Popular, Inc. (NASDAQ:BPOP) Q3 2023 Earnings Call Transcript

Popular, Inc. (NASDAQ:BPOP) Q3 2023 Earnings Call Transcript October 26, 2023

Popular, Inc. beats earnings expectations. Reported EPS is $1.9, expectations were $1.89.

Operator: Hello, and welcome to today’s Popular Inc. 3Q Earnings Call. My name is Jordan, and I’ll be coordinating your call today. [Operator Instructions]. I’m now going to hand over to Paul Cardillo, Investor Relations Officer of Popular to begin. Paul, please go ahead.

Paul Cardillo: Good morning, and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our CFO, Carlos Vazquez; 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 also be available during the Q&A session. Before we begin, 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. 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 our CEO, Ignacio Alvarez.

Ignacio Alvarez: Good morning, and thank you for joining the call. We are pleased to report another strong quarter. Net income totaled $137 million, which includes the effect of an after-tax goodwill impairment of $16 million in our U.S.-based equipment leasing subsidiary. Excluding this impact, net income would have been $153 million, $2 million more than the previous quarter. The increase in net income was driven by lower operating expenses and higher net interest income, offset in part by a higher provision for credit losses and higher income taxes. We grew loan balances by $1 billion during the quarter. BPPR generated loan growth across almost all business segments reflecting the continued strength of the local economy. Popular Bank achieved growth in commercial and construction loans.

Year-to-date, loan balances have grown by $2 billion. Our net interest margin decreased seven basis points to 3.07% in the quarter, primarily due to a 27-basis point increase in deposit costs. This was partially offset by higher loan balances and the repricing of loans in a higher interest rate environment. Noninterest income remains solid and continues to benefit from steady customer transactional activity. Excluding the goodwill charge, operating expenses decreased $17 million driven by lower professional fees and customer activity-related fees. Credit quality trends generally remain positive. Nonperforming loans decreased once again and net charge-offs remain well below pre-pandemic levels. While we are beginning to see some credit normalization in the Puerto Rico unsecured consumer segments, we are attentive to the evolving credit landscape and have taken action to address these developments.

Deposit balances at quarter end decreased by approximately $700 million, primarily due to a lower level of Puerto Rico public deposits. However, average deposits for the period increased by $1.4 billion, also driven by public deposit activities. Borrowings decreased by approximately $300 million due to the redemption of senior notes during the quarter. Tangible book value per share ended the quarter at $50.20 and a decrease of $1.17 per share as net income for the period was offset by an increase in the unrealized losses in our investment portfolio. Regulatory capital levels remained strong. Our common equity Tier 1 ratio in the third quarter was 16.8%. Please turn to Slide 4. I’m very pleased to highlight that during the third quarter, we crossed a significant milestone in Puerto Rico and now serve more than two million unique customers.

Utilization of digital channels among our retail customers also remain strong. Active users on our Mi Banco platform exceeded $1.1 million or 54% of our customer base. In addition, we continue to capture more than 60% of our deposits through digital channel. In the third quarter, consumer spending remained healthy with combined credit and debit card sales up 6% compared to the third quarter of 2022. Our auto and lease loan balances increased by $104 million compared to the second quarter as demand for cars has continued to be strong in Puerto Rico and available inventories have improved. Mortgage loan balances at BPPR increased by $121 million sequentially in the third quarter, driven primarily by home purchase activity. The Puerto Rico economy performed well during the third quarter.

Business activity is solid and remains in good shape as reflected in the continued positive trends in total employment and other economic data. The tourism and hospitality sector continues to be a source of strength for the local economy. There are roughly $51 billion of hurricane disaster recovery, infrastructure and pandemic rate funds that have yet to be dispersed. The pace of disbursement of these funds has accelerated, and we anticipate that these funds will support future economic activity for several years. As this infrastructure investment and the economy expands, we are well positioned to serve the needs of our customers and to benefit from such activity. In short, we are pleased with our results for the quarter, particularly our strong loan growth in both Puerto Rico and in the U.S. as well as the continued strength of our deposit base.

We are also encouraged by the strong performance of the Puerto Rico economy. We remain optimistic about the future of our primary market and our ability to manage and serve the needs of our growing customer base. I’ll now turn the call over to Carlos for more details on our financial results.

Carlos Vazquez: Thank you, Ignacio. Please turn to Slide 5. We reported net income of $137 million compared to $151 million in Q2. Quarterly net income includes the effect of a goodwill charge. Excluding the charge, net income was $153 million, $2 million higher than the prior quarter. Net interest income was $534 million, $2 million higher than Q2. On a taxable equivalent basis, net interest income was $564 million, an increase of $5 million from Q2 due to higher volume of tax exempt investment securities, offset in part by higher disallowed interest expenses in Puerto Rico taxes. Noninterest income was $160 million, essentially flat with Q2. The provision for current losses was $45 million compared to $37 million in the second quarter.

Total operating expenses were $466 million in Q3, an increase of $6 million from the prior quarter. This expense number includes a $23 million pretax and noncash goodwill impairment in our U.S.-based equipment leasing subsidiary. The goodwill impairment results roughly from two equal effects. First, a higher discount rate for the projected cash flows resulting from higher rates and equity premiums; and second, a lower projection of future income. Presently, this subsidiary has lease balances of about $113 million and remaining goodwill of $17 million. Excluding this noncash expense, Q3 expenses decreased by $17 million from the prior quarter. The variance in operating expenses was driven by lower professional fees by $12 million in advisory expenses from corporate initiatives, primarily related to regulatory compliance and transformation efforts and an $8 million reversal of an accrual related to regulatory termination fees in BPPR.

During Q3, we incurred $4 million transformation-related expenses compared to $7 million last quarter. Our transformation effort is progressing as planned. But due to the stage of execution of various major projects, the timing of some of the expenses will be somewhat delayed. Also, the decision to use in-house resources to repurchase previously planned consulting fees into longer-term investment or capitalize all our initiatives has resulted in a lower-than-forecasted expense. As a result, we now expect transformation expenses for 2023 to be approximately $30 million, down from our prior guidance of $50 million. We expect Q4 expenses to be approximately $475 million. Normalizing for the $23 million noncash goodwill impairment, total expenses for 2023 would be around $1.82 billion or $50 million better than our original guidance, driven by lower transformation expenses and cost control initiatives undertaken during the year.

If the proposed FDIC special assessment is implemented as presently drafted, we estimate Popular would incur an additional expense of roughly $66 million. We will provide 2024 expense guidance, including transformation efforts in our January webcast once next year’s budget is completed. Our expected tax rate — effective tax rate for the quarter was 25.1%. The higher Q3 tax rate was attributable to certain tax benefits recorded in the second quarter offset by lower income before tax. For the full year 2023, we continue to expect the effective tax rate to be between 22% and 25%. Please turn to Slide 6. Net interest margin decreased by 7 basis points to 3.07% in Q3. On a taxable equivalent basis, NIM was 3.24%, a decrease of 5 basis points versus Q2.

The decrease is driven by higher interest expense on deposits due to increased cost of public deposits and growth in high-cost deposit accounts at Popular Bank. This was partially offset by higher loan yields and balances across all major lending categories and higher yields in our cash balances and investments. At the end of the third quarter, Puerto Rico public deposits were roughly $17.8 billion, a decrease of roughly $700 million compared to Q2. Decrease in Q3 was consistent with historical trends. However, public deposit balances have remained higher than we had anticipated. As such, by the end of 2023, we now expect public deposits to be in a range of $16 billion to $18 billion compared to our prior expectation of $14 billion to $16 billion.

Excluding Puerto Rico public deposits, customer deposit balances group were up by $46 million, primarily driven by increases in time and savings deposits at Popular Bank, offset somewhat by retail outflows at BPPR. Approximately $300 million of client deposit balances at BPPR were transferred to our broker-dealer during the quarter, searching for higher yields. Ending loan balances increased by $1 billion compared to Q2, driven by growth in almost all loan segments at BPPR and on commercial and construction loans at PB. Year-to-date, loan balances have increased by $2 billion versus $2.3 billion for the same period a year ago. We are encouraged by the demand for credit at BPPR and PB. We will continue to take advantage of prudent opportunities to extend credit and improve the use and yield of our existing liquidity.

Our interest rate sensitivity is relatively neutral. We continue to expect the margin to resume an upward trajectory in Q4. The timing results from our forecasted loan and deposit growth and mix, investment portfolio strategy and the pace of repricing of public and incrementally retail and commercial deposits. Please turn to Slide 7. Deposit betas in the current tightening cycle are now above the prior cycle. We have seen a total cumulative deposit beta of 34% to date but the rate of increase of deposit costs continues to slow down. In BPPR, total deposit costs increased by 24 basis points compared to an increase of 26 basis points in Q2, led by public deposits. Excluding the public deposit balances, total deposit costs were 55 basis points compared to 50 basis points the prior quarter for a cumulative beta of 7%.

In the third quarter, the cost of public deposits increased by 47 basis points compared to our July estimate of 50 basis points. We expect the cost of public deposits to increase by approximately 10 basis points in Q4. The deposit pricing agreement with the Puerto Rico public sector is market linked with a lag. This source of funding results in an attractive spread under market rates. At Popular Bank, the deposit cost increased by 29 basis points compared to an increase of 54 basis points in Q2, led by retail deposits gathered primarily to our online channel. Please turn to Slide 8. Our investment portfolio is almost entirely comprised of treasury and agency mortgage-backed securities, which carry minimal credit risk. Including our cash position, this portfolio has an average duration of approximately 2.2 years.

In Q3, the unrealized loss of the AFS portfolio increased by $231 million, driven by an increase of $274 million in the Agency MBS portfolio, offset in part by a reduction of $44 million in the U.S. Treasury portfolio. At the end of the third quarter, the balance of unrealized loss in AOCI of our HTM portfolio stood at $702 million, a reduction of $44 million from Q2. We expect this loss will be amortized back into capital throughout the remaining life of that portfolio at a rate of approximately 5% per quarter through 2026. Please turn to Slide 9. Our return on tangible equity was 9.4% in the quarter. We continue to target a sustainable 14% ROTCE by the end of 2025, driven primarily by higher net income. Regulatory capital levels remain strong.

Our common equity Tier 1 ratio in Q3 of 16.8% decreased by 6 basis points from Q2. Tangible book value per share at quarter end was $50.20, an increase of $1.17 per share, mostly resulting from increased AOCI — sorry, a decrease of $1.17 per share. Given the continued uncertainty on the outlook for rates, the economy and the proposed regulatory response to advance in the banking sector, we will not engage in share repurchase during 2023. We do plan, however, to consider a dividend increase this year. We will review future capital actions as market conditions evolve. Our long-term outlook on capital return has not changed, anchored on our strong regulatory capital ratios. Over time, we expect our regulatory capital ratios to gravitate towards the levels of our mainland peers plus a buffer.

With that, I turn the call over to Lidio.

Lidio Soriano: Thank you, Carlos, and good morning. Overall, Popular continue to exhibit stable credit quality trends with low levels of net charge-offs and decreasing nonperforming loans. Consumer portfolio, however, reflected increased delinquencies and net charge-offs, primarily due to the expected credit normalization. We continue to closely monitor changes in the macroeconomic environment and on borrowing performance even higher interest rates and inflationary pressures. We believe that the improvements over recent years in risk management practices and the risk profile of the corporation’s loan portfolio positions Popular to continue to operate successfully under the current environment. Before discussing the credit metrics for the quarter, I would like to address the risk profile of our office commercial real estate exposure and consumer portfolios.

We have included additional information for these segments in the appendix to today’s presentation. Popular consolidated office CRE exposures limited representing only 1.9% or $634 million of our total loan portfolio. It is mainly comprised of low to mid-rise properties located in suburban areas and is well diversified across tenant type with an average loan size of $2.1 million. The portfolio has a favorable credit risk profile with low levels of NPLs and classified loans. In terms of our consumer portfolios, these have begun to normalize as expected, reflecting increased delinquencies and net charge-offs. The credit card, auto loan and lease portfolios continue to exhibit delinquencies and net charge-offs that are below pre-dynamic levels, although gradually increasing.

In the case of unsecured personal loans, however, the year-to-date net charge-off ratio is 3.4%, which is above the 2.5% average for the 2011-2019 period. We’re closely monitoring the performance of our consumer portfolio and have made changes to our underwriting criteria to decrease exposure to higher-risk segments. Turning to Slide 10. Nonperforming assets and nonperforming loans continued to decrease, driven by the commercial and mortgage portfolios. The decrease in the Puerto Rico commercial portfolio was aided by the payoff of an $11 million relationship. NPL inflows also decreased, driven by lower commercial inflows in Puerto Rico and lower commercial inflows in the U.S., offset in part by higher mortgage inflows in Puerto Rico. At the end of the quarter, the ratio of NPLs to total loans held in portfolio decreased to 1.1% from 1.2% in the previous quarter.

Turning to Slide 11. Net charge-offs increased from the prior quarter to $33 million or annualized 39 basis points of average loans held in portfolio. The increase was driven by higher consumer net charge-off in Puerto Rico, mainly in the auto and personal loans portfolio. This increase was in part offset by $11 million recovery from a commercial loan payoff. Please turn to Slide 12. The allowance for credit losses increased by $11 million to $711 million driven by reserve build up in the Puerto Rico auto and personal loans portfolio, changes in macroeconomic scenarios and loan growth. In the U.S., allowance for credit losses decreased by $18 million due to the implementation of a more granular model for the U.S. commercial real estate portfolio.

The provision for credit losses was $44 million compared to $36 million in the prior quarter. The corporation ratios of allowance for credit losses to total loans remained flat at 2.1%, while the ratio of ACL to NPL stood at 197%, up 15 percentage points from the previous quarter. To summarize, our loan portfolio continues to exhibit strong credit quality trends in the third quarter with low net charge-offs and decreasing nonperforming loans. Consumer portfolios, however, reflected increased delinquencies and net charge-offs due to credit normalization. We remain attentive to the evolving environment but remain encouraged by the performance of our loan book. With that, I would like to turn the call over to Ignacio for his concluding remarks.

Thank you.

Ignacio Alvarez: Thank you, Lidio and Carlos, for your updates. Our results for the quarter and year-to-date have been strong, driven by solid earnings, robust loan growth, stable credit quality and continued customer growth. It is an honor to serve over 2 million customers in Puerto Rico, providing a wide variety of products, services and channels, and we value immensely the trust that take place in us. Earlier this month, we celebrated Popular’s 130th anniversary. Since 1893, we have successfully adapted and led throughout changing conditions, and we are proud of our history and the legacy that has made Popular what it is today, a strong, vibrant organization with deep rooted values. I have the privilege of visiting many of our colleagues during the anniversary and was inspired by their passion and dedication.

We are encouraged with the progress of our transformation that position us well for the future. We are optimistic about the opportunities that lie ahead. Economic trends in Puerto Rico continue to be positive and a considerable amount of recovery funds yet to be disbursed are expected to support increased economic activity for the coming years. Our diversified business model, robust levels of capital and most importantly, the talent and dedication of our people position us well to support and meet the evolving needs of our growing customer base. We’re now ready to answer your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Timur Braziler of Wells Fargo Securities. Timur, the line is yours.

Timur Braziler: Hi, good morning.

Ignacio Alvarez: Good morning, Timur.

Carlos Vazquez: Good morning.

Timur Braziler: Hi, I’m wondering how much of the delayed transformation expenses occur in ’24. And I guess the total amount of transformation costs, is that now lower? Or is that expense just pushed out?

Carlos Vazquez: Yes. I mean some of the expenses have been recharacterized, Timur. So for example, as we mentioned, some expenses that we expected to be external consultants were brought in-house. And some of those may end up being capitalized as part of the project. Others have been delayed because the projects have taken a bit longer to get going or whatever the case may be. So it will be a combination of some pushed into ’24 and others that will not happen anymore. We will — that — what that combination might be, will be clear when we complete our project plan for ’24, and we complete our budget for ’24, and we will provide the guidance on expenses in January, as we normally do, including both overall expenses and transformation expenses.

Timur Braziler: Okay. And then I guess, looking at funding costs. To what extent are interest rates now done pressuring deposits and the pressure now comes from mix shift?

Carlos Vazquez: Well, I mean, to the extent that you think the Fed is done, we will continue to have an effect because of the one quarter lag of the effect of public sector deposit costs in Puerto Rico. But most of the rest will probably be a result of shift as opposed to base rates changing. With the sole exception of the Puerto Rico public sector, again will have the lag of the third quarter increases into the fourth quarter.

Timur Braziler: Okay. But those balances — just looking at period end, over average and then seasonal expected outflows in the fourth quarter those balances of public fund deposits should be materially lower on an average standpoint in 4Q. Is that correct?

Carlos Vazquez: Well, it depends. We’ve updated our range for year-end as you heard from 14 to 16 to 16 to 18, if the balances end up at the high end of that range, then the average for the fourth quarter will be not very different. They will be a bit lower than the average for the third quarter but not too much difference. So it will depend on where we end up in Q4.

Timur Braziler: Great. And then just last for me on the credit normalization, the unsecured PR consumer book. The comment about limiting exposure to higher-risk segments. Can you just maybe talk through what’s been the greatest source of stress in that portfolio? And which segment you’re referring to in that comment?

Lidio Soriano: I would say, lower FICOs and the auto portfolio of used card lower FICO segments.

Timur Braziler: Great, thanks for the questions.

Operator: Our next question comes from Brett Rabatin of Hovde Group. Brett, please go ahead.

Brett Rabatin: Good morning everyone.

Carlos Vazquez: Good morning, Brett.

Brett Rabatin: I wanted to start on the — back on the expenses in the third quarter and see if — and get a little more color, if I could on, I didn’t quite understand the noise around lower regulatory costs. Most are having higher. Can you maybe talk a little bit more about the items that reduced expenses in 3Q and then how that might change you think in the fourth quarter, relative to the $475 million guidance?

Carlos Vazquez: Yes. I mean it’s mostly professional fees, Brett. Now these are professional fees that we hired consultants to assist us in a whole bunch of different things. And the reduction in the quarter was mostly related to some assistance we get on regulatory matters or our transformation and things of that sort. But this was normally — this number goes up and down. It’s just that the professional fees number tends to be a lot more stable as opposed to coming down. So you noticed the change. But in any given quarter, the expense in those professional fees can gravitate from advice on regulation, to advice on transformation, to advice on something else. So it’s just a bit more notable this quarter but it is mostly professional fees. The other thing is we do have a reversal of an accrual for regulatory expenses that we had accrued — over accrued in that, and that’s an $8 million this quarter, which obviously also helped the expense number.

Ignacio Alvarez: I think it’s also fair to say that we are challenging our teams to make sure as much as possible in-house versus consulting or using our consultants more intelligently. So it’s not that regulatory costs are necessarily going down but the professional fees and consulting fees are going down.

Brett Rabatin: Okay. That’s helpful. And then on the margin, as we think about ’24, assuming the Fed has stopped, would seem like the margin would start moving higher with the government deposits not repricing every lag three months. Any thoughts on your willingness or ability to invest maybe some of the cash flow in the securities portfolio into higher rates and just how you see the NII dollars playing out over the coming year?