Good morning, and welcome to the Popular, Inc. Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to [indiscernible] for Popular. Please go ahead.

Good morning, and thank you for joining us on today's call. With us today is our CEO, Ignacio Alvarez; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano. They will review our results for the third quarter and then answer your questions. Other members of our management team will be available during the Q&A session. 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 supplement. You may find today's press release and our SEC filings on our web page at popular.com. I will now turn the call over to our CEO, Ignacio Alvarez.

Good morning, and thank you for joining the call. We are happy to report another strong quarter during which we achieved excellent financial results, closed the Reliable acquisition and executed several important capital actions. Before I address the quarter's highlights in more detail, I would like to comment on the progress we're seeing in Puerto Rico. We tracked different metrics, both internal and external, to get a sense of level of economic activity on the island. While in previous calls, we have been sharing variances from the same quarter of the prior year, September 2017 was an anomaly as the island was literally in the dark and out of business for a significant part of the month. The months of July and August allowed us to make a fair comparison and the trends are positive. If we were to include September, all of the quarter and year-to-date variances would be significantly better than those that we are sharing here. Debit and credit card activity reflected increased spending as compared to a year ago. The dollar volume of our customers' transactions for July and August was 18% higher than the same period in 2017. On a linked-quarter basis, spending figures reflected a slight reduction due to seasonality. If you look at the consumer loan activity, the trends are also encouraging. While originations in the first half of the year were 4% below 2017 levels, July and August originations were 6% higher than those of the same period last year. Within the consumer loan portfolio, there are important differences, with auto finance and mortgages at opposite ends of the spectrum. Our auto originations for July and August 2018, excluding Reliable, were 27% higher than in 2017. The industry as a whole is doing well. As of August, new car sales in Puerto…

Thank you, Carlos. Good morning to all. We are happy to report strong credit quality results for the third quarter in both our Puerto Rico and U.S. operations. Credit metrics in Puerto Rico continue to reflect positive trends with most of the metrics trending onwards or better than pre-hurricane levels. In general, actual results are within or better than the assumptions used to create our hurricane reserve in the third quarter of last year. In the consumer portfolio, early delinquencies and nonperforming loans are near or below pre-storm levels. Results for this quarter reflect the acquisition of Reliable, which included $9 million in consumer NPLs. Consumer charge-offs have been somewhat volatile post-hurricane, impacted by the payment moratorium and the temporary suspension of collection activities. The consumer net charge-off for the third quarter of 2018 was 3.02%, slightly higher than the second quarter of last year at 2.81%. At the end of the third quarter, mortgage NPL stood at $249 million, a decrease of $24 million compared to the last quarter. When compared to the second quarter of last year, prior to the storm, NPLs increased by $42 million. However, 30-89 delinquencies have decreased by approximately $73 million during the same time frame, reaching the lowest early delinquency levels in the last 5 years. Mortgage net charge-offs for the third quarter were 1.38% compared to 1.43% in the second quarter of last year. In commercial lending, overall credit metrics during the quarter remained stable and near pre-storm levels. During the quarter, commercial NPLs increased by $8 million, mainly driven by a single borrower of $16 million. Commercial net charge-off in the third quarter decreased by $6 million on a linked-quarter basis. In the case of the U.S., our operations continue to reflect stable credit quality metrics except for the taxi medallion…

Thank you, Lidio and Carlos, for your update. Please turn to Slide 12. Last month marked 1 year since the hurricanes devastated Puerto Rico and the Virgin Islands. At the time of our earnings call last October, approximately 70% of Puerto Rico was still without power. Many schools and businesses remained closed, and we were all working tirelessly to stabilize the situation and regain some sense of normalcy. While saddened by the loss of lives and massive property damage that affected so many people, we're extremely proud of how we have recovered despite these many obstacles. In addition to strong financial results, we have accomplished important milestones, such as the termination of our loss-share agreement, the acquisition of Reliable and the execution of several important capital actions. Our franchise in Puerto Rico is in a unique position to take advantage of opportunities that we are seeing as well as to effectively manage challenges that inevitably will arise. Our growth initiatives in the United States have good traction and we expect to see further progress. Finally, we have additional sources of value, such as our investments in Evertec and BHD, which continue to contribute to earnings and represent unrecognized investment value. On October 5, we celebrated our 125th anniversary. We are energized and determined to make good use of the positive momentum that we have built up over the past months to continue to deliver solid results and to drive shareholder value. We are now ready to answer your questions.

[Operator Instructions]. The first question comes from Alex Twerdahl with Sandler O'Neill.

I'm wondering if you could break out for us, Carlos, the deposit costs? I think you kind of alluded to them being low in -- lower in Puerto Rico, but just the overall deposit cost in Puerto Rico versus the mainland this quarter versus last quarter. Carlos Vázquez: Hold on for a second. Most of the increase was in Puerto Rico, Alex. And as we mentioned on the prepared remarks, it has to do with increasing costs for public sector clients in Puerto Rico. The -- hold on for a second. Yes, Puerto Rico was 13 basis points and the whole thing was 11.

Okay. 13 basis points higher this quarter versus last quarter? Carlos Vázquez: Yes.

Yes.

Okay. And then can you just give us a little bit of color around sort of the seasonal flows? Or any expected flows in the public sector deposits? Obviously, you've had some pretty big inflows over the last couple of years. And just kind of how should we think about those balances, just kind of as each quarter progresses? Carlos Vázquez: Well, we have been saying for about 1.5 years now that we expect those balances to come down. We have been perfectly wrong for 1.5 years now, so which we're trying to be cautious now we look at them forward. We continue to assume that as operations of government move towards normalcy as that deals get reached and normal debt payments start that those balances will come down. Exactly when that's going to happen is still unclear.

No. I think it's very hard to predict. Obviously, it will depend on, as Carlos said, as the deals get restructured and the government starts paying debt service and using other funds, obviously, the revenues from the government have been better to date than anticipated. So that's sort of fact, but it's very hard for us to predict that.

Okay. Is there any way to kind of carve out and sort of quantify what you might consider to be sort of more volatile deposits versus kind of core average operating account deposits for the public sectors? Carlos Vázquez: Yes. Alex, the formula that which we compensate our public sector clients is a little bit complicated because it includes the number of floors, negotiated rates. We have offsets because of fees for other service that we provide to government entities. But given where rates are now and how those interplay with all the other components I mentioned, I think moving forward, it's fair to assume that the delta change in deposit costs for our public sector clients will be close to the change in reference rates. So our beta are close to 1%, okay. In prior quarters, we have mentioned that while the deposit cost beta has been close to 0 for almost 2.5 years that we will -- it'll be hard to keep that, that way as rates continue to increase. So you're seeing a little bit of that effect now. Now having said that, the total cost of public deposits is still very attractive. It is lower than comparable wholesale funding and is net income accretive. So moving forward, if you assume that the composition of deposit stays static, moving forward, any future moves in rates like the 25 basis points we saw this quarter should result in quarter-to-quarter increase in deposit cost of similar to the one we saw this quarter, which is 7 basis points, okay. Now the difference between those 2 obviously is the fact that we do have a significant amount of net interest-bearing deposits and also the fact that the beta for our retail and commercial deposits is a lot lower. Overall, we continue to be asset-sensitive. So if rates go up, it's good for our financial performance. So assuming everything goes the way that market predicts, hopefully, we'll benefit from that.

Okay. Great. That's great. And then just kind of a high-level question. Ignacio, in your prepared remarks, you quoted that your customer base is up about 55,000 accounts since the hurricane. I mean, obviously, that number is -- doesn't quite jive with the population flows, and one of your competitors just kind of said a similar magnitude relative to size of their balance sheet. Where do you see these additional customers coming from? Is it new business formations? Is it people that just didn't have accounts before? Can you just kind of give us a sense for sort of where they're coming from?

I can give you some of these explanations we think we have, but it's all anecdotal. We don't have statistical information we can get that we've been trying to do more surveys, but there's a couple of things that are happening. Obviously, some of the -- in our case, I can say, some of our competitors have abandoned some of the markets that we're in and closed some of the branches. And normally, when you close branches and you -- we remain, we pick up customers. Some people have opened up more than one bank account. I think you're seeing a tendency in Puerto Rico where -- that we know for a fact that the number of people that have more than one bank have increased, so you're not necessarily putting all your eggs in one basket. We may think some of the federal recovery funds may have -- I think, although wasn't required, the federal government tried to push people to accept the monies electronically through a bank account. So there's a number of factors going on. I really would be hesitant to tell you we know the exact reasons because we don't. But we do know for a fact that in certain regions where other competitors have closed branches, the increase in customers has been greater. So there is obviously some relation there.

The next question comes from Brett Rabatin with Piper Jaffray.

I wanted to first ask on Reliable. I guess, I had thought that the original accretion or additional income, net income of $34 million, was low. And now you're $55 million. Can you talk about maybe the change there? And is that all on the income side? Or you also, as you've gotten a little further into that deal, fine-tuned your expense assumptions as we go through '19? Carlos Vázquez: Well, it's a combination of things, Brett. First of all, obviously, accreting the discount has a significant effect on that. So that's part of it. Second, our original estimate did not include servicing income because we did not have an agreement to service the loans when that estimate was put together. And thirdly, the market is doing a lot better than we thought when we put the estimate together in June. So the combination of all those 3 things, I think, add up to a forecast that is better, and we're very happy about it.

Okay. And then just thinking about the margin. One is when did you get the purchases of the treasuries and the T-Bills during the quarter? And by the way, it was great to see you guys use some liquidity on the balance sheet to put in higher-earning assets. And then as we think about the margin going forward, it would seem like an additional month of the additional auto would continue to put some margin higher absent even any changes in rates. Can you maybe give us some color around that? Carlos Vázquez: Yes. I think the purchase of the treasuries happened in the early part of the quarter. So there is quite a bit of reflection of that effect in this quarter. As far as -- maybe I suspect you're right. The math work that way, right? We have higher-yielding loans for a longer period of time. There'll be additional little benefit in the fourth quarter, yes.

Okay. And then just maybe if I can sneak one last one in on capital. I know you're not going to give me a specific number, Carlos. But if we think about buybacks and what we're seeing from some other banks, it would seem like your ASC next year could be a lot more aggressive than what you did this year. Is that a fair assumption? Carlos Vázquez: As Ignacio mentioned, we'll continue to try to follow the path of our peer banks, and all of them have moved higher during this year in their return of capital to shareholders through dividends and buybacks. We have -- we will hire as well, obviously. But we will continue to follow that path. We will hope that leads us to a higher return on capital. Exactly, in which components, we can't tell you because that is part of the negotiation.

The next question comes from Arren Cyganovich with Citi.

Just following up on the capital question, we're seeing the nice benefit of the portfolio acquisition. Are there any other portfolio acquisitions or other types of acquisitions so you can do use some of that excess capital beyond just the buybacks?

Yes. Historically, we've been very opportunistic buyers of portfolios. So if they're available, we will take a look at them. Reliable, obviously, had -- I would hesitate to say there's going to be anything close to Reliable out there in the short term, but we are always looking to deploy capital at the best means possible, and we often get a look at portfolios. So we will continue that trend. We'll keep looking. Carlos Vázquez: It's unlikely there's chunks of $2 billion sitting out there. But if there are, we'll take a look.

Okay. And then with respect to the Reliable deal, there's obviously a lot of benefit of the accretion for -- of the discount. Can you put some numbers around on what's remaining there and how -- what, I guess, the maturity tenor will be of that as we go through the next couple of years?

So the remaining discount at the end of the third quarter will be probably roughly around $110 million or so. You'll see more disclosures of that in our 10-Q filings. These are mostly auto loans that will run off quickly, probably 3 years. And there is a portion related to the commercial portfolio that has less than 1 year average life, so that part we'll be able to facilitate, of course, that's the smaller part of the discount.

The next question comes from Gerard Cassidy with RBC Capital Markets.

This is actually Steve Duong for Gerard. So just going back on rates, if -- assuming rates go up 100 basis points through the end of 2019 and the recent acquisition, Reliable acquisition, where do you see your NIM holding up towards the end of 2019? Carlos Vázquez: We don't give forward-looking views on NIM, Steve. I think we're -- as far as we've gone and given you the components we just mentioned. Again, we are asset-sensitive, so we will make more money. Exactly, where the NIM comes out also depends on asset mix, which up to this quarter, we had Reliable had been driving our change in NIM [indiscernible]. So that will also have an important component to worry [indiscernible] next year.

Okay. Fair enough. And I think you guys spoke about your mortgage originations before. I think you said there was an uptick in July. Can you just give us some more color on that?

Well, we're coming off a low base, but we did see increased activity for the first time in a long time in both July and August. So I think that it's -- we're hopeful, but it's still coming off a low base. Carlos Vázquez: The third quarter was better. 1 quarter doesn't make the trend, so we hope to see what happens in the fourth quarter.

It was actually positive, and we saw a growth. I think the originations were $170 million. Carlos Vázquez: They're clearly higher than the second quarter.

Second quarter. So that was a positive sign given the fact that interest rates went up and they still went up. But again, we got a ways to go in that sector.

And where was that occurring? In Puerto Rico, is that right?

Yes, the $170 million is Puerto Rico originations. We had an increase in States of.... Carlos Vázquez: The U.S. went up a little bit as well.

Yes. But the $170 million I mentioned is all Puerto Rico.

Okay, great. And if I could just get one more. And just do you guys have an update on your unrealized gains for Evertec and BHD? Carlos Vázquez: No. Evertec is -- I'll calculate that number and get back to you offline. Yes, it's a couple of $100 million.

The next question comes from Joe Gladue with Merion Capital Group.

Just wanted to touch on the U.S. operations a little bit. Yes, it's good to see the profitability continue to increase. Just wondering if -- where you see -- you think you can get the profitability of the U.S. operations too? And in terms of growth, what can you do, is deployment of capital on the mainland a possibility for growth there? Or just wondering about growth as well.

Well, I think that we are concentrating heavily on, as you say, profitability. So we have a number of initiatives, and I think, one of them were directed at improving our deposit franchise. We have a number of initiatives sort of a private bank initiatives that we've launched. We have a transformation of our retail branch network. So we're really working hard on our deposit cost. Obviously, we're growing our loan book also, but we're being -- we're growing it prudently. We're not doing anything crazy. So we'd rather grow slower, but prudently. So we're putting a lot of emphasis on profitability. In terms of inorganic growth in the States, we'll always look at it. The prices have been very high, as you know, lately, and we're at an interesting time in the economic cycle. So we'll look at opportunities that are presented to us, but we're going to be very careful.

The next question comes from Glen Manna with Keefe, Bruyette & Woods.

So just a quick question on some landscape here. The two months of servicing income on the auto loan portfolio, was that in other income? Or was that in other service fees on the P&L?

It was in other income. Carlos Vázquez: Other income.

Other income, okay. And Carlos, the $12 million in expenses that you gave for Reliable next quarter, does that include any acquisition-related expenses that might be nonrecurring? Because I think when you announced the deal, you said $13 million and you have about 4 books, so there's $9 million left. Carlos Vázquez: Yes. There is some expense noise obviously in the third quarter as well. Then probably, the best way to think about that is to add the -- normalize the third and the fourth and divide it by two and you'll come up with a number that looks like $10 million a quarter, something like that.

Okay. And just on capital and not so much on the buyback, but on the dividend. Are you inclined to go to kind of a normalized payout ratio? And would increasing your dividend be dependent on regulatory approval as well as kind of the buyback plan? Or just what's your thinking on that? Carlos Vázquez: Yes. I mean, there are things we can do in capital return that don't necessarily require Fed approval, Glen, but most of the things are contained in the same conversation that we have with our regulators, okay. So while technically some things might not will not require approval, we basically discuss the whole -- all the things together. Whether we end up with a slightly higher dividend payout versus slightly higher buyback, it sort of depends on those discussions. It would be fair to assume for -- by our investors that the Fed should be agnostic between one or the other. Sometimes, they are. Sometimes, they're not. And I cannot even try to explain to you why they would or wouldn't be. But -- and again, it's part of our negotiation. They are part of our business.

Well, does those negotiations all come to a conclusion at the same time? Or do they have different termination? Carlos Vázquez: They tend to, yes.

The next question is a follow-up from Brett Rabatin with Piper Jaffray.

Wanted just to follow up on two things. One is, Carlos, you said you'd still expect Puerto Rico -- you're looking for a little growth -- slight growth in the U.S., stable in Puerto Rico. Are you seeing your clients be more optimistic about what they're seeing? And when you say flat in Puerto Rico, is that assumption of new originations and maybe some payoffs of some existing stuff? Or can you give us a little more color on what you're seeing versus your guidance?

Yes. This is Ignacio. We're definitely seeing more optimism. And when you go around and you talk to clients, most of the clients have seen their performance improve during the year with the influx of the funds. And there's a general greater level of optimism. Some of this takes time. There's -- as I mentioned in my prepared remarks, there's a lot of liquidity in the system. So in fact, people are adjusting to the greater consumer demand with their own liquidity. And in many instances, they are paying down the debt. So we're working hard to keep our balances because people are paying down debt. But in general, I would say, undoubtedly, there is a greater sense of optimism among the business community in terms of the near- and medium-term prospects. Carlos Vázquez: Yes. As far as flow, if we assume that, whatever, 15% or 20% of our loan portfolio will normally come due in any given year, to keep their balances flat, we still have to originate like $4 billion a year, which is what our bankers are doing. So there is a lot of activity. Again, as Ignacio mentioned, that activity has not turned into net loan growth yet. When we see it, we'll be happy to comment about it. By the way, the answer on the Evertec gain is at present rate is about $220 million unrealized gains in Evertec, that's not in the numbers.

Okay. And then I guess, the other thing I want to follow up on was just you mentioned the fiscal plan, and I was looking at the draft on Monday, $82 billion total. Are you feeling more optimistic about the fiscal plan? And what you're seeing around some of the initiatives with PREPA and kind of the other things that need to be taken care of?

I think it's a mixed bag. I think, obviously, if you look at the fiscal plan in the near to medium term, the -- they have increased the estimate of federal funds that are going to flow into the island, which in effect has resulted in increase in the estimates of GDP growth for the next 4 years. So definitely, I think that if you look at the plan, it sort of backs what we're feeling. The next -- the near and medium term in Puerto Rico, you're going to see a stimulative impact. The -- I'm very optimistic about PREPA. So I'll put it this way, what worries us about the fiscal plan is that we're not seeing the level of collaboration between the government and the board that requires Puerto Rico to achieve the long-term growth. In the short term, I am very optimistic that PREPA is going to have a major difference. There are some reforms being carried out in the government in terms of monetary reforms in terms of permitting and rightsizing the government. They will have a big impact. I think PREPA will have the biggest impact. Unfortunately, we -- the level of cooperation that's required to have long -- the more difficult struc reforms isn't there. But in the short to medium term, the prospects are going to be good.

Okay. Sorry, maybe 1 or 2 others. The enterprise zone lending was kind of quiet for a while and now it's starting to heat up. I was just curious, if locally, what you're hearing about those opportunities that could be pretty meaningful?

A lot of, a lot, a lot of people come to the office, a lot of inquiries, a lot of people. The -- I think they'd published the regs, the initial regs last week. A lot of people are waiting for that. I think it's definitely important. I think to get that -- we're talking about long-term capital -- long-term economic growth in Puerto Rico, it requires an additional investment in our capital stock. So that's going to come partly from the public recovery fund. Hopefully, partly from private and public partnerships. And hopefully, this opportunity zone will be another source of investment in the capital stock, which really is the essential ingredient to long-term economic growth.

Okay. And then the government deposits from a regulatory perspective I had [indiscernible] a little under $8 billion total at the end of 2Q. If you gave it, I missed it, but the number in 3Q, if you have it?

Quarter-over-quarter, it grew about $1 billion. We're $8.6 billion -- we're about $8.6 billion at the end of the third quarter.

$8.6 billion, okay.

This concludes our question-and-answer session. I would like to turn the conference back over to Ignacio Alvarez for any closing remarks.

Thank you for your questions, and thanks for joining us today. The third quarter was another strong one for us, and we are pleased with our results. We will build on that momentum and update you on our progress in our next call. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.