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

Well, thanks, everybody. Continuing with the mid-cap banks, we're very excited to have Popular to join us coming up from San Juan. We have Javier Ferrer, the President and Chief Executive Officer; and Jorge Garcia, Chief Financial Officer, with us. So thanks a lot. Thanks for coming.

Great to be here. We're enjoying so far.

Thank you for having us.

Maybe just to start off, just a little bit of an update how things are going in the summer, where you're seeing the state of things?

Well, I think it's steady as it goes. We are seeing a lot of good activity in Puerto Rico, a lot of momentum. The economy continues to be strong. I think that, of course, we're benefiting from the Bad Bunny residency and that not only has brought in a big, big spend and a lot of movement and music, and culture and food, but also a lot of visitors to Puerto Rico. Not only from the United States, but also from Spain, Dominican Republic, other parts of Europe. So it's been a pretty intense and beautiful summer, I got to say, so far in Puerto Rico.

You're new to your role as CEO since our conference last year, but you've been part of senior management at the bank for a while. How should we view your priorities now compared to maybe where the -- what the focus was before?

Well, I mean, I've been with the bank for 11 years now. So the last few years with very, very tight connection to the businesses and strategy and ultimately, as transformation program, which is running on its third year. This December will be the last year of the first leg, as we call it, of the transformation program. So not many changes, I got to say, Jared, but definitely changes, if any, on focus. We have -- I think we're focusing on the next leg of transformation, and that has a lot to do with the new strategic framework that we unveiled a couple of weeks back to the leadership and also to everybody at Popular. And the idea behind it is to simplify what we're trying to accomplish within transformation and the strategy of the corporation, so that everybody can relate to what we're trying to accomplish. And I think that's very powerful. And if you allow me, I'll just go over the 3 objectives. I don't think you'll fall off your share because, ultimately, it's about delivering value to our shareholders. The first one is be the #1 bank for our customers, and that has everything to do with primacy. We have very strong primacy numbers in Puerto Rico, our top market. We need to continue to defend and grow in certain segments of primacy. And it's about share of wallet, being there for customers, earning their trust, delivering value for them. Second one is be simple and efficient. And that's exactly what it means. Very difficult to be simple, efficient, we need to make sure that we do things in a very cost-conscious way as we continue to invest in the company. And again, to deliver a best-in-class experience. The third one be a top-performing bank [ for price. ] And that's out there with what we're trying to achieve in terms of our ROTCE target. We put out a number. We continue to work towards trying to hit 12% by the end of the year, we've hit it. We've talked about 14%. So -- but it's all about profitability and also the employee experience, understanding that we need to have the best talent to run the bank and continue growing. So -- and those 3 sort of objectives have underlying sort of areas of work. In some cases, it would be digital experience, data and analytics, payments, which is obviously key given our footprint in Puerto Rico. And -- but I think the beauty of it is that it puts together impact to our employees, our customers and ultimately our shareholders. Our transformation has given us some very good early wins on the -- particularly on loan side products, small businesses being one of the segments that have been profitable for us transform. But again, I mean, we won't stop. Our north is to continue to become the most profitable bank we can become, and understand that we have a big responsibility Puerto Rico after 32 years working there, but there's still room for us to grow in Puerto Rico, the right way, we intend to do it.

As you said, Puerto Rico is benefiting from a sustained economic resurgence over the past few years with federal funding for infrastructure, potential benefits from onshoring due to tariffs and of course, Bad Bunny summer residency. How would you describe the current state of the economy and its resilience now?

Well, it's -- again, it's strong. Puerto Ricans are resilient. That's a great way of describing us and you're seeing in the economy. Clearly, there's some uncertainty out there given what's coming out of Washington, the tariffs and some inflation provoked by them. But again, I mean, we are not seeing any changes in the behavior of our customers. We are not seeing our commercial customers stop any of their big projects. We're seeing people investing both local, but also foreign investment and U.S. investment. Certainly, the fact that we are on the right side of the tariff wall and given our very strong manufacturing base and talent in Puerto Rico, we think that we are positioned quite strongly to continue attracting investment. And in the last few months, there's been 6, 7, 8 new sort of investment opportunities for people coming into Puerto Rico, either de novo or expanding production in Puerto Rico. So again, I mean, we are very, very nicely located. And also, we have the fiscal sort of flexibility of adding benefits to industries that want to move to Puerto Rico. It's no coincidence that we have 4 of the top 10 pharmaceutical companies operating from Puerto Rico, 3 or 4 of the top drugs in the world producing Puerto Rico currently, notwithstanding the fact that hurricanes may hit us once in a while. We've come back. That's why I love the resiliency, the word you used. It's defined us. But right now, of course, no situation is perfect, but we like the trajectory of Puerto Rico. And I think it's going to continue. We don't see anything that ought to stop it in the near to midterm.

This past quarter, you announced a large public-private partnership. You've talked about the continued flow of capital into the island. What do the loan growth dynamics look like as we look out through the rest of the year and sort of a starting point for next year? Both on the commercial side and certainly on the consumer side as people have more money.

Jorge, do you want to take that?

Sure. So Jared, during the second quarter earnings call, we reiterated our 3% to 5% loan growth guidance for the year. That's driven primarily by commercial activity. But certainly, in Puerto Rico, we expect the consumer portfolio to continue to contribute, both in the auto lending and unsecured consumer product as well as mortgage. If you look at the first half of the year, we've been very happy with the growth, both in the U.S. market and in Puerto Rico, both markets contributing to that. And as we look through the second half of the year, we continue to see some strong pipelines, large deals in both Puerto Rico and the U.S., but we are expecting a little bit of headwind in the U.S., particularly with paydowns on our construction portfolio. Our construction portfolio is mainly focused in New York, and it's really a development that usually ends up in a term loan on multifamily CRE projects. We don't always participate on the takeout loans. And what we're seeing is given the reduced construction pipeline for some of the uncertainties that are well documented, we do expect projects to come to their end quicker, and we're expecting some paydowns in the second half, and that adds a little bit to a headwind to that and why we are in that 3% to 5% guide.

Is there any thought of changing the U.S. Mainland strategy of your portfolio? You have tons of capital, you have strong deposits. Are you comfortable with your exposure in the Mainland now? Or could you look at expanding that at all?

We always look at opportunities to expand our book in the U.S., particularly in the niche businesses we operate. They're very profitable, always looking for opportunities of expansion into other areas. Also -- but that's not -- it's what other people are doing. And we always look at how to grow our U.S. bank. It's something that we consider.

Okay. There's, what, almost $50 billion of Federal stimulus still to come. I think there is some concern before the election that a Trump presidency could be disruptive to Puerto Rico and the flow of capital for these rebuilding plans. What's the state of the relationship between Puerto Rico and the Federal government now? And what should we expect in terms of timing for the deployment of that capital?

The state of the relationship is strong. I recognize, and we all were sort of a bit trepidant when the President revaluated because we remembered that he had very public confrontations with a local politician, the Mayor of San Juan. And obviously, they made the news, and it was a big thing. But I have to say that our new governor focused with the Republican party when she was our elected representative to Congress for a couple of terms with our vote to the House of Representatives. So when she was inaugurated in Puerto Rico, President Trump sent a letter, congratulating her. So the relationship between the Puerto Rico government and the White House is productive. So we did get some cuts at the beginning of the DOGE program. But they were not targeted to Puerto Rico. They were part of what was happening in the Mainland with Mr. Musk and his team. That has subsided. But none of them cut the obligated funds, which are close to $77 billion have to spend in Puerto Rico related to the hurricanes and COVID. Some of that -- some of the COVID will lapse. But we haven't heard anything that would lead us to think that, that's going to change. Now there has been a change recently with the White House dismissing 6 of 7 members of the Puerto Rico Fiscal Oversight Board. And that we'll have to wait and see who the new members are, what that will mean for the PREPA bankruptcy and the rebuilding of the grid. But we think that what's been said is, it's been couch in terms of Make Puerto Rico Great Again, using the Board more proactively to generate economic activity. So we're looking forward to that. And certainly, Popular has been a big participant in every single P3 project. And we've told the government of Puerto Rico, the Federal government and folks that are coming into the island to look for opportunities in that sector, in energy sector. But of course, we are best suited to be the local sort of partner for our financing. So again, I mean, we are looking forward to what the changes will bring, and we're hoping that it will be for the good of Puerto Rico.

It feels over the last few weeks, there's been a focus on the Caribbean in general from the military. And I saw that the Secretary of Defense or Secretary of War now, I was down in Puerto Rico and looking at expanding operations there. What's the potential? I know that there's really no info out there, but what type of stimulus could that be if there was more military spending coming through Puerto Rico? And could that accelerate some of the infrastructure improvements that are.

Yes and yes. Yes and yes. It's interesting that you make that you asked that question because in one of our meetings today, the question did pop up, absolutely. In Puerto Rico, there's always this issue of past history of using some of the land in Puerto Rico for military sort of training operations, and that the smaller islands that has raised political issues, obviously. But if you're reading the news, you're seeing the deployment towards the military -- deployment naval versus vis-a-vis Venezuela, right? So I don't think -- I mean, I don't have an approval of it, but clearly, you can connect the stance, the administration stance on Venezuela and the practice -- the military practice that has occurred in Puerto Rico in the last couple of weeks. So it would definitely assuming that the military comes back into some of the bases and reactivate that side of his presence in Puerto Rico, it will be a net positive to the economy for sure.

We have a few questions for the audience. I think we can run through them, but it's end of the day. So we appreciate that it's -- everyone is a little bit tired. But right now, what's your current position in Popular shares? One, overweight or long; two, equal weight; three, short; or four, not involved. So we have some opportunity to convince some people. And what would have the largest impact on improving the relative valuation of shares of Popular? One, better relative margin performance; two, above peer loan growth; three, better expense control; four, credit quality outperformance; five, more active share repurchase; or six, an accretive bank acquisition.

Interesting.

The loan growth and capital management agree with buybacks.

Yes.

All right. Any thoughts or comments on that?

No. I mean I think interesting to see the loan growth popping up here because when I think back of my tenure as Controller before I was in the CFO role and see Puerto Rico have struggled on loan growth and then to have experienced somewhere between 6% and 10% growth in the post-pandemic era, really outpacing our U.S., which has historically been our growth engine. It's interesting to see that there because we're very proud with the growth that we've seen in Puerto Rico, the economic environment, how we've been supportive of that and still are bullish perspective for future growth in Puerto Rico, both from organic clients and deepening those relationships with our existing clients as well as new entrants into the market. So we certainly drive our teams to focus on loan growth. So good to see that's aligned with the participants here in the crowd. In terms of active share repurchases, we do have an active program and continue to buy. We still believe our share price is attractive and continue to be active. So good alignment.

Great. Number three, what will organic loan growth be at Popular in 2026? One, 3% to 5%; two, 5% to 7%; three, 7% to 9%; or four, greater than 9%.

Good question.

Call it 3% to 7%, okay?

We'll give you the answer to that in January.

Yes, keep going like this.

Okay. And then our final question to what do you attribute the popular valuation discount relative to peers? One, elevated disaster risk in Puerto Rico; two, elevated credit risk due to higher consumer lending exposure versus peers; three, potential for weaker economic trends in Puerto Rico; or four, longer-term uncertainty around NII due to reliance on public funds. A little bit of a mix, including disaster. Yes, let's open it to questions in the audience. I think there's a microphone that over and over. Just one second.

Could you actually comment on those 4 items in that -- on that slide, just as to what is the other side of it to eliminate the concern of those things that are called out?

Well, I'm going to start with [ one ], even though we got 0 because this is something that for me is it's a good result. We don't think -- we understand that where we are geographically, but I think our performance, not only the bank's performance, but also Puerto Rico's performance in bouncing back, clearly with Federal help like in any other disaster situation in the United States. I want to say the proof is in the pudding, and we continue reconstructing and rebuilding, but it's good to get this result because this is very real. And it speaks to the death of folks answering the question, right? It would be a very bad answer to have given a big percentage to #1. I'm going to go to 3. Jorge, you want to do 2, and I'll do 3.

Sure. Okay. So on elevated credit risk, I mean, I think when we look at our loan composition, we actually see that as a strength for Popular. I mean it really kind of differentiates us from other regional banks in the U.S. that maybe have a higher concentration in CRE, given our broad base, we participate in all financial products for our consumer and commercial base particularly in Puerto Rico. So consumer lending, we might have a higher exposure. We see that as a strength. We got to look at risk-adjusted returns on that, particularly our exposure to auto lending. The yields that we get on auto lending in Puerto Rico on a risk-adjusted basis are probably represent maybe subprime lending in the U.S., while in Puerto Rico, it's really a prime borrower. You look at our originations are well above 700. So obviously, there's a history of Puerto Rico with maybe some mortgage losses and things like that, but that's pretty far in the rearview mirror. And given unemployment rates of 5.5% compared to maybe historical double-digit unemployment rates, given the amount of investment in Puerto Rico from private sources as well as the impact of the federal reconstruction funds and everything else going on, increasing wages, et cetera, the consumer in Puerto Rico is in a much stronger position today. So we don't -- I mean, obviously, we are focused. We spend a lot of time on risk management in this portfolio, but this is not something that's at least not keeping me up at night.

Yes. And three is somewhat related to two. I'd say that, of course, there's always potential for weaker economic trends anywhere, right? But I think that the economy in Puerto Rico is well diversified. And it's had its bumps. But we don't see anything, again, in the short term to midterm, which will negate its momentum. The growth -- the projected growth is not going to be double digits or even high single digits, but it's projected to continue growing steadily or at least plateau at about 2%, 1.5%, 2%, 2.5%. It depends which economist or who you're talking to. There's a lot of opinions. But we're thinking that given what we're seeing, the investment, the -- without considering events just like what Jared asked, which is a potential benefit to the economy. We feel that throughout time, the economy ought to do well, rebounding from the bankruptcy. Now there's certain things we don't control, right? We don't control, again, natural disasters. We don't control the quality of the public sector. We don't control some demographic trends, but Puerto Rico typically rebounds and grows now. For us, the important thing is to be a good partner there and continue to be profitable as the economy continues to generate positive results. I don't believe that the bank is tethered to a potential -- to a growth rate. So there are people who say, well, if the economy is only growing 2%, the bank is capped at that. I don't believe that's the case. It has not necessarily been the case in the past. And if there's a downturn, the way we look at it is we would be the stronger -- we want to be the stronger bank so that we come out of the cycle bigger and more profitable. That's why this impetus on our ROTCE results and profitability is top of mind for the institution. And not that it has changed dramatically, but I think the focus on it is what is changing or has changed in the near term in the last year or so. So again, if you live in a place, right, you do your darndest for it to grow and do better. There are no guarantees. But I see also the younger generation in Puerto Rico being a lot more entrepreneurs out of that generation, a lot of people thinking about exporting services and goods. So I don't think that it's a given that Puerto Rico necessarily will exhibit weaker economic trends in the near term, for sure. That's not what we're seeing.

Maybe, Jared, I'll have the last one.

If you want to.

On the last one, I think one of the first times I've seen kind of this concept of a negative long term on reliance on public funds. I want to first highlight that I think of the public funds almost like a repo book. I mean it is an important relationship. It's not one entity. It's not just the central government. It's over 200 public entities. These are real clients, and we have deep relationships with them. And we can't really -- money is fungible, but all that money needs to be collateralized. It's all collateralized with U.S. treasuries or agency-backed securities. So it's not like we're using that money to deploy it in lending, for example. So it does not -- first, it doesn't represent a liquidity event and that we could either monetize a collateral or use it as collateral to borrow in any one of our off-balance sheet sources. So right now, the public funds, first, we -- again, we like this relationship if -- but we've also extended the portfolios, right, in 2022, 2023. And that relationship actually is not providing the level of profitability than it did maybe in 2021 and 2022, given the extension. So over time, this is actually a tailwind that is providing for the investment thesis in Popular as a nice tailwind of improving our NII as our laddered investment approach that's funded by these deposits reprice. And I invite the participants to look at our webcast deck, we provided quite a bit of information on there as to where we see the kind of the book maturing at what level and the yields on those maturities and versus current market rates and the improvement that we can get. So I actually see this in the midterm -- short to midterm as a source of strength and driver of NII profitability. And in the longer term, we do believe that this is a long-term relationship that will continue to provide higher profitability than what it is doing today.

Anyone else? I guess sticking with the consumer discussion. We've seen the consumer in Puerto Rico, the strength improved consistently over the past few years. We've seen average deposit balances steadily increasing as well. Do you think this is sustainable? And how should we think about baseline consumer deposit growth and seasonality now that we've...

Yes. So we saw like many banks, an increase in average deposit balances during the pandemic as our clients benefited from all the stimulus from the Federal government, and we saw increases of up to 150% of average balances pre and post-pandemic. Right now, we're around 30% higher balances than pre-pandemic. And we believe those levels are sustainable and really during that period of time, what we have seen is that minimum wages in Puerto Rico have increased by about 40%. Wages in the construction sector, which is an important part and one of the areas of growth in Puerto Rico has grown about 50% on the minimum wage there. And all those have bumping up effects. And when we look at our client activity, particularly around direct deposits, which is really driven by payrolls and salaries, we've seen an increase of about 40%. So coincides with changes in the minimum wages and merit increases, et cetera, over that period of time. So we do believe kind of the levels where we're at, we don't expect to certainly see a lot of degradation in those average balances. In terms of seasonality, we do see seasonality, and we expect that to continue. Traditionally, for the first half of the year see some increases in deposit balances as particular retail clients benefit from tax refunds. And then we see them kind of spend that in the third quarter. And then the fourth quarter has more stability with some bias towards higher balances. And some of those higher balances are driven by local laws that require employers to provide a Christmas bonus of at least $600 per employee. Our clients get that in the fourth quarter, and that supports a little bit of that activity, plus you do get a little bit of a tendency of window dressing with commercial clients that might hoard some cash at the end of the year and to strengthen their balance sheet kind of for their audited financial statements. So that's the cyclicality. We expect that to continue. I think going forward, deposit growth in Puerto Rico probably driven more by general economic activity, obviously, inflationary effects and things like that.

On credit, credit trends have remained better than what we've seen has historically been the longer-term normalized level. Given the stronger health of the consumer that you just discussed and broader economic tailwinds, do you think these lower overall credit levels are sustainable?

I mean there's nothing that we're seeing as we've said various times today that we're seeing a shift or a change in the economic environment, the operating environment in Puerto Rico that would lead us to believe that, that should change. We've been very happy with how commercial portfolios and mortgage portfolios have performed. We did see some deterioration in the second half of 2023. We've reacted to that. We saw that normalization very quickly, particularly in the unsecured lending and auto portfolios throughout 2024 and the first half of this year. So we -- there's nothing that within our parameter or focus right now that concerns us that would change that. With commercial loans, you always can get idiosyncratic issues with any individual borrower that have a temporary impact on that, but there's no industry or segment that we're really focused on right now that would concern us.

Then maybe on capital. Capital is very strong, continues to grow even though with some of the capital management tools you're utilizing. How are you thinking about optimal capital levels here? I know that you still want to run maybe a little richer just given some of the geographic concentration. But longer term, where do you think an optimal capital level is for the franchise?

I mean we do have operating targets internally. We run stress tests that are important in establishing those operating targets, but we don't make those public. And certainly, as a management team, we do agree that our CET1 levels are high. We do believe that we should be running at a higher level than our peers, the U.S.-based peers, given our geographic concentration in Puerto Rico, but we don't believe that needs to be 400, 500, 600 basis points and whoever you compare us to. But we do like as a management team and as a Board, we do have a conservative approach. And we do like the flexibility and optionality that having higher levels of capital provide us, and we really want to bring those down over time. Second quarter, CET1 came down 20 basis points, and that was driven by growth -- loan growth, so increasing our risk-weighted assets, great opportunity to continue in that organic growth, strong buyback activity and then the dividends. We want to continue to deploy those levers and bring down our capital levels over time. We don't really want to do step functions. But we do realize we know the math. If you reduce the denominator and ROTCE goes out, we understand the benefits of that. But we are very much focused on improving the numerator, making sure that we improve profitability. We've been doing that. We understand the impact of reducing capital. That's not -- we're not blind to that. We are focused on that. It's just -- we believe that's more transactional versus the sustainability, it's going to really come from our investments and our efforts on the profitability side.

Great. Well, thanks. Any closing remarks?

No. It's been a great day. Thank you for having us. We've had fantastic conversations in one-on-ones, and I appreciate the opportunity to be here.

Well, thanks for joining us, and thanks, everybody, for joining us today. And with that, thanks.

Great. Thank you, Jared.

Thank you, Jared.