Popular, Inc. (BPOP) Q3 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Third Quarter 2011, Popular Inc. Earnings Conference Call. My name is Jasmine and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions). I would now like to turn the presentation over to your host for today’s conference to Mr. Enrique Martel, Manager of Corporate Communications. Please proceed.

Good morning and thank you for joining us on today’s call. Our Chairman and CEO, Richard Carrion; and our CFO, Jorge Junquera will review our third 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 that 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 may visit by going to www.popular.com. I will now turn the call over to Mr. Richard Carrion.

Good morning, and thank you for joining the call. Please turn to the second slide. For the third quarter, we reported net income of $27.5 million in our third consecutive profitable quarter compared with net income of $110.7 million in the second quarter. About one-third of the link quarter profit decline was due to the provision expense with most of the remainder due to a onetime $60 million tax benefit in the previous quarter. Our revenue generating capacity has remained strong throughout this credit cycle and the net interest margin has been above 4% for the last four quarters. Gross revenues for the quarter amounted to $492 million including $369.3 million in net interest income and $122.4 million in non-interest income. Revenues were partially offset in the third quarter by a higher provision expense that was driven by a rise in Puerto Rico commercial non-performers, which led us to provision roughly 111% of our non-covered charge-offs. As we have previously reiterated credit cards in Puerto Rico have continued higher than we expected at this point and we have provision accordingly. So let me address the credit issue before Jorge discusses the quarterly figures in more detail. The credit risk in our non-covered Puerto Rico commercial portfolio is greatly diversified across business sectors with no significant borrower concentration and has the low average loan size. No one business sector represents more than 10% of the loan portfolio balance. The commercial book on the island is comprised mainly of loans to small and middle sized businesses with an average loan size of 476,000. As we disclosed last month we completed the sale of $358 million of unpaid principal balance in construction and CRE loans at a price of 45% of the UPBS of March 31st which was in line with previous indications.…

Thank you Richard and good morning. Please, let’s move to slide four for an overview of our consolidated financial report for the third quarter. Our net income of $28 million in the third quarter was $83 million below the previous one. Both quarters include a series of special items which make it more difficult to identify the important trends in our business. So in order to present more clearly how our results change I will now move to the following slide which compares our pre-tax adjusted quarter three results with those of the previous quarter. On the left side we start by removing the special items from our quarter three results. These include a $5 million net benefit from the loan sales completed in September from approximately $17 million gain on sell less $13 million provision related to the reclassification to loans held-for-sale. An $8 million gain from the sale of $234 million in U.S. government securities and $5 million charge related to the retirement window at EVERTEC of which we own 49%. Excluding these items our pretax quarter three earnings amounted to $25 million which is $48 million below pre-tax earnings of $73 million in quarter two. Now we will reduce the main variations between the two. Starting with the provision expense, there was net increase of $32 million. The portion related to Puerto Rico business rose by $47 million excluding the one-time $13 million provision related to the loan sales. On the other hand we had a reduction of $23 million in the provision expense related to Westernbank over assets and $5 million reduction related to the U.S. business. Moving on to non-interest income there was a negative variation in FDIC loss share income of $44 million. Approximately $29 million was due to a reduction in the rate…

Thank you. Please turn to slide 11 and I want to take a minute to discuss the price of our stock which has declined 47% as of September 30th. Even though most financials were also beaten up we were hit harder than most. The decline is more than two and a half times that of the NASDAQ bank index which drop 19%. Well, I don’t know any CEO who doesn’t think his company is undervalued. We think that at current valuation levels the market is underestimating the value of our business. So let me briefly review what we believe a current or potential investor in Popular is getting in return for his investment. The dominant financial services franchise in Puerto Rico with a track record of 118 years and a corporation that has generated over $770 million in pre-provision net revenue during the past 12 months. A U.S. community banking business which this year return to profitability and has the fully reserved DTA of $1.3 billion dollars. A 49% ownership interest in EVERTEC, which is the leading transaction processing merchant acquisition and IT consulting company in the Caribbean, it generated operating EBITDA of $68 million in the two quarters ending on June 30th which was an increase of 14% over 2010. It is carried on our books at $188 million which when compared with EVERTEC year-to-date performance represents the multiple of 1.3 times revenue and 2.8 times operating EBITDA. Although our margin is strong there is potential for additional margin when interest rate is normalized. 74% of our balance sheet is funded with deposits and we are confident that when rates rise we should benefit materially. We are aware that the one factor that is preventing us from reaching potential profitability is credit cards. Although the economy has not improved…

Sure Ken. Let me tackle easy part then I’ll turn over to Lidio for more difficult part. But I think if you look at the increase, which was almost twice what we saw in the second quarter, and you put that together with the fact that of those inflows about half were clients that are currently paying, but that we have no doubt as to their documented ability to continue paying. I think a good part of it is response to a closer scrutiny of these cases and does not reflect any deterioration that we’ve seen in the third quarter. But let me let Lidio who has been a few months in the job give you his perspective on it.

I will add to that. When you consider the cycle of financial reporting by companies, most of them report at the end of the second quarter or during the second quarter and Popular as a company will tend to analyze it between the second and third quarter. So as we receive financial statements from companies at the end of 2010 and we analyze them we made the decision in certain cases for certain borrowers that the documents that are ready to pay was deficient and therefore we merit a non-performing status even though today they continue to pay. Ken Zerbe – Morgan Stanley: Okay. So, if I think about the 50% that are current, I mean would I be wrong if I assume that this was essentially an acceleration or pull forward of borrower who probably would’ve gone NPL next quarter or a quarter later, but you’ve pulled every one up to this quarter such that going forward we might not see as much increase if at all in NPLs or is that the way to think about it.

I think it’s difficult to make that prediction. We just say that, I mean we have – I think in Mr. Junquera’s presentation he mentioned that we have gone through a thorough portfolio review and as part of that process we think we have uncovered most of our issues. Well, certainly if things change we will make adjustments. Ken Zerbe – Morgan Stanley: Okay.

Let me just add here that given this somewhat of a change in the way that we manage these non-performers, in the past there was much more reliance on payment history. Nowadays, there is much more reliance on future cash flows and its ability to meet agreed terms. In the past there were probably many of the loans that are now being moved into non-performing would have never made that mark. At the end they’re probably – there was no loss at the end. It was just that the future cash flows of this customer given the credit cycle difficulties changed and it got more difficult. But that doesn’t mean that at the end the borrowers were going to totally fail in making payments, but the scrutiny has intensified and now there is a forward view of cash flows and then that now determines whether you have to move alone to non-performing or not. But not necessarily we are advancing customers that would have gone into future or that they will end up losing money or with that we will end up losing in their loans. So as Lidio said it’s difficult to tell, but it’s – we’ll manage it on – as we go along here. Ken Zerbe – Morgan Stanley: Okay and that helps. The other question I had was on the margin. How much of the margin, which was actually fairly stable this quarter, related to any kind of one-time or FDIC adjustments versus items that might be more sustainable. When we think about the margin going forward is that – should we be building in compression or is it actually fairly reasonable to say it’s going to be around these levels if not coming down a little bit.

Okay, it’s probably relatively stable but with a downward bias, because as we have mentioned the covered assets it’s a reducing asset and that is an asset that has a very wide spread. So if covered assets – the proportion of covered assets go down, it will then have a reducing effect on the margin. But offsetting that, yes, our efforts to continue to lower the cost of deposits, particularly in Puerto Rico is where we continue to see further opportunities. In the U.S. we think that we have reached a margin which is as high as we have experienced it and it will be difficult to continue to increase it going forward. But in Puerto Rico we see stability. Ken Zerbe – Morgan Stanley: No, I understood. I just wanted to make sure that there wasn’t any large one-time items that would lead to a cliff drop in your margin in the next quarter, but it makes sense.

Not at all. Ken Zerbe – Morgan Stanley: Okay, perfect. Thank you. Operator: [Operator Instructions]. Your next question comes from the line of Mr. Joe Gladue with B. Riley. You may proceed. Joe Gladue – B. Riley: Hi, I guess first off start off saying I like all the detail in the press release.

Thank you. Joe Gladue – B. Riley: But I guess let me touch on the net interest margin a little bit just to I guess ask a couple of detailed questions there. It looks like you have the cost of borrowings I guess increased even as you are paying down the FDIC receivable, just I guess what’s driving that increase in the cost of average borrowings?

Okay, yeah. Richard is going to address that Joe.

Yes, the reason behind that Joe is that the liability that – or the borrowing that we had been paying off most aggressively, which is the FDIC note, has a cost of 250 whereas the remaining borrowers have higher rate. So as we continue paying down the FDIC note, the resulting cost, the remaining borrowings will tend to creep upward, overall cost. Joe Gladue – B. Riley: Okay. And on the, I guess, on the asset yield side, pretty sharp decline in the yield on the mortgage loan. So was there some, I guess, interest reversals on loans migrating to non-accrual that was part of driving that or just wondering what's behind that.

It’s really increasing in CDRs and obviously we are not taking into income anything that is accumulated in those mortgages. So, yes, there was kind of not taking into income everything that is related to those loans that we cannot afford and where we send as CDRs. Joe Gladue – B. Riley: Okay. And I’ll ask a question on one of the slide, I guess, on page eight with the 30 to 89-day delinquencies. Just wanted to be sure, the numbers there are just the delinquencies that are still accruing that doesn’t include anything that’s been any other loans that were moved to non-accruing even though they were still performing?

That's correct. Joe Gladue – B. Riley: Okay. And I guess lastly just to ask a question on the North American operations. It had been profitable for several quarters in a row now. I think that, I guess, performance is sustainable?

Well, Carlos keeps telling me that it – not to multiply by four every time, but he does it every quarter, but I’ll let him do the same to you what he does to me.

We are hoping we can sustain it. The challenge is going to the same challenge that most banks our size have in the U.S. market and that is asset growth. Remember, we do have a big chunk of discontinued businesses that continued to roll off our balance sheet. So the magic will be whether we can keep a good ratio of growth while the discontinued businesses continue to roll off. Joe Gladue – B. Riley: All right. Well, thank you. That’s all I had.

Thanks, Joe. Operator: Next question comes from the line of Brett Scheiner with FBR. You may proceed. Brett Scheiner – FBR Capital Market: Hi, guys. The increase in commercial NPAs didn’t have a large associated charge off. It looks like charge offs were relatively flat. But, there also wasn’t a reserve during the quarter I assume just because of the greater NPA level. Can you talk – so it looks like $135 million in charge offs, $151 million in corporate vision, so net of $60 million reserve build, can you talk about reserve bleed versus reserve build going forward?

Well, I think most of the reserve builds – we don’t really give you the detail per portfolio. I think most of the reserve build was in the commercial portfolio here in Puerto Rico. We have been seeing much better performance in our consumer portfolios in Puerto Rico and across all portfolios in the U.S. So, overall in the U.S., we’ve been drawing down reserves and have had to reserve less for the consumer portfolio. So I think most of this was in the Puerto Rico commercial. And correct, charge offs did not inch up significantly.

Just to add to that. Exactly, I mean we have – when you look at our balance sheet and our business, we have two different – in terms of provision to expenses performance by geography. In Puerto Rico, we are providing more than the charge off. While in the U.S we are drawing down the reserve base and improve our performance and credit metrics of our business. As we continue to move forward, we expect the improvements in the U.S. to moderate and as the economy in Puerto Rico improve we should also expect the increases in Puerto Rico also to moderate on a going forward basis. Brett Scheiner – FBR Capital Market: Okay. Thank you. Operator: Your next question comes from the line of Derek Hewett with Keefe, Bruyette and Woods. Please proceed. Derek Hewett – Keefe Bruyette & Woods Inc.: Good morning.

Good morning. Derek Hewett – Keefe Bruyette & Woods Inc.: My first question is just in terms of profitability going forward yet kind hedged on the U.S. mainly on franchise just because you need – the need for asset growth, but what about for the company overall? Do you still expect it to remain profitable going forward?

Yes, we do. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay. And does that include any sort of issue with any potential goodwill write down? Is that even on your radar right now? Is that a possibility?

No, I think we typically review it every third – in the third quarter of the year before the Q. So we’re not looking at that. Although most people are looking at tangible book right now, but no we don’t see any good will right now. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay, great, thank you and then what percentage of your NPL inflows last quarter were paying as agreed?

Well, really we don’t have that number. I can get it for you and share it Derek. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay. And then just in terms of deposit pricing I think you said deposit prices or deposit funding cost in Puerto Rico went down I think nine basis points.

Nine basis points on deposit cost, that is right. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay, how much further do you think you guys can go?

Well, we gauge it based on overall cost vis-à-vis alternate funding sources such as broker CD rates and LIBOR and we think we still have a ways to go. As Jorge mentioned during his part there is about $5.5 billion maturing in time deposits over the next 12 months. So we think there is still opportunities to continue lowering that and I think that will counter balance the fact that on the asset side we will see the Westernbank portfolio taper off gradually. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay, and then at that $5.5 billion I might have missed this. Did you go over what was the average cost of that $5.5 billion and what are current market rates?

Well, it’s a – we don’t have that number right now, but definitely they are priced at a rate which is higher than what they will be rolled over provided that rates remain unchanged which is expected, yeah. Derek Hewett – Keefe Bruyette & Woods Inc.: Okay, great, thank you very much. Operator: [Operator Instructions] Your next question comes from line of A.J. Gydle with Goodentry Asset Management. Please proceed.

Hey guys, thanks for taking my question. You had mentioned that you are going through expense reductions or gearing up for 2012 and had reduced expenses it will be very helpful if you could try and quantify that?

Sure. We are looking at – mostly in Puerto Rico we are looking at streamlining a few things, primarily consolidation of additional branches which we think there is plenty of room to do that. Also we are targeting a head count reduction in the 200 to 250 FTE range over the next couple of months.

Is there any way you can put it just like a $10 million opportunity, $20 million –

I think there is about a $25 million opportunity there.

Per year?

Yeah.

Okay, and how long do you think that it should be done in the next few months you say?

I think most of the head count reduction should be achieved by the end of the first quarter and the branch consolidations probably will take us somewhere into the second quarter of the year.

Okay and just – can I ask a question on credit. And I am just trying to understand. I mean obviously the main question that everybody wants to know is kind of when your credit in the commercial portfolio bottoms. I understand you changed methodology. But I mean can you just give us a little more idea of what you are seeing? Is it just going to remain volatile or just can we become authentic credit and we might be stabilizing here.

Well, we have not changed methodology I think we gave the portfolio a little closer scrutiny for a few reasons not the least of which we have a new risk officer, but I don’t think there is any major change. I can tell you that there is major change between the third quarter and the second quarter in what we are seeing around town. We have seen just tougher conditions as we looked at the statements as they have come in and some of these business have been operating in a recessionary environment for four or five years. So it is taking a toll, but I can tell you that we have observed any marked deterioration in quality overall. I think in general banks have been a little more proactive given the regulatory environment in classifying these loans as non-performing in this cycle. On the more positive side I think our consumer portfolios have been evidencing a steady improvement over the last couple of years and those are extremely manageable and I am getting pre-crisis levels.

Okay, thank you. Operator: [Operator Instructions] Ladies and gentleman this concludes a question and answer session for today. Thank you for your participation on today’s conference. This concludes the presentation. You may now disconnect. Have a wonderful day!