Popular, Inc. (BPOP) Q1 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Popular Inc. First Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Paul Cardillo, Investor Relations Manager of Popular. Please go ahead, sir.

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 first quarter and then answer your questions. Other members of our management team will also 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 filing. 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. This was a great quarter for Popular and a solid start for the year. I will first address the highlights and key events for the quarter, then I will present an update on our business as well as some of thoughts around macroeconomic environment in Puerto Rico. Carlos will comment on the quarter's financial results, and Lidio will provide an update on credit trends and metrics. Please turn to Slide 3 to discuss the highlights of the first quarter. Popular reported quarterly net income of $168 million, which is $34 million higher than last quarter's adjusted net income. This quarter's results were driven by lower expenses and income taxes, partially offset by lower net interest income and lower mortgage banking activities. Net interest income was $5 million lower than in the previous quarter. This variance was mainly driven by Westernbank commercial loan that paid off in the fourth quarter as well as the impact of 2 fewer days in the first quarter. We continue to see strength in our auto business and deposit franchise as well as a higher volume and yield on our investment portfolio. Credit quality results were favorable this quarter as we saw lower NPLs, inflows and charge-offs compared to the fourth quarter. In February, we entered into a $250 million accelerated share repurchase program. And on April 1, we paid a dividend of $0.30 per share. Tangible book value per share in the quarter increased from $46.90 to $48.58. Now I'd like to give an update on some metrics we track and comment on the progress we are seeing in Puerto Rico. Please turn to Slide 4. With respect to migration trend, the most recently released [indiscernible] data from the [indiscernible] airport reflects that the net number of people who left the island from September 2017 through the end of 2018 was approximately 111,000. This is a significant amount but much lower than initial estimates. Total employment, which includes sales employee individuals, increased by nearly 1% through February compared to last year. The unemployment rate in February was 8.5% and has been approximately at the same level since August 2008. This is the lowest unemployment rate that has been seeing in Puerto Rico going back at least 55 years. As of February, salaried employment also grew, increasing by 2.3% year-over-year. This improvement was driven by an increase of 4.5% in the private sector, partially offset by a similar percentage decline in the public sector. The auto industry continued to perform very well. 25,000 new units have been sold year-to-date, up 12% compared to 2018. So net sales often considered an indicator of economic activity were down slightly when compared to year ago period. However, they were higher than in the fourth quarter and 14% higher than during the first quarters in both 2016 and 2017. Internal metrics we track to monitor economic and client activity are also showing encouraging trends. Our customers debit and credit card purchases through March increased by 1% compared to the same period in 2018 after taking into account the considerable surge in activity in early 2018 following the hurricane. Trends around consumer loan activity are also encouraging. Our originations for the first quarter of 2019, without considering the Reliable operation, were 4% higher than in the same period in 2018 driven by an increase in the auto business. Mortgage generation trends, however, are still running below pre-hurricane levels. On the commercial side, we expect incremental lending opportunities as the economy continues to improve. In fact, we are already starting to see a pickup in activity. Popular's customers in Puerto Rico have increased by 11,000 in the first quarter and by 75,000 over the past 12 months. While the Puerto Rico economy has shown signs of improvement, the sustainability and pace of further improvement will be heavily dependent on the magnitude and timing of federal recovery and private insurance fund flowing into the island. Regarding federal funds, the U.S. Office of Management and Budget reported that the federal government had allocated over $40 billion and could eventually spend up to $21 billion with recovery efforts. While the flow of disaster recovery fund has been slower than many hoped, the OMB estimates that close to $11 billion has already been dispersed in emergence relief assistance to individuals, public corporations and municipalities. The current Puerto Rico government fiscal plan anticipates that over $50 billion of federal insurance funds - insurance fund were to be dispersed in the next 8 years. Looking beyond the immediate stimulative impact of the recovery process, the island's long-term prospects will depend on the decisions regarding Puerto Rico's rebuilding and the implementation of necessary structural reforms. It is imperative that we take advantage of this unique opportunity to implement those reforms that are essential to achieving long-term sustainable growth. This will require discipline and increased cooperation within the fiscal oversight board and the local government. I will now turn the call over to Carlos who will discuss the financial results in more detail. Carlos Vázquez: Thank you, Ignacio. Good morning. Please turn to Slide 5 for the first quarter results. Note that additional information is provided on Slide 6 and the appendix to the slide deck. Today's earnings press release details variances in the fourth quarter, which were primarily driven by lower personnel costs, lower operating expenses and lower taxes, offset in part by lower net interest and noninterest income. Net interest income for the quarter was $471 million, down $5 million for the fourth quarter, affected by the nonrecurrence of last quarter's $5.7 million income resulting from the early payoff of a Westernbank commercial loan and the fact that there were two fewer days in the quarter, reducing NII by $8 million. Adjusting for these factors, net interest income grew sequentially in Q1 as we benefited from higher loan volumes, primarily in auto, as well as higher volume and yields in our investment portfolio, offset in part by lowered interest income on our U.S. segment. Our provision for the first quarter was flat. On a related note, there is a lot of interest about the potential effects of CECL. We are in the middle of the implementation of CECL, including more calibration and validation as well as finalizing the accounting decisions related to this announcement. At this time, we are still not in a position to share where the market preliminary numbers on CECL but hope to do so during the third quarter. In Q1, there was a $17 million decrease in noninterest income, primarily driven by lower mortgage banking activity and seasonally lower credit card interchange fees. Note that during the fourth quarter, we recorded a favorable fair value adjustment of $9 million on our MSR. Additionally, other operating income decreased by $11 million mostly due to $10 million in insurance recoveries in Q4. Total operating expenses for the first quarter were $347 million, a decrease of $49 million from the prior quarter. The majority of this decrease results from the recognition in Q4 of approximately $49 million of expense in three specific items: our early retirement program; increased profit-sharing; and the loss reported on the early extinguishment of debt. In the first quarter, business commercial costs were lower, reflecting the traditional seasonality of this expense. Finally, OREO expenses were flat sequentially. We still expect OREO expenses to normalize over time at a run rate of approximately $10 million per quarter, but the ramp-up has been slower than we expected. As previously discussed, expenses of Popular tend to exhibit some seasonality and should increase as we progress through the year. We continue to expect that average quarterly expenses in 2019 will be approximately $364 million, primarily driven by higher technology, regulatory and personnel costs. Obviously, we will strive to beat this number. We continue to expect that former Reliable operation to contribute a range of $55 million to $60 million in net income for 2019, including servicing fee income and conversion costs. The conversion of the 2 companies into a single platform should be completed by the middle of the year. Going forward, our commentary will be focused on the combined Popular auto entity. Our effective tax rate for the quarter was 23% within our 22% to 25% guidance for the year. Please turn to Slide 7. Our net interest margin was 4.2%, down 5 basis points from last quarter. Asset yields were flat in the quarter, and loan yields were down 4 basis points. Total deposit cost increased 6 basis points to 71 basis points. The cost of our interest-bearing deposits was up 8 basis points to 91 basis points, mostly due to higher volumes and rates for Puerto Rico public sector deposits and higher deposit costs in the U.S. The retail and corporate deposit segments in Puerto Rico saw a small increase in cost of 1 basis points. Auto sales in Puerto Rico continue to be strong in the first quarter. The combined portfolio of Reliable and Popular auto grow by 100 - grew by $160 million during the period. Our Puerto Rico mortgage business originated $135 million of loans in the first quarter, a decrease from $154 million in the fourth quarter. Originations continue to trend at a pace below pre-storm levels. Regarding loan growth, we continue to anticipate slight growth in overall loan balances for Popular in 2019. We do expect a shift in the contributors to loan growth with incremental growth in Puerto Rico and positive but slower growth in the U.S. portfolio. Please turn to Slide 8. Our capital levels remain strong relative to peer banks as well as with respect to well-capitalized regulatory requirements. In February, the corporation entered into a $250 million accelerated share repurchase transaction. As a result, we recognized in shareholders' equity approximately $200 million in Treasury stock and $50 million as a reduction of capital surplus. The final accounting treatment will depend on the average price of the shares during the term of the ASR. Our Q1 EPS was positively impacted by $0.01 because of this transaction. Our Common Equity Tier 1 ratio was 16.4%, down from a 16.9% on the net effects of our buyback, dividends and our quarterly results. Tangible book value in the quarter increased slightly. Our net income plus the reduction in the unrealized losses on our investment portfolio more than made up for the impact of the buyback and common and preferred dividends. However, due to the impact of the buyback on our share count, our tangible book value per share increased from $46.90 to $48.58. We will continue to pursue our target of maintaining and improving our double-digit return on tangible equity. With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. Credit quality results for the first quarter of the year were strong in our main operating margins. In Puerto Rico, credit quality metrics reflect lower nonperforming loans, lower nonperforming assets, lower NPL inflows and lower net charge-offs. We're encouraged by the trends in our Puerto Rico loan portfolio while remain attentive to changes in the operating margin. In the U.S., credit metrics reflect lower NPLs, lower net charge-off and stable and low NPL inflows. Please turn to Slide 9. At quarter end, our outstanding credit exposure to the Puerto Rico government, municipalities and other instrumentalities was $455 million, a decrease of $2 million from the prior quarter driven mainly by maturities on payments received from our municipal loan portfolio. At the end of the quarter, we have no direct exposure to the Puerto Rico government or its public corporations. Our municipality exposure consists mainly of senior priority loans to a select group of municipalities whose revenues are largely independent of the central government. In most cases, the good faith credit and unlimited taxing power of each municipality is pledged to a repayment of the loans. 75% of our exposure is to the fourth large municipalities in the San Juan metro area. We also have indirect lending facility in which the government acts as a guarantor. The largest of such exposure is in the form of residential mortgage loans to individual borrowers in which the government provides the guarantee similar to [indiscernible] programs in the U.S. Turn to Slide 10 to discuss credit metrics for the quarter. Nonperforming assets decreased by $36 million to $712 million in the first quarter. The decrease in nonperforming assets was the combination of a decrease of $25 million in nonperforming loans and a decrease of $11 million in OREOs. Nonperforming loans in Puerto Rico decreased by $23 million from the first quarter of 2018 driven mainly by lower commercial and mortgage NPL of $17 million and $6 million, respectively. The decrease in commercial NPL is mostly due to net charge-off activity, while the decrease in mortgage is mostly due to the continued improvement in delinquencies after the hurricanes. In the U.S., nonperforming loans decreased slightly by $2 million, mainly due to decreases in the consumer portfolio. At the end of the first quarter, the ratio of NPLs to total loans decreased slightly to 2.2% from 2.3% in the previous quarter. The decrease in OREOs was mainly driven by the Puerto Rico mortgage portfolio due to lower inflows. Please turn to Slide 11 for a summary of the trend in NPL inflows. Compared to the fourth quarter, NPL inflows, excluding consumer loans, decreased by $13 million, mostly in the Puerto Rico commercial portfolio. Puerto Rico mortgage inflows for the quarter are at 60% of the levels seen prior to the hurricanes and remained stable, mainly driven by lower early delinquencies post moratorium. In the U.S., NPL inflows were up at $4 million. Turning to Slide 12. Net charge-off for the quarter amounted to $61 million or an analyzed 92 basis points of average loans held-in-portfolio compared to $107 million or 1.63% in the prior quarter. Net charge-off decreased by $42 million in Puerto Rico and $4 million in the U.S. In Puerto Rico, the decrease is primarily driven by lower commercial net charge-off of $35 million as the prior quarter included charge-off from two large relationship. In addition, mortgage net charge-off decreased by $7 million from the prior quarter. In the U.S., the decrease is primarily driven by lower construction net charge-off of $6 million as the prior quarter included the charge-off of 1 relationship. The allowance for loan losses decreased by $19 million from the previous quarter to $551 million, mainly due to a decrease of $23 million in Puerto Rico, offset in part by an increase of $4 million in the U.S. The Puerto Rico decrease was primarily attributed to the charge-off of a $12 million previously reserved commercial relationship coupled with improvement in the loss trends in the market portfolio. The provision for loan losses remain flat at $42 million compared to the prior quarter. In Puerto Rico, the provision decreased by $12 million mainly due to the above mentioned charge-off of a previously reserved relationship. While in the U.S., the provision increased by $11 million mainly due to charge-off for the quarter and adjustments to the qualitative reserve component of the commercial portfolio. To summarize, credit quality results for the first quarter of the year were strong with improvements across all metrics in Puerto Rico and continued stability in the U.S. With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.

Thank you, Lidio and Carlos, for your updates. We began 2019 on a solid footing and are excited about our prospects for the year. Popular is in a strong position to benefit from an improving economic environment in Puerto Rico and to continue strengthening our operations in the U.S. Banco Popular's franchise in Puerto Rico is unique. Having consistently grown our retail and commercial customer base, we currently serve nearly 1.8 million customers. We do not take our leadership position for granted, however. We are focused on enhancing our customers experience throughout all our channels. Our extensive branch footwork remains a competitive advantage, which is complemented by our innovative digital solutions. Approximately 862,000 of our clients are active online, and almost 80% of these clients use mobile devices to interact with us. In March of this year, 50% of our deposit transactions in Puerto Rico were processed through smart ATMs and mobile devices, a figure that has been growing consistently. We stand ready to assist customers with their evolving banking need. The breadth and depth of our retail and commercial product offerings in Puerto Rico is unmatched. In the mainland United States, our operation, which is more focused, provides diversification to our footprint. We have a strong commercial lending unit that is complemented by two specialized national lending businesses, [indiscernible] association banking and healthcare. Finally, we have additional sources of value, such as our investments in Evertec and BHD Leon, which continue to contribute earnings and represent unrecognized investment value. We are energized and determined to make good use of this positive momentum to continue delivering solid results and to drive shareholder value. We are now ready to answer your questions.

[Operator Instructions]. And our first question today comes from Brett Rabatin with Piper Jaffray.

I wanted to start off with expenses, and you continue to give $364 million average guidance for the quarter, and I get it that, that OREO expenses was light this quarter. But even if you were to say that were $10 million instead of $2.7 million, it was still seem like you'd have some room there. Can you talk maybe about the other pieces to getting there and then just what are like your spending money on this year that is sort of raising that bar? Carlos Vázquez: Sure. Happy to. I mean the OREO was - the ramp-up in OREO hasn't happened at the speed at which we expected. We'll see how it goes in the second quarter. It depends on the foreclosure flows, and those have been slow. So we'll update you then on that. But as far as other expenses, the lines where we expect higher expenses in the second - in the last 3 quarters of the year are multiple lines. Number one, you get personnel cost. You have the yearly merit increase that happens later in the year that will affect expenses in the second half of the year. Number two, we have business promotion that always is backloaded in the year and will continue to be the case this year. It might actually be slightly higher expense depending on how our E-LOAN and white label efforts go in the mainland. The regulatory expenses will also continue to be high. There's a lot of expenses related to CECL alone. That will be - will tend to be backloaded in the year and there's all the regulatory initiatives. For example, we are - we believe one if not the smallest one, the smallest banks are subject to regulation part 3 70, which means we have to do a lot of work to assist the FDIC in separating what part of our deposits are insured. This effort, again, applies to all the large larger banks and, unfortunately, to us as well, and that requires a significant investment in systems as well. And lastly, normally, technology projects tend to have the expense backloaded in the year because the parties tend to get started early in the calendar year and then towards the end of the year is when you see the expenses show well. So those are some of the examples where we expect - the lines that we expect to be affected. Again, we continue to try to beat this guidance of 3 64 average per quarter. If there's a reason to adjust the guidance because we have better information next quarter, we will. But at this point in time, we don't have enough evidence to change it.

Okay. And Carlos, I want to make sure I understand 3 64 average, does that mean that's the lighter number in the first quarter could result in a higher than $364 million sort of run rate for the rest of the year? Or is that just on a quarterly kind of ongoing basis at 3 64 sort of... Carlos Vázquez: The 3 64 [ph] is quarterly average for the year. So yes, it would mean that the number will go up in the latter quarters. It doesn't necessarily go in the linear fashion, though, Brett.

Okay. Fair enough. Appreciate the color there. And then the only thing I want to ask is just with credit. In the provisioning level, it seem like kind of given the asset quality trends, it wouldn't be a reason that your provisioning would be much different than the past two quarters? Is that a fair assumption, or can you talk maybe about how you feel about credit and just the need for provisioning going forward? Carlos Vázquez: I think with the color that you said, the trends continue, I think I agree with you.

Okay. And then maybe just one last quick one on the government deposits. They were obviously up this quarter. Any visibility into what 2Q trends might be and then what you guys did with the securities book this quarter? Carlos Vázquez: Yes. I mean we - I think Ignacio had mentioned in the last webcast that because of tax season and all the revenues in the government are - tend to happen in the similar April 15 that we actually expect the deposits to go up before they went down. It is still a review that the government deposits will normalize our lower level where they are presently, Brett. But again, it's hard for us to nail that number down. However, the liquidity did go into our investment portfolio, but we have not changed the characteristics of the portfolio in any significant way. It continue to be very high credit and liquidity treasury agencies. There's nothing funky in the investment portfolio.

[Operator Instructions]. Our next question comes from Alex Twerdahl with Sandler O'Neill.

Just wondered if you can shed a little light or shed a little color on some of the federal money that you alluded to earlier, how that actually gets distributed in Puerto Rico and what kind of role Popular might play in that? For example, if HUD just raised a $1.5 billion check to the island, how's that actually wind flowing through the Puerto Rican economy?

Well, there's two different sources of funding, right, main sources, many different programs. But the main sources would be the CDBG funds, which are administered - they're delivered by HUD, but they're administered by Puerto Rico by the local housing department. And then there's the FEMA fund in which the Puerto Rico government directly negotiates with FEMA regarding how much it will cost to repair certain things, and they reach an agreement - when they reach an agreement, then those money get dispersed. The CBDG - the first $1.5 billion went to a process where there was a procedure. It was identified uses for that money, and the money is the line of credit that's ready to be dispersed in the Treasury Department. The way it works it's reimbursements, so line of credit of the Treasury. The second part of that is at about $8 billion, and they are going finalizing the process and the procedure and what that money we use for. But again, that money will be administered locally by the Puerto Rico Housing Department. Obviously, they're subject to supervision from HUD. The FEMA money is the Puerto Rico government directly with FEMA. There's going to be money for community development, housing, flood control - there's all kinds of things. So it's a very sort of complex process. The first $1.5 billion is ready to be dispersed. The $8 billion of CBDG is in the process of improving the concepts in which the money can be used. And then the FEMA, the government is currently negotiating with the FEMA regarding the loss estimates for the different categories of things for which happen with the reimbursement. For example, they negotiate how much the school system suffered, how much the electrical system suffered, how much the water system suffered, and all has to be negotiated.

Okay. So if we kind of think about how the money actually flows through the system, right now, work is being done, et cetera, but it's really not a check that's been written. It's the line of credit that will get capped as time progresses, and that money will actually had - so that money maybe hasn't even kind of actually hit the economy yet.

The CBDG money has not hit the economy yet. I admit a deminimis amount has actually been dispersed if I understand for some of the administrative expenses but deminimis. So that money has not hit the economy yet. Even $1.5 billion as much as the $8 billion. And most of the FEMA disaster relief, which is the longer disaster relief if they get in the Stafford Act has not been dispersed to use. There's the immediate relief that FEMA guide. But for example, the more permanent improvements, the electrical system and the water system that make them more resilient in the future, that has not yet been agreed with the FEMA. So there is still a lot - so if you go back to what I said about if you take the federal government's own numbers, they say over more - over $40 billion has earmarked for Puerto Rico, probably closer to $45 billion, let's say. About $11 billion has actually been dispersed. And when the President referred to the $90 billion figure, he was referring that that's the figure it could reach because of these FEMA negotiations where the government has to sit down with FEMA and negotiate how much they suffered. Now that money can come over, especially the latter money can come a very long period of time. The CBDG money will come in, in faster.

Okay. That's helpful. And I was wondering, Lidio, as you kind of look at complexion of some of the NPL inflows, and particularly the mortgage level, which has come down nicely over the last couple of years, is there anything that you noticed in sort of the characteristics of loans that are going bad now that might differ from what those loans that would becoming delinquent would look like if you go back 2 or 3 years ago?

Haven't done that analysis, but I will tell you that the quality of our mortgage origination have been strong over the years. So the credit profile and the loan-to-value profile of the new loans on remuneration is better than what we had in the past, so I expect that the inflows will have those credit characteristics as well. The reality is that the post hurricane, post moratorium have seen significant improvement in the overall delinquency. Early delinquency numbers that we typically do not provide for the webcast - with the Qs are all-time lows for the portfolio.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Ignacio Alvarez for any closing remarks.

Thank you for joining us today and for your questions. The first quarter was another strong one for us, and we are very pleased with our results. We intend to build on that momentum and update you on our progress in July. Have a great weekend, everyone. Thank you.

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