned that we're including a significant amount of excess cash that we had yet to deploy waiting to get a better read on exactly how some of the government deposits will behave moving forward. I'm not sure we have an answer to that question. But in the mean time we did put some of that cash to work and the investment criteria is the same as we normally had. There has been no significant changes in the content of our investment portfolio, it continues to gravitate to treasuries, agency and mortgage backs.

Thanks for the color.

Our next question comes from Alex Twerdahl with Sandler O'Neill. Please go ahead.

First off, I was wondering if you can just give us a little bit more color on what you are thinking for the timing and execution of the actual buyback program $75 million is great to see, but is that something that you expect to use all of over the course of 2017, or is it a rainy day fund or you know what are you kind of thoughts or is this still too early to kind of have made that determination?

I think it is fairly still too early, but I would assume that we will stick to implement to use the authorization over the next few months.

There is no in your mind, no kind of magic number will buy it back up to X percent of book value or anything like that or is it, is the intention really to return to shareholders?

No magic number.

And then just – I want to ask a little bit more color about this retail network transformation. We've seen a couple of press release come across over the last few months. Sort of where are you in that process. Is that something that you are going to try to implement every single one of your branches, how many have been done so far, and is the expense associated with those transformations? Is that fully incorporated in that $320 million per quarter run rate number?

The answer to the last question is yes. This is something that we're doing – that we call the retail transformation has taken place in the space and as you saw, we did a couple of de novos and some relocations as well as couple of transformations as well. We are doing something similar in Puerto Rico pushing a shift towards more digital transactions and that's going very well as well. And yes, it is incorporated in the $320 million number.

Is there something that's expected to kind of reach a plateau at some point in time in terms of the investments and then potentially be able to recognize some reduction and expenses elsewhere due to some efficiencies et cetera?

You know yes, but you know we are experiencing that as you make these channels – these digital channels more available, you get some increase in the number of transactions. So you don't immediately see a reduction in cost, because you know people they have more availability of the digital channels, they just do more, they just do more transactions. We're seeing things like we can reduce the size of branches and we will be trimming the network as we go along. But there is some significant transaction creation if you will. It's not a one-to-one substitution.

In the U.S., the goal is actually more to stress on our deposit business in the U.S. and that lead – having that lead eventually to lower deposit cost than actual savings and operating expenses.

And just one final question from me is. I just wonder if you can remind us on the criteria for M&A in the U.S., I think in the past you said, kind of up to around $2 billion in assets, Metro New York and Florida. Is that still the criteria, or has that changed at all?

I think the – so the pecking order of the things we would like to do is unchanged. We would like, as far as retail operations, would like to concentrate and density to the two markets where we operate which is New York – Metro New York and Metro Miami. Be this size of one acquisition will be something that makes sense with our U.S. bank. Our U.S. bank is roughly $9 billion to $10 billion bank, so something that's sits in the context. We will also consider specialized lending businesses that fit our credit criteria. As you know we have two very successful ones in our [indiscernible] and nursing home and managed care business, if we can add more to those, that will be great. We have looked at opportunities to strengthen our fee business in the U.S. But anything along those lines comes up, will be interesting to look at as well. But obviously we don't have a tendency to compete with some of our peer banks in the U.S. so the kind deals we look at, the list of deals is not as large as the list of other people. We'll have to be cautious to make sure that an acquisition that really makes sense.

Our next question comes from Dimitre Genov with Magnetar. Please go ahead.

I was wondering if you can comment a little bit on the path forward for additional capital returns. You said you are considering additional buybacks, dividend, M&A, can you provide some sort of timing around that and what are the next steps that will trigger additional returns of capital?

The intent of that line is to list for you all the things that we constantly look at and will continue to look at to, either deploy or share more of our capital with our shareholders. We are not a CCAR bank, so we're not attached to a schedule as the CCAR bank, the yearly schedule when they have to file things and when they get regulatory approval. So, we will make sure we follow that same path. Having said that, as you probably have seen through this process, we've been through in the last few months and our ultimate increase of the dividend and approval for buyback, it is reasonable to assume that the most – the most useful time at least for us to have a regulatory discussion with our regulators with the capital return is when our regulators have the most and most vital information and that would normally happen after we file our stress test in the summer of every year. Again, it doesn't mean we're limited to that, but that would be the most useful time to have those discussions. With regard to M&A and asset purchases, you know those come up when they come up. We are constantly looking at opportunities and if the opportunities become a real transaction, then we'll pursue it.

Is your list getting larger in terms of M&A opportunities or given the rally in original bank shares, is that smaller given, you know have the currency?

Given our currency, more probability, any transaction we would have done before the rally or will do now is going to be a cash transaction, so I'm not sure that changes our position significantly, if they change the price view of the seller and we'll find out when the time comes.

Our next question comes from Gerard Cassidy with RBC Capital Markets.

Good morning Richard, good morning Carlos. Is there any expiration date on the buyback, or is it indefinite when you can actually execute it?

There is no expiration date, but as Carlos mentioned earlier, we will probably move in the next few weeks.

The second question regarding the capital return as you mentioned you are not a CCAR bank. The CCAR banks some of them use the so called mulligan where they ask for too much in return of capital and they have to dial it back and that is disclosed by them. This amount that you announced today, was this what you asked for, or is this less or more – not more, but is it less than, or so it was right on the money?

You know obviously we keep those discussions in prior, let say it's what we asked for about evolve over time.

Okay. That's – I understand. Another question for you, can you guys give us some more color going forward now, we saw what you reported in the fourth quarter on the FDIC loss share expense. What's shall we, I guess it's a volatile number of course, what should we expect you think in 2017, I'm assuming there is no more you know litigation with the FDIC, so there shouldn't be any one-time charges?

Only one $6 billion litigation outstanding, but…

The FDIC expense will vary depending on recoveries and we have to share with the FDIC that we generate expense that are up and down. But I think normally somewhere in the $2 million a quarter expense will probably be…

Should be less volatile. Going forward there should be a lot less volatility in that numbers.

Okay. Super. I appreciate it guys. Thank you.

Our next question comes from Scott Valentin with Compass Point. Please go ahead.

This is [indiscernible] for Scott Valentin. Sort of beat the dead horse here, but on the capital return, I guess as you think about kind of balancing dividends and buybacks, obviously you are here near tangible book, I guess, how do we think about that going forward?. I guess obviously, you are closed on peer return on the dividend. Would you look for more of a balanced approach going forward?

Well, again, we wish we had this amount when the stock was in the 20s and we could buyback below tangible, but you balance these things out. We think again, this is what we got and we'll be looking as we move forward, we'll be looking to do more things, but right now there is nothing.

Fair enough. And just as it relates to tax reform, again you know we've heard of and I know it's you know a bit early to speculate, but as it relates to you tax, your run rate kind of effective tax rate going forward, you know if we look out say 2018, you've guided to 25% to 27% for 2017, but I guess would you see any benefit if there was a reduction and the effective tax rate just given the fact that Puerto Rico has a lower tax rate already?

Well I would probably impact our U.S. operations in the sense that we have to do something with the deferred tax asset in the U.S., but we also have a still – have a meaningful reserve. I don't know Carlos you want to comment.

I mean I guess the incremental tax rate in Puerto Rico is 39%, so we are able to generate some benefits in Puerto Rico that will be less evident if that higher tax rate come down, there is only so many other opportunities in the U.S. and remember that, it has a high tax rate even though we're not actually paying a lot of, really a cash transaction and a lot of that is driven by state income taxes, that lose their deduction status for federal taxes, so we're not actually paying them. So, I think it will be a while before we see a meaningful decrease in the effective tax rate in the U.S.

And if I could just slip one more on the mortgage banking income line, you know obviously in North America there are headwinds on mortgage banking, but if you could just provide some color I guess around your expectations as we move into next year, you obviously showed some stability in that line, quarter-over-quarter?

The mortgage banking income line is almost all Puerto Rico business. So, you are not seeing they are very many dynamics of what's happening to mortgage banks in the U.S. And most of the changes are just a reflection of slightly lower volume than before.

Thank you for taking my questions.

[Operator Instructions] Our next question comes from Ken Zerbe with Morgan Stanley. Please go ahead.

I guess first question just in terms of the capital return, I get what you said that you are going to start this in the next couple of months give or take, weeks or months. I guess first question is, are you going to do the entire $75 million serve all or once?

We have not discussed that.

We are preparing a list of all of our best friends that are calling us now to offer their services.

I'll let you take care of that, no problem. Anyway, second question is when – once you get the $75 million done, when is the next logical time that you might announce sort of the next buyback? Do you need to wait for the next stress test period?

The answer is what I mentioned earlier Ken. Technically, we don't. We don't have a schedule like the CCAR banks do. But in practice, the best time to have a substantive discussion was the fed, will be when they have specially that discussion happens as we get closer to the filing of the stress test is when they have.

Understood, and that what I thought I understood, which I guess, if I phrase it sort of what is the next logical time after announcement. Next question just in terms of the margin, I heard NIM stability from here. But that's a 402-ish plus or minus level, right. So, kind of going into 2017, NIM should probably be around 4%?

I'll take that. What we intended to say is that – what we tried to do, once we explain the reasons why the margin came down over that three quarters and explain why we hope for those reasons will not continue applying moving forward. With the stability, could be at this level or could be at an additional level, you know we don't give margin guidance.

Okay, so could be flatter, could be down. Okay. Alright, thanks you very much.

Our next question comes from Brian Klock with KBW. Please go ahead.

I apologize I got on late, but if this was asked already I apologize. I did hear a lot about capital return, so I won't ask you anything about capital return. But there was an earlier question on the potential for tax reform in the U.S. Mainland, and I'm not sure if you guys answered this question or not, but it would seem that from the U.S perspective, if you went to say a 35% to 25% corporate tax rate, there would only be maybe a $1.50 or so of a hit to your tangible book because of that, but you really wouldn't have the impact on the regulatory ratios right because of this lot of DTA.

You are correct on both things.

And there would be as you said, there would be net positive to your tax expense though in that situation because of your U.S. tax rate is pretty high from that GAAP perspective?

You are absolutely right.

And again I apologize if I missed it, but it looks like some pretty solid growth continues in the U.S. franchise, not sure if you've talked about it, but I guess if you could highlight the key areas there on what you think maybe the loan growth momentum you still have in the Mainland franchise?

Yes. We are still seeing pretty decent demand from our clients in both markets, both New York and South Florida. There the categories are the usual categories you've seen from us in the States, so CRE, some multi-family managed care and the (conversation) business. So no significant change in the story or the categories in which we're seeing client demand and again we've seen continuously good opportunities to continue to grow the book without significant sacrifice in underwriting criteria so far.

So, you got capital, you are growing the balance sheet and now you are returning some of that capital. So congratulations and thanks for taking my questions.

Our next question comes from Joe Gladue with Merion Capital Group. Please go ahead.

Just, I know it's a much smaller amount, but the remaining amounts in dispute with the FDIC on the loss share, did you mention when you expect that to be resolved?

I don't think they have set a date for the arbitration yet. So, we're a long ways off.

There is no panel yet, no date yet, so no date yet.

And related to that, I guess wondering if we'll see any noticeable reduction in professional fees or anything either now with the majority gone or will that not occur, will it not occur until the last little bit is resolved?

Well, it's a much smaller case, so hopefully that will translate into smaller fees. You never know with lawyers, but…hopefully.

And I guess lastly, I guess I just wanted to follow-up a little bit on the questions you had on the U.S. loan growth. Can you just give us a little more I guess clearly had some very strong percentage growth in the U.S. portfolio, just how are you accomplishing that and I mean can you guess maintain sort of that same level of growth going forward?

So far if you look at last few quarter, it varies high single digits, I think we have a quarter into it double digit growth, but it varies high single digit. I mean we are not under the pressure of some other banks that have announced a target growth, does it have to meet and then they guide every quarter to fill that bucket. We actually just do our work with clients and look at loan opportunities, and once they fit our portfolio, we do then have the other quarter, we add up the growth and we figure out what it was. So, it's – again we don't set out to grow a particular number. What we do set out to try these two deals that make sense for our book and for our clients and the result has been pretty positive so far. We see no indication that should change moving forward.

Okay. That's it for me. Thank you.

Our next questions comes from Alexander Karlan with Lake Trail Capital. Please go ahead.

Hi Carlos. Congratulations on that capital return. That's great to see. Sorry to go back, but can you just clarify exactly what you meant on NIM guidance? I was confused listening to the earlier question?

Yes. I mean what we attempted to do was explain the conditions that led to the NIM to slipover the last few quarters and mention that we don't expect those conditions to continue and that the result of that was would be to more stability moving forward in the NIM. It was not our intent to provide guidance at 4.02% which is where this quarter ended, but more – and then just to comment that the conditions that led for it coming down over the last few quarters we believe are not there anymore. So stability could – the NIM could go up. It doesn't mean it will stay where it is, it's more than anything that necessity is that, this is right and it shouldn't continue to come down.

[Operator Instructions]. We will now have a follow-up question from Dimitre Genov with Magnetar. Please go ahead.

Hi guys, just a follow-up question on the austerity comment in the first question. I guess you expect some reduction in government spending, but can you comment on what is the expected impact on you know your operations, whether it's loan growth, charge-offs or vehicle just overall activity if you can just give us some color on that?

You know, I don't really get the thrust of the question.

It's hard to answer your question, because the SIP when in operation will depend on the magnitude of what ends up happening and it's very hard to read right now exactly the magnitude of the compact requirement may end up doing, and also depends on where the compact occur, because some of those, some cutbacks in some government activities could actually be business opportunities for us if the activity they used to do, they have to have somebody else doing their behalf moving forward. So, it is hard right now. I appreciate your question, it's a valid question, but until we have a better reading on where the cutbacks will occur, when they occur and what they would look like, it is very hard to predict they will affect our operations. What we can say is, on the credit side, we have over the last few years continue to strengthen our portfolio, any cutback in the effect of government cutbacks is one of the things that we consider during the stress test, so we think we continue to be strong positioned even if some cutback come.

Do you track your exposure to government employees or just kind of…

We do.

We believe we're actually slightly under index, government employees in our total sign base, if you look at government employees versus the total employment base in Puerto Rico, because a lot of government employees tend to do some of their banking, they call us and the credit union, so we do track it again, we believe we under index slightly in that.

We will now conclude today's Q&A session and the conference call. Thank you for attending today's presentation. You may now disconnect.