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

Thank you for joining us for a Popular, Inc., a $73 billion in asset company headquartered in San Juan. It's about our 25th largest bank in the United States. And when we priced our sheets here, it had a market cap of just over $7 billion, $7.2 billion. With me today is Jorge Garcia, who is the Executive Vice President and Chief Financial Officer. He took over this role last April, April 1, 2024. So thank you for joining us.

Thank you.

He's been with the company since 2012. Jorge, I guess, maybe to start off, can you share with us -- I know we're only 2 months into the year, but what does it feel like in the economy down in Puerto Rico? And not only that, but how important is the Mainland's economy to the success of the Puerto Rican economy? We know there's a lot of benefits that you're still receiving from the natural disasters, you guys unfortunately incurred some years back. But if you could play that into just the natural economic growth and what's going on here in the U.S. as well.

First, in terms of the economic environment in Puerto Rico. We're right now at lowest unemployment in history in Puerto Rico, 5.4%, may sound high compared to U.S. numbers, but in terms of -- historically low, traditionally, Puerto Rico has served in double-digit unemployment. The good part about that unemployment number is that it's also a higher participation rate. We have more people working today in Puerto Rico than 10 years ago, where we had -- where we now have about 10% fewer people living on the island. So that environment is -- creates for a strong economic baseline. We have people earning higher wages. So the minimum wage in Puerto Rico over the last 4 years has increased about 40% and that has permeated across the board. We're seeing an increase -- a similar increase in construction projects that are federally funded. So that essentially has created that, all construction projects, right, have seen that increase. That one was more around 50% of the requirement. So all that to put in an environment that is supportive. You mentioned federal funds in Puerto Rico. That has been a significant tailwind for the Puerto Rico economy since before the pandemic. We still have about $45 billion of federal funds that have been obligated to support reconstruction efforts, there are thousands of ongoing projects. We're seeing disbursements of between $4 billion and $6 billion a year to support those projects. But more importantly, that's not the only activity that we're seeing in Puerto Rico. There's a lot of private money going into Puerto Rico. I've been in Puerto Rico for about 13 years. And for the first time, you see a lot of cranes kind of in the background particularly around the San Juan metropolitan area, a lot of investment in high rises and kind of on the luxury side. There's also been some announcements of couple of large hotel projects kind of covering both coasts. On the East Coast, there's an Auberge project that was announced and then also in the Southwest Coast of Puerto Rico, a project that is anchored by Mandarin Oriental. So these are all -- we don't necessarily mention those because we think we're going to lend into these projects. Some of these projects are multibillion-dollar projects and come with funding. But it is something that, as the economy of Puerto Rico benefits, we will benefit. Certainly, we have clients that would become suppliers or provide services in these projects, and that will be positive. In terms of the impact to the U.S. economy, certainly, if you look historically before the financial crisis, the Puerto Rico and U.S. economy moved in tandem. And then after the financial crisis, the U.S. started a long period of recovery, while Puerto Rico was in a low period of recession. So we had a recession for over 10 years in Puerto Rico from 2005 through 2017 when the hurricanes hit. Through the pandemic and during the pandemic, those 2 economies aligned again, right? So that disconnection went away. And so in terms of what's the impact, certainly it'd be naive to believe that if the U.S. saw a recession or a problem in the economy, that wouldn't impact and permeate Puerto Rico. While tourism is only about 10% of the GDP in Puerto Rico, a lot of that tourist base comes from Puerto Rico. We -- obviously, everybody understands the environment where we're seeing potential federal cuts or impacts on federal workers. We have federal workers in Puerto Rico, we are subject to the same risks that any state or jurisdiction in the U.S. would have. But the good side of it is that at least the Puerto Rico government today is in a better financial position to address any impact that comes from that.

And coming back to the federal appropriations to -- in the infrastructure, you mentioned about $45 billion remaining, $4 billion to $6 billion a year. Can you just contrast the $45 billion to the island's GDP? So people know how significant that number is?

Yes. No, absolutely. The GDP is somewhere in the $80 billion range. About half of that is manufacturing. And so it is a significant tailwind for the...

You just brought up manufacturing and how important that is to Puerto Rico. Is there any evidence yet this move for "onshoring" into the United States the data provided by the Department of Commerce shows an incredibly parabolic growth in manufacturing plants being built in the United States. Have you guys seen any of that yet?

So there's been a lot of discussion since the pandemic, right, for onshoring. And certainly, in the tariff environment, Puerto Rico is inside the tariff wall, right? So that's an additional motivation for companies to look at Puerto Rico to build manufacturing. The other thing is that if you think of the tariffs as the stick and the carrot is, move your operations to the U.S., a green pasture project in the U.S., particularly in pharma or biotech or medical devices will take a long time to come to go live. In Puerto Rico, there is excess capacity in these areas. We -- people think that the tax incentives that we had that finished off in 2005 that supported that industry, that meant that everybody left, and that's not correct. There's still a significant amount of our pharma output in Puerto Rico and biotech, things like 7 of the top 10 medicines are manufactured in Puerto Rico. And there is still excess capacity. And I'd love to be able to be able to identify a win where we say, this is tied to onshore. And before the tariffs, there really hasn't been any supportive tax strategy or government strategy to be able to bring those manufacturing facilities in Puerto Rico, like we saw in the Chip Act that supported Intel's decision. So maybe the tariff is an alternative to that encouragement, right? The business case becomes a little bit different. So we'll see. But it is definitely when we look at the potential negative effects of tariffs on inflation in Puerto Rico, which are not dissimilar to that impact in the U.S., having that opportunity of being a catalyst to bring more investment to Puerto Rico and utilize kind of a trained workforce that knows how to manage that as well as leveraging some of these facilities that exist could be an opportunity for Puerto Rico.

Got it. That's good insights. Maybe from the regulatory standpoint, obviously, we're on the cusp of a change in the direction of our bank regulators. Are there opportunities that may arise because of this for BPOP, whether on the island or on the mainland? And then second, we also hear that though you technically don't go through the stress test with the largest banks in the U.S. You still are stressed, obviously, through your regulators the New York Fed if I recall. Any color on what you're seeing or hearing about the regulators maybe being more constructive with the industry and yourselves to help facilitate growth?

Yes. So on -- let's talk about stress test. We are not subject to the same requirements, but we do run stress test. We believe it's an important discipline in a way and it has become a critical component of our capital management strategy. We -- so in that aspect, I don't know any -- certainly, it sounds like the Fed is going to focus on more clarity and maybe averaging out some of the -- reducing the volatility of the stress test results. Those are all things that will be welcome and we can incorporate into our assessment. But I'm not sure in that part that I see a big relief for us. In terms of the regulatory environment, clarity for us will be important. We're tailoring and if we can have more openness with tailoring given our size, that would be important, particularly when you combine the understanding. We talked a lot about this $100 billion kind of threshold, but we don't know if that starts at $80 billion or a $90 billion or -- so just having more transparency and clarity in that certainly would be helpful. In terms of the rest of the regulatory environment, I think there's still -- obviously, I would expect to see less new regulations. But I don't know how much reduction of regulation we would see, right, how much we leave. And at least we understand there's a concern in the industry that if the change in regulation is just exclusive to how we're supervised or how we are enforced, how those regulations are enforced rather than changing them in legislation and making those changes permanent, then you always have the risk that somebody can say in a new administration, these regulations were in place, they were not being forced, but you had to comply with them. And then you'd have to somehow look back and claw back or be responsible for something in a different supervisory environment. So at least we're being cautious in how we manage that. And I don't -- I mean, that's...

Got it. If pivoting over more to the business -- your business, what areas of lending do you guys see as being most interesting right now? And how could you pursue that those growth strategies to grow those types of portfolios?

Yes. So Gerard, as you know, we look at the markets, the U.S. market and Puerto Rico separately. In the U.S., we have really 3 areas of focus. I know that one of them is community association lending, and that's a national business that's self-funded, very strong deposits that come with lending portfolio. And while it's a national business, the largest concentration is in Florida, particularly in South Florida, given the unfortunate events of the building collapse in South Florida, there's some legislation that requires condo associations for buildings that are more than, I think, 3 stories high and 30 years in age to have some requirements for engineering testing, for maintenance, reserve. So that's generating demand. And you see that in our -- that's really a C&I lending business. So that's an area that we like. The historical performance of the portfolio has been fantastic, and we want to continue to grow and see the demand. The other one is healthcare. It's another national business that we run out of New York. It has some concentration in the Northeast. And that's an area that our portfolio is heavy on skilled nursing, have done some shelter financing, but focus on homelessness, not on immigration and supporting existing clients that are in the skilled nursing facilities. And then the last one is our construction business in New York. That tends to be an inflow for particularly multifamily lending. There's a lot of development related to multifamily. We're beginning to see demand under the new legislation, tax legislation in New York. We still believe that New York could benefit from more housing, right, in the housing development. And it's an area where we develop some expertise. It doesn't always lead to the takeout loan, right, but we do like that space. And then in Puerto Rico, it's a much broader based. There's been a lot of demand on the commercial side for roll-up strategy, M&A activity and that's supported by tax incentives that applied to both Puerto Rican residents, investors as well as foreign investors and foreign investors also benefit from lower multiples of cash flows in Puerto Rico. We still are pricing things at a lower rate in Puerto Rico and that's attractive. And then maybe different than other regionals, our size, we do have a very diverse consumer lending portfolio, both on credit cards, unsecured personal loans and auto lending. The auto lending has been a real success story for us in Puerto Rico, and we continue to focus on that.

Coming back to the condo association lending that you referenced, which you've been in that business for a while, like you said, they've have done well. Any idea what kind of growth -- because we all are aware of sadly what happened down in Florida, and how many properties now have to go through this is quite -- it's not dozens, it's 100s. So any idea of what kind of growth -- how big is that as a percentage of C&I now, just kind of about?

I think the portfolio is about $1 billion. And in terms of growth opportunities, I mean, our target for growth for this year is 3% to 5% growth on a consolidated basis. And then that includes our growth projections for that business. While there are a lot of associate condos that are subject to this, you also have to be careful about the ability for the condo association to be able to afford to pay. You see the -- you did see in the news the kind of the stories where people, the cost of the assessment is more than the property value or some issues related to that. So certainly, our expectation is to focus on clients that already exist in our portfolio and be very careful. I mean, we've been in this business for over 20 years. And like I said, it's historically not had any losses, right? And it has a lot to do with the properties that we are involved with in terms of lending and I wouldn't want to see us change that discipline.

Yes. No, no, you certainly don't, and that's for sure. So 3% to 5% total loan growth is what you referenced a moment ago? Moving to the other side of the balance sheet deposits. Can you share with us what you're seeing there in terms of growth? And then if you could just give everyone, once again, just the government [indiscernible] on Puerto Rico's deposits and how they're priced and how important they are and hard to kind of predict sometimes where they're going to be?

Absolutely. So we think of the process in 3 buckets. The #1 is the public deposits. And we think of that as a Puerto Rico government, but it really is over 200 different clients and thousands of accounts.

With the public deposits?

With the public deposits, yes.

In peurto rico?

Yes, it's municipalities. It's agency. So it's -- so when we look at the aggregate and that was around $20 billion at the end of the year. And -- so it's not always easy to be able to -- for our clients to project or predict their balances. So that always makes it harder for us. And a big driver is Puerto Rico has seen the combination of better tax collections, along with an oversight board that requires them to have a balanced budget. So when they set that budget, even if their tax collections exceed those projections, they're not allowed to really spend the extra money. So that just keeps adding to those balances. And those are price against short-term rates, minus the spread and they generally have a one quarter lag. And those are the highest beta deposits that we have. Certainly because that's contractual, that works both ways, right? So in the fourth quarter, we saw around a 56 basis point decrease in those deposits. And that's going a little bit against -- you compare it against a essentially 100 basis point reduction by the Fed during the last 4 months of the year. So you get a sense of kind of the lag and how you go through, so we would expect some still lower prices in the first quarter. The second one is the kind of core deposit business in Puerto Rico, retail and commercial clients. That's our largest source of deposits and liability funding and that has had a very low beta over the rising rates, so we're going to expect the same. We're not going to be able to adjust down. We have a lot of efforts focused on that part of our business. We did see some decreases that we had not anticipated during the third quarter last year kind of change our focus and our efforts, we look back, we see that over the last 2 or 3 years, given the amount of liquidity and a loan-to-deposit ratio, we have been very focused on lending, particularly in our branch network. And so making sure that people don't forget that muscle memory of getting back to the deposit and making sure our incentives are aligned for deposit retention, giving tools to our bankers and our relationship officers for exception pricing. But we would expect that to be a very low beta now. And then the last segment that we look at is U.S.-based deposits, and those are driven by both our bench network in New York and in Florida as well as direct online channels. Most of the growth has come from the direct online channel, which is an easier lever to grow. Those then also have a high beta, but different than Puerto Rico, those are subject to market conditions and competition. Even when we saw the Fed start bringing down rates, we saw some competitors actually increasing rates online. So there's always some dynamic to that pricing. Same thing as we see in New York and Florida. We see more competition in New York than we do in Florida. But I think maybe the -- there will be a lag there along the way, but the betas eventually will get there, absent any large liquidity event in the industry.

The -- coming back to deposits. Deposit growth, some of your peers that have been here at the conference for the last 2 days, talking about building out branches as a complement to the digital strategy. What's your guys' view about branches? Obviously, you're fully penetrated in Puerto Rico. So is there room from branch growth or even branch optimization where you might shut down a couple in Puerto Rico and consolidate?

We do -- in Puerto Rico, even though we have a large number of branches in Puerto Rico. Puerto Rico is still on a per capita basis pretty underbanked [indiscernible] But we do -- kind of on an ongoing basis do have branch optimization. If you look back over the last 10 years, a number of acquisitions that we've done in Puerto Rico, the last one in Doral, we just [ event ] the 10-year anniversary. You look through that portion, we have fewer branches today, even after all those acquisitions. So it is something that we do more natural. But the reality is that the level of transaction and activity that we have in most of our branches in Puerto Rico, is pretty significant. The other part is that if your biggest cost of a branch or real estate and people, the real estate is not a big part of the cost for a lot of those branches, and the people will probably have to supplement other areas as we still continue to have a lot of transactions in our branches. And I mean, Puerto Rico is still kind of old school, you have people come to the branches to make payments for government services or for their cable bill or telephone bills and those kinds of things that does generate some traffic in the branches and also some opportunities for sales, right? And so I don't see a significant change in optimization in Puerto Rico. In the U.S., in the past, I think most recently in 2022, we did some optimization in the U.S. So while there's still opportunity for us to add organically, there's still some levers that we can pull and we look at whenever you have a chance, particularly in a market expensive like New York, where you're looking at renewing leases and things like that, there becomes a much more bigger component of the savings and that business case is a little bit different than in Puerto Rico, just a nature of the market.

Yes. Got it. When you take a look at the credit quality of your organization is very strong today. Like others, during the financial crisis, you guys obviously run into some credit problems. Can you share with us just how you're looking at credit and credit quality for this year? Are there any areas that you've been paying extra attention to just as a safety measure or anything like that?

Sure. So -- in 2020 -- set back in 2023, we started seeing the second half a real normalization on our portfolios, particularly our consumer loans, right? We're very happy with the performance of commercial and mortgage portfolios. But but we're very focused on the consumer side. In 2024, our net charge-offs were around 68 basis points for the year. Our guide for 2025 is 70 to 90 basis points. So fairly stable if you think about it. And historically, if you look back, our net charge-offs were somewhere between 75 and 125 basis points. So we're still trending to the lower end of the historical numbers. And our focus there is really on personal loans, unsecured -- sorry, unsecured personal loans, credit cards and auto. Very happy with how the personal loans have reacted to changes in underwriting and collection efforts. When we look back and you look at the vintages, the pandemic vintages where like many U.S. consumer lender, we saw inflation in FICO scores that we didn't identify at the time that probably resulted in us providing more credit than we maybe would have or not charging the appropriate amount, right? So as we see those vintages kind of working their way through the portfolio and newer vintages having better performance, we start getting comfortable with those levels. Again, we're very happy with how that has reacted slower on the credit card side, the revolving nature of that relationship makes it a little harder to kind of get that normalized quicker, but we continue to work on that. And while maybe at a higher level than pre-pandemic, it makes sense, right? The pre-pandemic, you didn't have the rates that we have now for credit card borrowing and the inflation puts more pressure on that brorrower. So it makes sense that it'd be a little bit higher, but it also has been stable, right? We're not seeing the continuous trajectory that has stabilized. And then the last one is auto lending. At least there, you have some secure collateral that collateral, maybe we've seen a little bit of pressure on used cars as -- during the pandemic, a lot of used car prices went up because of the problems with the supply chain. You kind of see that effect and your loss given default, maybe it's a little higher than historically because of that. But even so, those charge-offs are still below the pre-pandemic level. And again, going back at the beginning, the consumer in Puerto Rico, there's nothing flashing concerns right now, again, unemployment, wage increase and just the level of economic impact in Puerto Rico right now, it's very positive.

When you look at the consumer loan portfolio, if you had to segmentize it by FICO score, any rough breakouts of x percents?

Yes. The bulk is I think the average when you look at the portfolio average of new originations, it's above 700, like 710 or something like that. So the portfolio tends to skew to strong FICO scores. FICO score continued to be the -- for us, the best indicator, right, of the credit quality and loss potential. So every once in a while, you start seeing some disconnect on kind of those -- the portions of kind of the quadrants of those FICO scoring. But overall, they're good scores. I [ mean very ] good credit. If you look at our building allowance, a lot of that, particularly in 2024, was driven by migration of FICO scores, how much of that is from the inflation in FICO scores I talked about versus more current stabilized FICO is a little bit different, difficult for me to gauge, but really comfortable with that.

You mentioned about credit losses potential for 2025. Is there anything you like to update us on 2025 trends or first quarter trends? And then second, can you remind us your medium-term ROTCE or ROE targets? And when do you think you might get there? But any opportunities...

So the first one, I'm sorry, we don't provide any updated guidance. So that will be quick and boring. In terms of the ROTCE targets, we do have a target for the fourth quarter of this year for at least 12%, and that's a sustainable 12%. One thing that's important when we look at our ROTCE targets, we add back an adjusted capital number where we add back the unrealized losses, right? So we don't benefit if that unrealized loss gets bigger and it's not hard If it gets smaller. So net of that, the target for the end of the fourth quarter is at least 12%. And as we look at, again, importantm it is a sustainable 12%. And if we look at -- further out, we do have a target of 14%. And the Popular is right now involved in a broad-based transformation effort, that's really focused on enhancing our customer experience and our employee experience and it's focused on investment on technology, but as well as leveraging data for personalization and how we provide our services and identify our clients. For example, in the fourth quarter, we launched a mass affluent product targeting around 17,000, 18,000 clients and $600 million in deposits, where we see it as a client base that maybe doesn't have as high a deposit balance as we would expect, given the inflow and outflow activity in their accounts, right? So it provides us an opportunity to determine -- get closer to that client, whether they have other banking relationships, whether it's a situation where we can sell them investment [ advice ] from our broker dealer, and that's an example of something that is really not a huge investment, but the targets where we believe the opportunity to continue to sell products to our client based in Puerto Rico.

Yes. We're running out of time, but I do want to ask you about capital since you're very well capitalized and Popular has always articulated that you're going to always have higher CET1 levels than your peer banks in the mainland because you are okay -- located in Puerto Rico. Can you give us an update on your thinking about CET1? And then what you would do with the excess capital, potentially more buybacks and some...

So we have a current authorization of about $500 million that we are executing upon at the end of the fourth quarter. We repurchase around $220 million. In the fourth quarter, we -- it's one of the first quarters in a while where we were able to increase our dividend by 13%, bought back roughly $150 million in the quarter and also grew risk-weighted assets, right, at 2.5% in the quarter. All that resulted in a reduction in CET1 about 40 basis points, right? And what we really want is to get to that lower target, right, operating target that is still going to be higher than our peers because we believe that incremental buffer is necessary given our geographic concentration in Puerto Rico. But we want to do it over time. We don't believe in a step function that might take away flexibility and optionality for us. But we do understand that we don't need to operate with a 500 or 600 basis point cushion, right, or buffer's. We just want to make sure that we get to that over time. And certainly leveraging organic and capital actions, it's a pace that we like.

Yes. So is it safe to assume that should you exercise the authorization fully, let's say, this year, we should see probably another authorization because capital level is so high?

So the authorization doesn't have a time line. Certainly, we want to make sure that our activity informs our shareholders of the pace as to how quickly or when we would consume. And the important thing is that we want to have the flexibility, Gerard, that our peers have, where we announced an authorization we don't commit to a time of the year to announce it. So it's some flexibility there. We want to have the flexibility of being opportunistic like we were in the fourth quarter, the price of the shares come down and we buy into it. Our share price was attractive 2 weeks ago, it's even more attractive today, right? So we just wanted our flexibility like our peers enjoy. We maybe lost that a little bit in 2022 with our -- the way we were executing ASRs and kind of this cadence, and we want to make sure that we have the flexibility we're not taking that away.

Great. Please join me in round of applause thanking Jorge for coming.