Popular, Inc. (BPOP) Q2 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011, Popular Incorporated Earnings Conference Call. My name is Jonathan and I am your operator for today. At this time, all participants are in a listen-only mode. We will be conduct a question-and-answer session after the prepared remarks. (Operator Instructions). And as a reminder, this conference call is being recorded for replay purposes. I would now like to hand the call of to, Mr. Enrique Martel, Manager of Corporate Communications. You may proceed, sir.

Good afternoon, and thank you for joining us on today's call. Our Chairman and CEO, Richard Carrion; and our CFO, Jorge Junquera will review our second quarter results and then answer your questions. They will be joined in the Q&A session by other members of our management team. Before we start, I would like to remind you that in today's call, we may make forward-looking statements, which 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, which you can visit by going to www.popular.com. I will now turn the call over to Mr. Carrion.

Good afternoon, and thank you for joining the call. Please turn to the second slide. For the second quarter, we've reported net income of $111 million compared with net income of $10 million loss in the first quarter and a loss of $44 million in the second quarter of 2010. Second quarter profit was mainly driven by higher net interest income and an extraordinary tax benefits of $60 million, which were partially offset by higher loan loss provision related to the non-covered loan portfolio. This is our second consecutive profitable quarter and we continue producing strong and consistent levels of revenues. While the level of credit cost remained elevated we continue to make progress. The most telling sign is our top line revenues which remained steady despite the economic challenges we faced in our market. Net interest income increased by $31 million to $375 million when compared with the previous quarter and our net interest margin remains well above 4%. We drew down the reserve for non-covered loan losses for the fourth consecutive quarter albeit at a reduced pace. Loan loss provision of $144 million includes $49 million related to the Westernbank covered assets, which represented higher recognized, credit losses in certain pools of loans. Keep in mind that an amount equal to 80% of the provision related to this covered loans flows back through net interest income due to the FDIC loss sharing agreement. Excluding covered loans, held-in portfolio and non-performers increased by $17 million. While we would like to see this number down every quarter we are encouraged by the fact that NPL inflows in our commercial and construction loan portfolio at Banco Popular de Puerto Rico have declined in the last two quarters. The FDIC assisted transaction has been instrumental in broadening and supporting our revenue streams…

Thank you, Richard. Let’s move to Slide 5 for an overview of our consolidated financial results for the second quarter. The three big moving parts in the quarter were the tax benefit, the increase in net interest income and the increase in the provision. On top of the tax agreement reach, we also benefited from a lower tax rate that was introduced when the Puerto Rico Tax Reform was enacted at the beginning of the year. The effective tax rate for Banco Popular de Puerto Rico for 2011 is estimated at 22%. Our net interest margin rose from 4.15% in the previous quarter to 4.48%. Reducing funding cost has been a major initiative of the corporation this past year. Our average cost of funds is falling over the last 12 months by 47 basis points to 1.9% while our average yield on loans and leases has increased by 41 basis points to 6.73%. The high cost debt will be paid in previous quarters, helped the margin in quarter two. And the major drive behind the improvement was a reduction in our cost of deposits. We have continued to make progress in reducing our Puerto Rico deposits as deposit costs, as a result our interest expense on the profits declined by $6 million or 8% in the second quarter. We will continue to take advantage of opportunities to further reduce our deposit cost primarily in our Puerto Rico business. The provision expense increased by $69 million with $33 million of the increase related to covered loans. The main point I would like to make of our covered loans is that they are performing better than initially expected. Our regular second quarter loan review found that overall expected credit losses declined versus the previous estimate. A minority of the pools of covered…

Thank you, Jorge. If you please turn to the last slide, I’ll wrap it up by reviewing the key takeaways from this quarter and key issues to focus on in the coming months. The consistent production of growth revenues, amid the headwinds is reassuring heading into the second half of 2011. We have a unique franchise in Puerto Rico and a Bank in the US focused on growing its community banking business under improved credit conditions. The rise in NPLs in the quarter reflects a still-sluggish economy in Puerto Rico, yet there are encouraging signs such as new public investments and the six-month decrease in NPL inflows. We suggest the cycle here could be bottoming out, albeit we will remain cautious. The performance of our covered loan portfolio continues to exceed expectations and has elevated our revenue generating capacity at a time of limited loan demand. We’ll continue to manage credit costs and pursue transactions for our held-for-sale portfolio. We’re also seeking opportunities to broaden our business through asset acquisitions that can be absorbed by our existing business platforms without undue added risk. Above all is our return to sustained profitability. It lessens problems and creates opportunities. We had a good forecast in 2011 and we’re working hard to finish the year even stronger. We thank you for your attention and I would like to now open up the call for questions.

[Operator Instructions] :

A question or two on the net interest margin, I noticed that the yield on mortgage loans was up a good bit from the first quarter. Just wondering, is some of that due to some of the purchase loans or the loan share originating coming in at higher yields or what?

No in fact what you said, the improvement is due to the new loans coming in that we acquired, a little over $500 million that we acquired in the first half of the year, those getting in at nice yield and bumped up the portfolio yield.

And on the funding side, you did have decrease in deposit costs, can you just touch on the competitive environment as are I guess other banks in Puerto Rico following your lead on the general competitive level getting more rational?

Rational is always in the eyes of the beholder. We still think there is somewhat of a disconnect, between the prices being paid for deposits vis-à-vis LIBOR and we think there is still you know room for improvement in loan pricing but all those three market types hate competition I guess. But it’s gotten better than certainly a year ago but we think there is still room for improvement.

Just ask one more. How much in a way of loans repurchased on the recourse agreement? Is that a significant amount in the second quarter? What’s the trend there?

I don’t have that number. I mean, we can dig it up for you, Joe, but I don’t think it’s been a significant amount. It was not really a significant during this quarter.

Okay, alright, thank you.

Okay.

And your next question is coming from the line of Ken Zerbe with Morgan Stanley. You may proceed.

Great, thanks. I guess, just to follow up on the funding cost question. I there anyway you can quantify how much further you think that your overall funding cost might decline over the next year so. I understand this is a general question to ask, but just trying to get a sense of magnitude?

Well I guess, when we look at the overall cost, I think we have a very low base. But when we look on the margin generating additional deposits, we are still somewhere around 30 to 35 basis points north of LIBOR so or the brokered loan rates, brokered CD rates. So, you know, we think there is some improvement we could see there as the market continues to exercise a little more discipline. That’s the only metric we really use. We look at cost on the margin, vis-à-vis, what comparable brokered CD rates would be.

Alright, and then the other question, your commercial and mortgage non-performers have been turning up the last couple of quarters, obviously the concern is that would those continue to turn up, it could result in the incremental losses or higher provision expense. What, I mean what can we on our side of the table look at or how do we get comfort that the trend doesn't continue to go up, provision expense follows?

I think well, obviously the overall level of non-performers, but I think its more relevant perhaps to look at the trend and look at the inflows of C&I loans and broken out by both the U.S. and Puerto Rico and there you know we do begin to feel a little more easy about it.

Alright, thanks. Richard Carrión: So it’s the inflows number that we are looking at.

Okay.

Okay.

And your next question is coming from the line of Brett Scheiner with FBR. You may proceed.

Hi guys nice to see the internal capital generation, just a couple of quick questions. One with the firmed out squarely and profitability, I mean you are showing excess capital in excess of TARP under BASEL III. Can you talk about timing of even a potential TARP – TARP repayment?

Okay, I will take that. It is true, you know we have now as we were anticipating our two quarters of profitability and that is definitely the first step, but we do not have right now a specific plan for any TARP repayment. And it’s probably premature to engage in that. Having said that, I want to tell you that we are continuously looking our capital and different ways of enhancing our capital structure including the repayment of any of the trust before securities on any of the securities that are the composition of capital in order to enhance it. So this is -- it’s a live situation that we are continually over-viewing.

Okay. And then do you have the accretable yield balance at the end of quarter?

Pardon me.

The total accretable yield balance at the end of the quarter?

Yeah. The total accretable.

Yeah.

Because to give you -- if you look at the yield on loans, the yield on the covered loans goes up and therefore your FDIC assets is accreting at a much slower rate.

No. I am saying do you have the total aggregate balance.

And…

I can follow up with you off line.

The total aggregate balance of – the total that will be accretable yield during the second quarter on our covered assets?

Yes.

Okay. I think we have it, it should be here. Yeah, it’s in the preliminary yields in the part of the press release or. The yield on the covered loans went up to 991 in the quarter.

Okay. You know how far could you guys outline the number in aggregate though, but we have got say thanks again.

Sure.

Okay.

And may be it’s the dollar amount, it was in a page 8 of the presentation and the total interest income from covered assets was 94 million during the quarter.

Okay.

(Operator Instructions) Your next question is coming from the line from Derek Hewett with KBW. Derek Hewett - Keefe Bruyette & Woods Inc.: Good morning gentlemen. A follow up question to the accretable yield, what was the net interest income contribution from Westernbank for the quarter?

Well, its difficult to say, we are not showing that and if you estimate you know you have the revenue sources that we have shown but then if you estimate cost of funds based on FDIC notes and any access of the FDIC notes that is funding forward assets at you know short-term rates of quarter to half a point, its probably around $20 million of cost estimated you know. This are with a wide brush that run $20 million of interest costs for the quarter, if you want the net yield but the net interest yield you want? Derek Hewett - Keefe Bruyette & Woods Inc.: No, just the net interest income. It would be – would it be the 100 million minus 20 million costs?

Then I assume to the page that we showed in page seven you put out some cost of funds which is you know roughly around $20 million and then estimate expenses that has already been reduced through synergies throughout the year. And it could be estimated anywhere between 20, $25 million and again you know these are very rough estimates.

You got the gross numbers there you know it’s roughly 100, 107, 106 in gross income for quarter. You got to take some interest expense of that and some operating expense of that so you know it is certainly north of $60 million for the quarter closely and apply some tax rate of 30% to that. Derek Hewett - Keefe Bruyette & Woods Inc.: Okay. So 60 million pre-tax and then whatever that is after an effective tax rate of roughly 30%. I recall you guys mentioning that was roughly a $40 million contribution last quarter

Yeah. Derek Hewett - Keefe Bruyette & Woods Inc.: So okay.

You are right. Nothing has changed, nothing changed much. Derek Hewett - Keefe Bruyette & Woods Inc.: Okay, great. And then what is your guidance, outlook for the US Mainland franchise going forward? I know last quarter you thought that you might be in the red for BPNA and essentially you broke even, are you expecting a loss in the third quarter or do you think you will remain either kind of breakeven to may be slightly profitability going forward?

Well, we have Carlos Vazquez here, so we’ll put him on the slot and I'll be taking notes.

You know, we are still working through our de-levering and cleaning up our historical, discontinued business portfolio. So we will continue to be challenged to show profit for the year, but we’re giving it a try and heading that way.

You have a follow-up question from the line of Joe Gladue with B. Riley.

We have credit risk management on the line, Vanessa Rodríguez, so Vanessa you want to tackle that one? Vanessa Rodríguez: Yes, in US region, the delinquencies in the early stage continue to show improvement. In Puerto Rico, some of the portfolios, consumer portfolios on doing well. We are cautious with our commercial loans, but delinquencies are still a little bit high.

[Operator Instructions] Then there is a question from the line of Ken Zerbe with Morgan Stanley.

You just mentioned that you are looking at trying to sell the Puerto Rico construction loans, is there any risk or may be not even a risk but can you just talk about kind of process you are going to go through to determine if there is any incremental marks that you are going to have to take or write down on that portfolio. I mean do you need to see where the bids are before you write it down or do you, I guess what are we looking on that?

Thank you for that and can I and if I may let me correct because I saw a note you wrote earlier today and you mentioned that we had increased our loan marks there, that is not the case. What that refers to, that amount referred to was advances we have made on loans that put in held-for-sale. So we advanced an amount, we have to write it down the amount we advance, once the loan has already been put in held-for-sale and that’s what that number referred to. It is not that we increased the mark. Now once you put a loan in held-for-sale, you must every quarter do an analysis of the loans and make sure your marks are where they should be. We did that this quarter and we found no difference, so we are comfortable with our loan marks, we are talking to some groups of people there you know. We have given them the list, they had been looking at it, some have done some onsite inspections and hopefully we will see something that makes sense and we will move ahead.

So on the advances, it’s a dollar for dollar writedown?

Well if you say mark them down to 48 and you advance a dollar, you have to write down $0.52 of that dollar.

Got it. Okay.

Irrespective of the fact that whether you made the advance, you think you will get it all back, you have to write it down at the value of the loan market.

And how much is there, potential advances that’s currently outstanding that you could be losing money on? Meaning that do you have, is it another $100 million of potential advances that could be either.

No, no. You know, again, it depends on you know, when we get these loans of the book. So the judgments you make on whether you are going to get this money back or not before you make, most of these are construction and development loans and you will make that decision before you make loan. There is some commitment outstanding that you know, we have to respect but it is not a significant number, probably in the order of.

$15 million to $20 million

$15 million to $20 million.

And with no further questions in queue, I would like to turn the call back to Mr. Richard Carrion, Chairman and CEO for closing remarks.

Again, thank you very much for joining the call. We hope we’ve cleared up again. You know, the little noise in the quarter, with the taxing, which we think is favorable and we decided to go ahead with it and you know we look forward to communicating with you in the near future.

Ladies and gentlemen, thank you for your participation in today’s call. The presentation has ended. You may now disconnect. Have a good day.