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

Good morning, everyone. This is Gerard Cassidy with RBC Capital Markets. Welcome back for another fireside chat as part of our Financial Institutions Conference. We're very pleased to have Popular this conversation. Carlos Vázquez is the Chief Financial Officer for Popular. He's been the chief financial officer since 2013 and he joined Popular in the – to head up the risk area back in 1997. And then some of you may know, Popular has about $65 billion in assets, with the majority of those assets obviously being in Puerto Rico. They also have presence of course, here in New York City as well as Southern Florida. The market cap of the company is just over $6 billion, trades at a slight premium to book value about 1.1x, and has a dividend yield of about 2.6%. Welcome, Carlos. Thank you so much for joining us again.

Happy to be here. Sorry we can't do it in person.

Yes. And let's keep our fingers crossed that, that will happen in 2023. Maybe since you're obviously in Puerto Rico with a good feel on the pulse of what's going on with the different bankruptcies and such, can you give us an update on what you guys are seeing with Judge – I think it was Judge Swain earlier this year gave you an approval of the bankruptcy. And maybe you just give us an update on how that's progressing and what are you guys seeing in your outlook on that?

Yes. There's two things going on that are most important, and they seem and try to actually be going up the directions. The restructuring of the central government debt has made a lot of progress. That plan, as you said, was approved by the judge some months ago. And we are not involved directly, but we are aware that both the fiscal control board, the government and the board have targeted closing for some time in mid-March. Everything that we know seems to indicate that they are still on track for that closing. So we are hoping that actually happens in mid-March and that closing takes place. That will be a pretty positive step for the island in that it removes a significant amount of uncertainty as far as the government and the government debt is concerned. I think it’s a pretty good signal for both the business and the investment environment in the island that we get this big cloud out of the system, and we become more normal jurisdiction in which to do business. And we also think it may have some collateral benefits that may even touch us. For example, it may lead to some rerating of the government debt in Puerto Rico that may actually have some – we may ride the coattails of that and get some of our ratings to what I think should be the correct levels as opposed to their present levels. So that seems to be on track. The one that I refer to that seems to be less on track is the restructuring of the electric company. On that front, a transaction was negotiated many months ago. But obviously the context of that transaction is very different from the context in which we were operating today. When that was done months ago, the price of oil was low and heading lower and now the price of oil is very high. Some of the parts of that restructuring had direct linkage between the tariff and the price of oil. Obviously, whatever the economics were so many months ago have changed. So as a result, the governor announced, I think yesterday -- day before yesterday, that he was recommending that we scrap that transaction. The fiscal control board agreed, by the way. And as of yesterday, I believe the judge had given the opportunity that the Board has a representative of PREPA and the bondholders sort of 55 days I believe to come up with a new plan. So on the PREPA front, I think it's sort of back to the drawing board. But the part that has to do with the government restructuring seems to be on track. The government restructuring, as you know, is not immaterial for Popular since we expect that a good part of the funding that is attached to that deal. The upfront payments will come from the deposits that the government has at the bank. I always like to repeat, it's not liquidity event because the deposit have to be collateralized by Puerto Rico also. We get our collateral back, we sell it, we report it, whatever. But if everything goes through, something that we think is in the neighborhood of $10 billion of deposits will go away. And that will go a long way to normalize our balance sheet, which is a little bit inflated because of that cash right now.

Yes. No, very helpful. And you touched on oil with PREPA of course. Could you share with us, when you think back to what was it 2014 or '15, the price of oil went up. Now it's a little higher today peaking versus the peak back then, but did it slow down the – I don't recall specifically the economic impact on Puerto Rico. Do you recall how the economy handled it? Because I know the island relies on oil quite a bit.

Yes. There's still two major reliance on oil; number one, transportation; and number two, energy. The transportation one historically, and I emphasize that, had been less elastic because there really is no alternative transportation. Puerto Rico, you drive to work or you drive to work, you can't just not drive and take public transportation. That's not an option. The reason I highlight that historically has been less elastic is I think that relationship has changed because of work from home. But we may be in a brand-new environment that we can't quantify right now. In '15 and '16, when the price went up, it did have a negative effect on the economy. At that point in time, we're contracting anyway. So maybe the contraction got a bit worse. Puerto Rico uses about 33 million barrels a year of oil. So if the price goes up $10, it’s $330 million; if it goes up $50, it’s $1.6 billion. And it is not -- and that is money is -- composite consumption capacity that goes away because the consumption not happens, but the money just goes into paying for the oil, which is outside of the island as opposed to internal consumption. So it does have an dampening effect. It could have a dampening effect on demand. At this point in time, our clients have some record levels of liquidity still. Our average retail and commercial client now has about 40% higher balances than they did in February 2020, pre-pandemic. So there's still lot of liquidity in the market. And how much effect the oil price will have will obviously depend on how long it goes, right? If there is a resolution of the Ukrainian conflict in the next few weeks, either because Russia ends up taking over the whole country or because there is a deal and the uncertainty in the market goes away, then we might see the spikes being short-lived and obviously then, the effect will be less serious. But it will depend on how long lived the spikes are. But it is consumption that goes away from local consumption to buying for external oil indirectly.

Yes. No, very helpful, Carlos. Thank you for that. When you look at the loan growth data from the HA data, we saw a nice pickup of industry loan growth toward the end of last year, and then it slowed down at the start of the year, some of it is seasonal. Maybe can you share with us what you're seeing for loan demand in Puerto Rico and also in the mainland offices in the early part of 2022?

Yes. Let's take the two pieces separately. Our mainland bank had a really, really good fourth quarter last year. They grew almost about $700 million. Now we are very happy about that. We don't think that necessarily is a trend. Part of the reason that the fourth quarter was so good is that our mainland bank had actually an unusually slow third quarter. So it's a little bit of catch up, but the economy was still very strong. We continue to see really good demand in our U.S. bank and the U.S. economy in the segments where we operate health care, condo association, New York Metro, Miami Metro is very strong. So the U.S. bank seems to be doing well. In Puerto Rico, we closed the year with a lot of positives in Puerto Rico. If you take away the effect of the forgiveness of PPP loans, almost every segment in Puerto Rico grew. And, as you mentioned, I've been CFO for 9 years or whatever it is. And I don't remember last time I was able to make that statement. So in the fourth quarter we saw growth in commercial ex PPP. Obviously we saw growth in personal loans. We saw growth in credit cards. We saw growth in auto. So basically almost all business segments in Puerto Rico grew in the fourth quarter. The only ones that didn’t was construction, and that's just lumpy depending when projects come online and get paid off and mortgage. And mortgage, we just have naturally running off portfolio because the portfolio is very large for the size of bank we are. So the origination doesn't match up with the runoff. So we thought that fourth quarter was very positive in Puerto Rico. We see the same. We think the first quarter might look similar. You are correct though that there is some seasonality in there as well, but fourth quarter was a good base, we hope, of more to come of the same. That is our hope. But we still think that we will not see net loan growth until the second half of the year, mostly because we have the headwind of PPP. We're going to lose about $325 million of balances in this quarter and next quarter, and then it will be done. That will be over with. And then we have the mortgage runoff I referred to earlier. That's probably about $110 million a quarter. So in the first half of this year, we will see $0.5 billion worth of loans run off on those two only. So even if our banks do a great job, which they always do, and originate and close new loans of $500 million bigger than what's being paid and repaid, we're still going to look flat. Now in the second half of the year, we hope that with PPP gone that we'll actually be able to see net loan growth on a more consistent basis.

Got it. Carlos, you guys have been successful in recent years and being very strategic in acquiring loan portfolios. And I know they're not easy to find, but maybe are there opportunities you think that may arise to pick up some loan portfolios this year or -- because everybody's in the need of loan growth that it's really slim pickings, if anything?

I think it's -- yes to both of your questions. We are looking. We are actively looking. We have a strong preference for our acquisition of assets over acquisition of companies because the regulatory process is so much simpler, but the second part of your question is also true. Since most banks are still awash in liquidity, they have no need to sell things that are attractive. So the kind of things that we have seen available are sort of dented things and things that have challenges, portfolios that have challenges. And we try to not to buy somebody else's challenges when we're adding assets. So most of what we've seen trade are either segments where we don't operate. For example, we don't do auto in the mainland as you know, we do auto in Puerto Rico, or portfolios that are don't exactly fit our credit box. So we are actively looking, but you are right. It is slim pickings out there simply because everybody has so much liquidity that the incentive to rationalize balance sheets has not been there for the last few quarters.

Got it. Boy, I haven't heard that expression scratch and dent in some years. That was a popular expression 15 years ago.

There are still some portfolios out there that, that applies to.

Okay, we'll stay away from those. We all learned the lessons. Obviously, the fed is changing its policies from monetary easing to monetary tightening, and that's going to be very beneficial to you and your peers. As rates go higher, margins obviously should expand. I think on your fourth quarter call, you indicated that a 25 basis point fed funds rate increase would correspond to about a $6 million to $8 million change in net interest income per quarter. Can you give us any updates? Are you still comfortable with that kind of forecast? And second as part of it, in subsequent rate increases, I'm assuming that it's not a linear relationship, meaning every 25 basis point will give us another $6 million to $8 million. Can you share with us your thoughts on what happens to net interest income in subsequent rate increases?

Sure. A couple of points to make on that. You’re correct. That was our statement on our webcast in January. Now number one, that was an estimate we did on a point in time. So static balance sheet 12/31, and that was very focused on just fed's funds increase, so the short term -- short part of the curve. So there is a very focused calculation on just the effect of short term increases to the balance sheet as of beyond the year. For example, and we want to make sure there is no confusion, if investors compare that statement to our interest rates that we have in our filings, in our latest K, the numbers are slightly different. And the reason that is what we model in the K is a parallel shift to whole curve as opposed to a front-end move, which is what we described in our call. So if those two numbers will be different, but that's the explanation, we're looking at different calculations for the two numbers. So we are still -- we still think those estimates are appropriate. We will update those estimates in our webcast in April, next month, when we have our webcast. And yes, you are correct that the relationship is not necessarily linear, but we haven't disclosed any numbers on the non-linearity of that. Your question will lead us to consider if we should when we disclose this thing in the webcast in April, but it is not linear. You're correct.

Okay. Very good. Hopefully you'll expand upon that on the webcast then. You mentioned obviously the deposits of the government will leave when they get the final settlement and stuff. Can you share with us currently, you have in liquidity, I think it's about $18 billion in cash and get deposits at the fed, et cetera. And that's up about 50% from a year earlier. What do you think once the government is paid off, what's a comfortable level of liquidity for you guys?

Not $18 billion, that's for sure. Now, I mean, to put it in the right context, the closing of the government restructuring is a super complex transaction, and we have to be ready for whenever that happens. The prospect of the government saying we have a deal, we need to transfer $10 million tomorrow, the answer to that request could not be from our side, give us a couple of days, we'll get there. So we have been running a level of cash that is unusual for us. And it was more in response to this potential, very high demand in one point in time. The other reason we are running a lot of cash is because until recently when rates started going up, we felt rather uncomfortable extending into, what was then a few months back, a very flat and really unattractive yield curve. So we understood that by extending a little bit, that will add a little bit to net income, but we're pretty sure that when we looked at that decision a year from now, we would have been sorry because we gave up future income. So we've been trying to be careful. We have added -- moved cash for our investment portfolio, every one of the last, I think, four quarters. So we kept adding to the investment portfolio as we felt more comfortable and rates become a little bit more attractive. When the overhang of the government restructuring goes away and therefore the volatility of demand for our cash is reduced, then we will revisit our willingness to extend because then the risk of our cash position will become less important. So our cash position will gravitate down to more historical levels, which I think has been probably $6 billion to $7 billion or $8 billion as opposed to $12 billion to $15 billion. It may be even lower if rates are really attractive. So we have been extending cash for the last few quarters. We will continue to consider that move as we go along. And the other thing that's over time we were very hopeful for is that organic loan growth helps us deploy some of that cash to loans. We would rather do loans than investments. So hopefully that happens as well. I mean, we are still at a very high level of cash and investments in our balance sheet. It as of the end of the year was over 50%. It is not our intent to be or look like a trust bank. That just happens the way it ended up. Over time, we will gravitate hopefully to the point where investment portfolio looks more historically consistent to what we've been in the past, which has been -- looks like most of the banks are the high 20% of assets as opposed to 50% of assets. But that would take some time obviously.

Yes. Got it. Very good. We're talking of the benefits from the change in fed policy to quantitative tightening from quantitative easing or monetary tightening, I should say. But it looks like they may employ quantitative tightening and shrink that balance sheet that they've grown so dramatically because of the pandemic. What are some of the risks that you guys look out for in an environment where maybe they do go into quantitative tightening, they do raise rates this year 4 or 5x. Again, I know there's for you and your peers, great benefits to that margin initially, but what are some of the risks that you keep your eyes on in that kind of environment?

Yes, I mean, there's the beneficial part of all that process that you described of rates going up and has a positive effect on margins and earnings for us. The potential negative effect of tightening will be that you take out liquidity from the system, the record level liquidity that we see in the deposits right now, it's very unusual. We sort of gotten used to it, but it actually is highly unusual that we are where we are. So I think we'll end up gravitating back to a more historical levels of market liquidity. You should see excess deposits in banks go down. So the situation we have now, which is very abnormal, should normalize. But I also think this is going to probably a process that will take time, Gerard. I think that the fed has a very difficult challenge in their hands to orchestrate the soft landing that we all hope they can achieve. External shocks like the war in Ukraine add risk to that process. So I think that at least the way I see it today, I think the fed will start increasing rates this month. They will probably at some point later this year do -- start the tightening and reducing their balance sheet, but it's not going to be a step function. It's going to be a gradual process and it will probably take time. So the change in market liquidity and therefore the ultimate change in deposit, the banking system will be something that will come slowly. I still expect that in this round, the deposit betas from most banks will be lower than they were in the last round, partly because there is so much excess liquid that people can be a bit more conservative on their deposit pricing at least in the short term.

In fact, you answered my next question, which was going to be about deposit betas. And I think in the last tightening cycle, if I recall, your margin may have bottomed down around 4.11% and may have peaked up, but peaked at about 4.53%, somewhere around there, that 10% to 15% type increase. If we see, and it's very hard to envision this because of the geopolitical issues we’re have today, but if we were to see by the end of '23, that fed funds rates were lifted 200 basis points over that time period, do you think that -- and I'm with you about the deposit betas. Because of the deposit liquidity, I think they're going to be lower this cycle as well. That kind of margin expansion should not – I don't want to say guess, but it seems like it could be repeated.

Yes. I agree conceptually. I have modeled the numbers to comment on your numbers, Gerard. The one thing to keep in mind though is that we starting from a very different point, right? First of all, as you said, the deposit flows are different. Our balance sheet composition is very different than it was in 2015. Our starting credit position is very different than it was then. I agree with your directional comment. I really can't comment smartly. I haven't modeled it that way on the effect you'll have on the miracle -- on nominal margins, but the effect should be positive. Yes. I mean, it -- as you well know when rates are going up, all of us bankers look really smart.

I have an expression, never mix up brains in a bull market. And so maybe you guys can do that with rates going higher. So it's a good point. Maybe we could touch on capital. You guys are incredibly well capitalized and, and you know, that of course, and you look at -- and I know you haven't given any specifics on where you want your CET1 ratio to be. And you've used some of that excess capital to do share repurchases. In fact, you just announced the accelerated repurchase program. You've been very conservative in doing the buybacks once a year, generally. You announce it, of course, in January. Is there a possibility that because of all the excess capital that you could do something a second time in this calendar year, or is it no, we're just going to stick with the once a year, we've established that trend, we like it, we're comfortable with it. How do you approach that?

Yes, well, this year is a little bit special, Gerard, because we also have the Evertec transaction that we announced a week ago.

Yes, that looks good.

So this year could be different depending on the timing and when that transaction closed. We have committed as part of that transaction to reduce our stake in Evertec. We’ve expressed to the market our intent, subject to regulatory approval obviously, to redeploy the net gains that we achieve from reducing our stake into buybacks. So this year, again, will be a bit different. The timetable of that second step happening will depend on when the transaction closes, but hopefully it will still be this year. On your broader question, we're doing the once a year in part because it's a process that has served us very well in the past. We have a very established process with the fed. It's been very successful. If you look back and there's been a lot of noise in the last few years, obviously, especially last year, but if you look back, for the last few years, we were actually able to return more than 100% of earnings when you add all our capital actions with shareholders, between our buybacks, our dividend increases, our retirement debt, and sub debt and preferred and all the deployment of capital, we've been able to deploy more than 100% of capital successfully for most of the last 2 or 3 years. Putting that in the context of your bigger question on our capital levels, you are correct. We have significant amounts of capital. It is still our goal to over time move our capital levels in the direction of our mainland peers. We will probably always operate at a buffer above our mainland peers, but that buffer is not 500 basis points. So we think we have room and this year, we've announced the first part of our capital return, the buyback of $400 million. We have another $100 million that we'll do optimistically probably the rest of this year. Assuming the Evertec transaction closes in the summer, as we hope it will, and assuming fed approval and everything else, we could hopefully do something else. And then in all probability right now, the next announcement after that would be our capital plan for '23, which would be in our webcast in January of '23. But it is still our goal to continue to gravitate our capital levels down. That has been a goal for a while. Fortunately for us, unfortunately for that goal, we keep making a lot of money. So even though we plan for it to go down, it hasn't, so God bless that problem. But the goal is still in place, and we hope to over time move the capital reaches that look closer to our mainland peers of where they are today.

Great. So investors love consistency, they love trends. And I applaud you to stick with the January timetable. So now we just have you guys increase that to a much larger number.

I'll give you the phone number of the fed, so you can call then and talk to them about that.

Okay, okay. Gladly, we'll do that for you, Carlos. Maybe we're running out of time, but I did want to get back to, and I'm glad you brought it up, the Evertec transaction. You gave us what you are going to do from the gain you're achieving and then selling down the position. But maybe give us a little color behind why did you do the transaction? Why is it beneficial to Popular?

Yes, the main reason to do it from our point of view was flexibility. Now we think the client experience will be the key to successful banking moving forward. Getting control of our client experience, we thought was critical, and that is what we achieved. We purchased back from Evertec most of our client-facing applications. So the reason number one is that. Reason number two is flexibility. In that, under the agreement, we don't have the exclusivity constraints we had before with Evertec on most of our technology supplies and services. So it does give us the possibility to expand the universe of people that service us. Number three, it allows us to accelerate the start of our movement to our sector, our technology target state that before we couldn't start until '25 when the contract was over. We are able to start that now. And lastly, we have changed the economics in ways that are important to us; number one, the costs are coming down now and they will be coming down again in 2025; and secondly, we get a revenue share we never had before in the payment space. And the payment space is one where we think that our partnership with Evertec is very powerful. And the two of us together working in payments is better than either of us working in payments. So that relationship we have extended, the duration of that relationship. And we think that's going to be for the benefit of both companies.

Got it. Carlos, is there any requirement that when you sell down the equity ownership position, that you need to keep a small piece of equity to keep the payment sharing that you just referenced in place or they're just two separate issues? And if you wanted to, you could sell it all off, not saying you're going to do it, but you could do it and still have the contract that you just described, right?

Yes, we could sell it and still have the contract we just described. There are 2 separate parts of the transactions. We have committed to sell down to at least 4.5% of our stake in the company, but we could sell everything. We haven't made that decision, but we have committed to sell at least to 4.5%. But there's no limitation. We could sell the whole stake if we ended up making that decision.

Great. Well, it looks like we've run out of time here. Always great to see you and hopefully in person next year. And thank you for giving us a really good insights unto what's going on at Popular and in Puerto Rico.

Happy to be here. Happy for the -- keep inviting us. So look forward to it. Thank you, Gerard.

Okay. Very good. Take care, Carlos. Bye.

Bye-bye.