Popular, Inc. (BPOP) Earnings Call Transcript & Summary

All right. Well, good afternoon, everyone. My name is Brock Vandervliet, and I'm the mid-cap bank analyst here at UBS. And very happy to be closing out our sessions today with Banco Popular and Carlos Vázquez, CFO. As hopefully everyone on this call knows, this has been my best idea for the year, and it's been working rather nicely. But -- so very happy to have Carlos with us today to walk through the story.

Happy to be here, Brock. And we're happy to be your best idea.

Well, it's funny. All these calls today with mainland banks have kind of started with the same things, but with Banco Popular, it's -- it really calls for a totally different set of questions. So as for people familiar or even not so familiar with the story, as you think about the unique -- the distinct catalyst for Puerto Rico, the potential debt restructuring, the CARES Act, hurricane aid, domestic tax saving, the Article 20 dynamic. How do you kind of think about those things in terms of bank performance over the intermediate term?

Yes. The -- I think one of the most interesting things about our case in Puerto Rico is we've been disconnected from the U.S. economy for a long time, over a decade. Now Puerto Rico tended to move in tandem with the U.S. economy and in 2005, 2006, that started. One of the more interesting things that I think we're back in a situation where it's reasonable to expect our economy will perform together with the U.S. economy, and that is mostly driven by the fact that the drivers of the client performance are the same for us in Puerto Rico and they are in the mainland, and they're mostly driven by the federal systems as a result of COVID, obviously. Now in our case, we do have some unique differences that should be beneficial and marginally better for the mainland is that while we will get the same kind of benefit from the federal systems that most of our peer banks in the mainland are getting, we do have the unique circumstance you mentioned and you described very well, Brock, that we also have the additional influx of investment that results from the -- from Hurricane Maria. Those funds that were allocated for Puerto Rico or assigned to Puerto Rico some years ago have taken a while to actually be deployed in the economy. And I think we're now in a position where that will start to happen. So we have some of the same underlying dynamics that drive the expectation of most of the mainland banks. But then we do have additional things like that extra investment that should be marginally beneficial for us over and above what's happening in the mainland. The debt restructuring of the island property venture is also important. There's an expectation that, that will be concluded late this year, early next year, and that will be the first step in the Government of Puerto Rico coming out of bankruptcy. And that, again, is our unique condition to Puerto Rico that doesn't really apply in the rest of mainland, that should give us some additional support for the economic growth. So we think we're pretty optimistic that all these things combined will give Puerto Rico economic growth that is significant and sustained for various years, and that's a condition we haven't had since -- for more than 12 years now.

The bank is -- obviously had a very long presence in Puerto Rico. How -- prior during and hopefully now after the bankruptcy, how did the bankruptcy specifically affect bank operations? I can think of the obvious where there's a flow of deposits that wouldn't have existed otherwise. Maybe talk about that. But what are some of the other impacts that you'd highlight?

Yes. I mean you can look at it from a different -- a couple of different perspectives. I think one that is sort of dear to my heart is on the investors from outside of Puerto Rico from that point of view. Having a bankrupt local government is a big deterrent to investor interest and investor appetite and investor confidence. And we've had to live with that for many years now. So if we can cross that bridge, I think it will be a nice positive. Years ago when the bankruptcy started, we would start almost all our investor meetings, our prospective investor meetings with a long, long discussion about the prospects for the island. And that part of the meeting can become shorter now, I think that will be great. The level of interest or the required return for mainland investors to invest, not necessarily in stock, but also in real assets in Puerto Rico, shopping centers, a big group of shopping centers just got sold to mainland investors, the same true of a group of warehouses and things like that. That will improve the required return to come down when the perception of risk is lower. When the government debt is restructured, while we don't know this for a fact, we suspect that, that will be a trigger for the rating agencies to be less conservative in Puerto Rico. And we're not a big issuer in the fixed income market. So it doesn't affect our business in a huge way. It does -- it's a reflective of investor confidence. And hopefully, we will get what we think is our ratings rightsized to where they should be as opposed to where they have been over the last few years. And the government being bankrupt, you mentioned the deposit side, Brock, which is important, we ended up sort of becoming the main bank for all hundreds and hundreds of different government entities. That was a big change. But the government being bankrupt also affected our loan side, our asset side in the balance sheet. If you look historically at Popular, we've always had hundreds of millions of dollars of loan exposure to the government of Puerto Rico in different forms and different entities for different purposes. And that exposure right now is basically 0. And it's 0 because we structure those loans correctly. So we get paid on all those loans independent of the bankruptcy. But the bankruptcy has made it very hard for us to find opportunities where debt structuring of credit can be done so that we can feel convinced that it is a good transaction for us to do. And that's why our government exposure is now 0. It's not because we don't want to lend to the government, it's just that in the context of a bankruptcy, it's very hard to structure deals in a way that gives us the confidence to actually lend more to the government. So when the government comes out of bankruptcy, all of a sudden, those opportunities I think will start showing up again. Again, we were very successful in all the exposure we had, went down to 0 because of payment and because of charge-offs. Hopefully, we can continue to deploy that expertise to structure transactions properly and safely so that we can also grow loans on that side.

What going back pre-bankruptcy, then roughly what percentage of the loan book was government exposure?

I don't -- it's been a while. So I don't remember off the top of my head. But we would normally do transactions in the hundreds of millions of dollars in tax advance spends to the government and some municipalities as well and things, so it was hundreds of millions in the past. I'll have to go back and look at the historical data. I'm also not sure we'll go back to doing exactly the way we did it in the past, frankly, in the environment. So that may change. But it's an interesting opportunity that we think, again, that we have the expertise to structure things properly for them to make sense both for governmental borrowers and for our credit banks.

Okay. I guess I'm going to add one stunt to teach your question on the call. When we did our call last week with a Puerto Rican homebuilder, one of the more interesting points he touched on was 5 million-or-so Puerto Ricans outside the island and many of the younger workers and better educated, historically, have left. And what do you think is the potential now for given greater opportunities on the island for that to potentially reverse?

Yes. I think we've seen some of that already, Brock, in that if you look at the immigration patterns in Puerto Rico, for about a decade, we actually saw a loss of population between 1% and 2% per year. But in the last 2 years, the population has actually been flat. So we may have -- we may be seeing a little bit of that already. Now I'm of the opinion that people don't leave Puerto Rico because they hate living here. I think people leave looking for opportunities. And when you look at that sort of last decade where we have population exodus every year, now it was a decade where the economy was contracting. There was no job creation. So when people are looking at opportunities, they have to go somewhere else to find them. Now we are looking at an environment that's very different now, where we have a reasonable expectation of economic growth for the next few years. With that growth, there should come real job creation. So it's a whole different situation completely from what we've had for the last 10 years. Now the more difficult question to answer is what will be the correlation between economic growth and population growth. And one of the reasons it's so difficult in Puerto Rico, is because economies when they come up with models that forecast population based on econometrics, they tend to look at history. And we haven't had the condition we're facing today of real economic growth moving forward for more than a decade. So whatever model economists had that correlated growth in population to economic growth is 12 years old. So that model is probably not very reliable. So I'm not sure we have very good tools to correlate the 2 things. But I think it's fair to assume that with the growing economy, the pressure for outmigration will come down, and there will be some attractiveness for people to come back. Again, exactly what the mix is going to be, that's a tougher call right now. We'll need more data, and we will need to live through some of it before we can start extrapolating that. Some -- we've seen some return of the Puerto Ricans in the mainland. Historically, that return would be people that have retired and come back to Puerto Rico for their retirement. Now we're seeing a lot more young professionals. Some of that return of young professionals has been what I would call temporary. Younger kids that were working in New York or working in the major cities in the U.S. and their employers went remote. And if they're going to work remote, they can be in an apartment with 2 other kids in New York paying $5,000 a month or being at their home paying nothing in Puerto Rico for free and still have the same job and the same income. So there's a little bit of a temporary dynamic in that. We'll have to see how that plays out. But it's also had interesting effects on the labor market 2 ways. From our point of view as a company, we've been able to hire people now that work remotely for us in the states that we wouldn't have been able to in the past. So we have a much larger asset -- access to professional people that we maybe didn't in the past. The flip side of that equation is that our professionals are getting offers from companies in the mainland that wouldn't have in the past. Because in the past, the company will have required them to move, and now they're saying, fine, you can stay in Puerto Rico and still work for us. So how that will play out, it's early days in that dynamic. So we don't know, we're just trying to respond to both of those opportunities and risks.

Got it. And sort of as a related question, I've heard it called act or article depending on the reference. But Act 20, Act 22 tax incentives from Puerto Rico for U.S. citizens, it's amazing. We've read so many stories of people moving to Florida and Texas for in comparison, very small tax benefits relative to what's on offer in Puerto Rico. How -- but then again, this isn't necessarily brand new either. How big an impact do you think this has?

I think the [indiscernible] have a marginal positive impact to the economy, okay? To give you an example, last year in 2020, the government formalized 380 decrees, which is what dictates how people can move down with tax exemptions for Law 22 investors. These are the personal investors are moving down. And they formalized close to 500 for Law 20 investors which are business activities as opposed to personnel moving down. So in total, those are what, 1,300 either persons or small businesses that have moved down. Those are clearly a net positive for the economy because if those people don't move down, the economic activity they create and whatever tax revenue, they create is 0, because multiply anything by 0, it's 0. So the fact that they are here is a net positive. There -- this influx of people is having a very marked effect on the high-end real estate market. So there, it's very, very palpable and very, very real. And some of the businesses they have is also -- are also adding some employment. The -- but we think the effect of those is, again, a net positive, but not large enough to be a significant change in the economy, at least in the short term. We have not seen those movements of people expand to the larger segment of people you referred to that moved to Florida or Texas, meaning a lot of retirees and things like that. We haven't seen it expand there yet. By the way, moving down and getting this increase is not very easy. It takes a process and there's everything else as well. The other thing is we do have unique characteristics that make the experience a little bit different. There may be a language challenge for some people when you move down and things like that versus Florida. So it's a little bit different. The idea that we'll see more flows like Florida and Texas is an interesting idea that is not evident so far.

Got it. And the 1,300 you mentioned that was in calendar year 2020?

Correct.

Got it. Got it. Okay. And do you think -- have you heard anything informally in terms of government rumblings about putting something on the table that would make it more attractive for Puerto Ricans to move home, move back.

Yes. I mean we haven't done it on a broad-based effort yet. The government has done some of those things in specific sectors. For example, they made a change for medical doctors since we have some sort of a shortage for medical doctors, especially in some specialties. So they made a change. But the change was very broad, it applied to all doctors operating in Puerto Rico, whether you're coming back or not. So they made it in that -- in that segment, and that has caused some doctors to consider moving back, for example. But they haven't attacked that on a broad base as far as a coordinated effort to bring some of the professionals in the mainland bank, not yet.

Got it. Got it. Okay. Why don't we shift to loan growth, which seems to be the topic #1 and -- across the entire sector at the moment. Yes, I know your guidance stylistically is very conservative. Is there -- what metrics would you look at or suggest that investors look at that might increase your expectation on loan growth? Or is it really that you've got to see it to actually talk about it?

Yes. And you're right, Brock. There's a little bit of stylistic in this. We are closer to be out of the 2 options you described than anything else. I mean we tend, as a company, to be happier talking about something that we've already delivered than probably something that may or may not come. So yes, we prefer to see it and then discuss why it happened, how it happened, and we expect it to continue then, so I think to say that we hope loan growth will come. We are positive on loan growth. I mean we think the loan growth will come as a result of the economic growth we're seeing, and we should see for the next few years in a very high level given that we have a very important market share in Puerto Rico. It wouldn't be unreasonable to think that our loan growth should look like the growth in the economy, right, because we are a big part of -- or contribute to a big part of the economy. And that all makes sense conceptually. And the things that would change that is if we are losing market share to competitors, which we don't plan to. We were gaining market share for competitors, which we hope to. Or if we're loosening credit standards, which we are very cautious with. Other than that, so the band should be around the level of economic growth, barring, of course, acquisitions and all the things. So that's probably the right way to think about what the ranges should be. Now what -- the components of that will change with time. Again, right now, given the dynamics of the portfolio with $1 billion of PPP loans being forgiven over the next 12 months, probably, and with very low interest rates, a high level of runoff in our big resi mortgage portfolio on the other side with our clients having record levels of liquidity in their accounts, our commercial -- our average commercial and retail client today has 43% higher account balances and deposits than they did in February of last year. So our average client is swimming in liquidity right now. And what that means is that they will, for immediate needs, they will probably use their cash before they come to us for loans. And that's why the demand is tepid. So we have 2 dynamics there, tepid demand because of high levels of cash from our clients. We have natural runoff in the book highlighted by PPP, obviously, that keep the runoff high. And that is why we mentioned, as you know, that we expect net loan growth to happen probably sometime in the first half of next year as opposed to late this year. Now most of the market has been moving in our direction, a lot of banks said late '21 last quarter, and now they're talking more about early '22 as well. By the way, we hope to be wrong on this one. We hope it happens in late '21, but we're not seeing it right now. We're not seeing the numbers add up to net loan growth in late '21, it looks more probable for us in early '22.

Got it. And that's a 43% higher deposits among just commercial customers or in commercial and retail?

Retail and commercial, both.

Retail and commercial.

Yes. So putting aside all the noise with government deposits. This is only our retail clients and our commercial clients.

Got it. One thing that was very striking in our call with this homebuilder CEO was the level of under investment, obviously, in housing in that conversation where roughly speaking, I guess, home construction at peak was about 13,000 homes pre 2004 and troughed at about 1,000, and most of that -- those were social housing.

Correct.

And you had a 10-year period where production was bouncing around 1,000 units. So there is this embedded demand for middle and upper tier housing. Does that -- is that a pattern that's really unique to housing? Or is that found in other parts of the economy where there was just kind of this walking in place for a decade?

I don't think it's unique to -- I'm hearing myself again. Sorry. Okay. I don't think it's unique to housing. But it surfaces in different ways in other parts of the economy, Brock. The way I think it surfaces, for example, in the commercial sector is that over the last decade, you've seen some of our clients become bigger and they have acquired some of their competitors. So again, in some of the production or retail segments, it would -- the -- it will show up that way instead of showing up in a lower level of housing, which is the clearest example on that front. So I think there's been a consolidation in many sectors in the economy that, again, surfaces in different ways. That's one of the reasons I think that why our credit portfolio has become so resilient. One of the contributors to that, I think, is that just like us in the bank that have survived a 10-year recession and a 100-year storm and 100-year earthquake and a global pandemic, our clients have as well. So a lot of the weaker clients we have, have fallen along the way. We are now left with a lot of clients that are survivors too, and they have dealt with adversity effectively and continue to grow their business. So part of the reason I think that other than, hopefully, we're doing better underwriting and everything else, that why our portfolio performs better is that we have a lot of very resilient clients that have survived really tough odds, and they're pretty good at what they do. So we think that -- I think that this -- personally, that is helpful as well.

As you look -- or your credit folks look at some of the financials for some of those organizations, I would imagine their balance sheets that have been rigged for heavy sailing, so to speak, for a long time. They're really batten down pretty tight. It strikes me that as that -- with the bankruptcy being resolved, hopefully, they could begin to run themselves in more of an aggressive way rather than quite so tight and that might affect loan growth, for example. How do you think of that?