This report includes management's discussion and analysis ("MD&A") of the
consolidated financial position and financial performance of Popular, Inc. (the
"Corporation" or "Popular"). All accompanying tables, financial statements and
notes included elsewhere in this report should be considered an integral part of
this analysis.
The Corporation is a diversified, publicly-owned financial holding company
subject to the supervision and regulation of the Board of Governors of the
Federal Reserve System. The Corporation has operations in Puerto Rico, the
United States ("U.S.") mainland, and the U.S. and British Virgin Islands. In
Puerto Rico, the Corporation provides retail and commercial banking services
through its principal banking subsidiary, Banco Popular de Puerto Rico ("BPPR"),
as well as mortgage banking, investment banking, broker-dealer, auto and
equipment leasing and financing, and insurance services through specialized
subsidiaries. In the U.S. mainland, the Corporation operates Banco Popular North
America ("BPNA"), including its wholly-owned subsidiary E-LOAN. BPNA focuses
efforts and resources on the core community banking business. BPNA, under the
name Popular Community Bank, operates branches in New York, California,
Illinois, New Jersey and Florida. E-LOAN markets deposit accounts under its name
for the benefit of BPNA. Note 31 to the consolidated financial statements
presents information about the Corporation's business segments. The Corporation
has a 48.5% interest in EVERTEC, which provides transaction processing services
throughout the Caribbean and Latin America, including servicing many of the
Corporation's system infrastructures and transaction processing businesses.
OVERVIEW
The second quarter of 2012 marks the sixth consecutive profitable quarter for
the Corporation. Net income amounted to $65.7 million for the quarter ended
June 30, 2012, compared with net income of $110.7 million for the same quarter
of the previous year. For the six months ended June 30, 2012, net income
amounted to $114.1 million, compared with net income of $120.8 million for the
same period in 2011.
Main events for the quarter ended June 30, 2012
• A tax benefit of $72.9 million was recognized in June 2012 resulting from
the tax treatment of the loans acquired in the Westernbank FDIC-assisted
transaction (the "Acquired Loans"). In June 2012, the Puerto Rico
Department of the Treasury (the "P.R. Treasury") and the Corporation
entered into a Closing Agreement (the "2012 Closing Agreement") to clarify
that those Acquired Loans are capital assets and any gain resulting from
such loans would be taxed at the capital gain tax rate of 15% instead of
the ordinary income tax rate of 30%. Refer to the Income Taxes section of
this MD&A and Note 29 to the consolidated financial statements for
additional information on the tax benefit and the 2012 Closing Agreement.
• Negative valuation adjustments on commercial and construction loans
held-for-sale of approximately $34.7 million were recorded by Banco
Popular de Puerto Rico ("BPPR") during the second quarter of 2012. The
quarterly valuation analyses of the outstanding commercial and
construction loans held-for-sale of BPPR, which considered the impact of
recent appraisals and market indicators, resulted in an unfavorable
adjustment of $27.3 million. Also, there were $7.4 million in additional
unfavorable valuation adjustments, mostly from the reclassification of
certain loans from loans held-for-sale to other real estate.
• Prepayment expense of $25.0 million was recognized as a result of the cancellation by BPPR of $350 million in outstanding repurchase agreements
with contractual maturities between March 2014 and May 2014 at an average
cost of 4.36%. The Corporation expects to recover this cost within an
approximate two-year period by replacing these repurchase agreements with
short-term borrowings at lower current market rates.
• Receipt of a $131 million dividend from EVERTEC in early May 2012, which
reduced the book value of the equity investment by the amount of the
dividend to $62 million, also contributed to further boost the
Corporation's liquidity position.
• The Corporation completed purchases of $273 million in mortgage loans at
BPNA and $225 million in consumer loans at BPPR during the second quarter
of 2012 as part of its strategy to continue to add high-quality assets to
its loan portfolio.
• Credit metrics of the Corporation's non-covered loan portfolio continued improving during the second quarter of 2012. Non-performing loans,
excluding covered loans, declined by $119 million to $1.6 billion as of
June 30, 2012, down 7% from March 31, 2012 and 33% from its peak in the
third quarter of 2010. The decrease was split between both the Puerto
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Rico and U.S. mainland regions. Net charge-offs declined for the third
consecutive quarter. On a linked-quarter basis, net charge-offs for the
second quarter of 2012 fell by $10.1 million to $98.0 million-the lowest
level since the first quarter of 2008. The decrease was mainly due to
lower losses in both P.R. and U.S. commercial loans.
• On May 29, 2012, the Corporation effected a 1-for-10 reverse split of its
common stock. The reverse split is described further in Note 16 to the
consolidated financial statements. All share and per share information has
been adjusted to retroactively reflect the reverse stock split.
The discussion that follows provides highlights of the Corporation's results of
operations for the quarter ended June 30, 2012, compared to the results of
operations for the same quarter of the previous year. It also provides some
highlights with respect to the Corporation's financial condition, credit
quality, capital and liquidity.
Financial highlights for the quarter ended June 30, 2012
• Taxable equivalent net interest income was $341.2 million for the second
quarter of 2012, down $33.3 million, or 9%, from the same quarter of the
prior year. The 29-basis-point decrease in the net interest margin from
4.72% to 4.43% was mainly attributable to a lower average yield in earning
assets by 62 basis points primarily in covered loans, non-covered
commercial and mortgage loans, and investment securities; partially offset
by a decrease in the cost of funds by 33 basis points, mainly from
deposits. The repayment of the FDIC note during 2011 also contributed with
the decrease in interest expense during the second quarter of 2012. The
higher taxable equivalent adjustment in the second quarter of 2011 was
attributable to the income tax benefit from exempt investments for the first six months of 2011 recorded in the second quarter of 2011, which had
been previously unavailable to the Corporation during the first quarter of
2011. The event that drove the recording of the higher taxable equivalent
adjustment in June 2011 is explained below in the tax benefit variance and
in the Net Interest Income section of this MD&A. Refer to the Net Interest
Income section of this MD&A for a discussion of the major variances in net
interest income, including yields and costs.
• Credit quality improvements provided noticeable results in both the Corporation's Puerto Rico and U.S. mainland operations. Most credit
metrics, such as the level of net charge-offs and non-performing loans in
most portfolios, reflected improved trends during the second quarter of
the current year.
Provision for loan losses in the second quarter of 2012 decreased by $25.1
million, or 17%, compared with the second quarter of 2011, including both
covered and non-covered loans held-in-portfolio. The provision for loan losses
for non-covered loans for the second quarter of 2012 reflected lower net
charge-offs by $35.4 million, including reductions in most non-covered loan
portfolio categories. Also, there was a reduction in the allowance for loan
losses, mainly from the commercial and consumer loan portfolios, as a result of
continued improvement in credit trends. During the second quarter of 2012, the
annualized net charge-offs to average non-covered loans held-in-portfolio ratio
fell to 1.85% in Puerto Rico and to 2.15% in the U.S. mainland operations from
2.21% and 3.45%, respectively, during the quarter ended June 30, 2011. Net
charge-offs for non-covered loans reached their lowest level since the first
quarter of 2008.
In addition, the non-covered non-performing loan portfolio declined by $175
million to $1.6 billion, down 10% from December 31, 2011, mainly due to
improvements in all loan categories. Non-covered non-performing loans
held-in-portfolio declined by 33% from its peak in the third quarter of 2010 and
stood at the lowest level since the first quarter of 2009. Inflows of commercial
and construction non-performing loans held-in-portfolio fell 65% from their peak
in the fourth quarter of 2010.
The improvements in credit quality led to a decrease in the allowance for loan
losses to non-covered loans held-in-portfolio ratio from 3.35% at December 31,
2011 to 3.14% at June 30, 2012. The general and specific reserves related to
non-covered loans amounted to $561 million and $88 million, respectively, at
June 30, 2012, compared with $631 million and $59 million, respectively, at
December 31, 2011. The decrease in the general reserve component was mainly
driven by lower loss trends in the commercial and consumer loan portfolios,
partially offset by higher general and specific reserves in the residential
mortgage loan portfolio of the BPPR reportable segment mainly due to higher loss
trends and loans restructured under the Corporation's loss mitigation program.
The provision for loan losses in the covered loan portfolio decreased by $11.1
million for the second quarter of 2012, compared with the same quarter of 2011.
The decrease in the provision was mainly driven by loans accounted for under ASC
310-30, as certain loan pools, mainly commercial and construction, reflected
higher increases in expected loss estimates for the quarter of June 30, 2011,
when compared with the revisions in expected loss estimates for the same period
in 2012. Net charge-offs on covered loans accounted for under ASC 310-30, which
related principally to certain
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construction and asset-based lending relationships, amounted to $28.8 million
for the second quarter of 2012, prompted by credit losses in excess of those
originally estimated at acquisition date. Net charge-offs on the covered loans
accounted for under ASC 310-20 amounted to $29.7 million for the second quarter
of 2012. These net charge-offs were mainly related to the discounted pay-offs
from two particular relationships, for which impaired amounts were reserved in
prior periods and did not impact the provision for loan losses during the
current quarter.
The increase in loss estimates on the covered loans is offset by the 80% loss
share agreements. Despite these specific pools that reflect higher loan losses
than originally expected, overall expected losses on the covered loan portfolio
continue to be lower than originally estimated. Lower expected losses will
overtime result in higher interest income as the increase in expected cash flows
than originally estimated is accreted into interest income over the life of the
loans.
• Non-interest income amounted to $93.7 million for the quarter ended
June 30, 2012, compared with $124.2 million for the same quarter in the
previous year. The unfavorable variance in FDIC loss share income of $36.1
million was mostly related to the negative amortization of the loss share
asset mainly due to a reduction in expected losses. Refer to Table 5 for a
description and amounts of the items that compose the FDIC loss share income (expense) caption. In addition, there were higher unfavorable
valuation adjustments on loans held-for-sale by $15.1 million mainly in
BPPR resulting from the impact of recent appraisals and market indicators,
partially offset by higher gains on sale of loans, net of trading account
losses, by $4.3 million primarily due to securitization transactions by
the mortgage banking business. These unfavorable variances were partially
offset by higher other services by $3.7 million and higher other operating
income by $10.2 million. The increase in other service fees was related to
lower unfavorable fair value adjustments on mortgage servicing rights,
higher credit card fees and increased commission income received from the
sale of investment products, partially offset by lower debit card fees.
Refer to the Non-Interest Income section of this MD&A for additional
information on the main variances that affected the non-interest income
categories.
• Total operating expenses increased by $46.1 million for the second quarter
of 2012, when compared with the same quarter of the previous year,
principally due to the prepayment expense of $25.0 million recognized
during the second quarter of 2012 as a result of the cancellation of
certain borrowings, as previously explained. In addition, there were
higher loan collection expenses from the lending business and the management of other real estate properties, personnel costs, business
promotion and other operating expenses. Refer to the Operating Expenses
section in this MD&A for additional explanations on the factors that
influenced the variances in the different operating expense categories.
• Tax benefit of $77.9 million for the quarter ended June 30, 2012, compared
with a tax benefit of $38.1 million for the same period of the previous
year. As indicated previously, the results for the second quarter of 2012
reflect a tax benefit of $72.9 million related to the tax treatment of the
Acquired Loans.
The income tax benefit for the quarter ended June 30, 2011 was also impacted by
a special tax transaction. On June 30, 2011, the P.R. Treasury and the
Corporation agreed that for tax purposes the deductions related to certain
charge-offs recorded on the financial statements of the Corporation during the
years 2009 and 2010 would be deferred until 2013 through 2016. Because of this
2011 Closing Agreement, the results for the second quarter of 2011 reflect an
income tax benefit of $53.6 million related to the recovery of certain tax
benefits not previously recorded during years 2009 and 2010, and an income tax
benefit of $11.9 million related to the tax benefits of the exempt income for
the six months ended June 30, 2011.
• Total assets amounted to $36.6 billion at June 30, 2012, compared with
$37.3 billion at December 31, 2011. Total loans held-in-portfolio declined
by $269 million from the end of 2011, consisting principally of a decline
of $332 million in the covered loan portfolio, $371 million in non-covered
commercial loans held-in-portfolio and $139 million in the legacy loans at
BPNA. These decreases were offset by increases of $382 million and $192
million in the non-covered mortgage and consumer loan portfolios mainly
due to the previously mentioned loan purchases during the second quarter
of 2012.
• Deposits amounted to $27.4 billion at June 30, 2012, compared with $27.9
billion at December 31, 2011. The decrease in time deposits from
December 31, 2011 to June 30, 2012 of $1.1 billion was principally in
brokered certificates of deposit and non-brokered certificates of deposit
of the BPPR operations, mainly retail certificates of deposit, driven in
part by the continuous efforts to reduce cost of deposits in the
Corporation's banking operations. These decreases were partially offset by
increases in savings, NOW, money market and demand deposits by $0.6
billion.
• The Corporation's borrowings amounted to $3.6 billion at June 30, 2012, compared with $4.3 billion at December 31, 2011. The reduction in
borrowings was driven by a decrease in assets sold under agreements to
repurchase of $0.7 million, principally due to the previously mentioned
early extinguishment of debt and to certain other repurchase agreements
maturing during the second quarter of 2012.
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• Stockholders' equity amounted to $4.0 billion at June 30, 2012, compared
to $3.9 billion at December 31, 2011. Capital ratios continued to be
strong. Tier I common risk-based capital ratio increased to 16.31% at
June 30, 2012, from 15.97% at December 31, 2011. Tangible common equity
ratio at June 30, 2012 was 9.09%, up from 8.62% at December 31, 2011.
Table 1 provides selected financial data and performance indicators for the
quarters and six months ended June 30, 2012 and 2011.
The Corporation continues executing its strategy to achieve various objectives,
including (1) reducing credit costs, (2) growing its net interest margin,
(3) building its high-quality asset portfolio to maintain strong revenues,
(4) optimizing operating expenses and (5) continuing to improve the results of
its U.S. community banking business. The Corporation continues exploring
opportunities to further reduce its cost base by streamlining the origination
processes, lowering branch-network expenses and tackling inefficiencies in
identified areas. However, management's focus on accelerating the resolution of
non-performing loans has increased the costs associated with these efforts-legal
fees, appraisals, collections, valuation adjustments, among others. Meaningful
reductions in these expenses will only be achieved through sustained improvement
in non-performing asset levels.
Although the economic situation in the Corporation's markets has stabilized or
improved, as evidenced by recent economic indicators and the Corporation's
credit trends, the Corporation's lending areas both in Puerto Rico and the U.S.
mainland continue to experience weak loan demand. The combination of weak loan
demand and higher costs related to collection efforts are challenges faced by
the Corporation.
As a result of weak loan demand in both the Puerto Rico. and U.S. mainland
operations, the Corporation will continue to seek acquisitions of moderate-risk
assets with good returns to supplement internal originations.
As a financial services company, the Corporation's earnings are significantly
affected by general business and economic conditions. Lending and deposit
activities and fee income generation are influenced by the level of business
spending and investment, consumer income, spending and savings, capital market
activities, competition, customer preferences, interest rate conditions and
prevailing market rates on competing products.
The Corporation continuously monitors general business and economic conditions,
industry-related indicators and trends, competition, interest rate volatility,
credit quality indicators, loan and deposit demand, operational and systems
efficiencies, revenue enhancements and changes in the regulation of financial
services companies.
The Corporation operates in a highly regulated environment and may be adversely
affected by changes in federal and local laws and regulations. Also, competition
with other financial institutions could adversely affect its profitability.
The description of the Corporation's business contained in Item 1 of the
Corporation's 2011 Annual Report, while not all inclusive, discusses additional
information about the business of the Corporation and risk factors, many beyond
the Corporation's control that, in addition to the other information in this
Form 10-Q, readers should consider.
The Corporation's common stock is traded on the NASDAQ Global Select Market
under the symbol BPOP.
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Table 1-Financial Highlights
Financial Condition Highlights Average for the six months
December 31,
(In thousands) June 30, 2012 2011 Variance 2012 2011 Variance
Money market investments $ 949,828 $ 1,376,174 $ (426,346 ) $ 1,104,135$ 1,159,477 $ (55,342 )
Investment and trading securities 5,793,199 5,751,417
41,782 5,685,903 6,383,995 (698,092 )
Loans 25,046,676 25,314,392 (267,716 ) 24,849,365 25,887,785 (1,038,420 )
Earning assets 31,789,703 32,441,983 (652,280 ) 31,639,403 33,431,257 (1,791,854 )
Total assets 36,612,179 37,348,432 (736,253 ) 36,386,372 38,775,414 (2,389,042 )
Deposits* 27,414,780 27,942,127 (527,347 ) 27,218,046 27,462,905 (244,859 )
Borrowings 3,620,419 4,293,669 (673,250 ) 4,264,640 6,615,143 (2,350,503 )
Stockholders' equity 4,021,237 3,918,753 102,484 3,780,014 3,655,074 124,940
* Average deposits exclude average derivatives.
Operating Highlights Second Quarter Six months ended June 30,
(In thousands, except per share
information) 2012 2011 Variance 2012 2011 Variance
Net interest income $ 341,200 $ 374,542 $
(33,342 ) $ 678,782$ 717,901 $ (39,119 )
Provision for loan losses-non-covered
loans
81,743 95,712 (13,969 ) 164,257 155,474 8,783
Provision for loan losses-covered
loans 37,456 48,605 (11,149 ) 55,665 64,162 (8,497 )
Non-interest income 93,724 124,160 (30,436 ) 217,632 288,528 (70,896 )
Operating expenses 327,879 281,800 46,079 624,046 556,849 67,197
(Loss) income before income tax (12,154 ) 72,585 (84,739 ) 52,446 229,944 (177,498 )
Income tax (benefit) expense (77,893 ) (38,100 ) (39,793 ) (61,701 ) 109,127 (170,828 )
Net income $ 65,739 $ 110,685 $ (44,946 ) $ 114,147 $ 120,817 $ (6,670 )
Net income applicable to common stock $ 64,809$ 109,754 $
(44,945 ) $ 112,286$ 118,956 $ (6,670 )
Net income per common share-basic and
diluted $ 0.63 $ 1.07 $ (0.44 ) $ 1.10 $ 1.16 $ (0.06 )
Second Quarter Six months ended June 30,
Selected Statistical Information 2012 2011 2012 2011
Common Stock Data
Market price
High $ 21.20 $ 32.40 $ 23.00 $ 35.33
Low 13.58 26.30 13.58 26.30
End 16.61 27.60 16.61 27.60Book value per common share at period end 38.62 38.22
38.62 38.22
Profitability Ratios
Return on assets 0.73 % 1.14 % 0.63 % 0.63 %
Return on common equity 6.94 12.02 6.05 6.66
Net interest spread (taxable equivalent) 4.17 4.49 4.15 4.20
Net interest margin (taxable equivalent) 4.43 4.72 4.41 4.45
Capitalization Ratios
Average equity to average assets 10.51 % 9.57 % 10.39 % 9.43 %
Tier I capital to risk-weighted assets 16.31 15.21 16.31 15.21
Total capital to risk-weighted assets 17.59 16.49 17.59 16.49
Leverage ratio 11.09 10.16 11.09 10.16
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CRITICAL ACCOUNTING POLICIES / ESTIMATES
The accounting and reporting policies followed by the Corporation and its
subsidiaries conform to generally accepted accounting principles in the United
States of America and general practices within the financial services industry.
Various elements of the Corporation's accounting policies, by their nature, are
inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. These estimates are made under facts and circumstances
at a point in time and changes in those facts and circumstances could produce
actual results that differ from those estimates.
Management has discussed the development and selection of the critical
accounting policies and estimates with the Corporation's Audit Committee. The
Corporation has identified as critical accounting policies those related to:
(i) Fair Value Measurement of Financial Instruments; (ii) Loans and Allowance
for Loan Losses; (iii) Acquisition Accounting for Loans and Related
Indemnification Asset; (iv) Income Taxes; (v) Goodwill, and (vi) Pension and
Postretirement Benefit Obligations. For a summary of these critical accounting
policies and estimates, refer to that particular section in the MD&A included in
Popular, Inc.'s 2011 Financial Review and Supplementary Information to
Stockholders, incorporated by reference in Popular, Inc.'s Annual Report on Form
10-K for the year ended December 31, 2011 (the "2011 Annual Report"). Also,
refer to Note 2 to the consolidated financial statements included in the 2011
Annual Report for a summary of the Corporation's significant accounting
policies.
Allowance for Loan Losses
One of the most critical and complex accounting estimates is associated with the
determination of the allowance for loan losses. The provision for loan losses
charged to current operations is based on this determination. The Corporation's
assessment of the allowance for loan losses is determined in accordance with the
guidance of loss contingencies in ASC Subtopic 450-20 and loan impairment
guidance in ASC Section 310-10-35.
The accounting guidance provides for the recognition of a loss allowance for
groups of homogeneous loans. The determination for general reserves of the
allowance for loan losses includes the following principal factors:
• Historical net loss rates (including losses from impaired loans) by loan
type and by legal entity adjusted for recent net charge-off trends and
environmental factors. The base net loss rates are based on the moving
average of annualized net charge-offs computed over a 36-month historical
loss window for the commercial and construction loan portfolios, and an
18-month period for the consumer and mortgage loan portfolios.
• Net charge-off trend factors are applied to adjust the base loss rates
based on recent loss trends. The Corporation applies a trend factor when
base losses are below recent loss trends. Currently, the trend factor is
based on the last 12 months of losses for the commercial, construction and
legacy loan portfolios and 6 months of losses for the consumer and
mortgage loan portfolios. The trend factor accounts for inherent
imprecision and the "lagging perspective" in base loss rates. The trend factor replaces the base-loss period when it is higher than base loss up
to a determined cap.
• Environmental factors, which include credit and macroeconomic indicators
such as employment, price index and construction permits, were adopted to
account for current market conditions that are likely to cause estimated
credit losses to differ from historical losses. The Corporation reflects
the effect of these environmental factors on each loan group as an
adjustment that, as appropriate, increases or decreases the historical
loss rate applied to each group. Environmental factors provide updated
perspective on credit and economic conditions. Correlation and regression
analyses are used to select and weight these indicators.
During the first quarter of 2012, in order to better reflect current market
conditions, management revised the estimation process for evaluating the
adequacy of the general reserve component of the allowance for loan losses for
the Corporation's commercial and construction loan portfolios. The change in the
methodology is described in the paragraphs below. The net effect of these
changes amounted to a $24.8 million reduction in the Corporation's allowance for
loan losses, resulting from a reduction of $40.5 million due to the enhancements
to the allowance for loan losses methodology, offset in part by a $15.7 million
increase in environmental factor reserves due to the Corporation's decision to
monitor recent trends in its commercial loan portfolio at the BPPR reportable
segment that although improving, continue to warrant additional scrutiny.
Management made the following principal changes to the methodology during the
first quarter of 2012:
• Established a more granular stratification of the commercial loan
portfolios to enhance the homogeneity of the loan classes. Previously, the
Corporation used loan groupings for commercial loan portfolios based on
business lines and collateral types (secured / unsecured loans). As part
of the loan segregation, management evaluated the risk profiles of the
loan portfolio, recent and historical credit and loss trends, current and
expected portfolio behavior and economic
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indicators. The revised groupings consider product types (construction,
commercial multifamily, commercial & industrial, non-owner occupied commercial
real estate ("CRE") and owner occupied CRE) and business lines for each of the
Corporation's reportable segments, BPPR and BPNA. In addition, the Corporation
established a legacy portfolio at the BPNA reportable segment, comprised of
commercial loans, construction loans and commercial lease financings related to
certain lending products exited by the Corporation as part of restructuring
efforts carried out in prior years.
The refinement in the loan groupings resulted in a decrease to the allowance for
loan losses of $7.9 million at March 31, 2012, which consisted of a $9.7 million
reduction related to the BPNA reportable segment, partially offset by an
increase of $1.8 million related to the BPPR reportable segment.
• Increased the historical look-back period for determining the loss trend
factor. The Corporation increased the look-back period for assessing
recent trends applicable to the determination of commercial, construction
and legacy loan net charge-offs from 6 months to 12 months.
Previously, the Corporation used a trend factor based on 6 months of net
charge-offs as it aligned the estimation of inherent losses for the
Corporation's commercial and construction loan portfolios with deteriorating
trends.
Given the current overall commercial and construction credit quality
improvements noted on recent periods in terms of loss trends, non-performing
loan balances and non-performing loan inflows, management concluded that a
12-month look-back period for the trend factor aligns the Corporation's
allowance for loan losses methodology to current credit quality trends.
The increase in the historical look-back period for determining the loss trend
factor resulted in a decrease to the allowance for loan losses of $28.1 million
at March 31, 2012, of which $24.0 million related to the BPPR reportable segment
and $4.1 million to the BPNA reportable segment.
There were additional enhancements to the allowance for loan losses methodology
which accounted for a reduction to the allowance for loan losses of $4.5 million
at March 31, 2012, of which $3.9 million related to the BPNA reportable segment
and $0.6 million to the BPPR reportable segment. This reduction related to loan
portfolios with minimal or zero loss history.
There were no changes in the methodology for environmental factor reserves.
There were no changes to the allowance for loan losses methodology for the
Corporation's consumer and mortgage loan portfolios during the first quarter of
2012.
Refer to Note 2 "Summary of Significant Accounting Policies" and the Critical
Accounting Policies / Estimates section of the MD&A included in the
Corporation's 2011 Annual Report for additional information on the Corporation's
credit accounting policies, including interest recognition, troubled debt
restructuring, accounting for impaired loans and other information with respect
to the determination of specific reserves for loans individually evaluated for
impairment.
STATEMENT OF OPERATIONS ANALYSIS
NET INTEREST INCOME
Net interest income, on a taxable equivalent basis, is presented with its
different components on Tables 2 and 3 for the quarter and six months ended
June 30, 2012 as compared with the same periods in 2011, segregated by major
categories of interest earning assets and interest bearing liabilities.
The interest earning assets include the investment securities and loans that are
exempt from income tax, principally in Puerto Rico. The main sources of
tax-exempt interest income are certain investments in obligations of the U.S.
Government, its agencies and sponsored entities, and certain obligations of the
Commonwealth of Puerto Rico and its agencies. To facilitate the comparison of
all interest related to these assets, the interest income has been converted to
a taxable equivalent basis, using the applicable statutory income tax rates for
each period presented. The taxable equivalent computation considers the interest
expense disallowance required by the Puerto Rico tax law. During the third
quarter of 2010, BPPR's tax position changed and, as a result, the benefit that
would have been obtained from exempt investments was not applicable. However,
BPPR's tax position inverted during the second quarter of 2011 and the entity
was able to benefit from tax exempt income previously unavailable. Therefore,
the income tax benefit for the first six months of 2011 was recorded during the
second quarter of that year, resulting in a decrease in the taxable equivalent
adjustment, as shown in Table 2. The Corporation continues to derive a tax
benefit from exempt investments during 2012.
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Average outstanding securities balances are based upon amortized cost excluding
any unrealized gains or losses on securities available-for-sale. Non-accrual
loans have been included in the respective average loans and leases categories.
Loan fees collected and costs incurred in the origination of loans are deferred
and amortized over the term of the loan as an adjustment to interest yield.
Prepayment penalties, late fees collected and the amortization of premiums /
discounts on purchased loans are also included as part of the loan yield.
Interest income for the quarter and six months ended June 30, 2012 included a
favorable impact, excluding the discount accretion on covered loans accounted
for under ASC 310-20 and ASC 310-30, of $5.5 million and $10.6 million, related
to those items, compared with a favorable impact of $5.4 million and $10.5
million for the same periods in 2011. Interest income on covered loans for the
quarter and six months ended June 30, 2011 was favorably impacted by the
discount accretion on covered loans accounted for under ASC 310-20 (revolving
lines of credit), which amounted to $9.1 million and $33.6 million,
respectively. This discount was fully accreted during the third quarter of 2011.
The decrease in the net interest margin, on a taxable equivalent basis, for the
quarter ended June 30, 2012 when compared with the same period in the previous
year, was mostly related to a reduction in the yield of earning assets, mainly
in the loan portfolio. The covered loans and mortgage portfolio present notable
reductions in their yields. The decrease in the yield of covered loans resulted
from various factors which included the previously mentioned benefit derived in
2011 as a result of the discount accretion related to loans accounted for under
ASC 310-20 that is not present in 2012 and of collections received from certain
large borrowers that had the effect of recognizing into income the unamortized
discount of a particular pool and increasing the accretable yield to be
recognized over a relatively short period of time for another pool. The mortgage
loan portfolio exhibited a reduction in yield which is attributable to
originations in a lower rate environment, reversals of interest for delinquent
loans, loan purchases realized, mostly in the U.S. mainland, of loans that carry
a lower yield than the overall portfolio, and loans repurchased under credit
recourse agreements which are delinquent at repurchase but are put through loss
mitigation programs for potential restructuring. Also, the yield of investment
securities decreased in part due to the previously mentioned variance in the
taxable equivalent adjustment and the reinvestment of cash flows from
mortgage-backed securities into lower yielding collateralized mortgage
obligations.
Items that partially offset the reductions in net interest margin included a
decrease in the average cost of interest bearing deposits, the repayment of the
note issued to the FDIC as part of the Westernbank transaction, and a higher
yield in the non-covered construction loan portfolio which resulted from a lower
proportion of non-performing assets.
The average loan balance for the second quarter of 2012 experienced a
substantial reduction when compared with the same quarter in the previous year.
Throughout 2011 and 2012, the commercial and construction loan portfolios have
been impacted by soft new loan demand, sales and resolutions of non-performing
loans, and charge-offs which although reflecting favorable trends continue at
high levels. Additionally, contributing to the reduction in average loan
balances was the normal amortization of the covered loan portfolio. In contrast,
the increase experienced in mortgage loans reflected primarily the effect of
loan purchases made by the Corporation's Puerto Rico operations during 2011 of
performing mortgage loans, the previously mentioned loan acquisitions made
during the current quarter by the U.S. operations, loan originations and the
effect of loan repurchases under credit recourse agreements. The average balance
of investment securities decreased as a result of maturities and prepayments of
mortgage-related investment securities. The borrowings category reflects a
reduction of $1.9 billion in the average balance of the note issued to the FDIC.
This note was repaid during 2011. The other sources of funds category reflects a
reduction in the loss share asset, in part as a result of collections made for
claims filed with the FDIC.
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Table 2-Analysis of Levels & Yields on a Taxable Equivalent Basis
Quarters ended June 30,
Variance
Average Volume Average Yields / Costs Interest Attributable to
2012 2011 Variance 2012 2011 Variance 2012 2011 Variance Rate Volume
($ in millions) (In thousands)
$1,113 $ 1,195 $ (82 ) 0.35 % 0.31 % 0.04 % Money market investments $ 964
$ 926 $ 38 $ 52 $ (14 )
5,232 5,659 (427 ) 3.56 4.34 (0.78 ) Investment securities 46,621
61,418 (14,797 ) (9,192 ) (5,605 )
474 763 (289 ) 5.64 5.59 0.05 Trading securities 6,648 10,641 (3,993 ) 65 (4,058 )
Total money market, investment and trading
6,819 7,617 (798 ) 3.18 3.83 (0.65 ) securities 54,233 72,985 (18,752 ) (9,075 ) (9,677 )
Loans:
10,238 11,024 (786 ) 5.03 5.19 (0.16 ) Commercial 127,952 142,568 (14,616 ) (4,676 ) (9,940 )
494 803 (309 ) 2.78 1.34 1.44 Construction 3,421 2,676 745 2,067 (1,322 )
546 583 (37 ) 8.65 8.85 (0.20 ) Leasing 11,801 12,909 (1,108 ) (298 ) (810 )
5,713 5,124 589 5.62 6.79 (1.17 ) Mortgage 80,319
86,962 (6,643 ) (15,959 ) 9,316
3,640 3,610 30 10.07 10.26 (0.19 ) Consumer 91,135
92,343 (1,208 ) (3,059 ) 1,851
20,631 21,144 (513 ) 6.12 6.40 (0.28 ) Sub-total loans 314,628
337,458 (22,830 ) (21,925 ) (905 )
4,129 4,686 (557 ) 7.69 9.91 (2.22 ) Covered loans 79,094
115,897 (36,803 ) (24,028 ) (12,775 )
24,760 25,830 (1,070 ) 6.39 7.03
(0.64 ) Total loans 393,722
453,355 (59,633 ) (45,953 ) (13,680 )
$ 31,579$ 33,447 $ (1,868 ) 5.69 % 6.31 %
(0.62 )% Total earning assets $ 447,955
$ 526,340 $ (78,385 ) $ (55,028 ) $ (23,357 )
Interest bearing deposits:
$ 5,555$ 5,353$ 202 0.45 % 0.63 %
(0.18 )% NOW and money market* $ 6,207 $ 8,371 $ (2,164 ) $ (2,438 ) $ 274
6,562 6,257 305 0.38 0.64 (0.26 ) Savings 6,190 10,012 (3,822 ) (4,371 ) 549
9,752 10,990 (1,238 ) 1.49 1.91 (0.42 ) Time deposits 36,117 52,289 (16,172 ) (10,647 ) (5,525 )
21,869 22,600 (731 ) 0.89 1.25 (0.36 ) Total deposits 48,514 70,672 (22,158 ) (17,456 ) (4,702 )
2,300 2,745 (445 ) 2.28 2.00 0.28 Short-term borrowings 13,044 13,719 (675 ) 3,278 (3,953 )
- 1,859 (1,859 ) - 2.44 (2.44 ) FDIC note - 11,321 (11,321 ) - (11,321 )
480 453 27 15.91 15.89 0.02 TARP funds** 19,087 18,000 1,087 26 1,061
1,385 1,429 (44 ) 5.27 5.23 0.04 Other medium and long-term debt 18,237 18,645 (408 ) (103 ) (305 )
26,034 29,086 (3,052 ) 1.52 1.82
(0.30 ) Total interest bearing liabilities 98,882
132,357 (33,475 ) (14,255 ) (19,220 )
5,309 5,044 265 Non-interest bearing demand deposits
236 (683 ) 919 Other sources of funds
$ 31,579 $ 33,447 $ (1,868 ) 1.26 % 1.59 % (0.33 )% Total source of funds 98,882 132,357 (33,475 ) (14,255 ) (19,220 )
4.43 % 4.72 % (0.29 )% Net interest margin
Net interest income on a taxable equivalent
basis 349,073 393,983 (44,910 ) $ (40,773 ) $ (4,137 )
4.17 % 4.49 % (0.32 )% Net interest spread
Taxable equivalent adjustment 7,873 19,441 (11,568 )
Net interest income $ 341,200 $ 374,542 $ (33,342 )
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Note: The changes that are not due solely to volume or rate are allocated to
volume and rate based on the proportion of the change in each category.
* Includes interest bearing demand deposits corresponding to certain government
entities in Puerto Rico.
** Junior subordinated deferrable interest debentures held by the U.S. Treasury.
The results for the six-month period ended June 30, 2012 were impacted by the
same factors described in the quarterly results. A lower yield in the loan
portfolio, mainly covered loans and non-covered mortgage loans, along with a
reduction in the yield of investment securities, contributed to a lower net
interest margin. However, collections made during the first quarter of 2012
related to a large loan relationship in the U.S. mainland operations, which had
been placed in non-accrual status, contributed to a higher positive effect in
the yield of the non-covered construction loan portfolio. Also, the normalized
comparison in the taxable equivalent adjustment reduced the negative yield
variance exhibited by the investment portfolio.
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Table 3 - Analysis of Levels & Yields on a Taxable Equivalent Basis
Six months ended June 30, 2012
Average Volume Average Yields / Costs Interest Attributable to
2012 2011 Variance 2012 2011 Variance 2012 2011 Variance Rate Volume
($ in millions) (In thousands)
$1,104 $ 1,159 $ (55 ) 0.35 % 0.33 % 0.02 % Money market investments $ 1,912 $ 1,873 $ 39 $ 14 $ 25
5,224 5,661 (437 ) 3.66 4.02 (0.36 ) Investment securities 95,561
113,874 (18,313 ) (8,044 ) (10,269 )
462 723 (261 ) 5.82 5.63 0.19 Trading securities 13,377 20,182 (6,805 ) 713 (7,518 )
Total money market, investment and trading
6,790 7,543 (753 ) 3.27 3.61 (0.34 ) securities 110,850 135,929 (25,079 ) (7,317 ) (17,762 )
Loans:
10,340 11,139 (799 ) 4.99 5.10 (0.11 ) Commercial 256,817 281,746 (24,929 ) (5,041 ) (19,888 )
509 834 (325 ) 3.94 1.45 2.49 Construction 9,956 5,987 3,969 7,044 (3,075 )
550 587 (37 ) 8.66 8.93 (0.27 ) Leasing 23,823 26,228 (2,405 ) (790 ) (1,615 )
5,589 4,939 650 5.67 6.45 (0.78 ) Mortgage 158,465 159,278 (813 ) (20,433 ) 19,620
3,650 3,639 11 10.12 10.31 (0.19 ) Consumer 183,725
186,049 (2,324 ) (5,396 ) 3,072
20,638 21,138 (500 ) 6.16 6.28 (0.12 ) Sub-total loans 632,786
659,288 (26,502 ) (24,616 ) (1,886 )
4,211 4,750 (539 ) 7.34 9.26 (1.92 ) Covered loans 153,859
218,445 (64,586 ) (41,253 ) (23,333 )
24,849 25,888 (1,039 ) 6.36 6.82
(0.46 ) Total loans 786,645
877,733 (91,088 ) (65,869 ) (25,219 )
$ 31,639$ 33,431 $ (1,792 ) 5.69 % 6.10 %
(0.41 )% Total earning assets $ 897,495
$ 1,013,662 $ (116,167 ) $ (73,186 ) $ (42,981 )
Interest bearing deposits:
$ 5,400$ 5,166$ 234 0.46 % 0.67 %
(0.21 )% NOW and money market* $ 12,278
$ 17,286 $ (5,008 ) $ (5,669 ) $ 661
6,535 6,249 286 0.38 0.73 (0.35 ) Savings 12,455
22,570 (10,115 ) (11,257 ) 1,142
10,022 11,063 (1,041 ) 1.51 1.96
(0.45 ) Time deposits 75,460
107,695 (32,235 ) (22,308 ) (9,927 )
21,957 22,478 (521 ) 0.92 1.32 (0.40 ) Total deposits 100,193
147,551 (47,358 ) (39,234 ) (8,124 )
2,405 2,744 (339 ) 2.23 2.04 0.19 Short-term borrowings 26,627
27,734 (1,107 ) 5,704 (6,811 )
- 2,075 (2,075 ) - 2.38 (2.38 ) FDIC note - 24,716 (24,716 ) - (24,716 )
476 450 26 15.91 15.88 0.03 TARP funds** 37,883 35,753 2,130 58 2,072
1,383 1,346 37 5.28 5.76 (0.48 ) Other medium and long-term debt 36,448
38,695 (2,247 ) (700 ) (1,547 )
26,221 29,093 (2,872 ) 1.54 1.90
(0.36 ) Total interest bearing liabilities 201,151
274,449 (73,298 ) (34,172 ) (39,126 )
5,261 4,985 276 Non-interest bearing demand deposits
157 (647 ) 804 Other sources of funds
$ 31,639 $ 33,431 $ (1,792 ) 1.28 % 1.65 % (0.37 )% Total source of funds 201,151 274,449 (73,298 ) (34,172 ) (39,126 )
4.41 % 4.45 % (0.04 )% Net interest margin
Net interest income on a taxable equivalent
basis 696,344 739,213 (42,869 ) $ (39,014 ) $ (3,855 )
4.15 % 4.20 % (0.05 )% Net interest spread
Taxable equivalent adjustment 17,562 21,312 (3,750 )
Net interest income $ 678,782 $ 717,901 $ (39,119 )
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Note: The changes that are not due solely to volume or rate are allocated to
volume and rate based on the proportion of the change in each category.
* Includes interest bearing demand deposits corresponding to certain government
entities in Puerto Rico.
** Junior subordinated deferrable interest debentures held by the U.S. Treasury.
PROVISION FOR LOAN LOSSES
The Corporation's provision for loan losses totaled $119.2 million for the
quarter ended June 30, 2012 compared with $144.3 million for the same period in
2011. The provision for loan losses for the six months ended June 30, 2012
amounted to $219.9 million, compared with $219.6 million. The provision for loan
losses for the six months ended June 30, 2012 included the net benefit of $24.8
million, recorded in the first quarter of 2012, related to revisions in the
allowance for loan losses methodology of $40.5 million net of $15.7 million
related to environmental factor reserves for the BPPR commercial loan portfolio,
as described in the Critical Accounting Policies / Estimates section. Refer to
the Overview, Reportable Segments and Credit Risk Management and Loan Quality
sections of this MD&A for an explanation of the main factors to the reduction in
the provision for loan losses and a detailed analysis of net charge-offs,
non-performing assets, the allowance for loan losses and selected loan losses
statistics.
NON-INTEREST INCOME
Refer to Table 4 for a breakdown on non-interest income by major categories for
the quarters and six months ended June 30, 2012 and 2011.
Table 4-Non-Interest Income
Quarter ended June 30, Six months ended June 30,
(In thousands) 2012 2011 Variance 2012 2011 Variance
Service charges on deposit
accounts $ 46,130 $ 46,802 $ (672 ) $ 92,719 $ 92,432 $ 287
Other service fees:
Debit card fees 9,411 13,795 (4,384 ) 18,576 26,720 (8,144 )
Insurance fees 12,063 12,208 (145 ) 24,453 24,134 319
Credit card fees 14,268 11,792 2,476 26,827 22,368 4,459
Sale and administration of
investment products 9,645 7,657 1,988 18,534 14,787 3,747
Mortgage servicing fees, net of
fair value adjustments 6,335 2,269 4,066 19,266 8,529 10,737
Trust fees 4,069 4,110 (41 ) 8,150 7,605 545
Processing fees 1,639 1,740 (101 ) 3,413 3,437 (24 )
Other fees 4,597 4,736 (139 ) 8,847 9,379 (532 )
Total other service fees 62,027 58,307 3,720 128,066 116,959 11,107
Net (loss) on sale and valuation
adjustments of investment
securities (349 ) (90 ) (259 ) (349 ) (90 ) (259 )
Trading account (loss) profit (7,283 ) 874 (8,157 ) (9,426 ) 375 (9,801 )
Net gain (loss) on sale of
loans, including valuation
adjustment on loans
held-for-sale (15,397 ) (12,782 ) (2,615 ) 74 (5,538 ) 5,612
Adjustment (expense) to
indemnity reserves on loans sold (5,398 ) (9,454 ) 4,056 (9,273 ) (19,302 ) 10,029
FDIC loss share income (expense) 2,575 38,670 (36,095 ) (12,680 ) 54,705 (67,385 )
Fair value change in equity
appreciation instrument - 578 (578 ) - 8,323 (8,323 )
Other operating income 11,419 1,255 10,164 28,501 40,664 (12,163 )
Total non-interest income $ 93,724 $ 124,160 $ (30,436 ) $ 217,632 $ 288,528 $ (70,896 )
The following narrative provides explanations for the main variances in
non-interest income for the quarter and six months ended June 30, 2012, when
compared with the same periods of the previous year.
• Table 4 provides a breakdown of other service fees. The principal variance
was in the category of mortgage servicing fees due to lower unfavorable
fair value adjustments on mortgage servicing rights. There were also
higher credit card fees mainly due to higher interchange fees from
increased customer purchasing activity, and higher commission income received from the sale of investment products by the retail division of
Popular Securities, partially offset by lower debit cards fees mostly from
lower interchange income due to the effect of the Durbin Amendment of the
Dodd-Frank Act that began to take effect in October 1, 2011.
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• Trading account losses for the quarter and six months ended June 30, 2012
corresponded principally to the Corporation's mortgage banking business in
Puerto Rico. This category is influenced by the volume and pricing of
mortgage-backed securities, as well as losses on derivatives that are
economically offset by gains on securitization transactions, but which
benefits are recorded in the net (loss) gain on sale of loans category.
• Table 6 provides a description of the main items influencing the variance
in the category of net (loss) gain on sale of loans, including valuation
adjustments on loans held-for-sale. The valuation adjustments corresponded
principally to the commercial and construction loans of the BPPR
reportable segment, including additional write-downs recorded when certain
loans held-for-sale were recharacterized to other real estate owned due to
repossession of the collateral. The quarterly valuation adjustments
consider recent appraisals and market indicators. The unfavorable variance
from the valuation adjustments was partially offset by higher gains on the
sale of loans, mainly from mortgage loans securitized by the BPPR
reportable segment.
• Lower unfavorable adjustments recorded to indemnity reserves on loans sold
corresponded mostly to the BPPR reportable segment and were principally
due to improvements in credit quality trends of mortgage loans serviced
subject to credit recourse and in the probability of default, foreclosure
rate and constant prepayment rate assumptions, as well as a declining
portfolio given that the Corporation is no longer selling loans subject to
credit recourse.
• FDIC loss share income (expense) was the main driver for the unfavorable
variance in non-interest income. Table 5 provides a breakdown of the
nature of the items that triggered the net unfavorable variance. The
decrease in FDIC loss share income for the quarter and six months ended
June 30, 2012, when compared with the same periods of the previous year,
resulted mostly from the amortization (negative accretion) of the FDIC
loss share asset mainly due to a reduction in the expected losses on the covered loans. The negative variance was also due to lower provision for
loan losses on the covered loans during the second quarter of 2012 as 80%
is recaptured into non-interest income under the loss share agreements.
These unfavorable variances were partially offset by a favorable impact
from the mirror accounting on the 80% FDIC coverage for reimbursable
expenses that are associated with collection efforts on the covered loan
portfolio and by a favorable impact on the mirror accounting for the
discount accretion on loans and unfunded commitments accounted for under ASC Subtopic 310-20 since the discount on these particular loans had been
fully accreted by the end of the third quarter of 2011. Refer to the
Financial Condition Analysis section, particularly the area that explains
covered loans and the loss share asset, for additional explanations on the
accounting and behavior of these assets and the corresponding discount
accretion / amortization that impacts earnings.
• There was also an unfavorable variance on the fair value of the equity appreciation instrument issued to the FDIC as part of the Westernbank
FDIC-assisted transaction of $8.3 million since the results for the six
months ended June 30, 2011 included the positive impact of valuing the
instrument which expired on May of 2011.
• The other operating income category in Table 4 shows a favorable variance
of $10.2 million when comparing the results of the second quarter of 2012
with the same period in the previous year. The quarter ended June 30, 2012
included a $2.5 million gain from the sale of the wholesale indirect
general agency property and casualty business of Popular Insurance. The
variance was also influenced by higher investment banking fees from the
institutional business of Popular Securities during 2012 and to losses
recognized in 2011 related to fund investments on a retirement plan
investment product which was discontinued. Furthermore, impacting the
year-to-date variance in other operating income, during the six-month
period ended June 30, 2011 the Corporation recognized a gain of $20.6
million from the sale of the Corporation's equity investment in CONTADO.
Also, impacting the year-to-date variance was lower income from
investments accounted for under the equity method by $4.0 million,
principally driven by a negative variance in the equity pick-up from the
Corporation's equity interest in EVERTEC of $9.9 million, partially offset
by a favorable variance in the equity pick-up from PRLP 2011 Holdings, LLC
of $5.7 million.
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Table 5-Financial Information-Westernbank FDIC-Assisted Transaction
Quarters ended June 30, Six months ended June 30,
(In thousands) 2012 2011 Variance 2012 2011 Variance
Interest income:
Interest income on covered
loans, except for discount
accretion on ASC 310-20 covered
loans $ 79,094 $ 106,762 $ (27,668 ) $ 153,859 $ 184,862 $ (31,003 )
Discount accretion on ASC 310-20
covered loans - 9,135 (9,135 ) - 33,583 (33,583 )
Total interest income on covered
loans 79,094 115,897 (36,803 ) 153,859 218,445 (64,586 )
FDIC loss share income
(expense):
(Amortization) accretion of loss
share indemnification asset (37,413 ) 8,637 (46,050 ) (66,788 ) 34,433 (101,221 )
80% mirror accounting on credit
impairment losses[1] 29,426 38,884 (9,458 ) 42,848 51,329 (8,481 )
80% mirror accounting on
reimbursable expenses 10,663 1,017 9,646 12,468 1,017 11,451
80% mirror accounting on
discount accretion on loans and
unfunded commitments accounted
for under ASC 310-20 (248 ) (8,538 ) 8,290 (496 ) (30,003 ) 29,507
Change in true-up payment
obligation (236 ) (1,555 ) 1,319 (1,858 ) (3,044 ) 1,186
Other 383 225 158 1,146 973 173
Total FDIC loss share income
(expense) 2,575 38,670 (36,095 ) (12,680 ) 54,705 (67,385 )
Fair value change in equity
appreciation instrument - 578 (578 ) - 8,323 (8,323 )
Amortization of contingent
liability on unfunded
commitments (included in other
operating income) 310 1,011 (701 ) 620 3,395 (2,775 )
Total revenues 81,979 156,156 (74,177 ) 141,799 284,868 (143,069 )
Provision for loan losses 37,456 48,605 (11,149
) 55,665 64,162 (8,497 )
Total revenues less provision
for loan losses $ 44,523 $ 107,551 $ (63,028 ) $ 86,134 $ 220,706 $ (134,572 )
[1] Reductions in expected cash flows for ASC 310-30 loans, which may impact the
provision for loan losses, may consider reductions in both principal and
interest cash flow expectations. The amount covered under the FDIC loss
sharing agreements for interest not collected from borrowers is limited under
the agreements (approximately 90 days); accordingly, these amounts are not
subject fully to the 80% mirror accounting.
Average balances
Quarters ended June 30, Six months ended June 30,
(In millions) 2012 2011 Variance 2012 2011 Variance
Covered loans $ 4,129 $ 4,686 $ (557 ) $ 4,211 $ 4,750 $ (539 )
FDIC loss share asset 1,700 2,421 (721 ) 1,801 2,416 (615 )
Note issued to the FDIC - 1,859 (1,859 ) - 2,075 (2,075 )
Table 6-Breakdown of Net (Loss) Gain on Sale of Loans, including Valuation
Adjustments
Quarter ended June 30, Six months ended June 30,
(In thousands) 2012 2011 Variance 2012 2011 Variance
Net gain on sale of loans $ 16,657 $ 6,796 $ 9,861 $ 33,425 $ 15,041 $ 18,384
Valuation adjustment on loans
held-for-sale, including
write-downs for loans
held-for-sale recharacterized to
other real estate (repossessed
collateral) (34,678 ) (19,578 ) (15,100 ) (38,244 ) (20,579 ) (17,665 )
Recoveries on loans held-for-sale
due to collections in excess of
carrying value 2,624 - 2,624 4,893 - 4,893
Total $ (15,397 ) $ (12,782 ) $ (2,615 ) $ 74 $ (5,538 ) $ 5,612
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Operating Expenses
Table 7 provides a breakdown of operating expenses by major categories.
Table 7-Operating Expenses
Quarters ended June 30, Six months ended June 30,
(In thousands) 2012 2011 Variance 2012 2011 Variance
Personnel costs:
Salaries $ 75,881 $ 76,698 $ (817 ) $ 152,780 $ 150,489 $ 2,291
Commissions, incentives and other
bonuses 14,359 11,995 2,364 27,085 21,918 5,167
Pension, postretirement and medical
insurance 16,114 12,810 3,304 34,539 24,795 9,744
Other personnel costs, including payroll
taxes 9,982 9,456 526 23,423 19,897 3,526
Total personnel costs 116,336 110,959 5,377 237,827 217,099 20,728
Net occupancy expenses 24,963 25,957 (994 ) 49,125 50,543 (1,418 )
Equipment expenses 10,900 10,761 139 22,241 22,797 (556 )
Other taxes 12,074 14,623 (2,549 ) 25,512 26,595 (1,083 )
Professional fees:
Collections, appraisals and other credit
related fees 11,163 7,958 3,205 21,400 15,710 5,690
Programming, processing and other
technology services 26,359 24,410 1,949 50,920 48,558 2,362
Other professional fees 14,605 17,111 (2,506 ) 27,912 31,899 (3,987 )
Total professional fees 52,127 49,479 2,648 100,232 96,167 4,065
Communications 6,645 7,188 (543 ) 13,776 14,398 (622 )
Business promotion 16,980 11,332 5,648 29,830 21,192 8,638
FDIC deposit insurance 22,907 27,682 (4,775 ) 47,833 45,355 2,478
Loss on early extinguishment of debt 25,072 289 24,783 25,141 8,528 16,613
Other real estate owned (OREO) expenses 2,380 6,440 (4,060 ) 16,545 8,651 7,894
Other operating expenses:
Credit and debit card processing, volume
and interchange expenses 4,960 4,206 754 9,641 8,149 1,492
Transportation and travel 1,889 1,865 24 3,360 3,385 (25 )
Printing and supplies 1,456 1,265 191 2,490 2,488 2
All other 26,659 7,499 19,160 35,369 26,992 8,377
Total other operating expenses 34,964 14,835 20,129 50,860 41,014 9,846
Amortization of intangibles 2,531 2,255 276 5,124 4,510 614
Total operating expenses $ 327,879 $ 281,800 $
46,079 $ 624,046$ 556,849$ 67,197
The increase in operating expenses was impacted by the following main factors:
• As shown in Table 7, personnel costs increased by $5.4 million and $20.7 million, respectively, for the quarter and six months ended June 30, 2012,
when compared to the same periods in 2011, and consisted of the following
principal variances:
• higher pension, postretirement and medical insurance expenses increased by $3.3 million and $9.7 million, respectively, for the
quarter and six months ended June 30, 2012, when compared with the
same periods of the previous year. This included an increase in the
net periodic pension cost of $3.4 million and $6.9 million,
respectively, mainly due to the impact of higher amortization of net
losses for the period driven by a decrease in the assumed
discount
rate of the pension benefit obligation and lower expected return on
plan assets. Refer to Note 27 to the consolidated financial statements
for a breakdown of the net periodic pension cost. Medical insurance
costs also contributed to the increase for the six months ended
June 30, 2012 vis-à-vis the same period in the previous year by $2.9
million, resulting from higher claims activity and revisedpremiums;
• higher incentives, commission and other bonuses by $2.4 million and
$5.2 million, respectively, for the quarter and six months ended
June 30, 2012, when compared with the same periods in 2011,
mainly due
to higher sales incentives and retail commissions and other
performance incentives;
• salaries expense increased by $2.3 million for the six months ended
June 30, 2012, when compared with the same period in 2011, mainly due
to higher vacation and other compensation accruals. There was a
reduction in FTEs from June 30, 2011 to June 30, 2012 of 272 FTEs
mainly driven by retired employees, but which retirement was not
effective until February 1, 2012; and
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• higher other personnel costs, including payroll taxes, by $3.5 million
for the six months ended June 30, 2012, when compared with the same
period of 2011, primarily due to $1.4 million in severance accruals
recognized during the first quarter of 2012 related to an employee
exit program that was executed as part of the Corporation's efficiency
efforts and payroll taxes such as unemployment, social
security and
workers compensation. For the second quarter and six months ended
June 30, 2012, there were higher staff uniform expenses by $1.0
million and $1.2 million, respectively, when compared to the same
periods of 2011.
• lower other taxes by $2.5 million in the quarter ended June 30, 2012, when
compared to the same period in 2011, mainly driven by a $2.1 million
reduction in property taxes in the BPPR reportable segment;
• professional fees increased by $2.6 million and $4.1 million, respectively, for the quarter and six months ended June 30, 2012, when
compared to the same periods in 2011, mainly related with loan collection
efforts through attorneys in the Puerto Rico operations, some of which are
reimbursable by the FDIC;
• an increase of $5.6 million and $8.6 million, respectively, in business promotion expense for the quarter and six months ended June 30, 2012, when
compared to the same periods in 2011, mainly driven by costs from credit
card reward programs and other retail product promotional campaigns in
Puerto Rico and from BPNA's rebranding efforts;
• lower FDIC deposit insurance assessments by $4.8 million for the quarter
ended June 30, 2012 and higher FDIC deposit insurance assessments by $2.5
million during the six-month period of 2012, when compared to the same
periods of the previous year, primarily related to the BPPR reportable
segment;
• higher loss on extinguishment of debt by $24.8 million and $16.6 million, respectively, for the quarter and six months ended June 30, 2012, when
compared to the same periods in 2011, mainly due to the prepayment expense
of $25.0 million recorded during the second quarter of 2012 related to the
early termination of $350 million in outstanding repurchase agreements
with contractual maturities between March 2014 and May 2014, partially
offset by $8.0 million in prepayment penalties recorded during the first
quarter of 2011 on the repayment of $100 million in medium-term notes;
• decrease in OREO expenses of $4.1 million for the quarter ended June 30,
2012, when compared to the same quarter of the previous year, primarily
driven by higher gains on the sale of construction real estate properties
in the U.S. mainland. OREO expenses increased by $7.9 million during the
six months ended June 30, 2012, when compared to the same period in 2011,
mainly as a result of higher write-downs in residential mortgage and
commercial properties due to downward adjustments to the collateral values
of residential and commercial properties in the BPPR reportable segment,
partially offset by higher gains on the sale of construction real estate
properties in the U.S. mainland; and
• the category of all other operating expenses increased by $19.2 million
and $8.4 million for the quarter and six months ended June 30, 2012, when
compared to the same periods in 2011, mainly due to higher tax and
insurance advances, property maintenance and repair expenses, and to other
costs associated with the collection efforts of the Westernbank covered
loan portfolio. Under the loss share agreements, 80% of certain expenses
are reimbursable by the FDIC and although the related expenses are
reflected in this category, the 80% offset to these expenses is recorded
in the income statement category of FDIC loss share income (expense) in
non-interest income. During 2012, there were also higher servicing and
claims-related costs, a $3.1 million charge related to a legal settlement
in the Corporation's U.S. mainland operations and higher provision for
other operational losses. Furthermore, there were lower credits to the
provision for unfunded credit commitments by $4.2 million in the second
quarter of 2012, compared with the second quarter of 2011, mainly due to decreases in the funding rate and a lower magnitude of improvements in the
potential loss expectations. The variance in the provision for unfunded
commitments for the six-month period was not significant. These
unfavorable variances in other operating expenses were partially offset by
lower impairment losses on the investment in TRANRED (Venezuela).
Income Taxes
Income tax benefit amounted to $77.9 million for the quarter ended June 30,
2012, compared with an income tax benefit of $38.1 million for the same quarter
of 2011. The increase in income tax benefit was primarily due to a tax benefit
of $72.9 million recorded in June 2012 related to the reduction of the deferred
tax liability on the estimated gains for tax purposes related to the loans
acquired from Westernbank (the "Acquired Loans"), as previously described in the
Overview section of this MD&A. Under the Closing Agreement signed by the
Corporation with the P.R. Treasury, both parties agreed that the Acquired Loans
are capital assets and any gain resulting from such loans will be taxed at the
capital gain tax rate of 15% instead of the ordinary income tax rate of 30%,
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thus reducing the deferred tax liability on the estimated gain and recognizing
an income tax benefit for accounting purposes. Also contributing to the
quarterly variance in income tax was lower income recognized by the Puerto Rico
operations during the second quarter of 2012, compared with the same period of
2011.
Additionally, during the second quarter of 2011, a tax benefit of $53.6 million
was recorded for the recovery of certain tax benefits not previously recorded
during years 2009 (the benefit of reduced tax rates for capital gains) and 2010
(the benefit of the exempt income) as a result of a Closing Agreement signed by
the Corporation and the P.R. Treasury in June 2011. Under this agreement, both
parties agreed that for tax purposes the deductions related to certain
charge-offs recorded on the financial statements of Popular for the years 2009
and 2010 could be deferred until 2013, 2014, 2015 and 2016. In addition, as a
result of this 2011 Closing Agreement, the Corporation recorded a tax benefit of
$11.9 million related to the tax benefits of the exempt income for the first six
months of 2011.
The components of income tax for the quarters ended June 30, 2012 and 2011 are
included in Table 8.
Table 8-Components of Income Tax Expense (Benefit)-Quarter
Quarters ended
June 30, 2012 June 30, 2011
% of pre-tax % of pre-tax
(In thousands) Amount income Amount income
Computed income tax at statutory
rates $ (3,646 ) 30 % $ 21,776 30 %
Net benefit of net tax exempt
interest income (3,739 ) 31 (15,206 ) (21 )
Deferred tax asset valuation
allowance (48 ) - 3,945 5
Non-deductible expenses 5,726 (47 ) 5,400 7
Difference in tax rates due to
multiple jurisdictions (1,149 ) 9 (1,866 ) (2 )
Recognition of tax benefits from
previous years[1] - - (53,615 ) (74 )
Effect of income subject to
preferential tax rate[2] (73,298 ) 603 (100 ) -
State taxes and others (1,739 ) 14 1,566 2
Income tax (benefit) expense $ (77,893 ) 640 % $ (38,100 ) (53 )%
[1] Represents the impact of the Ruling and Closing Agreement with the P.R.
Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in
June 2012.
Income tax benefit amounted to $61.7 million for the six months ended June 30,
2012, compared with an income tax expense of $109.1 million for the same period
of 2011. The decrease in income tax expense was primarily due to the Closing
Agreements between the Corporation and P.R. Treasury signed in June 2012 and
2011, as mentioned above, and due to lower income recognized by the Puerto Rico
operations during the six months ended June 30, 2012 compared with the same
six-month period in 2011.
Furthermore, also impacting the year-to-date variance, on January 1, 2011, the
Governor of Puerto Rico signed Act Number 1 (Internal Revenue Code for a New
Puerto Rico) which, among the most significant changes applicable to
corporations, was the reduction in the marginal tax rate from 39% to 30%.
Consequently, as a result of this reduction in rate, the Corporation recognized
during the first quarter of 2011 income tax expense of $103.3 million and a
corresponding reduction in the net deferred tax assets of the Puerto Rico
operations.
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The components of income tax for the six months ended June 30, 2012 and 2011 are
included in Table 9.
Table 9-Components of Income Tax Expense (Benefit) - Year-to-Date
Six months ended
June 30, 2012 June 30, 2011
% of pre-tax % of pre-tax
(In thousands) Amount income Amount income
Computed income tax at statutory
rates $ 15,734 30 % $ 68,984 30 %
Net benefit of net tax exempt
interest income (10,753 ) (21 ) (17,613 ) (8 )
Deferred tax asset valuation
allowance 1,119 2 (1,360 ) (1 )
Non-deductible expenses 11,365 22 10,726 5
Difference in tax rates due to
multiple jurisdictions (4,356 ) (8 ) (4,344 ) (2 )
Initial adjustment in deferred tax
due to change in tax rate - - 103,287 45
Recognition of tax benefits from
previous years[1] - - (53,615 ) (23 )
Effect of income subject to
preferential tax rate[2] (74,269 ) (142 ) (332 ) -
State taxes and others (541 ) (1 ) 3,394 1
Income tax (benefit) expense $ (61,701 ) (118 )% $ 109,127 47 %
[1] Represents the impact of the Ruling and Closing Agreement with the P.R.
Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in
June 2012.
Refer to Note 29 to the consolidated financial statements for a breakdown of the
Corporation's net deferred tax assets as of June 30, 2012.
REPORTABLE SEGMENT RESULTS
The Corporation's reportable segments for managerial reporting purposes consist
of Banco Popular de Puerto Rico and Banco Popular North America. A Corporate
group has been defined to support the reportable segments. For managerial
reporting purposes, the costs incurred by the Corporate group are not allocated
to the reportable segments.
For a description of the Corporation's reportable segments, including additional
financial information and the underlying management accounting process, refer to
Note 31 to the consolidated financial statements.
The Corporate group reported a net loss of $30.6 million for the second quarter
and $58.9 million for the six months ended June 30, 2012, compared with net loss
of $31.6 million for the second quarter and $47.9 million for the six months
ended June 30, 2011. The unfavorable variance in the year-to-date results for
the Corporate group was the net effect of (i) gain recognized during the
six-month period ended June 30, 2011 from the sale of its equity investment in
CONTADO; and (ii) lower income, net of intra-entity eliminations, from the
equity interest in EVERTEC, partially offset by (iii) prepayment penalties
incurred in 2011 on the early cancellation of medium-term notes and (iv) lower
impairment losses related to the investment in TRANRED (Venezuela).
Banco Popular de Puerto Rico
The Banco Popular de Puerto Rico reportable segment's net income amounted to
$86.0 million for the quarter ended June 30, 2012, compared with $139.8 million
for the same quarter of the previous year. The principal factors that
contributed to the variance in the financial results included the following:
• lower net interest income by $26.7 million, or 8%, mostly due to a
reduction in interest income from the covered loan portfolio by $36.8
million due to the discount accretion on covered loans accounted for under
ASC 310-20 (revolving lines of credit), which amounted to $9.1 million
during the second quarter of 2011 (the discount had been fully accreted by
the end of the third quarter of 2011), and collections received during
that period in 2011 from certain large borrowers that had the effect of
recognizing into income the unamortized discount of a particular pool and
increasing the accretable yield to
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be recognized over a relatively short period of time for another pool. In
addition, contributing to the reduction in interest income was a lower
average balance of covered loans by $557 million, as compared with the
same quarter in 2011. Also, a reduction of approximately $1.0 billion in
the average volume of money market, investment and trading securities
resulted in a reduction in interest income of $13.6 million. The
unfavorable impact resulting from these reductions in interest income was
partially offset by a $16.8 million reduction in deposit costs, resulting
in a decrease in cost of interest bearing deposits of 38 basis points. The
interest expense on borrowed money declined by $12.9 million principally
associated with the full prepayment by the end of 2011 of the note issued
to the FDIC as part of the Westernbank FDIC-assisted transaction. The BPPR
reportable segment had a net interest margin of 5.07% for the quarter
ended June 30, 2012, compared with 5.19% for the same period in 2011;
• lower provision for loan losses by $15.6 million, or 13%, due to the decrease in the provision for loan losses on the covered loan portfolio of
$11.1 million, or 23%, and $4.5 million in the provision for loan losses
on the non-covered loan portfolio. The decrease in the provision for loan
losses on covered loans was mainly driven by a lower provision on loans
accounted for under ASC Subtopic 310-30 as certain pools, principally
commercial and construction loan pools, reflected higher increases in
expected loss estimates for the quarter ended June 30, 2011, when compared
with the revisions in expected loss estimates for the same period in
2012. The decrease in the provision for loan losses on the non-covered
loan portfolio reflected lower net charge-offs by $11.7 million and
reductions in the allowance for loan losses mostly for the commercial and
consumer loan portfolios, partly offset by higher reserve requirements for
the mortgage portfolio prompted by higher loss trends and higher specific
reserves for loans restructured under the Corporation's loss mitigation
program. The increase in the residential mortgage loan loss trends was
principally related to the implementation of a revised charge-off policy
during the first quarter of 2012. This revised policy is described in the
Credit Risk Management and Loan Quality section of this MD&A;
• lower non-interest income by $28.5 million, or 25%, mainly due to FDIC
loss share income of $2.6 million recognized in the second quarter of
2012, compared with $38.7 million for the same quarter previous year.
Refer to Table 5 for components of that latter variance. The decrease in
non-interest income was also due to an unfavorable variance of $15.3
million in valuation adjustments on loans held-for-sale, principally the
commercial and construction loans held by BPPR as described in the
Non-Interest Income section of this MD&A. These unfavorable variances were
partially offset by higher gain on sale of loans, net of trading account
losses, by $6.4 million mostly due to higher gains on loan sales and
securitization transactions; higher other operating income by $7.6 million which considers the gain of $2.5 million from the sale of the wholesale
indirect property and casualty business of Popular Insurance during the
second quarter of 2012 and higher investment banking fees. Also, there
were lower adjustments by $4.7 million to increase the indemnity reserve
on loans serviced; and higher other service fees by $4.6 million, mainly
from lower unfavorable valuation adjustments to the value of mortgage
servicing rights, higher credit card fees and revenues for the sale of
investment products, partially offset by lower debit card fees;
• higher operating expenses by $50.5 million, or 23%, mainly due to an increase of $24.8 million in loss on early extinguishment of debt,
primarily related to the cancellation of the repurchase agreements. Also,
there was an unfavorable variance of $16.3 million in other operating
expenses mostly due to costs associated with the collection efforts of the
covered loan portfolio, of which 80% is reimbursed by the FDIC, and higher
provision for unfunded credit commitments by $5.0 million. The increase in
operating expenses was also due to higher business promotion expense by
$4.4 million mostly from credit card reward programs and other retail
product promotional campaigns; higher professional fees by $3.5 million
mainly due to loan collection efforts through attorneys, some of which are
reimbursable by the FDIC; and higher other real estate owned costs by $3.2
million related to higher subsequent fair value adjustments on commercial
and construction properties; and
• lower income tax expense by $36.2 million, mainly due to a tax benefit of
$72.9 million recognized during the second quarter of 2012 resulting from
the Closing Agreement with the P.R. Treasury related to the tax treatment
of the loans acquired in the Westernbank FDIC-assisted transaction,
compared with a tax benefit of $53.6 million for the same period in 2011
resulting from the Closing Agreement with the P.R. Treasury for the
recognition of certain tax benefits not previously recorded during years
2009 (the benefit of reduced tax rates for capital gains) and 2010 (the
benefit of the exempt income). The decrease in the income tax expense
category was also due to lower income in the Corporation's Puerto Rico
operations, compared to the same period of 2011.
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Net income for the six months ended June 30, 2012 totaled $152.9 million,
compared with $143.4 million for the same period in the previous year. These
results reflected:
• lower net interest income by $32.1 million, or 5%, mostly due to a reduction in interest income from the covered loan portfolio by $64.6
million resulting from $33.6 million of discount accretion recognized
during the six months ended June 30, 2011 on revolving lines of credit
accounted for pursuant to ASC 310-20, and from a lower average balance of
covered loans by $540 million. Also, a reduction of approximately $1.1
billion in the average volume of money market, investment and trading
securities resulted in a lower interest income of $26.2 million. The
unfavorable impact resulting from these reductions was partially offset by
a $35.8 million reduction in deposit costs or 43 basis points and $26.9
million in the cost of borrowings mostly associated with the prepayment of
the note issued to the FDIC. The net interest margin remained flat at
4.98% in both six-month periods ended June 30, 2012 and 2011;
• higher provision for loan losses by $3.0 million, or 2%, due to the
increase in the provision for loan losses on the non-covered loan
portfolio of $11.5 million, or 9%, partially offset by a decrease of $8.5
million in the provision for loan losses on the covered loan portfolio.
The decrease in the provision for loan losses on covered loans was mainly
driven by a lower provision on loans accounted for under ASC Subtopic
310-30 as certain pools, principally commercial and construction loan
pools, reflected higher increases in expected loss estimates for the six
months ended June 30, 2011 when compared with the revisions in expected
loss estimates for the same period in 2012. The provision for loan losses
for the non-covered portfolio reflected lower net charge-offs by $21.9
million and reductions in the allowance for loan losses, mainly driven by
the commercial and consumer portfolios, as a result of continued
improvement in credit trends. As explained above, these reductions were
more than offset by higher allowance levels for the mortgage loan portfolio prompted by higher loss trends and higher specific reserves for
loans restructured under the Corporation's loss mitigation program;
• lower non-interest income by $36.5 million, or 16%, mainly due to FDIC loss share expense of $12.7 million recognized for the six months ended
June 30, 2012, compared with FDIC loss share income of $54.7 million for
the same period previous year. Refer to Table 5 for components of that
latter variance. The decrease in non-interest income was also due to an
unfavorable variance of $18.8 million in valuation adjustments on loans held-for-sale. These unfavorable variances were partially offset by higher
gain on sale of loans, net of trading account losses, by $16.5 million due
to higher gains on securitization transactions and lower adjustments by
$11.6 million to increase the indemnity reserve on loans serviced. Also,
there were favorable variances of $13.0 million in other service fees and
$9.7 million in other operating income, due to the same factors explained
for the quarterly variances;
• higher operating expenses by $84.0 million, or 20%, mainly due to an increase of $24.6 million in loss on early extinguishment of debt; an
increase in personnel costs of $14.8 million due to higher net periodic
pension costs, medical insurance costs, commissions and severance
accruals, among other factors; and an increase of $13.5 million in other
operating expenses mostly due to costs associated with the collection
efforts of the covered loan portfolio, of which 80% is reimbursed by the
FDIC. Also there were unfavorable variances of $13.4 million in other real
estate owned costs, principally due to downward adjustments to collateral
values of commercial, construction and residential mortgage properties;
$7.1 million in FDIC deposit insurance assessment and $6.9 million in
business promotion expense; and
• lower income tax expense by $165.0 million, mainly due to $103.3 million
in income tax expense recognized during the first quarter of 2011 with a
corresponding reduction in the Puerto Rico Corporation's net deferred tax
asset as a result of the reduction in the marginal corporate income tax
rate due to the Puerto Rico tax reform. The favorable variance was also
attributable to the previously mentioned tax benefit of $72.9 million
recognized in 2012 resulting from a Closing Agreement with the P.R.
Treasury related to the tax treatment of the loans acquired in the
Westernbank FDIC-assisted transaction, compared with a tax benefit of
$53.6 million recognized in 2011 resulting from a Closing Agreement with
the P.R. Treasury for the recognition of certain tax benefits not
previously recorded during years 2009 (the benefit of reduced tax rates
for capital gains) and 2010 (the benefit of the exempt income). The
decrease in income tax expense was also due to lower income in the Corporation's Puerto Rico operations compared to the same period of 2011.
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Banco Popular North America
For the quarter ended June 30, 2012, the reportable segment of Banco Popular
North America reported net income of $10.6 million, compared with $2.6 million
for the same quarter of the previous year. The principal factors that
contributed to the variance in the financial results included the following:
• lower net interest income by $5.0 million, or 7%, which was primarily the
effect of lower average volume by $612 million in the loan portfolio,
partially offset by an increase of $316 million in the average balance of
investment securities and to lower deposit balances. The reduction in the
average loan portfolio is net of an increase of $124 million in the
average balance of the mortgage portfolio as a result of the acquisition
of approximately $273 million in performing mortgage loans during the
quarter ended June 30, 2012. The decrease in interest income was partially
offset by lower deposits costs. The BPNA reportable segment had a net
interest margin of 3.55% for the quarter ended June 30, 2012, compared
with 3.64% for the same period in 2011;
• lower provision for loan losses by $9.7 million, or 39%, principally the
result of lower net charge-offs by $23.7 million, partly offset by a lower
allowance for loan losses release, as the second quarter of 2011 included
higher reductions in the allowance due to lower portfolio balances and
overall improvements in portfolio behavior;
• lower non-interest income by $3.9 million, or 20%, mostly due to lower
gain on sale of loans, net of fair value adjustments, by $2.5 million
related to lower gains on the sale of commercial and mortgage loans, and
lower other service fees by $1.2 million, mostly related to debit card
fees, due to the effect of the Durbin Amendment of the Dodd-Frank Act; and
• lower operating expenses by $7.3 million, or 11%, mainly due to lower
other real estate owned costs by $7.2 million due to higher gains on the
sale of construction real estate properties.
Net income for the six months ended June 30, 2012 totaled $19.9 million,
compared with $24.9 million for the same period in the previous year. These
results reflected:
• lower net interest income by $5.8 million, or 4%, which was primarily the
effect of lower average volume by $808 million in the loan portfolio,
partially offset by higher volume of investment securities and lower
deposit balances. The net interest margin increased from 3.62% for the six
months ended June 30, 2011 to 3.67% for the same period in 2012, mostly
due to lower cost of deposits by 33 basis points and collection of interest on construction loans that were previously non-accruing and which
were paid-off during the first quarter of 2012;
• lower provision for loan losses by $3.0 million, or 9%, principally as a
result of lower net charge-offs by $44.9 million mainly from the legacy,
commercial and consumer loan portfolios due to improved credit
performance. As mentioned above, these favorable variances were partly
offset by a lower allowance for loan losses release, as the second quarter
of 2011 included higher reductions due to lower portfolio balances and
overall improvements in portfolio behavior. In addition, the first quarter
of 2011 included a $13.8 million benefit due to improved pricing from the
sale of the non-conventional mortgage loan portfolio;
• lower non-interest income by $5.8 million, or 16%, mostly due to lower other service fees by $2.7 million, mostly related to debit card fees, and
lower gain on sale of loans, net of valuation adjustments on loans
held-for-sale, by $2.4 million due to lower gains on the sale of mortgage
loans; and
• lower operating expenses by $3.6 million, or 3%, mainly due lower other
real estate owned costs by $5.5 million related to higher gains on the
sale of construction real estate properties, and lower FDIC deposit
insurance assessments by $4.6 million. These favorable variances were
partially offset by an increase of $4.5 million in personnel costs mainly
due to higher headcount and benefit accruals, and higher business
promotion expenses by $1.7 million due to the rebranding of the BPNA
franchise.
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FINANCIAL CONDITION ANALYSIS
Assets
The Corporation's total assets were $36.6 billion at June 30, 2012 and $37.3
billion at December 31, 2011. Refer to the consolidated financial statements
included in this report for the Corporation's consolidated statements of
financial condition as of such dates. The reduction in total assets was
principally in the categories of money market investments, loans covered under
FDIC loss sharing agreements and the FDIC loss share asset.
Money market investments
Money market investments amounted to $0.9 billion at June 30, 2012, compared
with $1.4 billion as of December 31, 2011. The reduction was principally in time
deposits by $339 million, mainly in excess balances held at the Federal Reserve
Bank, and federal funds sold by $70 million, which are dependent in part on
excess short-term liquidity derived principally from customer deposits.
Investment securities
Table 10 provides a breakdown of the Corporation's portfolio of investment
securities available-for-sale ("AFS") and held-to-maturity ("HTM") on a combined
basis. Also, Notes 5 and 6 to the consolidated financial statements provide
additional information with respect to the Corporation's investment securities
AFS and HTM. Purchases of collateralized mortgage obligations were principally
in the form of U.S. Government agency-issued collateralized mortgage
obligations. The reduction in mortgage-backed securities was due to maturities
and prepayments.
Table 10-Breakdown of Investment Securities Available-for-Sale and
Held-to-Maturity
June 30, December 31,
(In millions) 2012 2011 Variance
U.S. Treasury securities $ 37.9 $ 38.7 $ (0.8 )
Obligations of U.S. Government sponsored
entities 1,039.4 985.5 53.9
Obligations of Puerto Rico, States and
political subdivisions 147.9 157.7 (9.8 )
Collateralized mortgage obligations 2,042.1 1,755.6 286.5
Mortgage-backed securities 1,875.7 2,139.6 (263.9 )
Equity securities 7.0 6.9 0.1
Others 51.4 51.2 0.2
Total investment securities AFS and HTM $ 5,201.4 $ 5,135.2 $ 66.2
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Loans
Refer to Table 11, for a breakdown of the Corporation's loan portfolio, the
principal category of earning assets. Loans covered under the FDIC loss sharing
agreements are presented in a separate line item in Table 11. The risks on
covered loans are significantly different as a result of the loss protection
provided by the FDIC.
In general, the changes in most loan categories reflect soft loan demand, the
impact of loan charge-offs, and portfolio run-off of the exited loan origination
channels at the BPNA reportable segment. The decreases were partially offset by
mortgage and installment loan growth mainly due to the loan purchases of
consumer loans in Puerto Rico and of mortgage loans in the U.S. mainland
operations as described in the Overview section of this MD&A, and mortgage loan
originations and repurchases under recourse agreements in Puerto Rico.
Table 11-Loans Ending Balances
(In thousands) June 30, 2012 December 31, 2011 Variance
Loans not covered under FDIC loss
sharing agreements:
Commercial $ 9,602,815 $ 9,973,327 $ (370,512 )
Construction 249,743 239,939 9,804
Legacy[1] 509,829 648,409 (138,580 )
Lease financing 537,917 548,706 (10,789 )
Mortgage 5,899,973 5,518,460 381,513
Consumer 3,865,532 3,673,755 191,777
Total non-covered loans
held-in-portfolio 20,665,809 20,602,596 63,213
Loans covered under FDIC loss sharing
agreements:
Commercial 2,331,176 2,512,742 (181,566 )
Construction 469,765 546,826 (77,061 )
Mortgage 1,116,476 1,172,954 (56,478 )
Consumer 98,913 116,181 (17,268 )
Total covered loans
held-in-portfolio[2] 4,016,330
4,348,703 (332,373 )
Total loans held-in-portfolio 24,682,139
24,951,299 (269,160 )
Loans held-for-sale:
Commercial 18,072 25,730 (7,658 )
Construction 160,102 236,045 (75,943 )
Legacy[1] 425 468 (43 )
Mortgage 185,938 100,850 85,088
Total loans held-for-sale 364,537 363,093 1,444
Total loans $ 25,046,676 $ 25,314,392 $ (267,716 )
[1] The legacy portfolio is comprised of commercial loans, construction loans and
lease financings related to certain lending products exited by the
Corporation as part of restructuring efforts carried out in prior years at
the BPNA reportable segment.
[2] Refer to Note 7 to the consolidated financial statements for the composition
of the loans covered under FDIC loss sharing agreements.
The explanations for loan portfolio variances discussed below exclude the impact
of the covered loans.
The decrease in commercial loans held-in-portfolio from December 31, 2011 to
June 30, 2012 was reflected in the BPPR and BPNA reportable segments by $307
million and $63 million, respectively. The decline in the Puerto Rico operations
was experienced in the categories of commercial loans secured by real estate and
in commercial and industrial loans and was mostly associated with the
cancellation and repayment of certain commercial lines of credit in Puerto Rico
and charge-offs of $87 million during the six-month period ended June 30, 2012.
The decrease in the U.S. operations was principally the result of portfolio
runoff and charge-offs of $37 million.
The BPNA legacy portfolio (refer to footnote 1 in Table 11) reflected declines
in commercial loans of $110 million, construction loans of $24 million and lease
financings of $5 million from December 31, 2011 to June 30, 2012. These declines
were principally related to portfolio run-off and charge-offs of $20 million for
the six months ended June 30, 2012.
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The decline in the lease financing portfolio corresponded to the BPPR reportable
segment and is primarily due to a general slowdown in originations.
Mortgage loans held-in-portfolio increased by $257 million and $125 million from
December 31, 2011 to June 30, 2012 in the BPNA and BPPR reportable segments,
respectively. The increase in BPNA reportable segment was mainly due to
residential loan purchases which amounted to $293 million (unpaid principal
balance at acquisition date) during 2012, partially offset by loan repayments.
The increase in the BPPR reportable segment was principally associated with loan
repurchases under credit recourse agreements, many of which are put under the
Corporation's loss mitigation programs, which approximated $82 million for the
six-month period ended June 30, 2012, and to loans originated and purchased,
offset by collections and charge-offs. The Corporation has been successful in
maintaining suitable origination volumes as clients continue benefiting from
government programs that incentivize housing demand and the continuous low
interest rate environment. Most new production is securitized into
mortgage-backed securities in the secondary markets. Refer to the "Guarantees
associated with loans sold / serviced" section in this MD&A, for information on
the mortgage loan repurchases under credit recourse arrangements.
The increase in consumer loans from December 31, 2011 to June 30, 2012 was
derived from the BPPR reportable segment by $229 million mainly due to the
previously mentioned acquisition of $225 million in personal loans and an
increase of $21 million in auto loans, partially offset by a reduction of $20
million in credit cards. The BPNA reportable segment's consumer loan portfolio
reflected a reduction of $37 million when compared with December 31, 2011. This
decrease was mainly due to loan portfolio run-off of the exited lines of
business, including E-LOAN, and charge-offs.
The increase in mortgage loans held-for-sale from December 31, 2011 to June 30,
2012 was mostly due to loans originated and purchased which are to be sold
through agency securitizations in the secondary markets.
The decrease in commercial and construction loans held-for-sale loans from
December 31, 2011 to June 30, 2012 was principally driven by the BPPR reportable
segment resulting from negative valuation adjustments as described in the
Overview and Non-Interest income sections of this MD&A and to reclassifications
of certain loans held-for-sale to other real estate owned upon possession of the
real estate collateral.
Covered loans were initially recorded at fair value. Their carrying value was
approximately $4.0 billion at June 30, 2012. Refer to Table 11 for a breakdown
of the covered loans by major loan type categories. A substantial amount of the
covered loans, or approximately $3.7 billion of their carrying value at June 30,
2012, was accounted for under ASC Subtopic 310-30. The decline in covered loans
from December 31, 2011 to June 30, 2012 was principally due to collections and
to charge-offs amounting to $63 million for the six-month period ended June 30,
2012, partially offset by discount accretion. Tables 12 and 13 provide the
activity in the carrying amount and outstanding discount on the covered loans
accounted for under ASC 310-30. The outstanding accretable discount is impacted
by increases in cash flow expectations on the loan pools based on quarterly
revisions of the portfolio. The increase in the accretable discount is
recognized as interest income using the effective yield method over the
estimated life of each applicable loan pool.
Table 12-Activity in the Carrying Amount of Covered Loans Accounted for Under
ASC 310-30
Quarter ended Six months ended
June 30, June 30,
(In thousands) 2012 2011 2012 2011
Beginning balance $ 3,894,905 $ 4,423,496 $ 4,036,471 $ 4,539,928
Accretion 73,988 100,185 143,325 173,117
Collections / charge-offs (239,404 ) (258,616 ) (450,307 ) (447,980 )
Ending balance $ 3,729,489 $ 4,265,065 $ 3,729,489 $ 4,265,065
Allowance for loan losses (ALLL) (93,971 ) (48,257 ) (93,971 ) (48,257 )
Ending balance, net of ALLL $ 3,635,518 $ 4,216,808 $ 3,635,518 $ 4,216,808
Table 13-Activity in the Outstanding Accretable Discount on Covered Loans
Accounted for Under ASC 310-30
Quarter ended June 30, Six months ended June 30,
(In thousands) 2012 2011 2012 2011
Beginning balance $ 1,542,519 $ 1,258,176 $ 1,470,259 $ 1,331,108
Accretion [1] (73,988 ) (100,185 ) (143,325 ) (173,117 )
Change in expected cash flows 106,319 458,928 247,916 458,928
Ending balance $ 1,574,850 $ 1,616,919 $ 1,574,850 $ 1,616,919
[1] Positive to earnings, which is included in interest income.
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The higher loan discount accretion in 2011, which is recorded in interest
income, resulted principally from accelerated cash payments collected from a
number of large borrowers, some of which the Corporation had estimated
significantly higher losses. These cash flows resulted in a faster recognition
of the corresponding loan pools' accretable yield. Furthermore, the recasting of
loss estimates for pools accounted under ASC 310-30 during the quarter ended
June 30, 2011 resulted in lower estimated loan losses than originally
anticipated. The reduction in estimated losses increased the accretable yield to
be recognized over the life of the loans. For certain loan pools that reflect
higher loan losses than originally estimated, the increase in loss estimates for
these particular pools are recognized immediately through the provision for loan
losses, but are offset by the 80% loss share agreement. This offset is also
recorded in non-interest income.
Although the reduction in estimated loan losses increases the accretable yield
to be recognized over the life of the loans, it also has the effect of lowering
the realizable value of the loss share asset since the Corporation would receive
fewer FDIC payments under the loss share agreements.
FDIC loss share asset
Table 14 sets forth the activity in the FDIC loss share asset for the six months
ended June 30, 2012.
Table 14-Activity of Loss Share Asset
Six months ended June 30,
(In thousands) 2012 2011
Balance at beginning of year $ 1,915,128 $ 2,410,219
(Amortization) accretion of loss share
indemnification asset, net (66,788 ) 34,433
Credit impairment losses to be covered under loss
sharing agreements 42,848
51,329
Decrease due to reciprocal accounting on the
discount accretion for loans and unfunded
commitments accounted for under ASC Subtopic 310-20 (496 ) (30,003 )
Payments received from FDIC under loss sharing
agreements (262,807 ) (15,694 )
Other adjustments attributable to FDIC loss sharing
agreements 3,709 (5,028 )
Balance at end of period $ 1,631,594 $ 2,445,256
The FDIC loss share indemnification asset is recognized on the same basis as the
assets subject to the loss share protection from the FDIC, except that the
amortization / accretion terms differ. Decreases in expected reimbursements from
the FDIC due to improvements in expected cash flows to be received from
borrowers, as compared with the initial estimates, are recognized as a reduction
to non-interest income prospectively over the life of the loss share agreements.
This is because the indemnification asset balance is being reduced to the
expected reimbursement amount from the FDIC. Table 15 presents the activity
associated with the outstanding balance of the FDIC loss share asset
amortization (or negative discount) for the periods presented.
Table 15-Activity in the Remaining FDIC Loss Share Asset Discount
Quarter ended June 30, Six months ended June 30,
(In thousands) 2012 2011 2012 2011Balance at beginning of period [1] $ 106,781 $ (113,487 )
$ 117,916 $ (139,283 )
(Amortization of negative discount)
accretion of discount [2] (37,413 ) 8,637 (66,788 ) 34,433
Impact of lower projected losses 51,940 187,546 70,180 187,546
Balance at end of period $ 121,308 $ 82,696 $ 121,308 $ 82,696
[1] Positive balance represents negative discount (debit to assets), while a
negative balance represents a discount (credit to assets).
[2] Amortization results in a negative impact to non-interest income, while a
positive balance results in a positive impact to non-interest income,
particularly FDIC loss share income / expense.
While the Corporation was originally accreting to the future value of the loss
share indemnity asset, the lowered loss estimates in mid-2011 required the
Corporation to amortize the loss share asset to its currently lower expected
collectible balance, thus resulting in negative accretion. Due to the shorter
life of the indemnity asset compared with the expected life of the covered
loans, this negative accretion temporarily offsets the benefit of higher cash
flows accounted through the accretable yield on the loans.
Other real estate owned
Other real estate represents real estate property received in satisfaction of
debt. Collection efforts and a slowdown in OREO sales have led to an increase in
the amount of other real estate owned, which increased in total from $282
million at December 31, 2011 to $352 million at June 30, 2012. Table 16 provides
the activity in other real estate for the six months ended June 30, 2012. The
amounts included as "covered other real estate" are sheltered by the FDIC loss
sharing agreements.
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Table 16-Other Real Estate ("OREO") Activity
For the six months ended June 30, 2012
Non-covered Covered
OREO-commercial Non-covered OREO-commercial Covered
(In thousands) and construction OREO-mortgage and construction OREO-mortgage TotalBalance at beginning of period $ 94,016 $ 78,481
$ 90,097 $ 19,038 $ 281,632
Write-downs in value (8,938 ) (9,928 ) (3,503 ) (377 ) (22,746 )
Additions 62,367 54,569 34,183 5,858 156,977
Sales (24,261 ) (18,745 ) (17,249 ) (2,973 ) (63,228 )
Other adjustments (165 ) (767 ) 165 (146 ) (913 )
Ending balance $ 123,019 $ 103,610 $ 103,693 $ 21,400 $ 351,722
Other assets
Table 17 provides a breakdown of the principal categories that comprise the
caption of "Other assets" in the consolidated statements of condition at
June 30, 2012 and December 31, 2011.
Table 17-Breakdown of Other Assets
(In thousands) June 30, 2012 December 31, 2011 Variance
Net deferred tax assets (net of
valuation allowance) $ 572,744 $ 429,691 $ 143,053
Investments under the equity method 223,960 313,152 (89,192 )
Bank-owned life insurance program 231,428 238,077 (6,649 )
Prepaid FDIC insurance assessment 32,617 58,082 (25,465 )
Prepaid taxes 107,827 17,441 90,386
Other prepaid expenses 56,063 59,894 (3,831 )
Derivative assets 53,244 61,886 (8,642 )
Trades receivables from brokers and
counterparties 87,774 69,535 18,239
Others 212,137 214,635 (2,498 )
Total other assets $ 1,577,794 $ 1,462,393 $ 115,401
The increase in other assets from December 31, 2011 to June 30, 2012 reflects an
increase in net deferred tax assets mainly due to the reduction in the deferred
tax liability of $72.9 million associated with the tax treatment of the loans
acquired in the Westernbank FDIC-assisted transaction since the gains resulting
from such loans will be taxed at the capital gain tax rate of 15% instead of the
ordinary income tax rate of 30%. Also, as part of the previously mentioned
Closing Agreement, the P.R. Treasury and the Corporation agreed that for tax
purposes the deductions related to previously recognized charge-offs originated
from the Westernbank FDIC-assisted transaction for the years 2010 through May
2012 will be deferred until years 2017 to 2020. As a result of this aspect of
the Closing Agreement, the Corporation made a payment of $45.5 million to the
P.R. Treasury and recorded an increase in the deferred tax asset in June 2012.
The increase in prepaid taxes was principally associated with the tax prepayment
on the estimated capital gains of the Westernbank acquired loans which is
further described in Note 29 to the consolidated financial statements. These
increases were partially offset by lower investments accounted for under the
equity method, mainly due to the previously mentioned cash dividend received
from EVERTEC's parent company of $131 million which reduced the Corporation's
equity investment in the entity, partially offset by the impact of the
Corporation's share in earnings of various equity method investees and a
reduction in the negative impact of intra-entity eliminations for loans and
deposits between the Corporation and the investees. Additionally, there was a
reduction in the prepaid FDIC insurance assessment from the end of 2011 to
June 30, 2012 due to amortization.
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Deposits and Borrowings
The composition of the Corporation's financing sources to total assets at
June 30, 2012 and December 31, 2011 is included in Table 18.
Table 18-Financing to Total Assets
June 30, December 31, % increase (decrease) % of total assets
(In millions) 2012 2011 from 2011 to 2012 2012 2011Non-interest bearing deposits $ 5,579 $ 5,655
(1.3 )% 15.2 % 15.1 %
Interest-bearing core deposits 16,179 15,690 3.1 44.2 42.0
Other interest-bearing deposits 5,657 6,597 (14.2 ) 15.5 17.7
Repurchase agreements 1,427 2,141 (33.3 ) 3.9 5.7
Other short-term borrowings 316 296 6.8 0.9 0.8
Notes payable 1,878 1,856 1.2 5.1 5.0
Others 1,555 1,194 30.2 4.2 3.2
Stockholders' equity 4,021 3,919 2.6 11.0 10.5
Deposits
A breakdown of the Corporation's deposits at period-end is included in Table 19.
Table 19-Deposits Ending Balances
(In thousands) June 30, 2012 December 31, 2011 Variance
Demand deposits [1] $ 6,379,289 $ 6,256,530 $ 122,759
Savings, NOW and money market deposits
(non-brokered) 11,031,476 10,762,869 268,607
Savings, NOW and money market deposits
(brokered) 433,694 212,688 221,006
Time deposits (non-brokered) 6,950,063 7,552,434 (602,371 )
Time deposits (brokered CDs) 2,620,258 3,157,606 (537,348 )
Total deposits $ 27,414,780 $ 27,942,127 $ (527,347 )
[1] Includes interest and non-interest bearing demand deposits.
The increase in demand deposits from December 31, 2011 to June 30, 2012 was
mainly related to higher deposits from governmental agencies and other
commercial accounts, partially offset by lower balance of deposits in trust that
were short-term and were mostly associated with certain Puerto Rico government
bond issuances. The net decrease in brokered deposits was primarily at BPPR. The
Corporation raised brokered deposits in the latter months of 2011 to fund the
repayment of the outstanding balance of the note that was issued to the FDIC as
part of the Westernbank FDIC-assisted transaction. Following the repayment of
the FDIC note, the use of brokered deposits was anticipated to fall and the
funds were replaced with FHLB advances. The decrease in non-brokered time
deposits was principally at BPPR due to efforts to continue to lower cost of
funds. Despite the decrease, the Corporation has successfully maintained the
Corporation's main relationships and has been able to substitute funds with
other deposit types at lower rates. Also, lower deposit costs have contributed
favorably to maintain the Corporation's net interest margin above 4%. These
decreases were partially offset by an increase of savings, NOW and money market
deposits, both from the retail and commercial sectors.
Borrowings
The Corporation's borrowings amounted to $3.6 billion at June 30, 2012, compared
with $4.3 billion at December 31, 2011. The decrease from December 31, 2011 to
June 30, 2012 was related to lower financing through repurchase agreements by
$714 million,
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which included the previously mentioned early extinguishment of $350 million in
repurchase agreements. Refer to Note 14 to the consolidated financial statements
for detailed information on the Corporation's borrowings at June 30, 2012 and
December 31, 2011. Also, refer to the Liquidity section in this MD&A for
additional information on the Corporation's funding sources.
Other liabilities
The increase in other liabilities of $362 million from December 31, 2011 to
June 30, 2012 resulted from an increase in payables due to counterparties from
the cancelation of the repo agreements, including loss on extinguishment and
interest due, since the cash transfer settled shortly after quarter end.
Stockholders' Equity
Stockholders' equity totaled $4.0 billion at June 30, 2012, compared with $3.9
billion at December 31, 2011. The increase was principally due to internal
capital generation. Refer to the consolidated statements of financial condition
and of stockholders' equity for information on the composition of stockholders'
equity. Also, the disclosures of accumulated other comprehensive income, an
integral component of stockholders' equity, are included in the consolidated
statements of comprehensive income.
REGULATORY CAPITAL
The Corporation continues to exceed the well-capitalized guidelines under the
federal banking regulations. The regulatory capital ratios and amounts of total
risk-based capital, Tier 1 risk-based capital and Tier 1 leverage at June 30,
2012 and December 31, 2011 are presented on Table 20. As of such dates, BPPR and
BPNA were well-capitalized.
