Popular, Inc. (BPOP) Q3 2012 Earnings Report, Transcript and Summary

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

Good morning. Thank you for joining us on today’s call. Our Chairman and CEO, Richard Carrión, CFO, Jorge Junquera, and our CRO, Lidio Soriano 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 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. We also want to announce that we will hold our Investor Day on Friday, December 14 in San Juan. We will furnish the press release next week with details. I will now turn the call over to Mr. Richard Carrión. Richard Carrión: Good morning and thank you all for joining the call. I would like to address three topics in my remarks this morning. First, I will provide a high level overview of third quarter results and Jorge will provide more details in his remarks. Second, I would like to take a step back from this quarter’s results and provide some perspective on where we are today and how we are managing Popular to create shareholder value. And third, I want to focus on the fundamental strength of our company and the reasons we believe there is a substantial value in the franchise that is not being reflected in our current share price. So please turn to the second slide. We have $47.2…

Thank you, Richard. Good morning. Let's turn to slide five to review the financial highlights. Third quarter was relatively free of noise and I am sure that you appreciate that. I certainly do. Absent the noise, our performance became clear, stable revenues, lower provision, and lower funding cost through our third quarter results. Before I go into the details I want to point out that we have added some new disclosures to our earnings releases this quarter in an effort to add some clarity on key issues. In particular, we have added a table on the second page of the release that highlights the main financial statement impacts related to the accounting for the covered portfolio. As we discussed last quarter, the accounting of this portfolio is complex, so I wanted to give you a way to see quarterly variances in one slide. In the third quarter, we earned greater income from our non-covered portfolio and thoroughly reduced our cost of funds, thanks to our continued push to lower the cost of deposits. And to the benefit of having prepaid high cost repos in previous quarters. The cost of deposits fell by 9 basis points or $6 million and the cost of borrowings fell by 56 basis points or $3 million. Net interest expense on deposits during this quarter was 35% lower than the same quarter last year. Higher volumes in our mortgage and consumer portfolios helped offset higher prepayments in our investments portfolio and a decline in interest income from our covered portfolio. We remind that in the second quarter a number of loan resolutions increased income from our covered portfolio. Non-interest income went up primarily because of favorable variance of $24 million in the valuation of our held for sale portfolio. The negative valuation adjustment amounted to $3…

Thank you, Jorge. Before I go through the slides, let me first start by highlighting three key credit trends. First, third quarter results reflect improvements in overall credit quality and the successful execution of our loss mitigation strategy. As of the end of the third quarter, non-performing assets and non-performing loans are at the lowest level since 2010 and 2009 respectively, and net charge-offs have decreased for four consecutive quarters. Second, we continue to benefit in the U.S. by the improving economy and our derisking strategies. NPL declined from the second quarter by $20 million to $226 million and are down $530 million or 67% from the peak amount. Net charge-offs in the U.S. declined to the lowest level since 2009 at $25 million. Third, the quality of our Puerto Rico loan portfolio continues to improve driven by a combination of measures put in place to strengthen our risk management capabilities and the stabilization to improvement of economic indicators in Puerto Rico such as stable employment, increasing retail sales and increasing tourism figures. During the quarter, the largest NPL was resolved at its book of $50 million. This transaction and the resolution of two other large relationships reduced NPL held for sale by 39% or $70 million to $109 million. Please turn to slide seven. Total loans held in portfolio grew slightly to $20.8 million due to a higher mortgage origination in Puerto Rico and purchases of high quality portfolios. NPLs held in portfolio declined from the previous quarter by $12 million to their lowest levels since the first quarter of 2009. NPLs are down 34% from their peak in the third quarter of 2010. The decrease in the third quarter was led by a $17 million reduction in U.S. commercial loans and an $18 million reduction in Puerto Rico…

(Operator Instructions) And our first question is from the line of Joe Gladue from B. Riley.

I want to start off with a few asset quality questions. First off, just wondering if you could give us a little more color on the resolution of some of the construction loans during the quarter. Was that sales or payoffs or just ….? Richard Carrión: The ones that Lidio referred to in his remarks were actual sales, Joe. Yeah,

Individual sales. Richard Carrión: Yeah.

Okay. And I guess....

And (inaudible) we’ve negotiated with borrowers. So it’s a combination of sales and discounted payoff negotiated with the borrowers. Richard Carrión: The bigger one, the biggest one, the $50 million one was the sale. Was an outright sale.

And also I have noticed there was some increase in the balance of construction loans. Just I guess wondering where you -- was that increases in draw-downs on existing loans or is that new loans?

We have very selectively started some construction lending. In Puerto Rico that is mostly related to commercial property or a judicial building that is being built for the federal government. So that’s driven by that.

Okay. Just could you tell us what the level of accruing TDRs was at the end of the quarter? Richard Carrión: He was ready for this one, Joe.

Yeah, I think every quarter I miss this one, so this time I do have it. We have about accruing TDRs, as of the end of the September are about $629 million.

Okay. And I guess, lastly, I will just ask, just about the outlook for loan demand. I guess there is a little bit of growth in the non-covered portfolio this quarter but I guess not enough to offset the decline in covered loans. Just wondered if you could give us sort of a breakdown of where you see loan demand in segments, in geography, and when that might overtake the decline in the covered loans? Richard Carrión: All right. Let me take a stab on that. In Puerto Rico obviously we have the decline in covered loans and that will be gradual over time. We are seeing, in the commercial side we are seeing some demand in the upper-end in what we would call corporate but certainly not corporate by mainland U.S. standards. But we are seeing some demand, some investments there. Much less so and very slow loan growth and demand in the small and middle business sector. Consumer is pretty much stable with the exception of automobiles. Automobiles, we've seen sales go up quite a bit and that part is growing as is the mortgage portfolio. In the U.S., I would tell you that on the commercial side, that we are seeing a fairly flat demand and there we have some legacy portfolios that are coming down. So, the demand we're seeing is not enough to make up for that fall. So, finding assets is a key question for us.

Your next question is from the line of Ken Zerbe from Morgan Stanley.

I appreciate all the color that you gave on Basel III, and I apologize if I missed this, but did you or could you provide what the pro forma impact to your Tier 1 common would be if you applied Basel III as of this quarter? Richard Carrión: Yeah, I think it's roughly 200 basis points. But I don't think anybody is applying Basel III tomorrow. But if that were the case, I mean, we thought it would be more meaningful to actually go through the more dynamic analysis of how it actually would get implemented although even those dates are under review. But if we were to do it right away, I think the impact is roughly 200 basis points on the common equity Tier 1. So it takes us from 12.72% to 10.70%.

Understood. Okay. It just helps putting everyone on the same basis. The other question I had, maybe just help us think about the reduction in NPAs. I know it's one of your top priorities. You've certainly been very vocal about reducing NPAs, I think, we've all kind of been frustrated maybe of how slow the reduction has actually happened. When you think about going forward with the NPA reduction, what is your timing. I just want to make sure that we are all on the same page that when you think about by the end of the year, by the end 2013, these are kind of the milestones which you are trying to hit, that way we can think about it in the right way. Richard Carrión: Sure. We'll probably, I mean we're not going to put a number out there. We certainly have a target but as you know these deals come -- Puerto Rico is a lot less liquid market than in the U.S. We've had a lot more success dealing with some of these things in the U.S. where there is a much more liquid market for these assets. That's not the case in Puerto Rico. Nonetheless, there are deals and we've seen some of these deals. If we see a significant deal of size that makes sense, we're going to go ahead and do it. We think it's a high priority for us. We are working on it. We hope to continue reducing it substantially over the next few quarters but we don’t have a specific number that we want to put out there.

Your next question will come from the line of Todd Hagerman, Sterne Agee.

Just wanted to talk a little bit more about the commercial and construction portfolios and how it relates to the held for sales and held for investment. Obviously you have made pretty dramatic improvement year-over-year in both of those portfolios and held for sale came down pretty meaningfully. Could you just talk a little bit more about how we should think about that pace? Obviously you had some sales this quarter that occurred, but kind of following on the previous question with the pace of improvement. It’s been pretty meaningful over the last year, are you starting to see more opportunities to further reduce that in a more accelerated fashion? How should we think about that given kind of the trends? Richard Carrión: Again, these opportunities don't necessarily follow a continuous line. They are a bit more sarcastic in nature. But yes, we are seeing, as the economy gets a little better, we are seeing more interest, more people are coming down, taking a look, picking their tires and it’s just a matter of coming to agreement. We have seen the balance come down quite significantly particularly in that held for sale portfolio and we are seeing a number of resolutions in our held for investment portfolio. So, again, we do think it will continue at this pace.

Okay. Great. And then just secondly, in the States one of the significant impacts this quarter is new OCC guidance related to modifications in consumers filing for bankruptcy. I know you're not an OCC bank per se with the Fed and the Commonwealth. But has that been an issue that's been raised by the Fed or is it an issue that you're currently looking at with your existing portfolio kind of given the changes that we're seeing in the U.S.? Richard Carrión: Let me have Lidio take a stab at that.

Yes. Thank you, Richard. The majority of our residential portfolio is in Puerto Rico. In Puerto Rico, the majority of the bankruptcies are reorganization rather than liquidation. The OCC direction was related to Chapter 7 liquidation in which the borrower does not reaffirm his or her mortgage debt. That is not a material -- that will not have a material impact in our organization because of our business in Puerto Rico.

Okay. So, is that something now that, I'm assuming nothing happened this quarter, but is that something that potentially may have, not to say a material, not to say -- as you put it, not much of an impact but is that something that you're evaluating for the fourth quarter?

Not a material impact. I mean, as I said, in Puerto Rico more than 90% of the bankruptcies are reorganization rather than liquidations.

(Operator Instructions) Our next question is coming from the line of Gerard Cassidy, RBC Capital Markets. Our next question is coming from the line of Derek Hewett, KBW.

A quick question on the margin. It's kind of flat to maybe slightly up relative to the beginning of the year. How much longer do you guys think you can defend the margin at these levels before we start to see it? Richard Carrión: Well, we have two opposing forces. On the one hand, on the assets side, I think we have the impact of the Westernbank portfolio beginning to wane. On the cost side, however, we have been lowering the cost of deposits significantly and that has outweighed the former. So, we are comfortable with where our margins are. Obviously, we defend it tooth and nail and we are continuing to try to maintain it at this level which we think is way higher and it is a competitive advantage for us.

(Operator Instructions) And at this time I'm showing no further questions in queue. Ladies and gentlemen that concludes today's conference. Popular Inc. would like to thank you for your participation and you may now disconnect. Everyone have a great day.