Popular, Inc. (BPOP) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q2 2012 Popular Inc. Earnings Conference Call. My name is (Clara) and I’ll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Enrique Martell, Corporate Communications. Please proceed sir.

Good morning. Thank you for joining us on today’s call. Chairman and CEO, Richard Carrión; our CFO, Jorge Junquera; and our CRO, Lidio Soriano 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 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, which you may visit by going to 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. Please turn to the second slide. For the second quarter, we reported net income of $66 million, compared with the profit of $48 million in first quarter, our sixth consecutive profitable quarter. We remain on track in executing our strategy by improving credit, building our asset portfolios to maintain our strong revenues, optimizing operating expenses, and continuing improvements on our U.S. operations. Our revenue generating capacity was clearly displayed in the second quarter with a net interest margin of 4.33% that stands well above our peer average and gross revenues amounting to $435 million. A major takeaway from the results of the second quarter is that credit metrics continued to improve. Excluding bulk sales, the quarterly decline of $120 million in non-performing loans is our largest quarterly decrease in this credit cycle, while charge-offs reached their lowest level since 2008.…

Thank you, Richard. Good morning please turn to slide 4, as you can see our second quarter results has some unusual items that I will explain by going into the main changes in revenues and expenses versus the previous quarter. Starting off at the top net interest income of $341 million was $4 million over the previous quarter with our net interest margin raising by 6 basis points to 4.33%, this was a result of two items. First, the yield on the covered loan portfolio rose 69 basis points to 7.7% reflecting higher accretable yield principally due to accelerated recoveries in a single loan pool. Secondly, deposit costs fell by 5 basis points in the quarter to 0.89%. This decline demonstrates additional progress in bringing down deposit costs. Year-over-year our costs of deposits have declined 40 basis points. On the asset side, yield on securities declined 9 basis points to 2.98%, while the yield on loans excluding the covered loans declined 5 basis points. This was principally due to growth during the quarter in residential mortgage loans, while higher yielding categories such as credit cards and personal loans declined modestly showing yet another strong quarter originations in our Puerto Rico markets business increased by $81 million to $397 million in the second quarter. While we have been able to offset weak loan demand with opportunistic portfolio acquisitions, we continued to face challenges in organic loan origination. Let’s move to slide 5 for better detail of the quarter-over-quarter variances. Service fess and other operating income declined by $10 million in the second quarter mostly driven by the negative variation in the valuation of mortgage servicing rights which decreased slightly by $1 million in this quarter after reducing by $6 million in the previous one. There was also negative variance of $7…

Thank you, Jorge. From a credit metric standpoint, the key observation for the quarter is continuing to improve. I would like to do two things today. First, I will highlight (credit trends) and then take a closer look at our Puerto Rico mortgage exposure. Please turn to slide number 6. Total non-covered loans grew slightly to $21 billion aided by the previously mentioned purchases in consumer and mortgage loans. NPLs, excluding covered loans, declined by $120 million to $1.56 billion, down 7% from the first quarter and 33% from its peak in the third quarter of 2010. NPLs are at the lowest level since the first quarter of 2009. The linked quarter decrease was experienced across both regions and across all portfolios. Net charge-offs declined for the third consecutive quarter. On a linked quarter basis, net charge-offs fell by $10 million to $98 million, the lowest level since the first quarter of 2008. The decrease was mainly due to lower losses in both Puerto Rico and U.S. commercial loans. The provision for loan losses amounted to $82 million. As you may recall, the enhancements of our allowance methodology in the first quarter had a positive effect on the results of that period. The provision in the second quarter reflects lower losses and improved credit metrics from the commercial, legacy, and consumer loan portfolios. This improvement in credit metrics were in part offset by increasing the reserve requirements for the Puerto Rico mortgage portfolio due to higher losses and specific reserve requirements for loans restructure on the loss mitigation program. As explained in our previous webcast, the increase in mortgage loss trends was principally related to implementation of our revised charge-off policy during the first quarter of 2012. We remain very comfortable with the risk profile of this portfolio. I will…

(Operator Instructions) The first question comes from the line of Joe Gladue with B. Riley. Please proceed. Joe Gladue – B. Riley: Hi. Richard Carrión: Hi, Joe. Joe Gladue – B. Riley: Richard, let me just follow-up on one of your last comments about Basel III, just wondering if you could touch on what you think some of the major impacts that will be on your business and if it caused you to change any of your business practices – types of loans or securities? Richard Carrión: So, far I think the major impact will be felt in our mortgage business. We’re looking at waiting through these rules. It looks like the major impact will be on the mortgage side. Again we’re not crazy about it, but we don’t see anything in there that we can live with it will obviously require some adjustments about, but we haven’t seen anything that we can’t live with. I don’t know Jorge if you want to add?

No, that’s correct. You mean that this is a process that it will be phased in through a period of time. And given that it will be increasing capital organically throughout this time, we conclude there is no reason we conclude that we will have to raise capital, because of Basel III we feel comfortable. Joe Gladue – B. Riley: Okay. Let me ask a question or two to about I guess asset quality just I guess some numbers. Could you tell us where I guess the current TDRs and early stage delinquencies stood at quarter end? Richard Carrión: I don’t have the numbers in front of me we’ll provide that information after the call, Joe. Joe Gladue – B. Riley: Okay. Richard Carrión: It’s something that we include in our regular package, its part of – will be part of the 10-Q, but we’ll provide you that after the call. Joe Gladue – B. Riley: Okay. And I guess lastly, I’ll just ask in regards to the loan purchases just wondering one in a quarter they were when you made them and how much impact they might have won – still to come? Richard Carrión: Yeah, the Puerto Rico when actually closed on June 28, the U.S. was in it throughout the quarter, they were a number of purchases. Carlos, you have different dates on it, but they were throughout the quarter. Carlos Vázquez: The biggest part of the U.S. purchase was during the month of May. Joe Gladue – B. Riley: Okay, alright. Thank you.

Your next question comes from the line of Robert Greene from Sterne Agee. Please proceed. Robert Greene – Sterne Agee: Good morning. Just a couple of quick questions, I think first I just want to revisit your revised guidance expectations, I know there is obviously a lot of moving parts with the quarter and sort of going forward. But the $10 million reduction I guess in – with the guidance, I was wondering what was specifically attributable to that whether it’s slow in top line, higher than expected expenses or I guess higher than expected provision? Richard Carrión: Well, it’s a combination of things. One is we are seeing very weak loan demand and we are depending on loan purchases to make better. And as you know these things sometimes come up or sometimes they don’t come up. So, there is some uncertainty to the downside there. Additionally, we are finding as we go through the cost reductions, we are finding a lot of costs that are associated with NPL and it’s very difficult to bring those down until we are – we bring all the NPLs that are down. We had in this quarter that negative amortization of FDIC asset which I explained so masterfully that was $8 million in cote, so that was in levels that we weren’t trying. Robert Greene – Sterne Agee: Okay, it’s very helpful. And then I guess going over to credit quality on the commercial inflows big improvement in Puerto Rico looked a little bit more flat in the U.S. and I understand it’s lumpy, but do you expect sort of that $45 million run rate to improve or is that kind of status quo for the foreseeable future?

I will say I mean in the U.S. business we are further along in terms of improving the credit quality. So, I think some of the dynamics of improvement in Puerto Rico versus improvement in U.S. are different in that regard I think you will see - continue to see improvement or I think you’ll continue to see improvement in Puerto Rico and improvement in the U.S. will be more leveled? Robert Greene – Sterne Agee: Okay. And then just one last follow-up on credit quality, it looks like there was a modest reserve release in the non-covered portfolio. But overall, I’m sorry reserve coverage in mortgage went up. I’m just wondering how much of that is attributable to the change in charge-off policy versus the portfolio purchases or any of the sort of reevaluation of the portfolio loss content?

I think the increases in the allowance for the mortgage portfolio driven by two factors as you mentioned. We changed the charge-off policy and that has implemented – it has an impact in the methodology and cumulative procedure we use in order to estimate losses. But in addition to that we have had significant activity in terms of loss mitigation programs and drove up their restructuring and that activity has also increased the level of research for our portfolio. Robert Greene – Sterne Agee: Alright, I think that’s well do, thank you very much. Richard Carrión: Thank you, Bob.

Your next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed. Ken Zerbe – Morgan Stanley: In terms of the selling of the NPA – pieces of the NPA portfolio you mentioned a couple of times can you just give us sort of an update in terms of you’re – the likely ability you guys have to sell that reasonably soon or bring to that down including the willingness of buyers to purchase some of those NPAs? Thanks. Richard Carrión: We have quite a few discussions going on and it’s difficult to predict when these reach fruition. There are a few deals that we think can happen certainly in the second-half of the year. Some individual deals and there are a few people looking at portfolios. But I just can’t give you assurance that we’ll get it done. We do think we will bring the level done considerably and we are very focused on that, because it’s not only bringing the NPA level down, it impacts a lot of other expenses that we’d like to come down. Ken Zerbe – Morgan Stanley: And was there any other reduction this quarter in the NPAs related to sales or was that just that’s a broad question, but anything unusual on the reduction of NPAs this quarter or is that just very plain blocking and tackling and bringing it down? Richard Carrión: It was blocking and tackling, but one or two did come in that we have been working on a while, but no sales, usually pay-off not sales, it’s kind of pay-offs on the sales. Ken Zerbe – Morgan Stanley: Okay and just last question about a month… Richard Carrión: I’m giving it to Lidio, so if I am telling the truth.

You go ahead. Ken Zerbe – Morgan Stanley: Okay, about a month ago when you guys were at our Conference I think Jorge gave an estimate for the impact of Basel given the higher risk weightings on the resi was about 100 to 200 basis points. I was just wondering if you guys had done any more work to get more precise estimate? Richard Carrión: We are again calibrating that, but it’s not going to be more than that. And as I’ve told you, we don’t anticipate needing to raise any capital, any additional capital to comply with new things, it will make something from the business difficult, but we don’t anticipate the need to raise capital even in the full stress scenario. Ken Zerbe – Morgan Stanley: Great. Thanks.

(Operator Instructions) Your next question comes from the line of Michael Sarcone from Sandler O'Neill. Please proceed. Michael Sarcone – Sandler O'Neill: Hey, good morning guys. Richard Carrión: Good morning. Michael Sarcone – Sandler O'Neill: Thanks. As it relates to funding costs just on the repro agreement terminations, do you have an estimate to how beneficial it will be to the margin replacing that with lower cost repos?

Certainly we would expect this to improve the margin point forward for recent developments on it. It’s within the entire amount it has a few basis points that sure will come handy in the future. Richard Carrión: We’ll make it up over the next 24 months so…

That’s right. It would be – the default will be coming in 2013 Michael Sarcone – Sandler O'Neill: Okay. And on deposit costs is there much more room to come down on those? Richard Carrión: There is still some more room as I mentioned probably in the last couple of calls, it’s getting tighter. It’s getting more difficult as we have reached levels that really bottomed out, but there is probably another 5 to 10 basis points hopefully. Michael Sarcone – Sandler O'Neill: Okay. And then switching to the mainland franchise, can you just refresh us on your outlook there and potential strategic alternatives? Richard Carrión: Carlos is here, so let me – let him handle that, he has been quiet. Carlos Vázquez: We made a lot of progress this year. And as Lidio referred to in the first quarter, the U.S. operation did benefit from some reserve releases. And in the second quarter, we also achieved the solution of some long-standing up from the loans, which have resulted a little bit. So, we continued to be positive. As Richard mentioned earlier, we expect contribute to overall the Corporation this year. So, I wouldn’t go out as far as multiplying the first six months by two, okay.

You bet. Carlos Vázquez: And strategically, we are still focused on just continuing to improve the operation, our biggest operations in New York, which we just re-branded five weeks ago. So, we are focused on basics and blocking and tackling as we discussed earlier. Michael Sarcone – Sandler O'Neill: Okay, thanks guys. Richard Carrión: Okay.

Your next question comes from the line of Derek Hewett with KBW. Please proceed. Derek Hewett – KBW: Good morning. Richard Carrión: Good morning, Derek. Derek Hewett – KBW: Hey, do you guys have the current cash balances held at the holding company as of the second quarter? Richard Carrión: Size of the holding company?

About $300 million. Richard Carrión: Yeah. Derek Hewett – KBW: And is that just cash or cash equivalents as does that include any of the – I think the holding company has some investments in the…

No, that’s cash and cash equivalent. Derek Hewett – KBW: Okay. And then moving on to the NPA balances that are held-for-sale, what percentage of unpaid principal balance are those loans currently marked at?

37%, 37.5% more or less. Derek Hewett – KBW: Okay, great. Thank you very much.

Your next question comes from the line of Jason O’Donnell with (indiscernible) Research. Please proceed.

Good morning. Richard Carrión: Good morning, Jason.

Can you just comment maybe on your outlook for core non-interest income for the remainder of the year? It looks like the other service fees and other operating income lines were down linked quarter and maybe just remind us of what the key items are in the other operating income line that are driving those big linked quarter variances? Richard Carrión: Bear in mind that – that other income is down for a couple of reasons. One is that write-down in held-for-sale comes off the gain on sale piece, which is part of other income. So, when you compare it, you got to bear that in mind. Other than that, I think it should remain fairly strong. I think we’re looking at fairly flat for the rest of the year.

Okay. So, you expect other service fees to that particular line to rebound for the remainder of the year? Richard Carrión: Yeah. The thing that creates some volatility in that line is the FDIC stuff and that goes up and down depending on the covered loan provision expense and 80% of that in any expenses. We have, for example, this quarter I think we have $13 million in our operating expenses that they reimbursed up to us, so that’s $10 million. So, it jumps up and down with that kind of stuff. You got to take that out.

Okay, thanks guys. Richard Carrión: Okay.

I would now like to turn the call over to management for closing remarks. Richard Carrión: Okay. Well, thank you very much for joining us and see you next time.

Thank you.

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.