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

Everybody for joining us for our final fireside chat with BPOP, Popular. As many of you know, is based in Puerto Rico, of course. It's the 24th largest U.S. commercial bank with about $71 billion in assets, has a market cap of around $6 billion impressively has a common equity Tier 1 ratio of over -- just over 16%. Very pleased and privileged to be with Carlos Vazquez today. He joined Popular back in 1997. And as some of you may know, he has announced his retirement. He finishes his illustrious career at the end of this month, and I'm very privileged to share the podium with him. And I think your last -- investor conference. So we're very pleased to -- thank you and very privileged to have you here. So thank you so much, Carlos. And we wish you tons of fun in retirement at the end of the month. Do you have a clock keeping track of every day?

Absolutely. Keeping track every day. It is time.

Yes. And his replacement Jorge Garcia is here sitting in the front row with Paul Cardillo, who heads up Investor Relations, if you want to introduce yourself Jorge, you're obviously welcome to do that.

Maybe to start off, we know banks or products of their economy. You certainly know that as World Carlos. And can you share with us what's the progress that the Puerto Rican government is making towards exiting the bankruptcy and talk about PREPA and the restructuring and how that all plays into what's going on in Puerto Rico?

Yes, this is a very timely question because actually, I believe -- today in the afternoon was the beginning of the court hearings for the PREPA restructuring. Most of the people that know a lot about it, suspect that those hearings will take a couple of weeks. I think there's a general expectation that after hearing all the parts, the presiding judge will actually approve the PREPA plan as proposed. And if that happens, it's sort of an important point because PREPA is the last remaining material piece of the government debt that was pending restructuring in Puerto Rico. So once we get PREPA done, you can check the box and sort of the whole chapter, the 7-year chapter of the bankruptcy, the government of Puerto Rico will be behind us. So I think that will be very positive for the island. It will be positive for the continued investment in the electric sector restructuring. To give you one example, PREPA, if you're setting up a new private generation plant in Puerto Rico, your offtake contract is with PREPA. So to the extent that PREPA a bankrupt company, those offtake contracts were very difficult to finance. Once PREPA is out of that bankruptcy, then it will probably facilitate the financing of some of these generation projects that are all private now. So having PREPA done is important from the legal point of view. It's important operationally for the continued investment in the electric sector renewal. And it's important cyclically to get the whole face of the bankruptcies are essentially over with. There will be continuous more challenges for many things, and those will take years to resolve, but basically, the -- [ conceptually ] the bankruptcy will be done.

And as you mentioned, it's been a 7-year kind of process time line. And so psychologically, I have to believe it's going to be like a new era for Puerto Ricans and folks to invest in Puerto Rico. Do you think that could bring more investment dollars into Puerto Rico once this is finally resolved?

I think that's happening already because I think the business people have seen, the evolution of the restructuring and all the pieces have continued to get resolved and increase the probability that the remaining pieces will be resolved. So I think a lot of people are already treating it as is if it's going to happen in some reasonable form. And a lot of the investment that was maybe delayed in years ago because of the uncertainty on the government situation, I think we passed that bridge already some time ago. But checking the box will still be important.

Yes. One of the items you and I have talked about over the years is that the out migration from the island to the Mainland has slowed, which is maybe stopped completely. What do you think is going to -- because I'm assuming from our conversations, most of the folks leaving as job opportunities in the Mainland, not because they didn't like obviously where they grew up or lived. What's going to -- what do you think could bring more folks back to Puerto Rico, the ones that may have left?

I'm not sure net population growth is necessarily a reasonable target because we have the same demographics that you have in the Mainland, the whole population is getting older, demographics are long-term, trends are very difficult to change. So I think most people would probably be pretty happy if we can maintain the populate study. That's roughly been what has happened for the last couple of years. You're right, we lost roughly 10% of the population over a decade. And most people left because there was no job creation in Puerto Rico. So they need a job and they need to go. For the last 2 years plus, there's been net job creation in Puerto Rico. We have more nominal number of people working today in Puerto Rico than we've had since 2007. And 2007, the population was 3.4 million people now 3.2 million people. So the job creation has been significant and very real. With that job creation, you've seen population stabilize. Unfortunately, the economists can't do their own payments equations, correlating creation with population because the last time that happened in Puerto Rico was before 2005. So whatever the equations were then, they just don't work anymore. And we probably need 2 or 3 more years under our belt before the new equation can be put together that makes sense and has reasonable level of reliability. But as long as there are jobs, people will stay. And we've been very lucky for the last 2-plus years of real job creation. And hopefully, we'll continue that trend for a while. And that will keep population steady.

Yes. I remember in our conversations, you often reference like a 10-year recession that you worked in as -- at the bank, this growth that you're seeing now, as you just referenced. Can you highlight some of the areas because many folks, especially in the metro New York area, oftentimes think of Puerto Rico as a destination point, obviously, for vacations. I know tourism is important. But there are some other sectors that are maybe even more important, like manufacturing, maybe you could give us some color on what you're seeing going on for economic growth.

I mean tourism -- Northeast is very important for tourism, please keep coming. You're welcome. It's fantastic. But tourism is only about 7% of the economy. There is a perception that is a much bigger number because in most of the Caribbean, it's a much larger number there. And it's only 7%, not because the sector is small because in dollar terms, it's a pretty big sector but because the rest of the economy is pretty big. The largest sector in the economy continues to be manufacturing. And there's a perception that after the tax benefits went away in the early 2000s, all manufacturing left Puerto Rico, and that's just not true. We're still very strong. The kind of thing that happened is that pharmaceutical production shifted from prescription drugs to generics. We have a very strong medical equipment manufacturing sector. To give you a few examples, if anybody here is wearing contact lenses, right? It's a pretty good chance those were manufactured in Puerto Rico, okay? Many of you have a pacemaker. I hope not, but if you do, pretty good chance that was manufacturing in Puerto Rico. If you have used an IV bag anytime in the last few years, there's pretty good chance it's also manufactured in Puerto Rico. In fact, when Hurricane Maria happened a few months after the hurricane, there was a very serious shortage for IV bags in the United States. And everybody is trying to figure out why is this happening. And it is because a very large part of the supply of IV bags for the whole country is manufactured in Puerto Rico and [indiscernible]. So manufacturing continues to be the heart of the economy. It's about half of the size of the economy. And then you have services and insurance and banking and medical services be -- start being the next few segments. Yes.

You mentioned Hurricane Maria, and I know there's also been other -- the earthquake that you had as well, the pandemic. The federal spending or the monies that have come into the country, about how much is -- if you had to estimate about what it was going to be, where are we on that time line in terms of incremental spending coming?

It's hard to hit the exact numbers because there's hundreds of programs that are involved in this. Best guess, still around $50 billion of that allocated money left to be spent. The rate at which that money is being spent continues to increase. So most people are guessing that in '23, the amount of the assistance funds spent is probably in the $3 billion range. It was somewhat lower than that in the prior year. Hopefully, it will be somewhat higher than that this year. But there's also some limits in the economy, how much money can be spent. So if it was $3 billion next -- last year, it's not going to be $6 billion this year. It's unlikely because we have constraints. For example, a big part of this investment is in construction, infrastructure construction, housing construction and we have a hard time getting construction workers. The number of construction workers have grown by about 50% in the last few years, but it's still half of where it was at its peak in the early 2000s. So there's really a lot of efforts to train construction workers and trades people. So that's ongoing. There's always some involvement of illegal immigration that contributes to construction, and it's probably helpful. There's been a lot of efforts to facilitate legal immigration for construction, but those haven't gone very far with the state department. But there is a limit of how much the of the money can be spent and it's just the capacity of the economy to actually put it to work.

Correct. Are you implying you're going to be wearing a hard hat soon. And...

Only if it's a vacation hard hat.

There you go. Before we talk some specifics on Popular, what do you think the monetary policy of the Fed going from, obviously, tightening to eventually easing. And what kind of impact do you think that could have on maybe the banking system, but more specifically Popular?

Well, the Fed tightening monetize policy In practice, what it means or banks is that deposits are going down for the whole system. So to the extent that deposits are not going back and down in the top 5 banks, that means the rest of us are losing more deposits and that's inevitable. That's just maths. So with deposits going down, the system will have to be very attentive on liquidity issues. You compound that with regulatory pressure and new regulations from the banking agencies on liquidity requirements and a number of things. So that's something that we have to be very careful about. And the other risk is the one that everybody was terrified about, everyone 12 months ago is that the Fed might overdo it and we end up with a recession. Now it seems that the consensus has moved away from that risk. But that risk is still there. And my colleagues were just telling me earlier today that the other thing that is important now is that we do have elections coming up in November. And so if the Fed does not move by the summer, while they are not supposed to be influenced by politics, there's a good chance they may want to set it out for a while and a few months of setting things out could change the outcome. So we have to do attentive to that.

Yes. No. I agree with you wholeheartedly. Maybe we could talk a little bit about loan growth. You had some real nice loan growth over the past 2 years. You're looking -- I think you guided for maybe 3% to 6% loan growth in 2024. Can you share with us what's driving it? And what -- how you succeeded in '23, but what's also then driving '24's outlook?

Yes, it's actually fun to talk about loan growth, but -- because for many years, when we were talking about loan growth, what we were able to say is that we hope to keep Puerto Rico steady and we'll grow a little bit in the States. That was what we used to say for many, many years. So talking about loan growth is a nice change. Yes. It's been 2 years of very strong loan growth. So we grew loans about $3 billion in '22 and about $3 billion in '23. The growth was throughout. So most of our portfolios in Puerto Rico grew, the portfolio in the states also grew. But we combine that with strong growth in Puerto Rico, of course, it makes a big difference. So almost all portfolios grew consumer and commercial. But the big driver in dollar terms is commercial. So that was a big contributor to the growth in Puerto Rico as economic activity will start getting stronger, as we saw more investment coming into the island, a lot of significant and large loans that we made over the last couple of years have been investments that people purchasing property, purchasing warehouses, purchasing a health insurance company and the new owners come and they want to have a local relationship in Puerto Rico. And if they want to borrow to finance part of the investment, if they want to borrow a significant amount, we, of course, have more lending capacity than anybody else in the market. So it's been strong driven by commercial. One of the reasons, if you do $3 billion for our loan book for the last 2 years has been slightly more than 9% growth in both of those 2 years. One of the reasons we are guiding to a slightly lower number is that one of the things that contributed to that strong growth in the last 2 years was very unusual large commercial transactions. And the best known one because we rarely speak about specific transactions is the financing that was attached to the public private partnership of the highways that happened in December. There was a very large transaction, something in the ballpark of $1.2 billion. And we participated as joint league with a foreign bank, and our ticket in that financing was $300 million. There is not a lot of -- we don't do $300 million loans frequently, okay? If you look at last year, there's a couple of other significant large commercial deals, the same was true the prior year. We are not necessarily seeing those big transactions continuing. So that is part of why we're guiding to a number that is a bit lower. We are still seeing strong growth. We're expecting strong growth. We -- and when you think about it, and you and I discussed this many times, generically, banking assets will grow at the rate of the growth of the economy, right? Economy in Puerto Rico is expected to grow about 1.5%, maybe touch more than that next year. So even our 3% to 6% is a significant pickup above the normalized rate of growth of banking assets. So ultimately, we're saying that we hope to continue to gain market share, which is pretty important.

Yes. Speaking of market share, obviously, you have a dominant share in Puerto Rico. And when you look at the mix of your business, the majority of business is obviously in Puerto Rico versus the homeland. How do you manage -- I mean, you have such a different presence in Puerto Rico versus here in the mainland. So how do you guys manage that because you are the go-to bank in Puerto Rico. Not to say you're not the go-to bank in certain parts of the Metro New York and Florida market but obviously, you don't have the market share here. So how do you manage that -- these different approaches?

We are running different business. In Puerto Rico, we are the bank that everybody looks up to. And in the States, we're looking up to a lot of other big banks. It is difficult because we are very skilled at being the biggest, a bit less so skilled at pursuing the biggest. So but you have to pursue different strategies, your pricing is different, your capacity to attack different segments is different. At the end of the day -- and this sounds like a little bit of a funny comparison. But in Puerto Rico, we're -- we look more like a mini JPMorgan or mini [indiscernible] than we do a regional bank. We offer every segment for every product, every market, through every channel, all the time, where you are, whatever you want. It's very rare for our real competitors in the states to have as big a consumer business as we do, or as broader consumer business as we do. So we're a little bit unique in that sense and a little bit different. But it makes running the bank a lot more fun. So.

There you go. In the vein of you and I can teach old dogs new tricks. You guys had a new one. You gave annual guidance in the fourth quarter...

How about that?

On net interest income. So I guess they can teach us new trick.

We finally yield it. I have a few things.

Yes. There you go. And it's about a 9% to 13% increase is what you guys are suggesting. As interest rates evolve this year, how are you positioned to make sure -- to ensure that you get close to that kind of success?

Well, if you look at our NII sensitivity, our balance sheet is pretty flat. We're not really significantly exposed in either direction to changes in interest rates. So what is going to drive that growth is a number of things. Number one, the back book versus front book of our investment portfolio. We roughly have $1 billion worth of the portfolio maturing every quarter. The maturing piece has a yield, sort of like 1.6%, 1.7%, something in that ballpark. And that has been reinvested at market rates. So it has a nice pickup deal there. We also have the loan growth we expect, which is also invested in moving cash into higher-yielding assets. And one part that is missed frequently, but it's still very important. Even if our loans are flat, we probably have something between 20% to 25% of the loan book maturing every year. So our bankers are very busy even when the loan book is flat, much more busy when it's growing. And all of that, that is maturing and renewing is hopefully maturing and renewing to higher rates as well. So it will be driven by all of that. The other important effect will be what happens with deposit cost. The cost part of it is mostly in the states where we have a more volatile portion of our deposits in the U.S. because they're Internet-based. In Puerto Rico is probably more a matter of mix. Because if we have more public deposits, more expensive, less retail and commercial deposits are less expensive than the cost could go -- the actual costs could go against that. But those are the components. Again, we think if things go the way we hope they will go in the year, that is a good range and that will probably be a good outcome for the rig.

Got it. What are your views on deposit betas? Obviously, they were different than in the 2016 to '18 time period. So when you think about maybe what your terminal deposit beta might be after this tightening cycle peaks or ends. But then on the other side, can you share with us what happens if rates start to come down, how your deposit pricing will be impacted?

Yes. I mean we have sort of 2 pieces of the puzzle here. The bank in the States and the bank in Puerto Rico. Sorry, 3 pieces and the Popular deposits. Popular have a beta 1, one quarter left. So that is -- it's pretty easy. The retail and commercial deposits in Puerto Rico, you are correct. The beta has been higher than it was historically but it's still a fraction of the beta that you see for most banks in the States. So deposit pricing in Puerto Rico has continued to be very positive. Beta in Puerto Rico has come up a lot slower than it has anywhere else. On the flip side of that, it's probably what we'll probably see is the basis of Puerto Rico as they went up slower, and they did not go as high, they will also come down slower on the back end of rates coming down. In the U.S., it should be more -- it should be closer to how the market moves with one exception, and that exception is going back to your question of the Fed tightening. So if there's less liquidity and banks become even more aggressive competing for deposits in the U.S. market that in the U.S. market, we might see betas on the side also moved lower than historic. Yes. We'll have to see.

Is there any evidence yet in the homeland market of liquidity issues that is already showing up in some deposit pricing. Have we seen any -- or have you guys see any there...

No, we've continued to see the market responsive to attractive rate offerings with ample liquidity, if you do that for a period of time. So we haven't seen an issue of supply yet. But we have to keep watching is the Fed continues to reduce money supply. So eventually, there could be an effect we haven't seen yet.

Got it. One of the hallmarks of Popular has been its strength and its common equity Tier 1 ratio. Many investors think that you've got excess capital. Maybe the regulators think that no, I don't think they ever think that...

There is no such bucket in the regulator's mind.

No. The 2 things about the regulators. They love as much capital. There's never too little. And whenever banks get into discussions with the regulators or disagreements, the regulators are undefeated. So other things get remised. So I know you guys don't give a specific CET1 target, but do you think you have excess capital? Or how do you kind of think about the CET1 ratio?

Well, the way we've talked our capital has been pretty consistent for a while now. And the statement we make is that over time, we would expect our capital levels, our capital ratios to slowly gravitate down in the direction of our mainland peers plus the spread. It's always going to be a spread. And the spread is based on a couple of things. Number one, that's the way the Fed things, which helps. And number two, we actually agree with the Fed on this one, which is unusual. But we do have geographic concentration. Number one. And the second part of that consideration is that while we're not a SIFI, we're not important for the U.S. financial system, we are very important for the Puerto Rico financial system. So we are like a mini SIFI. Therefore, some capital trend is welcome. So over time, we will gravitate to our mainland peers plus a spread, spread dynamic. It changes depending on what people are worried about. But the big challenge now is that we don't even know what the average capital of our mainland peers is, any more, because we don't know what the rules that would apply. And we don't know how our mainland peers will react. So we really know what the target yet. Now having said all of that, where we are, there's some room for us to move there. Exactly how much room, we'll define it over time. We don't expect a step function in any form. The regulators are allergic to step functions down in capital, not up, but down, they are allergic to it, so it be a step function. But hopefully, over time, we can achieve that glide path down. We've been trying for the last 5 years plus since we restarted our capital return program. And it gets lost sometime in observers that we actually returned about -- we retired about 1/3 of our stock, since we started that program. What can I -- we'll be cautious, and we'll try to be respectful of capital because the capital you -- you can always get it when you'll need it -- a little bit careful.

True. Maybe in talking about share repurchases, what are some of the considerations in your thought process of reinstating the stock repurchases?

It's 3 things. We want more clarity. Number one, on what's going to happen with the economy, that's gotten better in the last few months. We want more clarity on regulation, that's not gotten better. But hopefully, it might. I mean a big one that's pending is liquidity regulations. We don't have anything concrete on that, and that's pretty important. And the last piece, which is related to the first is what's going to happen with rates? As we get more clarity on those 3 things, also the 3 big considerations we have on how we think of capital hopefully, we can get to a position where we can build more comfortable trying to define something to move forward.

Yes. Just speaking about the capital return still to shareholders, you recently raised the quarterly dividend, $0.62, it's about maybe 28% dividend payout ratio based upon some estimates for the upcoming year. What is -- do you guys have a targeted payout ratio that you're comfortable with?

Historically, the regulators have guided something around 30% is the area where they feel comfortable. We tend to think about that guidance when we are thinking about dividends. Hopefully, what that means is that we will continue to make more money in the future. So the dividend actually will go up and we'll still be in that ballpark of around 30%, probably in [indiscernible].

Yes. You've, over the years been acted been buying assets or loans, also acquisitions of depositors. Any thoughts on what could be on the horizon for Popular in either area?

Yes. We will prefer to buy assets, regulatory burden is a lot lower. We haven't with the recent years, not because we haven't looked, but the right things haven't come along. Our CEO has been pretty clear that M&A is not top shelf for us right now is not a top priority. So again, that doesn't mean we don't look at what's happening in the market. And frankly, from my point of view, I'm not sure the numbers work nowadays anyway. So even if it were a priority, I'm not sure a lot would happen. But no, we're very focused on our transformation and doing a number of things we're doing internally. That's a higher priority at this point in time. PFA particular interesting book of assets were to show up that fit our underwriting criteria and our interest in the right sector, we'll always look there. We do have the capital. We do have the liquidity to do it. And again, the fact that we haven't done it doesn't mean that we haven't been looking.

Yes. You're also getting back to outlook, gave a 14% ROTC target for the end of '25. Maybe can you share with us some of the inputs to that? I mean, obviously, business growth, profitability improvement, is it also maybe lower tangible common equity to get that up as well?

Yes. Well, there is a -- that calculation assumes that there is some activity on the capital return. So there is an assumption in there. We have not made that assumption public, but there is an assumption of continuous capital return in that number. The number is mostly driven by higher revenues. So it's not driven by a nicely named expense reduction program. We do expect our expenses to grow less quickly in the future, but it's mostly driven by revenue growth and the revenue growth comes from serving more clients and doing more things with the clients we have and the new clients that we make.

And just a final question here as time is running out. After 30 years of being in the banking business, retiring at the end of the month, what have been some of the most memorable highlights that you've seen over your career. And what have been some of the biggest changes. And then lastly, the third part of the question is, what do you think investors underappreciate in analyzing bank stocks?

Thinking back on 30-plus years of doing this, actually 42, if you go the way back to my beginning at JPMorgan. Probably the most interesting thing is how much has changed, but how little has changed if you really look through it. At the end of the day, strength matters. Strong balance sheet matters, strong liquidity matters, strong capital matters. Second, flexibility and agility is important. You need to have an organization and a management team that can move on it, because of unexpected events, and react quickly and react smartly. Fortunately or unfortunately, for us, we have our practice in that, as you know. I mean we have a management team that's gone through a 10-year recession, a bankrupt government, a 100-year storm, 100-year earthquake and a global pandemic. And yet, we are performing quite well. So we learned agility and flexibility the hard way. The third thing is you need a moat. Whatever you moat is. Your moat may be technology-based, you moat maybe branch-based, your moat maybe product-based, your moat may be client based and what segment clients like to serve, but you need a moat. That is very, very important. And the last thing is, and it sounds old-fashioned, but you've lived this many times in your long career as well. The things that mattered don't change that much. And at the end of the day, deposits roll in banking. So if you have a strong deposit base, when it's not fashionable, you'll probably will do well in the long run.

There you go. That's great insights. Please join me in a round of applause thanking Carlos and wishing him well.

Thank you, Gerard.