Popular, Inc. (NASDAQ:BPOP) Q2 2023 Earnings Call Transcript

Popular, Inc. (NASDAQ:BPOP) Q2 2023 Earnings Call Transcript July 26, 2023

Popular, Inc. beats earnings expectations. Reported EPS is $2.1, expectations were $1.81.

Operator: Good morning, everyone, and welcome to today’s conference call titled Popular, Inc. Q2 2023 Earnings call. My name is Ellen, and I’ll be coordinating the call for today. [Operator Instructions] I will now hand over to Paul Cardillo, Investor Relations Officer to begin. Paul, please go ahead whenever you are ready.

Paul Cardillo: Good morning, and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano. They will review our results for the second quarter and then answer your questions. Other members of our management team will also be available during the Q&A session. Before we begin, I would like to remind you that on today’s call, we may make forward-looking statements that are based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s earnings press release and are detailed in our SEC filings. You may find today’s press release and our SEC filings on our webpage at popular.com. I will now turn the call over to our CEO, Ignacio Alvarez.

Ignacio Alvarez: Good morning, and thank you for joining the call. The second quarter was another strong one in which we achieved net income of $151 million, $8 million lower than the first quarter results of $159 million. Net interest income and non-interest income remained strong. The decrease in net income was driven by higher operating expenses, offset in part by a lower provision for credit losses. We grew loan balances by $693 million during the quarter. Banco Popular generated loan growth across all segments, while Popular Bank achieved growth in commercial and construction loans, offset in part by runoff in the mortgage and consumer portfolios. Year-to-date, loan balances have grown by more than approximately $953 million.

Our net interest margin increased by 8 basis points to 3.14% in the quarter, primarily as a result of a 29 basis point increase in deposit costs. This was partially offset by higher loan balances and the repricing of adjustable rate loans in a higher interest rate environment as well as higher balance of money market investments driven by our strong deposit growth. Non-interest income continued to improve. Excluding the $7 million insurance claim reimbursement recorded in the first quarter, fee income was $5 million higher. Revenues related to customer transaction activity were particularly strong, and we also began to see some early results from our various transformation initiatives. Operating expenses increased by $20 million as we continue to strategically invest in our people in areas such as regulatory compliance and technology and projects related to our transformation.

Credit quality trends remain positive. NPLs once again decreased in the period and net charge-offs remain well below pre-pandemic levels. We maintained robust liquidity anchored by our deposit franchise and our high levels of cash reserves and unpledged securities. Overall, deposits were up $3.1 billion in the quarter, and liquidity sources increased by $1.9 billion. We have a well-diversified deposit franchise in Puerto Rico with an average balance of less than $10,000 per retail account. Our total consolidated borrowings remained flat during the quarter. Regulatory capital levels remain strong. Our common equity Tier 1 ratio in the second quarter was 16.9%. Additionally, tangible book value per share ended the quarter at $51.37, an increase of $1.22 per share.

Earlier this month, we announced that on August 14, we will redeem at par all outstanding 300 million aggregate principal amount of our senior notes that mature in September of 2023. Please turn to Slide 4. Our customer base in Puerto Rico grew by approximately 9,500 during the quarter, reaching nearly 2 million unique customers. Adoption of digital channels among our retail customers remain strong. Active users on our Mi Banco platform exceeded 1.1 million or 56% of our customer base. In addition, we continue to capture more than 60% of our deposits through digital channels. This trend remains significantly higher than pre-pandemic levels, demonstrating our customers’ adoption of this technology. In the second quarter, consumer spending remained healthy with combined credit and debit card sales up 3% compared to the second quarter of 2022.

Our auto and lease originations increased by 29% compared to the first quarter, as demand for cars has continued to be strong in Puerto Rico. Mortgage production in Puerto Rico appears to have stabilized in the second quarter. The dollar volume of mortgage originations at Banco Popular increased by 20%, compared to the second quarter of last year, driven primarily by home purchase activity. The Puerto Rico economy performed well during the second quarter. Business activity is solid and remains in good shape as reflected in the continued positive trends in total employment and other economic data. The tourism and hospitality sector continues to be a source of strength for the local economy. Year-to-date, San Juan Airport has seen record levels of passenger traffic.

Hotel demand has also been very strong. Year-to-date, occupancy, average daily rates and RevPAR are all at the highest level seen in nearly a decade. There are still approximately $45 billion of hurricane disaster recovery funds yet to be dispersed. We expect that these funds will support economic activity in many sectors in the coming years. In fact, we are beginning to see these funds being disbursed into local construction projects. Access infrastructure investment in the economy expands, we are well positioned to serve the needs of our customers and benefit from such activity. In short, we are pleased with our results for the quarter, particularly our strong loan growth in both Puerto Rico and in the U.S. as well as the continued strength of our deposit base, liquidity and credit quality.

We are encouraged by the resiliency of the U.S. economy and strong economic activity in Puerto Rico. We remain optimistic about the future of Puerto Rico, our primary market, and our ability to manage and serve the needs of our growing customer base. I’ll now turn the call over to Carlos for more details on our financial results.

Carlos Vazquez: Thank you, Ignacio. Please turn to Slide 5. We reported net income of $151 million compared to $159 million in Q1. Net interest income was $532 million, in-line with Q1. On a taxable equivalent basis, net interest income was $558 million, down $12 million from Q1 due to a higher disallowed interest expense in the calculation of taxes in Puerto Rico. Non-interest income was $160 million, a $2 million decrease from Q1, which included a $7 million insurance claim reimbursement. Excluding the Q1 reimbursement, during the quarter, non-interest income increased by $5 million, driven by customer activity. Service charges and deposit accounts increased by $3 million, mainly due to higher cash management fees on commercial customer accounts.

Additionally, other service fees increased by $4 million, primarily driven by higher credit and debit card fees due to higher volume of customer transactions. Going forward, we expect non-interest income to be approximately $155 million to $160 million per quarter. The increase from our prior $150 million quarterly guidance is partly due to two transformation-related initiatives that have yielded early results. First, we have enhanced the pricing segmentation in our commercial cash management business in Puerto Rico. And second, last year, we introduced a commercial credit card product for Puerto Rico SME businesses. Both initiatives have contributed additional fee income. The provision of our credit losses was $37 million compared to $48 million in the first quarter.

Total operating expenses were $640 million in Q2, an increase of $20 million from the prior quarter. This increase was primarily driven by higher professional fees by $17 million related to regulatory compliance and cybersecurity initiatives as well as technology and software expenses that increased by $4 million. During Q2, we incurred $7 million of transformation-related expenses compared to $6 million last quarter. We continue to anticipate transformation-related expenses of approximately $50 million in 2023 as these efforts are expected to accelerate in the second half of the year. Other large expense variances were higher business promotion expense by $6 million, mostly related to credit card customer loyalty programs. Higher processing and transactional services expenses by $4 million due to retail credit and debit card replacement cost.

Photo by Jose Vazquez on Unsplash

And finally, lower personnel costs by $7 million, primarily related to lower equity-based compensation expenses. Personnel costs historically exhibited a seasonal decrease in the second quarter, then typically increase for the remaining of the year, in part due to the impact of annual metric increases, which are effective on July 1. Our quarterly expense trajectory has historically ramped up as the year progresses. We anticipate that 2023 will be consistent with our experience and continue to expect expenses for the year of approximately $1.87 billion. We will strive to come in below this expected level of expenses. Our effective tax rate for the quarter was 22%. For the full-year 2023, we now expect an effective tax rate to be between 22% and 25%.

This range is somewhat tighter than the 21% to 26% range provided during our last webcast. Please turn to Slide 6. Net interest income was $532 million. On a taxable equivalent basis, it was $558 million, $12 million lower than in the first quarter. Net interest margin decreased by 8 basis points to 3.14% in Q2. On a tactical equivalent basis, NIM was 3.29%, a decrease of 17 basis points versus Q1. The decrease is driven by higher interest expense on deposits, due to the increase in balance cost of public sector deposits as well as growth in high-cost deposit accounts at Popular Bank. This was partially offset by higher loan yields and balances across all major lending categories. At the end of the second quarter, public sector deposits were roughly $18.5 billion, an increase of $3 billion compared to Q1.

The increase in Q2 was consistent with historical trends. And as such, by the end of 2023, we still expect public deposits to be in the range of $14 billion to $16 billion. It is important to reiterate that by law in Puerto Rico, public deposits must be 100% collateralized, while changes in the level of these deposits may impact profitability, they do not have a significant impact on our liquidity. Excluding Puerto Rico public deposits, customer deposit balances were essentially unchanged in the quarter. We did, however, see some mix shift as non-interest-bearing deposits decreased by $624 million in the quarter. This was offset by increases in time and saving deposits of Popular Bank gathered through a direct online channel. In Q2, we continue to see commercial and high net worth clients pursuing better yields on excess liquidity by moving these funds outside the banking sector.

However, we have been able to capture a good portion of these in our broker-dealer, we saw inflows from deposit customers of approximately $350 million in Q2. Our ending loan balances increased by $693 million compared to Q1, driven by growth in all loan segments at BPPR and Bank commercial and construction loans at PB. This growth is net of a transfer to held for sale of a $46 million private label credit card portfolio. That portfolio was sold at our par value in early Q3. We are encouraged by the demand for credit at BPPR and PB. We will continue to take advantage of prudent opportunities to extend credit and improve the use and yield of our existing liquidity. Our interest rate sensitivity continues to be relatively neutral. As this year progresses, we expect the margin to resume an upward trajectory.

The timing will depend on our loan and deposit growth and mix, investment portfolio strategy and the pace of repricing of public and incrementally retail and commercial deposits. Deposit betas in the current timing cycle are now above the prior cycle. We have seen a total cumulative deposit beta of 31% to date in this cycle. In BPPR, total deposit costs increased by 34 basis points compared to an increase of 35 basis points in Q1, led by public sector deposits. Excluding the public sector balances, deposit costs in BPPR increased by 14 basis points. In PB, deposit costs increased by 55 basis points versus 67 basis points in Q1, led by retail deposits gathered primarily through our online channel. In Puerto Rico, our combined retail and commercial deposit betas, cycle-to-date continue to be less than 10%.

Given the increase in short-term interest rates, we expect a continued increase in the cost of public sector deposits. The deposit pricing agreement with the Puerto Rico public sector is market linked with the like. This source of funding results in an attractive spread on their market rates. In the second quarter, the cost of public sector deposits increased by 39 basis points compared to our April estimate of 60 basis points. The different risks in balance fluctuations and the mechanics of the interest expense calculation. We expect the cost of public deposits to increase by approximately 50 basis points in Q3. Please turn to Slide 8. Our investment portfolio is almost entirely comprised of treasury and agency mortgage-backed securities, which carry minimal credit risk.

Including our cash position, this portfolio has an average duration of approximately 2.3 years. As of the end of the second quarter, the balance of the unrealized loss in our HTM portfolio stood at $746 million, a reduction of $43 million from Q1. We expect this loss will be amortized back into capital throughout the remaining life of that portfolio at a rate of approximately 5% per quarter through 2026. Please turn to Slide 9. Our return on tangible equity was 10.6% in the quarter. Regulatory capital levels remain strong. Our common equity Tier 1 ratio in Q2 of 16.9% increased by 14 basis points from Q1. Tangible book value per share at quarter end was $51.37, an increase of $1.22 per share. Given the continued uncertainty on the outlook for rates, the economy and the potential regulatory response to events in the banking sector, we do not expect to engage in a share repurchase during the remainder of 2023.

We do plan, however, to consider a dividend increase later this year. We will review future capital actions as market conditions evolve. Our long-term outlook on capital return has not changed anchors our strong regulatory capital ratios. Over time, we expect our regulatory capital ratio to gravitate towards the level of our maintenance peers plus Sprint. With that, I turn the call over to Lidio.

Lidio Soriano: Thank you, Carlos, and good morning. Overall, Popular continue to exhibit strong credit quality trends with low levels of net charge-offs and decreasing non-performing loans. We believe that the improvements over the last few years in the risk profile of the corporation’s loan portfolio positions Popular to operate successfully in the current environment. However, we continue to closely monitor changes in our performance and the macroeconomic environment, even inflationary pressures and geopolitical risk. Before discussing the credit metrics for the quarter, I would like to address the risk profile of three loan segments: office CRE, credit cards and auto and lease financing portfolio. We have also included additional information for this segments in the appendix to today’s presentations.

The office segment is receiving a lot of attention in the current environment due [indiscernible] to remote work and higher interest rates. Popular consolidated office CRE exposure is limited, representing only 1.8% or $600 million of our total loan portfolio and is mainly comprised of low to mid-rise properties located in suburban areas and is well diversified across payment type with an average loan size of $2 million. We have no exposure to large office tenant CRE in the mainland urban city centers. The portfolio has a favorable credit risk profile with low levels of NPLs and classified loans. In terms of our credit card and auto and lease portfolios, the credit risk profile of these portfolios is anchored on the strength of the job market economic activity in Puerto Rico, coupled with the credit quality of our originations over the last few years.

In terms of credit cards, 30-plus delinquency is at 2.8% compared to an average of 3.7% in the 2011, 2019 pre-pandemic period. And year-to-date, net charge-offs are at 2.4% compared to an average of 3.7% in the pre-pandemic period. In terms of auto loans, 30-plus delinquency is at 3.7% compared to an average of 6.2% in the 2011 – 2019 period, and year-to-date net charge-offs are at 60 basis points compared to an average of 1.9% in the pre-pandemic period. For lease financing, 30-plus delinquency is at 1.3% compared to an average of 2.1% in the 2011-2019 period, and year-to-date net charge-offs are at 20 basis points compared to an average of 70 basis points in the pre-pandemic period. Turning to Slide number 10. Non-performing assets decreased by $32 million to $472 million this quarter, driven by an NPL decrease in Puerto Rico of $27 million due to lower mortgage NPLs by $30 million, offset in part by higher construction NPLs due to a single $9 million relationship.

Overall balances also decreased by $6 million. NPL inflows decreased by $10 million quarter-over-quarter, driven by lower commercial NPLs in Puerto Rico by $13 million and lower mortgage NPLs in Puerto Rico by $7 million, offset in part by the previously mentioned construction NPL relationship. Inflows in the U.S. remained flat quarter-over-quarter. At the end of the quarter, the ratio of NPLs to total loans held in portfolio decreased to 1.2% from 1.3% in the previous quarter. Turning to Slide number 11. Net charge-offs amounted to $24 million or annualized to a 9 basis point of average loans held in portfolio compared to $33 million or 41 basis points in the prior quarter. The quarter-over-quarter improvement was driven by a $10.5 million line of credit charge-off in the prior quarter.

Please turn to Slide number 12. At June 30, 2023, the ACL increased by $11 million to $700 million, driven by portfolio changes due to higher specific reserves, higher volume and changing the FICO mix of consumer portfolios. Changes in the macroeconomic scenario caused the ACL to increase by $8 million, which were offset in part by a change in the mix in the probability weight of macroeconomic scenarios by $6 million. During the second quarter, we lowered the probability weights assigned to the pessimistic scenario and increase the priority of weight assigned to the baseline scenario. Changes to qualitative reserve reduced the ACL by $5 million. The provision for credit losses was $37 million compared to $48 million in the prior quarter. In Puerto Rico, the provision was $28 million compared to $45 million in the prior quarter while the provision for the U.S. was $7 million compared to $2 million.

The corporation ratio of ACL to loan servicing portfolio remained flat at 2.1%, while the ratio of ACL to NPL stood at 182% compared to 167% in the previous quarter. To summarize, our loan portfolio continues to exhibit strong credit quality trends in the second quarter with low net charge-offs and decrease in non-performing loans. We remain attentive to the evolving environment, we remain encouraged by the post-pandemic performance of our loan book. With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.

Ignacio Alvarez: Thank you, Lidio and Carlos, for your updates. Our results for the first half of 2023 were strong, driven by solid earnings, robust loan growth, positive credit quality and continued customer growth. Our diversified business model, robust levels of capital and most importantly, the talent and dedication of our people position us well to support and meet the evolving needs of our growing customer base. We are optimistic about the opportunities that lie ahead. Economic trends in Puerto Rico continue to be positive, a considerable amount of recovery funds yet to be disbursed are expected to support increased economic activity in the coming years. We made progress in our transformation initiatives during the quarter, which, over time, will drive more customer connectivity, operational efficiencies and greater potential for profitable growth and sustained return on capital.

In June, we released our annual corporate sustainability report. We continue to focus on providing opportunity for progress for taking the environment and promoting leadership. We are mindful of the responsibility we have to Puerto Rico as the leading banking institution and to all the communities that we proudly serve. We are now ready to answer your questions.

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Q&A Session

Operator: [Operator Instructions] We will take our first question from Timur Braziler from Wells Fargo. Timur, your line is now open. Please go ahead.

Timur Braziler: Hi. Good morning. Maybe starting on the loan growth, that’s remained quite strong now for many consecutive quarters. I’m just wondering, as you look ahead, is this kind of where we’re at for the foreseeable future? Or just given the remaining idiosyncratic tailwinds for the island, does loan growth actually accelerate as some of these construction projects you referenced come online?

Ignacio Alvarez: Well, this is Ignacio. As in the past, it’s always hard to project and forecast loan growth in Puerto Rico is coming and it’s very lumpy, especially the larger loans that drive some of the growth but what I can say is that we continue to have good pipelines, good demand from our customers. We’re not seeing that decrease so again, I don’t want to put a percentage level on it, but we have strong loan demand both in Puerto Rico and the U.S. So I wouldn’t put a number on it, but we certainly don’t see it decelerating at this point.

Timur Braziler: Okay. And then as far as appetite for mainland credit, the growth in construction I’m assuming that’s contractual in loans funding up and then just maybe speak more broadly about appetite and growing the mainland portfolio in the face of what’s expected to be an uncertain credit environment at the back end of the year?

Ignacio Alvarez: Yes. Lidio, could add more to that. But I want to point out that we’ve always been a construction lender, especially in the New York metro area but we are not very involved in the office sector. So we’re mostly – most of our construction is around multifamily. So I think we’re continuing to be prudent and lending to existing clients. But I don’t see us pulling back from our traditional markets that we serve. Again, we’re not in the office sector. I don’t know, Lidio, if you want to add anything.

Lidio Soriano: That’s perfect.

Timur Braziler: Okay. And then maybe switching to the funding of this loan growth, just given the seasonal trends in public funds and those coming down in the back end of the year, coupled with the loan-to-deposit ratio that still has plenty of room to move higher. Is there a wantingness to fund the upcoming loan growth through incremental deposits? Or are you okay borrowing at this level in funding the new growth?

Carlos Vazquez: Hi Tim, it’s Carlos. At this point in time, we do have a very strong liquidity position. So everything else being equal, our first quarter call would be our cash to fund on loan growth. We are very lucky that the yields on our loan book are quite attractive. So they’re even more attractive than the yields we can achieve in some of our investment portfolio. So that will be first call. At this point in time, I don’t envision as having significant margins to fund on growth.