Popular, Inc. (BPOP) Q3 2016 Earnings Report, Transcript and Summary

Good morning. And welcome to the Popular Inc. Third Quarter 2016 Earnings conference call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. And now I'll turn the call over to the Investor Relations Officer at Popular Inc. Brett Scheiner.

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 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 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 the third quarter. Then I'll 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 an update of credit trends and metrics. Please turn to Slide number 2. In the third quarter, Popular reported net income of $47 million, which includes the impact of the $55 million adverse award on the recent arbitration with the FDIC? Adjusted net income totaled $95 million, up $4 million from last quarter’s adjusted results. We continue to generate strong revenues with capital levels well above peer averages. Tangible book value was $44.86, up from $44.62 last quarter. Our net interest income was down $7 million from the prior quarter. Our net interest margin of 4.12% declined from last quarter’s 4.33% of the result of lower yields on the Westernbank portfolio. Lower yields on increased liquidity due to high public sector deposits and slightly higher funding cost in the US. Our spreads remain strong relative to peers with our Puerto Rico net interest margin of 4.49%. We’re also encouraged by the trends in our U.S. business, particularly the continued strong commercial loan production. Total NPAs this quarter up $805 million including covered loans were down $30 million from last quarter’s $836 million mostly due to the PREPA sale in the quarter. Non-covered NPLs were $579 million or 2.6% of non-covered loans, up $2 million from last quarter. NPL inflows decreased by $6 million mainly due to reduction in Puerto Rico commercial inflows of $40 million, offset in part by an increase in Puerto Rico mortgage inflows of $8 million. Our net charge-off were $35 million, or 63 basis points, flat to last quarter excluding a $5 million recovery in the prior period. At quarter end, available holding company liquidity stood at approximately $409 million. This liquidity position provides an access of two years debt service coverage with no maturities until 2019. The market value of our stake in EVERTEC is approximately $196 million and significantly exceeds our positions current book value of $37 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. During last year's third quarter, we reinstituted our common stock dividend and intend to return additional capital to our shareholders over time. As we discussed last quarter, we filed our Dodd-Frank Stress Test at the end of July. The strong result of which were made public last week. In addition, we filed our capital plan soon after our stress test. And our regulators continue to review our stress test and capital plan and we hope to update you by the end of the year. Please turn to Slide 3. Before I turn it over to Carlos, let me comment on our Puerto Rico Government exposures and the Puerto Rico fiscal situation. During the quarter, we sold our $75 million PREPA loan for an $8.5 million pretax gain on its $40 million book value. Our direct outstanding exposure to the Puerto Rico Government is $524 million, down $58 million from the previous quarter. The sequential decline is mostly due to the previously mentioned loan sell. Nearly all of our direct Puerto Rico Government exposure is in loans to municipality not publicly traded securities of the central government or its public 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 development in this portfolio closely and make future adjustments as needed, while selectively participating in funding the Puerto Rico Government's capital needs when we feel the risk reward is appropriate. Regarding the Puerto Rico Government's fiscal challenges, in June federal legislation created a fiscal oversight board for the island and established a legal framework and path to an orderly debt restructure. It also created a bipartisan congressional taskforce to make recommendations to help promote economic growth. This legislation reduces uncertainty which has had a meaningful impact on investor, business and consumer confidence in recent years. In the near term, the law provides a stay on litigation, allowing for a more orderly debt restructuring process particularly given recent default from several classes of Puerto Rico debt. Over time, we believe the Board and restructuring framework will result in increased fiscal discipline and facilitate a transition toward a 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 stemming from improved business and consumer confidence, energy infrastructure development and hopefully a pay down of balances owe to suppliers by the Puerto Rico Government. Ultimately, these actions will lay a foundation for a sustainable economic growth. The members of the permit oversight board were named in September and a chairman was selected. The most pressing charge is named an executive director to manage the fiscal rebalancing and debt restructuring process. As we move into 2017, the Board's focus will likely shift to the fiscal 2018 Puerto Rico Government budget as well as more subset to discussion with bond holders. In addition, the bipartisan US congressional task force named this past summer is expected to offer recommendation and report to the US Congress by the end of the year on way to start economic growth in Puerto Rico. As we stated last quarter, we believe the critical items with this task force to consider are proposals focused on job creation and attracting investment, as well as analyzing Puerto Rico's equitable access to federal healthcare program. The ultimate success of the oversight board depends on the cooperation of groups that frequently have conflicted interest. In addition, a new Puerto Rico Government and administration will be elected in two week. Progress on these fronts will require patience as the board is not expected to name an executive director before the end of the year. In sum, we believe this legislation and the actions that will follow albeit painful are step in the right direction to restore the fiscal health of the Puerto Rico Government and ultimately 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 a 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 4, as our CFO, Carlos Vazquez, discusses our financial results in further details.

Thank you, Richard and good morning. Slide 4 presents our GAAP financial results for the third quarter. Slide 5 shows our calculation of adjusted net income with additional information available in the appendix. Today's earnings press release detailed variances in the second quarter with lower net interest income and higher operating expenses. FDIC loss share expense increased meaningfully due to the previously announced $55 million charge resulting from the FDIC arbitration. Net interest income for the third quarter was $354 million, down $7 million from the second quarter mostly due to lower balances and yield in our Westernbank portfolio. Our margin was 4.12%, down from 4.33% last quarter due to lower yields on the Westernbank portfolio and lower yield on cash and securities that result from increased liquidity mostly from higher public sector deposits. The average yield of our $1.8 billion Westernbank loan portfolio decreased to 8.65% from 9.94% last quarter, reverting to levels similar to those of the first quarter of 2016. As previously disclosed, a portion of the elevated yield last quarter was due to resolution of various cases. As was the case in Q2, changes in expected cash flows of individual relationships can make the yield and this portfolio volatile. Over time, we expect this yield to decline as a result of repayment and loan resolutions. Excluding the Westernbank loans, we benefit from relatively stable loan yields in the rest of our portfolio. The cost of our interest bearing deposits was up two basis points to 57 basis points on higher cost of time deposits in the US. We continue to deliver organic commercial loan growth in our US operation with quarterly growth of 4%. While 2016 loan balances would likely be stable, in 2017 we anticipate slight growth in overall loan balances with the US more than compensating for the Westernbank run off and limited growth in Puerto Rico. On the Island, we have historically offset limited organic growth with selective loan portfolio purchases. We will continue to pursue the acquisition strategy if attractive transactions become available. Noninterest income excluding FDIC loss share activity increased by $50 million compared to last quarter. On the gain of the sale of our PREPA loan and higher income from our equity investment. FDIC loss share expenses were higher by $49 million primarily driven by the impact of the previously announced FDIC arbitration decision. Excluding this affect, this expense would have been down $6 million for the period. Our Puerto Rico mortgage business originated $235 million of loans in the second quarter, down from $254 million last quarter. Total operating expenses for the quarter were $324 million, up $15 million on higher operational and fraught losses, personnel cost and goodwill impairment of $4 million in our Puerto Rico securities subsidiary. We anticipate that some of these expense line items will revert back to prior trend. In the coming quarter, we expect operating expenses approximately $320 million. These additional expenses include the promotion and growth of our D2 channel, our US retail network transformation and investment in technology compliance and back office infrastructure. We anticipate this increase in expenses from prior quarters to be offset during 2017 by lower FDIC loss share expense, high net interest income from our US loan growth and higher service charges in Puerto Rico. Our effective tax rate for the third quarter was 25% which included $4 million benefit from the release of a tax reserve in Puerto Rico. Through the end of 2017, we expect our quarterly tax rate to average between 25% and 27%. As disclosed earlier this month, we are disappointed with the unfavorable result in the arbitration of the $55 million receivable previously under dispute with the FDIC. After accounting for this decision, we have a remaining $152 million FDIC receivable. $87 million of that amount represent reimbursable losses that are still in dispute while the remaining balance of $65 million is related to the single family mortgage loss share agreement which expires in four years. We currently expect to collect the remaining disputed balance of $87 million. The arbitration hearing related to $82 million of the receivable on dispute is schedule for next month. And we should have a final word by year end. As we've stated before, any amount of the loss share asset ultimately now collected from the FDIC will be charge off. Please turn to Slide number 6. We continue to enjoy strong capital levels relative to Mainland and Puerto Rico peers as well as with respect to well capitalized regulatory requirements. All of Popular's capital ratios remain robust and well above regulatory requirements. As reflected by the result of our Dodd-Frank Stress Test made by last week. Lidio will expand on this later. Our Tier1 common equity ratio was 16.6%, up 30 basis points from 16.3% in the prior quarter. While being responsive to the challenging environment in our local market, we are pursuing additional opportunities to aptly manage our capital including additional dividend and share repurchase as well as M&A and asset acquisition. Last year we resumed the payment of our quarterly common stock dividend of $0.50 a share roughly six months after filing our stress test. While we had hoped that the regulatory consultation process will be faster this year that has not proven to be the case. As Richard mentioned, our regulators continue to review our stress test results and capital fund. We look forward to providing an update the market once our discussion with them is finalized. We now hope this can take place by year end. It continues to be our goal to maintain strong capital levels are appropriate for Popular's risk profile as we work towards our target of double digital return on tangible equity. With that, I'll 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 third quarter. In Puerto Rico, credit metrics reflect lower net charge offs, lower NPLs, lower NPA and lower NPL inflows as compared to the previous quarter. In the U.S., credit metrics reflect stable NPLs, stable inflows into NPL and low net charge-offs. Key events during the quarter included the sale of return off credit cards and personal loans in Puerto Rico that resulted in $7 million recovery and the sale of the PREPA loan have resulted in a gain on sale of $8.5 million. As Richard covered on slide number 3, our current outstanding direct exposure to the Puerto Rico Government, municipalities and other instrumentalities is $524 million, decreasing by $58 million from last quarter mainly due to the sales of PREPA loan coupled with schedule principal payments received on existing loans. Our total outstanding exposure to the Central Government and public corporations is minimal, representing only 0.6% of total Tier 1 capital. As we have discussed in the past, most of Popular’s 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. These exposures are carefully underwritten book of business with senior interest in the municipalities identified 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 by amount, the second most Popular’s municipality. These four municipalities comprise approximately 74% of our total municipality exposure and combined have operating surplus of approximately $30 million and debt service capacity in excess of 2x. In addition, these municipalities have meaningful sources of liquidity outside of deposits held at GDB. We also have indirect lending facilities in which the government acts as a guarantor. The largest social exposure is in the form of residential mortgage loans to individual borrowers in which the government provides a guarantee, similar to original programs in the U.S. As mentioned by Carlos this week we disclosed our Dodd-Frank Stress Test. The test combines the Fed's mandated several adverse scenario for the US with a severely adverse scenario for Puerto Rico in which Dodd and Frank rate peaks at 20.6% and economic activity measured by GMP decreased by 6.7% during the first calendar year. Under such scenario, we forecast over 8% loan losses in the nine quarter period and reflect 2.65% impact to our Tier 1 common equity ratio over that time. Maintaining a meaningful cushion in excess of world capitalized status at all time. Turn to Slide number 7 to discuss credit metrics for the quarter. Non-performing assets including corporate loans decreased by $30 million to $805 million driven by the sale of the PREPA loan, offset in part by an OREO increase of $7 million mainly in the Puerto Rico mortgage portfolio. Non-performing loans improved slightly by $1.6 million driven by higher mortgage NPLs in Puerto Rico of $8 million offset in part by lower commercial NPLs of $6 million in Puerto Rico. The ratio of NPLs to total loans held in portfolio remain flat at 2.6% quarter-over-quarter. Please turn to Slide number 8 for a summary of the trend in NPLs inflows. Compared to the previous quarter, NPL inflows excluding consumer loans decreased by $6 million mainly due to our reduction in Puerto Rico commercial inflows of $40 million, offset in part by increase in Puerto Rico mortgage inflows of $8 million. NPL inflows in the US were flat on a linked quarter basis at $9 million. Please turn to the next slide to discuss other credit metrics. Net charge-off amounting to $35 million or an annualized 63 basis points of average loans held in portfolio were flat from the second quarter of 2016. As previously mentioned, the results for this quarter included a $7 million recovery from the sale of previously charge-off consumer loan. Excluding this impact, the increase in net charge-off was mainly driven by a variance in the Puerto Rico construction portfolio due to lower recoveries, coupled with higher losses of $2 million in the US mortgage portfolio. The provision for loan losses in the third quarter increased by $3 million to $43 million mainly as a result of strong portfolio growth in the US region. The provision to net charge-off ratio was 121%, down from 127% in the prior quarter excluding last quarter's book sale recovery. The corporation allowance for loan losses increased by $8 million from the previous quarter with equal increases in Puerto Rico and the US. The ratio of allowance for loan losses to loans held in portfolio was flat to the previous quarter at 2.3%. The ratio for allowance for loan losses to NPL held in portfolio stood at 91%, up 1% from last quarter. To summarize, by continues stable credit performance despite challenging economic conditions in Puerto Rico, is the result of the steps we have taken to derisk our loan portfolio by reducing its exposure to asset classes with historically high loss content. In addition, we've strengthened 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'd like to turn the call over to Richard for his concluding remarks. Thank you.

Thank you, Lidio. And please turn to Slide 10. 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, or 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 two years, we have repaid close to $1 billion in part; had two credits MOUs lifted, restructured our U.S. balance sheet and back office, purchased $2 billion of assets in the Doral transaction and reinstated our common stock dividend after six years. We'll continue to seek additional growth opportunities in the current environment. The actions taken by the oversight board in the coming months will be defining moment for Puerto Rico's future. We remain confident the 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 is from Brett Rabatin in Piper Jaffray.

Hi, good morning, everyone. Wanted to first ask obviously there has been a delay with the capital plan. Can you maybe share with us if you could, your thoughts on what you were hoping to do in terms of a buyback or any color around the initiative there?

Well, we'd rather wait till we finish our discussions with regulators. Obviously, we would like to return some capital and it will probably a combination of the two but we are -- we submitted our plan, we'll finish our discussions with the regulators which unfortunately the timing is not up to us. And we will announce it right away.

Okay. And then if I heard it correctly, $320 million of quarterly expense run rate for 2017, right? Does that start in 4Q and then can you talk about what initiatives are driving that?

Yes. I mean as you know Brett we are -- our expense is tend to be rather volatile so different lines change quite a bit every quarter. That is one of the reasons while we -- when we give you some guidance on expenses we play at the aggregate level just because all the pieces end up moving quite a bit. The pieces that move this quarter were operational losses and personnel cost and goodwill in profit securities but there is other things that we expect to continue to move. As I mentioned the business thus continue to require some investment. That is part of the reason the expenses is going up. Again we are continuing to invest on our D2 channel. We are working on improving the capacity of our use operation to fund itself and fund itself more attractive rate by making the French network better.

It looks complex.

That implies -- that includes moving some branches -- opening some branches, remodeling some branches, making some branches smaller, a number of activities. And then technology compliance and back office continue to require additional investment and that is obviously true of us and maybe other bank. So some of that is going in that those lines as well.

And then I want to make sure I heard you correctly. Your body language I think sounds more optimistic than I think I have heard it on the economy. Was just wanting to make sure I kind of got that read right? And then as far as loan purchases go, can you talk about your plans there and what you did in 3Q?

Well, I guess if we sound more confident is because we continue to see the stable credit metrics and as the pieces of PROMISA Board start following into place. We at least see some movement in a direction. That's not to say everything is rosy. There is a plenty of concerns that one -- the board really starts getting down. We will also see some cuts in government expenses and that will impact the economy if it is not offset on the other hand with new investment. We are also encouraged by what we are seeing in the US in terms of a lot of growth particularly in C&I loans which runs counter to what we've been seeing from other mac so we are encouraged there.

With regards to loan purchases, there was no significant loan purchase in the third quarter, Brett. And it is something that we are always looking and if good opportunity shows up we are ready and capable to move on them but nothing significant in the third quarter.

The next question is from Brian Klock, Keefe, Bruyette & Woods.

Hi, good morning, gentlemen. So, Carlos, I just wanted to follow up on the expense side of things. I know you mentioned that you think that even though the expense number may be a little volatile and higher close or near that 320 level that came in at the third quarter. So when I think about the fee income, there is some noise in there was some of the indemnification reserves and you said there would be a lower loss share. And I guess what is the rate efficiency ratio we should be thinking about or what is the right level of fee income that you think we could be at to help partially offset the higher expenses?

At this time, the way you look any brand is pretty much what I mentioned in my comments and while you are correct in -- we see higher running rate on expenses. We also see in 2017 higher income to compensate for the higher expenses. We believe more so that will come from again it lower at the lesser expense, some higher net interest income and also some higher service charges in Puerto Rico, those will be principal contributors to offset in the additional expenses. As usual there will be others, there will be surprises going both way but if anything the more important message is that while the expenses would probably be slightly higher, we are also seeing some income to offset that.

Okay. Maybe just a follow-up. I know you guys have talked about -- obviously with had a couple of the quarters in a row from the asset quality side, charge-offs and provisions that beat my estimates in the last few quarters. I think when you put all of that together I guess what do you think, what kind of an ROA do you think you can generate in next year with that as the kind of expectation or guidance? Is that something that could get you back in the mid-90s and closer to a 1% ROA in 2017?

And I think you guys in the industry are always right so I'll go whatever you guys are saying.

Well, I'm not sure about that but I guess is that something that you think is doable. I've got a 91 basis point ROA this quarter, do think it is possible to enhance that towards the 1% next your?

I will never contradict to Brian. If that's what you think we will do our best.

The next question is from Ken Zerbe at Morgan Stanley.

Thanks. Good morning. Just going back to the capital plan, maybe this is just more for my benefit because I understood the whole DFAST process which you submit your DFAST plan, you get a non-objection. I guess your capital return is not necessarily a requirement of DFAST. I guess I'm just surprised by the delay in the announcement. Like what am I missing here that it now becomes that the regulators have I guess is that they have not non-objected if that makes sense to you. I'm trying to figure out why there is a delay.

I think that you got it right. You are missing the difference between theory and practice. And it is then not objecting, no. So we just have to wait it out, it is their timing not ours unfortunately. If it were to up to us believe me we would move a lot faster.

I mean you are right, Ken, fortunately or unfortunately it depend on which side you want to take, there is no formal processing in our case. So there is no set timetable nothing like that so it is just ongoing regulatory dialogue. And it takes some time. As I mentioned we had hoped this would move faster than last year. But our hope has not proving to be right. We will continue to work on it. Discussions continue and as soon as we know we'll let you know.

And I'm assuming you can't tell us any of the details and that is fine but at least are you able to tell us have they come back to you with sort of detailed or specific issues that at least they are addressing with you or are you literally in the dark in terms of what they are looking for?

As you know, we don't -- we usually don't comment on regulatory discussion. And we are never going to start today. But we describe what's happening at the dialogue and that was not by chance. So we are in discussion and when those reached their conclusion then we'll let you know.

For the lawyers, it is a dialogue but it is somewhat asymmetric okay. Let me get that in before the lawyers slap me down.

Understood, that makes sense. The offset to the expenses because I know you repeated a few times the lower FDIC expenses and that is fine. But then the higher NII and the higher deposit service charges in Puerto Rico, I guess my question is what gives you the confidence that you are going to be able to get those higher deposit service charges in Puerto Rico or the higher NII? Because I know obviously with NIM down and asset growth fairly muted, is it fair to assume that those particular items are a much smaller piece of the offset versus the FDIC?

No. We haven't given you -- we haven't broken it down for you. I mean the higher net interest income, we also commented that we expect asset growth slight low growth in loan balances next year, that is including everything the run off with Westernbank and everything else. So no more course of business if our loan book goes up which is the higher net interest income and the service charges to some -- large extent I relate to higher deposit balance. And by the way the higher deposit balance is while we prefer to deposit from the public sector frequently, the higher deposit balances are actually across all our client, our retail clients, our individual clients, our commercial clients, we have seen deposit growth in all types of deposits not only public sector deposits.

The next question comes from Gerard Cassidy at RBC.

Good morning, gentlemen. How are you? Can you share with us -- and I know it is hard to say in normalized times considering what the island's economy and fiscal situation has been going through as well as yourselves. But when you look at the amount of capital you think you are going to need to run this organization from a CET1 standpoint, obviously your capital is very high today. What would you consider to be a normal level if things were more normal down in Puerto Rico?

That's a tough question, hard to answer as you know. We currently think it is lower that is now. And in all probably it will always be higher than our peer banks slightly higher.

Agreed

Exactly how, where you draw the line between those two boundaries, there is where the magic comes and that line actually is not static. It might be dynamic given your discussion with regulators.

Okay. Can you also, you guys touched upon the FDIC loss sharing, you lost that claim. On slide 18 you give us what is remaining and there is still another claim in dispute of $87 million. Can you share the difference in these claims versus the ones that you just lost or are these I assume these are not the same ones?

Yes. They are not the same ones. It is a different arbitration panel, different issue. We have one for 82 that in essence a final argument will take part next week. So we should get some resolution there before the end of the year and sure that, that's the big one .The other one is, it is a smaller one roughly around $6 million. So that has even been scheduled for the final argument.

But different set of pack as Richard mentioned different arbitration panel so essentially it is a pretty different process.

Not only one

And the issue of dispute is the issues as different as the whole process meaning one may have been over claims for losses on loans and another one is on taxes? How about the core dispute, I mean is it different?

Yes. The core dispute is different one, completely different one. One was related to NAB restructure and another one is related to section 4.1 wholesale authorizations, so those are the issues, two separate issues.

Great. This is probably not an easy question to answer. It is more subjective than objective but clearly it appears that Puerto Rico economically and fiscally has hit bottom and now you are starting the long process of hopefully coming out of these troubles. Is there any evidence yet that the population has started to slow -- the outmigration of population to the states particularly to Florida, has that slowed at all or do you have any sense of where that is going at this time?

Well, we have no evidence that it has slowed. In fact, if anything it is slightly more this year than it was last year. No real evidence and I think they are coming -- the coming month will determine the course of that. I don't know Lidio you may want to add something.

Yes. I'd just say that population migration has -- the affect not the cost so I think it will reverse and we see improving our economy

Next question comes from Alex Twerdahl at Sandler O’Neill.

Good morning, guys. A couple of questions. First, just heading back to the capital discussion, you guys said that there is no set timeframe on how these discussions will play out. But based on your conversations last year leading up to the announcement of the dividend and the DFAST, et cetera and based on kind of where you know you are today, can you assign a degree of confidence when you say that you hope to have an announcement by the end of the year, can you assign a degree of confidence that we will get some sort of announcement pre-Christmas?

About 73.5% is probably will be -- no, really, I mean we really can't, I am sorry; I don't mean to be flip. It is frustrating for us as well frankly. But it is their timing. We do think that it will be in the next couple of months but we really can't put a number on it.

Okay. Better than 50% though would you say?

73.5% plus

Okay. That is going in my note.

You are going to forecast the result of elections too in the meantime.

And then is the whole process you are going through right now with the capital return is that a once per your process? I mean could you announce something in December and then revisit it in June or is it really just kind of -- it has to be done only once per year?

See there is no set process, Alex. The technical answer to your question is that it could happen in any time. But being practical one of the more important inputs into discussions or the decision is the stress test. So the stress test will tend to be the gating issue or the gating item to a discussion being more productive. But again since there is no process, it technically could happen in any time yes.

Okay. And then in the past you guys have given some good trends on just debit card and credit card swipes on the island. I was wondering if you have any updated trends over the last couple of months.

Pretty stable but nothing, auto loans I mean auto sales have been up but in general retail has been stable. No major change in new direction.

Okay. And then you had a huge amount of inflows of deposits this past quarter I think a lot of them were government related deposits. Should we just assume those stay basically money markets for the foreseeable future? Or I mean how do you project or anticipate or plan for inflows and outflows of $1.5 billion of deposits in a quarter?

We are kind of keeping it very short term for the time being so we get a better feel of how things will run in the next -- over the next year as the new fiscal plan takes place how that will play out if there is any debt restructuring changes and how the cash flow, needs of the government change, we are sort of keeping it short term so we get a better feel for what we think will be rock solid, bear in mind most of these are operating account with the big one being the treasury TCA account. So we will get better feel for it but for the time being we are keeping it with very short maturity on the asset side.

Are you paying interest on those deposits?

Yes. It is a minimal amount. You have to pay interest on all government deposits.

In some, yes, in some of them -- this is one of the reasons that our margin suffered to touch while is net interest income accretive, we make more dollars in interest income, it is actually margin dilutive. But as other part of the business we obviously get service fee for providing services to this client as well. So it doesn't all come to the margin line but as Richard said as we get a better reading on what the right and continue levels of the deposit will be, we will make calls on our investor portfolio. But again don't lose sight of the fact that it is not all public deposits, about a third of the increased deposit this last quarter was non public deposits, was client deposit, corporate and personal deposit.

Okay. And then just a final question for me, Lidio, do you have early stage delinquency trends?

Yes. Give me one second; on a quarter-over-quarter basis our early delinquency numbers are stable around 3.1%, with $30 million improvement in Puerto Rico offset by slight deterioration in the US, the deterioration in the US mainly driven by administrative delinquency.

The next question is from Matthew Keating of Barclays.

Yes, good morning. Thank you for taking the question. I appreciate the color on the loan growth expectations for next year being slightly positive and also the color on deposit trends being pretty robust. If you had to put a number on where deposit growth could trend, because it seems as though deposit growth has obviously been the principle driver of the Company's average earning asset growth over the past couple of years. Do you think you could still see mid single-digit or better deposit growth next year given sort of the puts and takes you might see on the public deposits, et cetera? Thanks.

No. It is hard to call it now. I'd say probably two things .First of all, it is always important to make the point the public deposits are not a liquidity issue for us since they have to be collateralized with all deposits to go down we get our securities our collateral back and we can either repos that later so it is not a liquidity issue. But it is a big number and again it is very hard to forecast exactly where that numbers going to go. So actually that makes way to balance overall. I mean what gives us more peace of mind is the fact that our non public deposits are going up. And we have been successful and saw continuing to grow the positive NIM of business together with the balance sheet. So if you look at the big piece is there is unknown in deposits in Puerto Rico. You have the US growing to balance sheet and hopefully growing deposits with it. And some core deposit growth on non public deposit peer. The big delta would be the public deposit and it is very hard for us to product that right now.

That is helpful. Thank you. Then I guess forgive me if I missed this, but mortgage banking has been sort of a volatile line item over the last couple of years. But it seems to have stabilized recently around $15 million, $16 million range. Do you think that is a decent run rate given what you are seeing within the Puerto Rican economy for mortgage banking results as we look out? Or should we see that continue to decline or actually expand going forward? Thanks.

The main delta you will see in that business is going to be -- if we have more nations would have more gain on sales. The bark has been pretty steady and slightly lower this year. So that improbably right now. And the other big delta is the value of the MSR and that's going to -- as you know gets affected by a whole bunch of stuff to the prepayment rate assumptions changes, interest rate changes. Thus there is a bit more volatile and harder to predict line. So the core business is slightly smaller than it used to be. And these two lines are the more volatile line. So the line of gain on sale should be fairly steady and something happens and the MSR depends on interest rate, requirement rates, repayment rate, speed and bunch of other stuff so that was hard to figure out.

The next question is from Joe Gladue at Merion Capital.

My question is I guess wondering if you could give us a little bit of color on the two different market areas in the US, just sort of how they are doing in terms of loan and deposits and expectations between the New York and Florida markets?

Well, they are both doing pretty well. Obviously, we have more coverage in New York in a bigger business, a book of business in New York but Florida is doing well where we have a pretty specialized line of business there in terms of association lending economy, new association lending and that business is doing extremely well as well. So I think it's equally good, obviously we have a bigger base New York or covers in New York so it is that what in terms of both dollar terms it is growing more but relatively they are both doing well.

The next question is from Jesus Bueno at Compass Point.

Thank you very much for taking my questions. I appreciate the color earlier on loan growth for 2017. Just looking specifically at the results in the Puerto Rico unit, it was encouraging to see the commercial balances up quarter over quarter. Could you just discuss some of the puts and takes there? I'm just trying to understand whether it is origination driven or perhaps if there is something there, maybe slower paydowns that impacted that?

We have the issue it was that you know well that while the headline and the financial equation of government continue to be very challenging in Puerto Rico. The economy is actually not doing horribly; it is essentially fly around zero. When you look at our bankers, our bankers are really busy and they are thinking a lot of loans and proposals and they are doing, they are trying to do a lot of business. So far the business they have succeeding in doing to allow just refill the bucket from normal run off but it is not because there is not lot of happening. So the market is active. Market continues to be competitive. We are very busy, so our client are making strategic move, our buying competitors are expanding their business. And we are trying to play a role in all of that. While the balances have tended to be flat. The composition changes a lot and client pays us back, new clients borrow and we continue to be very active and hopefully we can add more than subtract more moving forward but it is -- when the economy is around zero and your bank our size will tend to reflect movement to the economy.

Thanks for the color. Just staying on kind of loan growth, I know you mentioned that part of your US growth will be supplemented by purchases. But I guess as we are thinking about balancing organic growth versus purchases I guess what do you anticipate your mix is going to be? And as it relates to that, the purchases you made earlier in the year, I know you were testing out the vintages to see the loss rates. But how exactly has that -- how have the loss rates played out relative to your initial expectations before you started those purchases?

I think when we initially undertook let's say the tests and we started some of buying some of those loans we had a built a model to try to project expected losses, I'll say so far they are behaving as we expected when we initially embark in the test.

So there is no surprises, Jesus is the answer. So proof of concept has been positive and we will probably make a call in the next few weeks or whether we wanted go back to that but so far no surprises, it has been positive so far. We haven't had third party purchase in the US for quarter and half to the second quarter. So all of what you see this quarter has been organic growth. And my commentary on low purchase is actually mostly it was directly Puerto Rico more than the States. And we will continue to look but those opportunities come when they come and then we just make a call on whether it is risk profile and return profile make sense for us or not. And move it if feels right.

Understood, thank you. If I could just slip one more in. Could you remind us -- if we were to see a rate increase in December, what would be the benefit to your NII just based off of a 25 basis point move?

We are slightly asset sensitive so it will be good for us. I don't know we will make big bet on interest rate on our balance sheet, so it will be plus something probably either ballpark of $10 million, something in that ballpark. It is not going to change the date, we will be nice. So if you have a vote on rates going up go up go with us.

[Operator Instructions] There are no further questions at this time. And the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.