Popular reported a 2Q20 net income to common stockholders of $127.3 million, up 278.4% compared to the $33.6 million posted in 1Q20.
On a per share basis, BPOP reported earnings of $1.49 compared to $0.37 in 1Q20. The 2Q20 results exceeded our $1.06 estimate and the median $0.93 Street consensus estimate. The primary driver of the outperformance versus our projections were a lower-than-expected provision for loan losses and lower operating expenses, offset partially by lower interest income and lower noninterest income. Highlights of the quarter include:
- Gross loans held-for-investment showed strong growth, advancing $1.4 billion or 5.1% compared to 1Q20, while rising to 29.1 billion. The primary driver was the $1.4 billion in PPP loans originated during the quarter. Mortgage loans also rose, contributing $427 million to loan growth during the quarter. Offsetting these gains were reductions of $237 million in consumer loans and $50 million in auto loans. The BPPR segment showed loan growth of roughly $1.2 billion while the Popular US segment grew approximately $208 million. Government restrictions related to COVID-19 that prevented banks from closing mortgage loans and extending auto loans have been relaxed to some extent, allowing growth of $395 million in Puerto Rico mortgage loans,
- Total deposits rose $9.0 billion or 20.2% linked-quarter to $53.8 billion. Noninterest bearing deposits experienced a $3.1 billion increase, while interest bearing deposits, led by savings, NOW and money market accounts, grew $5.9 billion. Public sector deposits advanced by $4.2 billion sequentially to roughly $14.0 billion. Meanwhile, brokered deposits increased $152 million. The bulk of the deposit increase occurred in the BPPR segment. The growth in deposits was far in excess of the $1.4 billion in loan growth, with the excess going into the securities portfolio (up $4.95 billion) and money market investments (up $3.7 billion sequentially).
- Net interest income fell $22.2 million or 4.7% from the prior quarter, as a 15.5% rise in average earning assets was unable to overcome 69 bps of NIM compression to 3.25%. Average loan yields fell 55 bps sequentially, with the biggest drop occurring in average commercial loan yields, which slumped 88 bps due in part to the low yields on PPP loans. In addition, lower-yielding securities became a greater portion of earning assets. Meanwhile, the average cost of interest bearing deposits fell 29 bps sequentially, leading to a 30 bps decrease in the average cost of interest bearing liabilities. The big increase in deposits during the quarter without a corresponding rise in loan demand resulted in a sharp rise in low-yielding assets that hurt the NIM.
- Noninterest income declined $14.6 million or 11.5% sequentially in 2Q20. The disruptions caused by the stay-at-home orders and business closures were again apparent in several areas, as credit & debit card fees fell $8.6 million due to lower transaction volumes, deposit service charges declined $11.5 million due partly to waivers of fees during the pandemic, and mortgage banking revenues fell $2.6 million due lower service fees and an unfavorable fair value adjustment on mortgage servicing rights. Partially offsetting these decreases, BPOP posted a favorable $3.6 million adjustment to indemnity reserves on previously sold loans, and a $5.2 million unrealized gain equity securities related to deferred compensation, though this item has an offsetting expense included in personnel expenses.
- Noninterest expenses fell $24.4 million or 6.5% linked-quarter to $348.2 million. Compensation fell $7.7 million due to lower commissions, annual incentives, and other bonuses. Professional fees dipped $8.5 million due to lower processing & technology services and lower advisory expenses. Also contributing to the expense reduction was a $1.9 million decline in marketing fees and a $2.8 million drop in OREO expenses due to a suspension of foreclosure activity. Many of these declines are the result of plans management announced last quarter to reduce operating expenses in light of the reduced economic activity. The guidance at that point was for quarterly operating expenses, excluding profit sharing expenses, to average approximately $369 million for the year, though results for 2Q20 came in considerably below that figure.
- BPOP posted an income tax expense of $24.6 million in 2Q20, which translates to an effective tax rate of 16.2%, which is within management’ expectation of an effective tax rate of 14%-18% for 2020.
- The 2Q20 provision for credit losses was $62.4 million, down $127.3 million or 67.1% compared to the $189.7 million recorded in 1Q20. The prior quarter included significant provision expense related to changes to the economic outlook as a result of the COVID-19 pandemic, as well as a Day 1 impact of adopting the CECL accounting standard of $315.1 million. The allowance for loan and lease losses dipped $1.3 million to $918.4 million. The allowance for credit losses now stands at 3.16% of loans held-for-investment and 120.81% of NPLs, compared to 3.32% and 119.65%, respectively, at March 31, 2020.
- NPLs held-in-portfolio decreased $8.5 million or 1.1% sequentially. As a result, NPLs decreased to 2.62% of total loans from 2.78% at March 31, 2020 but were up from 2.09% a year ago. NPL inflows rose $21.0 million in 2Q20 to $106.2 million compared to $85.1 million in 1Q20. Meanwhile, OREO decreased $10.0 million or 8.1%. Total NPAs declined to 1.40% of total assets compared to 1.71% at March 31, 2020. Net charge-offs increased 3.9% sequentially, rising to 0.92% of average loans held-in-portfolio versus 0.91% in 1Q20.
- Regulatory capital ratios decreased modestly compared to 1Q20. The leverage ratio fell to 8.13% from 8.94% in the prior period, the total risk-based capital ratio declined to 18.27% from 18.36%. All of BPOP’s regulatory ratios remain far in excess of the minimums required to be considered “well-capitalized”.
- Tangible book value per share rose to $60.13 from $56.17 at March 31, 2020. Meanwhile, the TCE ratio slipped to 8.15% at June 30, 2020, down from 9.50% as of March 31, 2020.
- The previously announced accelerated stock repurchase (ASR) plan was pushed forward by the pandemic and the subsequent sharp decline in stock market valuations. BPOP completed the ASR in May, receiving 4.7 million shares at that time, bringing the total repurchase to 11.8 million shares at an average price of $42.3043 per share. The final transaction under the ASR accounted for $2.20 of the $3.96 increase in tangible book value during the quarter.
Earnings Estimates:
Despite the weak economic environment, government relief programs have created a surge in liquidity for many banks. Popular experienced a significant boost to its loan portfolio as a result of the PPP program, but an even greater spike in deposits, as PPP funds found their way into Popular deposit accounts while other government relief efforts caused a boost in public deposits. The jump in liquidity went into low yielding PPP loans and low yielding securities, causing a significant drag on the bank’s NIM.
The course of the COVID-19 pandemic is unclear. Given the current deterioration in metrics nationwide, however, it appears that the reduced economic activity associated with the pandemic could be with us for the remainder of 2020. Still, the liquidity being pumped into the economy should have an impact. We expect loans to decline modestly over the next few quarters as PPP loans are forgiven. Healthier originations of mortgage and auto loans will offset some of the lost PPP loans, but not all of it. We expect modest loan growth of roughly 2.0% in 2021. On the deposit side, we expect the excess public funds and the customer deposits associated with the PPP loans to show significant drawdowns over the next several quarters. This should drive reductions in short-term investments. While the interest rate environment is still unfavorable, an improved mix of earning assets coupled with accelerated fee recognition from PPP loan forgiveness should help the NIM regain some of the ground lost in 2Q20. We are projecting 7 bps of NIM expansion in 3Q20. Our full year NIM projection for 2020 is now 3.48%, much lower than our previous estimate of 3.85%. The jump in liquidity accounts for most of the change.
Credit costs, which have trended favorably for the last several years, will be a more significant variable in results going forward. Payment moratoriums make it difficult to glean what we can expect in terms of charge-offs, but there is little doubt that a number of business and consumer an increase in charge-offs leading to loan loss provisions of $95 million to $110 million per quarter over the next year. This is considerably higher than the $62 million recorded in 2Q20, but still well below the $190 million posted in 1Q20.
With the changes outlined above, we are raising our 2020 EPS estimate from $4.06 to $4.53, while reducing our 2021 estimate from $5.13 to $3.52, primarily reflecting a lower NIM expectation. We are setting our initial 2022 estimate at $3.76.
Outlook:
Puerto Rico is suffering from the same business disruptions from the COVID-19 pandemic as the reat of the U.S. However, Puerto Rico is still dealing with the aftereffects of Hurricane Maria in late 2017, a government debt crisis, and earthquakes in early 2020. Contrary to what many believe, Puerto Rico is not entirely dependent on tourism. This sector accounts for approximately 7% of GDP. Still, this sector has been deeply harmed by the pandemic. Other sectors, however, such as the pharmaceutical and medical device manufacturing segments could see long-term benefits from the pandemic, as moves to reduce reliance on China and other foreign countries prompts calls for increased incentive to bring manufacturing of critical items back to the U.S. Of more immediate impact, the disaster relief programs related to the hurricanes and earthquakes could provide some support to Puerto Rico’s economy that other jurisdictions lack. There is little doubt that many small businesses will close for good before this crisis is over. Still, we believe that Puerto Rico has the resiliency and means to recover at a similar pace with other parts of the U.S.
As the dominant financial institution in Puerto Rico, Popular has a number of advantages, including it’s ubiquitous branch network and its pricing power. Popular has long maintained exceptional profitability in Puerto Rico. This profitability may be reduced for a time, but we expect Popular’s advantage over peer mainland banks to continue. Of course, the bank also maintains very strong capital levels, and we believe the company is still well positioned to provide increasing levels of capital returns to shareholders when the current crisis passes.
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