Popular, Inc: 3Q20 Earnings Review

Popular reported 3Q20 net income to common stockholders of $168.1 million, up 32.0% compared to the $127.3 million posted in 2Q20.

On a per share basis, BPOP reported earnings of $2.00 compared to $1.49 in 2Q20. The 3Q20 results exceeded our $1.38 estimate and the median $1.15 Street consensus estimate. The primary driver of the outperformance versus our projections were a lower-than-expected provision for loan losses and higher noninterest income, offset partially by greater-than-expected NIM compression.

Highlights from the quarter include:

• Gross loans held-for-investment showed modest growth, advancing $322 million or 1.1% compared to 2Q20, while rising to 29.4 billion. During the quarter, Popular repurchased $808 million of mortgage loans from loan servicing portfolios with FHLMC, FNMA, and GNMA in order to reduce future exposures to principal and interest advances and to deploy liquidity. As a result, mortgage loans grew $403 million or 5.4% during the quarter. However, commercial loans (including multifamily, CRE and C&I) declined $123.7 million, or 0.9% sequentially, offsetting part of the growth in mortgage loans. The BPPR segment showed loan growth of roughly $241 million while the Popular US segment grew approximately $82 million.
• Total deposits rose $2.2 billion or 4.0% linked-quarter to $56.0 billion. Noninterest bearing deposits experienced a $1.0 billion increase, while interest bearing deposits, led by savings, NOW and money market accounts, grew $1.2 billion. Public sector deposits advanced by $0.5 billion sequentially to roughly $14.5 billion. Meanwhile, brokered deposits decreased $3 million. The growth in deposits was far in excess of the $322 million in loan growth, with the excess going into money market investments (up $2.2 billion sequentially).
• Net interest income rose $10.1 million or 2.2% from the prior quarter, as a 7.6% rise in average earning assets overcame 19 bps of NIM compression to 3.06%. Average loan yields fell 8 bps sequentially, with the biggest drop occurring in average consumer loan yields, which slid 22 bps sequentially. More importantly, lower-yielding securities continued to grow as a portion of earning assets, with money market, trading and investment securities now surpassing loans as a percentage of total earning assets (52.3% to 47.7%). Meanwhile, the average cost of interest bearing deposits fell 8 bps sequentially, leading to an 8 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 advanced $16.7 million or 14.9% sequentially in 3Q20. The easing of stay-at-home orders and business closures showed up in increased credit & debit card fees (up $13.4 million) and deposit service charges (up $6.7 million). However, mortgage banking revenues fell $13.3 million, driven largely by unfavorable fair value adjustments related to the bulk loan repurchase from FNMA and FHLMC. This same transaction had a favorable impact of $5.3 million on adjustments to indemnity reserves. Also contributing to the increased noninterest income was a $2.7 million rise in securities gains and a $4.2 million advance in “other” noninterest income due partly to higher income on equity investments.
• Noninterest expenses climbed $12.8 million or 3.7% linked-quarter to $361.1 million. Compensation fell $3.2 million due to lower salaries and deferred compensation costs. Meanwhile, professional fees rose $3.9 million due to processing costs related to higher customer activity, and equipment costs increased $3.2 million due to higher amortization expenses. Also contributing to the expense rise was a $2.4 million advance in marketing fees and a $7.4 million jump in “other” noninterest expenses due to an operational loss reserves and provision for unused loan commitments. Management lowered its guidance for quarterly operating expenses, excluding profit sharing expenses, from the previous average of approximately $369 million for the year to an average of $365 million. Management expects 4Q20 operating expenses to be approximately $378 million, excluding the $23.1 million in expected expenses related to the branch closures announced along with the earnings release.
• BPOP posted an income tax expense of $41.2 million in 3Q20, which translates to an effective tax rate of 19.6%, which is above the 16.2% recorded in 2Q20, but still positions the company within management’ expectation of an effective tax rate of 14%-18% for 2020.
• The 3Q20 provision for credit losses was $19.1 million, down $43.3 million or 69.4% compared to the $62.4 million recorded in 2Q20 due mostly to lower net charge-offs. The allowance for loan and lease losses rose $7.4 million to $925.9 million. The allowance for credit losses now stands at 3.15% of loans held-for-investment and 126.07% of NPLs, compared to 3.16% and 120.81%, respectively, at June 30, 2020.
• NPLs held-in-portfolio decreased $25.8 million or 3.4% sequentially, led by a $33 million drop in Puerto Rico offset by a $7 million rise in the U.S. As a result, NPLs decreased to 2.50% of total loans from 2.62% at June 30, 2020 but increased from 2.07% a year ago. NPL inflows rose $5.9 million in 3Q20 to $112.1 million compared to $106.2 million in 2Q20. Meanwhile, OREO decreased $13.3 million or 11.7%. Total NPAs declined to 1.27% of total assets compared to 1.40% at June 30, 2020. Net charge-offs decreased 74.0% sequentially, falling to 0.24% of average loans held-in-portfolio versus 0.92% in 2Q20.
• Regulatory capital ratios were fairly stable, and most increased modestly compared to 2Q20. The leverage ratio fell to 7.80% from 8.13% in the prior period, but the total risk-based capital ratio advanced to 18.49% from 18.29%. 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 $61.69 from $60.13 at June 30, 2020. Meanwhile, the TCE ratio slipped to 7.97% at June 30, 2020, down from 8.15% as of June 30, 2020.
• Popular announced a branch optimization plan in its New York region, involving closure of 11 underperforming branches in the region while retaining 27 branches. The closures will result in a pre-tax charge of $24.5 million with $23.1 million expected to be incurred in 4Q20. The cost savings from the closures are expected to be roughly $13.0 million annually.

Earnings Estimates:

Though still down compared to 2019, economic activity seems to have picked up considerably in 3Q20 compared to 2Q20. The easing of COVID-19 restrictions and an influx of Federal relief funds to address Hurricane Maria, the earthquakes in the south, and the pandemic have helped soften the blow from these crises. Popular is still showing a significant hoard of deposits and liquidity as a result of the relief funds while also holding onto a significant amount of PPP loans in its loan portfolio. Though the extra assets have raised net interest income, the impact on the NIM has been depressive.

Management noted increased cement sales on the island as a sign of expanded economic activity, as well as growing volumes of auto and mortgage loan originations. We expect loans to decline modestly in 4Q20 as PPP loans are forgiven. We expect modest loan growth of roughly 2.1% 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 expand some in 4Q20 before falling back again in subsequent quarters. We are projecting 9 bps of NIM expansion in 4Q20. Our full year NIM projection for 2021 is now 3.16% compared to the 3.33% we are anticipating for full year 2020.

Credit costs, which have trended favorably for the last several years, improved again in 3Q20, but much of the improvement is related to payment moratoriums and government relief efforts extended to combat the pandemic-related downturn. This favorable environment may last through year-end before we start to see significant increases in NPLs and charge-offs resulting from the COVID-19 restrictions. We are still projecting loan loss provisions of $87 million to $100 million per quarter in 2021, a slight decrease from our prior projection, but well above the $19 million recorded in 3Q20.

With the changes outlined above, we are raising our 2020 EPS estimate from $4.53 to $5.38. We are also raising our 2021 estimate from $3.52 to $4.66 and our 2022 estimate from $3.76 to $5.04.

Outlook:

Many uncertainties remain related to the COVID-19 pandemic and how quickly economic activity can recover from it. Despite adding this crisis on top of the other crises Puerto Rico continues to deal with (aftereffects from Hurricane Maria, the government debt crisis, an decade-long recession, and earthquakes in the southern part of the island), the outlook for the island seems to have improved in recent months. Activity in the residential real estate market, car sales, and other segments of the economy have rebounded faster than many people expected. Most economic indicators remain well below levels from this time last year, but trends are good. It appears that disaster relief funds are flowing and helping to drive some of the recovery.

Popular seems to be well-positioned to take advantage of the rebound. While excess liquidity will likely remain a drag on margins for some time, expense reductions and rising revenues from increased economic activity should help boost EPS noticeably going forward. In addition, the bank maintains strong capital levels and we anticipate substantial capital returns to shareholders in the form of increased dividends and share buybacks as the impact of the pandemic becomes clearer and the regulators become more comfortable with the economic outlook for the island.

While we have enjoyed covering Popular, Inc. for close to twenty-five years, shifting corporate responsibilities do not allow us time to provide the same level of diligence to our equity research as we would like. Consequently, we are discontinuing coverage of Popular, Inc.

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