BPOP: Loan Growth, Capital Actions Lead to Higher EPS Estimates; Maintaining Target Price and Reiterating Outperform Rating.
- Popular, Inc. (BPOP – NASDAQ – Recent Intraday Price: $57.48)
- Rating: Outperform / Buy Price: $59.00 / Target (Sell) Price: $66.00
Popular reported a 4Q19 net income to common stockholders of $165.9 million, up 0.9% compared to the $164.4 million posted in 3Q19. On a per share basis, BPOP reported earnings of $1.72 compared to $1.70 in 3Q19. The 4Q19 results exceeded our $1.67 estimate and the median Street estimate of $1.55. The primary drivers of the outperformance versus our projections were a higher-than-expected noninterest income, primarily mortgage banking revenues and loan sale gains, lower noninterest expenses, mainly compensation, and a lower effective tax rate caused by an $18 million benefit for amendments to prior year tax returns. These favorable variances were partially offset by lower-than-expected net interest income. Highlights of the quarter include:
- Gross loans held-for-investment showed solid growth, advancing $398.9 million or 1.5% compared to 3Q19, while rising to 27.4 billion. The primary movers were a $167 million rise in consumer loans, a $109 million increase in commercial loans (including multifamily and CRE), and a $77 million advance in leases. The BPPR segment showed loan growth of roughly $250 million while the Popular US segment grew approximately $152 million.
- Total deposits fell $408 million or 0.9% linked-quarter to $43.8 billion. Noninterest bearing deposits experienced a $796 million reduction, while interest bearing deposits, led by savings, NOW, and money market accounts, grew $388 million. Public sector deposits declined to $10.5 billion, a decline of $0.9 billion from the prior quarter. Meanwhile, brokered deposits decreased $106 million. The bulk of the deposit decrease, $374 million, occurred in the BPPR segment, while the drop in the Popular US segment was a modest $6 million. With the drop in deposits, the funding needed to support loan growth came from a shift in fed funds and other low yielding assets into both loans and securities, improving the mix of earning assets.
- Net interest income fell $9.6 million or 2.0% from the prior quarter, as a 2.2% rise in average earning assets was offset by 17 bps of NIM compression to 3.83%. Average loan yields fell 13 bps sequentially, thanks partly to a 22 bps drop in average commercial loan yields. In addition, lower-yielding securities became a larger portion of earning assets, further contributing to the decline in yields. Meanwhile, the average cost of interest bearing deposits fell 5 bps sequentially, leading to a 5 bps decrease in the average cost of interest bearing liabilities.
- Noninterest income rose $9.7 million or 6.8% sequentially in 4Q19. A $3.0 million advance in mortgage banking income marked and a similar $3.0 million rise in insurance revenues contributed to the rise. In addition, a $4.7 million favorable adjustment to contingency reserves on previously sold loans also boosted the results. Offsetting these favorable variances was a $3.3 million drop in ”other” noninterest income due lower earnings from investments under the equity method and lower modification fees on loss mitigation efforts.
- Noninterest expenses grew $14.1 million or 3.7% linked-quarter to $390.6 million. Compensation advanced $10.6 million due to higher commissions, annual incentives, and staffing increases. Marketing fees rose $4.8 million due to seasonal promotions and charitable donations. Professional fees climbed $4.6 million due to higher advisory expenses to promote corporate initiatives. These were partially offset by a $7.0 million decrease in “other” noninterest expenses driven by lower legal contingency reserves and a $2.6 million loss on an undeveloped corporate site sold in the prior quarter. Management now expects 2020 quarterly operating expenses, excluding profit sharing expenses, to be approximately $383 million, well above the $362 million average for 2019.
- BPOP posted an income tax expense of $15.3 million in 4Q19, which translates to an effective tax rate of 8.4%. This is well below the 20.0% rate posted in 3Q19 and the 21.0% rate we had projected. The lower effective rate was primarily due to a revision in the amount of tax exempt income earned in the years 2015 to 2017. Management now expects an effective tax rate of 19%-21% for 2020.
- The 4Q19 loan loss provision was $47.2 million, up $10.7 million or 29.2% compared to the $36.5 million recorded in 3Q19. The allowance for loan and lease losses declined $34.7 million to $477.7 million. The allowance for loan losses now stands at 1.74% of loans held-for-investment and 90.50% of NPLs, compared to 1.90% and 91.86%, respectively, at September 30, 2019.
- Management provided a revised assessment of the impact of adopting the CECL standard in 2020. The current assessment shows the need for an addition of $320-$350 million (down from the original $360-$400 million range) in the allowance for loan and lease losses upon implementation of CECL. This represents a 67%-73% increase. The Puerto Rico mortgage, credit card and auto loan segments are the primary drivers of the increase. Such an increase would reduce tangible book value by roughly $2.00 per share on Day 1, with the full impact phased-in over three years. The increased allowance would also cause a 25 bps reduction in the CET-1 ratio.
- NPLs decreased $30.0 million or 5.4% sequentially. The bulk of this decrease stems from an $8.4 million reduction in NPLs in the U.S. due to the sale of construction loans during the quarter, and a $21.6 million reduction in PR on lower mortgage and commercial NPLs. NPLS decreased to 1.93% of total loans, down from 2.07% at September 30, 2019 and 2.31% a year ago. NPL inflows fell $22.9 million in 4Q19 to $75 million compared to $98 million in 3Q19. Meanwhile, OREO increased $4.1 million or 3.5%. Total NPAs dipped to 1.25% of total assets compared to 1.29% at September 30, 2019. Net charge-offs increased 20.7% sequentially, rising to 1.21% of average loans held-in-portfolio versus 1.01% in 3Q19.
- Regulatory capital ratios increased modestly compared to 3Q19. The leverage ratio rose to 10.05% from 9.87% in the prior period, the total risk-based capital ratio advanced to 20.34% from 20.05%. 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 $55.10 from $53.41 at September 30, 2019, while the TCE ratio stood at 10.24% at December 31, 2019, up from 9.97% as of September 30, 2019.
- Management announced several new capital actions, including an increase in the quarterly common stock dividend from $0.30 to $0.40, a new $500 million share repurchase program, and the redemption of $28 million of 8.25% Series B preferred stock. The preferred stock redemption will reduce quarterly preferred dividends by approximately $578k, with the full impact reflected in 2Q20.
Earnings Estimates:
Although some non-recurring items helped Popular post better-than-expected 4Q19 results, most trends were pointing in a favorable direction. The company continues to show improvement in asset quality, loan growth was strong, though deposit generation lagged, and fee income grew nicely. The NIM declined more than we projected, but we believe the negative impact on asset yields from the last several Fed rate cuts has largely worked its way through the system. We expect only minor additional NIM compression in the next quarter or two before margins stabilize. We have also reduced the effective tax rate we are using to 20.2% from 21.0%. Management is guiding to a range of 19%-21% and we prefer not to be at the very top of that range. As expected, the company announced several capital actions that should have a noticeable impact on EPS. The new, larger share repurchase program is now reflected in our model, as is the redemption of the Series B preferred stock. These two actions act to lower the average diluted share count we use while increasing net income available to common shareholders.
With the changes outlined above, we are raising our 2020 EPS estimate from $6.05 to $6.61, and our 2021 estimate from $6.70 to $7.28.
Valuation:
Despite the earthquakes that hit the southern part of the island, Puerto Rico’s economy is still benefitting from insurance and disaster relief funds related to Hurricane Maria. While these funds are arriving more slowly than anticipated, we still believe they will continue to keep the economy in the flat to slightly growing mode, which is a welcome relief from the incessant decline the island had struggled with for the prior decade.
BPOP stock now trades a P/TBV multiple of 104.3%, while similar-size mainland peers trade at a median of 162.1%.
Our $66.00 price target represents a 104.7% TBV multiple, applied to the $63.07 TBV we are projecting at December 31, 2020. Looked at another way, the $66.00 target translates to a forward multiple of 10.0x the $6.61 in EPS we are projecting over the next four quarters (1Q20-4Q20). Our target price implies a 14.8% gain from the current price, or a 16.9% total return if we include the stock’s 2.09% dividend yield . Consequently, we are reiterating our Outperform rating for BPOP.