Popular Inc

NASDAQ:BPOP

Earnings Call Transcript 2019-Q2

[Operator]

Good day and welcome to the Popular, Inc. Q2 2019 Earnings Conference Call and Webcast. [Operator Instructions] Please note today’s event is being recorded. I would now like to turn the conference over to Mr. Paul Cardillo, Investor Relations Manager at Popular. Please go ahead, sir.

[Paul Cardillo, Investor Relations Manager]

Good morning and thank you for joining us on today’s call. With us today is our CEO, Ignacio Alvarez; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano. They will review our results for the second quarter and then answer your questions. Other members of our management team will also be available during the Q&A session.

Before we start, I would like to remind you that on today’s call we may make forward-looking statements that are based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s earnings press release and are detailed in our SEC filings. You may find today’s press release and our SEC filings on our webpage at popular.com.

I will now turn the call over to our CEO, Ignacio Alvarez.

[Ignacio Alvarez, Chief Executive Officer]

Good morning and thank you for joining the call. We had a very strong second quarter and continue to build upon the success achieved in the first quarter. I will address key events for the quarter, then give an update on our business and provide some thoughts around the environment in Puerto Rico. Carlos will comment on the quarter’s financial results and Lidio will provide an update on credit trends and metrics.

Please turn to Slide 3. We reported quarterly net income of $171 million, which is $3 million higher than last quarter’s net income. This quarter’s results were driven by higher net interest and non-interest income and lower income taxes partially offset by higher expenses and lower revenues for mortgage banking activities. Net interest income was $5 million higher than the previous quarter. While this variance was mainly driven by the impact of 1 more day in the second quarter, our deposit business and lending operation continued to show strength. This was particularly evident in auto and commercial loans. Additionally, we saw higher volume and yield on our investment portfolio. Credit quality results were solid, continuing their positive trend. We saw lower NPLs, inflows and charge-offs compared to the first quarter. Tangible book value per share increased by $2.86 to $51.44.

Now, I would like to give an update on some of the metrics we track and comment on the business environment in Puerto Rico. Please turn to Slide 4. With respect to migration trends, the most recently released passenger data from the San Juan Airport reflects that the net number of people who left the island in the first quarter was approximately 2,000. Excluding the first quarter of 2018 which was substantially impacted by the inflow of people coming back to Puerto Rico following the hurricane, this figure reflects a significant reduction compared to the first quarters of 2015, ‘16 and ‘17 which average out migration of approximately 18,000. In June, total employment, which includes self-employed individuals, was flat both year-to-date and year-over-year. The unemployment rate remained stable in June at 8.4% and is the lowest unemployment rate in Puerto Rico going back at least 55 years. Salaried employment grew increasing by 0.8% year-over-year. Once again this quarter, the improvement was driven by an increase of 3% in private sector jobs offset by a 5% decline in public employment. The auto industry continued to perform well. 52,000 new units have been sold year-to-date through June, up 4% compared to 2018.

Cement sales were down 8% when compared to the first 6 months of 2018, though there was a considerable surge in activity in early 2018 following the hurricane. However, sales have improved sequentially and were 14% higher than the comparable periods in both 2016 and 2017. Internal metrics we track to monitor economic and client activity are also showing encouraging trends. Our customers’ debit and credit card purchases in the second quarter increased by 2% compared to the same period in 2018 and grew 10% sequentially. Consumer loan trends in Puerto Rico have also been favorable, especially auto sector. Mortgage origination trends improved significantly compared to last quarter driven by higher home purchase activity. On the commercial loan side, balances were flat and we expect that incremental lending activities will be tied to the performance of the local economy. Popular’s customers in Puerto Rico have increased by 24,000 since December 2018 and by 71,000 over the past 12 months, including the 30,000 customers that were acquired with the Reliable transaction.

As we have commented before, the sustainability and pace of further progress in the Puerto Rico economy will be heavily dependent on the magnitude and timing of federal funds flowing to the island. The disbursements of these funds have been slower than many had hoped and the local political environment as you know is complicated and uncertain. Given recent events on the island, there will likely be even greater federal oversight and this would probably cause further delays. However, we do not believe that the total amount of recovery funds that ultimately come to Puerto Rico will be reduced.

I will now turn the call over to Carlos who will discuss the financial results in greater detail.

[Carlos Vázquez, Chief Financial Officer]

Thank you, Ignacio. Good morning. Please turn to Slide 5 for second quarter results. Note that the additional information is provided in the appendix to our slide deck. Today’s earnings press release details variances in the first quarter, primarily higher net interest income, lower taxes offset in part by higher operating expenses. Net interest income for the quarter was $476 million, an increase of $5.4 million mostly as a result of having 1 more day in the second quarter, which added $3.7 million.

In Q2, our net interest income benefited from higher commercial loan volumes in the U.S. and consumer loan volumes in Puerto Rico. It also benefited from a higher contribution from a larger investment portfolio driven by an increase in Puerto Rico deposits. This was offset in part by higher cost of deposits in the U.S. and on public deposits in Puerto Rico. We continue to be asset sensitive though the recent expectation of lower interest rates will negatively impact our results. We anticipate that each 25 basis point drop at interest rates will negatively impact our quarterly net interest income by $4 million to $5 million. Other factors like asset mix and the shape of the yield curve will also impact this number.

Our provision for the second quarter was essentially flat. Lidio will expand on credit related matters shortly. The $2 million increase in our non-interest income was primarily driven by a fairly broad-based increase in fees including higher credit card interchange fees, insurance fees, account service charges and trust services. Additionally, we recorded a positive adjustment of $4.4 million resulting from the resolution of amenity claims for previously sold loans. This was somewhat offset by lower income from our mortgage banking activities driven by an unfavorable fair value adjustment on MSRs of $13.4 million in the second quarter resulting from the expectation of lower rates and higher prepayments.

Total operating expenses were $363 million, an increase of $15.6 million from the prior quarter. OREO expenses were down $1.5 million sequentially, reflecting higher gain on sale of properties. Our previously guided level of $10 million per quarter for this expense line has not materialized. However, other expenses have increased slightly to offset that difference. Professional fees were $7.8 million higher in the quarter primarily driven by increased expenditures in regulatory accounting technology and legal fees. Business promotional costs were also higher, reflecting higher seasonal advertising cost and higher consumer reward program expenses. The latter is a result of increased client activity.

Historically, expenses at Popular have experienced some seasonality and should increase as we progress through the year. We reiterate our expectation that average quarterly expenses in 2019 will be approximately $364 million driven mostly by higher technology, regulatory and personnel costs. Obviously, we will strive to beat this number. Our effective tax rate for the quarter was 19%, but this included a benefit of $6.3 million from prior year adjustments. Excluding these adjustments, our effective tax rate was 22% within our 22% to 24% guidance for the full year.

Please turn to Slide 6. Our net interest margin was 4.11%, down 9 basis points from last quarter. Asset yields were down 5 basis points in the quarter primarily due to asset mix. Increased deposits led to an increase in lower yielding money market and investment balances. These higher investment volumes added to our net income but reduced our overall asset yield. Loan yields were down just 2 basis points. Total deposit costs in the quarter increased 4 basis points to 75 basis points. The cost of our interest-bearing deposits was up 5 basis points to 96 basis points mostly due to higher volume and rates for Puerto Rico public sector deposits and higher deposit costs in the U.S. The cost of retail and corporate deposits in Puerto Rico was unchanged from the first quarter.

As Ignacio mentioned earlier, second quarter auto sales in Puerto Rico were strong. Our auto portfolio grew by $83 million in the second quarter. The Puerto Rico mortgage business originated $183 million of loans in the second quarter, increasing by $48 million versus the first quarter. This origination volume is also up from $169 million in the second quarter of 2018 and skewed in favor of existing home purchases. Summarizing the outlook for Popular’s loan portfolios. We continue to anticipate slight growth in overall loan balances for Popular in 2019, with incremental growth in Puerto Rico and positive but slower growth in the U.S.

Please turn to Slide 7. Our capital levels remain strong relative to mainland peer banks as well as with respect to well-capitalized regulatory requirements. Our Common Equity Tier 1 ratio was 16.8%, up from 16.4%. And tangible book value in the quarter increased by $2.86 per share from $48.58 to $51.44. The increase was driven by our quarterly net income and higher realized gains on the investment portfolio, which more than offset the impact of our common and preferred dividend. We will continue to pursue our target of maintaining and improving our double-digit returns on tangible equity.

Earlier this month, the federal banking regulatory agencies issued a final rule that simplified certain regulatory capital requirements. Among other things, this rule that will be effective on April 1, 2020 will relax the limitations on the amount of mortgage servicing assets and certain deferred tax assets allowed at CET1. It will also increase the risk weighting of certain deferred tax assets. On a pro forma basis, as of June 30, 2019, the impact of the final rule would have been a reduction of approximately 55 basis points to Popular’s CET1. Finally, regarding CECL, we are still not in a position to share an estimated effect on our allowance and capital but still hope to share some estimates in the third quarter.

With that, I turn the call over to Lidio.

[Lidio Soriano, Chief Risk Officer]

Thank you, Carlos and good morning. Credit quality results for the second quarter of the year were strong in both our operating markets. In Puerto Rico, credit quality reflects lower non-performing loans, lower non-performing assets, lower NPL inflows and lower net charge-off. We’re encouraged by the trends in our Puerto Rico loan portfolio. In the U.S., credit metrics reflect stable NPLs, stable NPL inflows and stable net charge-offs.

Please turn to Slide #8. At quarter end, our outstanding direct exposure to the Puerto Rico government, municipalities and other instrumentalities was $455 million, flat from the prior quarter. At the end of the quarter, we had no direct exposure to the Puerto Rico central government or its public corporation. Our municipality exposure consists mainly of senior priority loans to a select group of municipalities whose revenues are largely independent of the central government. In most cases, the good faith, credit and unlimited taxing power of each municipality is pledged to the repayment of the loans. 75% of our exposure is to the 4 large municipalities in the San Juan metro area. Our municipal borrowers typically make two payments annually: interest on principal on July 1 and interest on January 1. On July 1, we received the scheduled principal payment of $22 million. We also have indirect lending facilities in which the government acts as a guarantor. The largest such exposure is in the form of residential mortgage loans to individual borrowers in which the government provides a guarantee similar to FHA programs in the U.S.

Turn to Slide #9 to discuss credit metrics for the quarter. Non-performing assets decreased by $28 million on a linked quarter basis from $712 million in the previous quarter to $683 million this quarter. The decrease in non-performing assets was a combination of a decrease of $22 million in non-performing loans and a decrease of $7 million in other real estate homes. Non-performing loans in Puerto Rico decreased by $22 million from the first quarter, driven mainly by lower commercial and mortgage NPLs of $17 million and $9 million, respectively. The decrease in commercial NPLs was mostly due to collection received, while the decrease in mortgage was mostly due to continued improvement in the portfolio after the hurricane. In the U.S., non-performing loans remained flat, up $42 million or 60 basis points of total loans. At the end of the second quarter, the ratio of NPLs to total loans decreased slightly to 2.1% from 2.2% in the previous quarter. The decrease in OREOs was mainly driven by the Puerto Rico mortgage portfolio due to an increase in sales activity.

Please turn to Slide #10 for a summary of the trends in NPL inflows. Compared to the first quarter, NPL inflows, excluding consumer loans decreased by $3 million mostly in the Puerto Rico commercial portfolio, Puerto Rico mortgage inflows for the quarter are at 60% of the levels seen prior to the hurricanes and remain stable, mainly driven by lower early delinquency post moratorium. In the U.S., NPL inflows were $6 million.

Turning to Slide #11, net charge-offs for the quarter amounted to $47 million or annualized 71 basis points of average loans held in portfolio compared to $61 million or 92 basis points in the prior quarter. The decrease in net charge-off was driven by a decrease of $17 million in Puerto Rico, offset in part by an increase of $4 million in the U.S. In Puerto Rico, the decrease is primarily driven by lower commercial net charge-off of $16 million as the prior quarter included a charge-off from a single large relationship. In addition, Puerto Rico mortgage net charge-off decreased by $2 million from the prior quarter and now stand at 56 basis points, the lowest level in years. In the U.S., the increase is primarily driven by charge-off from our taxi medallion portfolio, which has a current value of $32.5 million net of reserves. The allowance for loan losses decreased by $7 million from the previous quarter to $544 million, mainly due to a decrease of $8 million in Puerto Rico, offset in part by an increase of $1 million in the U.S.

The Puerto Rico decrease was primarily attributed to improvements in the loss trends in the mortgage portfolio. The ratio of allowance for loan losses to loans held in portfolio was 2.01% in the second quarter compared to 2.07% in the previous quarter. The ratio of the allowance for loan losses to NPLs held in portfolio stood at 96.3% compared to 93.9% in the previous quarter. The provision for loan losses remained essentially flat at $40 million compared to the prior quarter. In Puerto Rico, the provision decreased by $2 million. While in the U.S., the provision increased by $1 million. To summarize, credit quality results for the second quarter were strong with improvements across all metrics in Puerto Rico and continued stability in the U.S.

With that, I will like to turn the call over to Ignacio for his concluding remarks. Thank you.

[Ignacio Alvarez, Chief Executive Officer]

Thank you, Lidio and Carlos, for your updates. Our robust second quarter results give us momentum as we enter the second half of the year. Our Puerto Rico franchise is extraordinary. We’ve consistently grown our retail and commercial customer base and served nearly 1.8 million customers. However, we do not take our leadership position for granted, and we remain focused on enhancing our customers’ experience across all channels. Our unmatched branch network is enhanced by our innovative digital solution. Approximately 873,000 of our clients are active online, and 78% of these clients use mobile devices to interact with us.

In June this year, 51% of our deposit transactions in Puerto Rico were processed through smart ATMs and mobile devices, a figure that has been growing consistently. The breadth and depth of our retail and commercial product offerings in Puerto Rico allow us to meet the evolving banking needs of our customers. Our operation in the mainland United States, while more focused, provides a diversification to our footprint. We have a strong commercial lending unit that is complemented by 2 specialized national lending businesses: condo association banking and health care. Our investments in Evertec and BHD León continue to contribute to earnings and represent unrecognized investment value. We are energized by our results and remain focused on enhancing shareholder value.

We are now ready to answer your questions.

[Operator]

[Operator Instructions] Today’s first question comes from Brett Rabatin of Piper Jaffray please go ahead.

[Brett Rabatin, Piper Jaffray]

Hey good morning everyone

[Carlos Vázquez, Chief Financial Officer]

Good morning.

[Brett Rabatin, Piper Jaffray]

Wanted to first ask the narrative was kind of supposed to be that the commercial book was growing more in Puerto Rico versus maybe a pullback in the U.S. just given relative pricing. And what you were seeing this quarter, the growth was actually in the U.S. on the commercial side. And I am curious if that was in the condo health care sector that you mentioned. And then maybe just some color around the commercial book in Puerto Rico linked quarter – what affected the linked quarter change in the balances?

[Carlos Vázquez, Chief Financial Officer]

The narrative, as you described it, of growth in Puerto Rico, we expect it to actually be in different sectors. But its not going to be in every sector, every quarter, Brett. We’ve had very consistent contribution from the auto sector, almost every quarter. Last quarter, our commercial grew. This quarter was sort of flattish. That in a given quarter may be simply be a reflection of prepayments and payments like clients and anything else, not necessarily a reflection on origination. But the important point is that we are seeing the portfolio in Puerto Rico grow overall. And the contributions will shift from quarter-to-quarter between different segments. In the U.S., we comment that in the last quarter that commercial growth had been slower. There was a little bit of catch-up in the second quarter. So it was a strong second quarter. But for the year in full, we’re still running at a slightly slower pace than we were if you look at the prior quarter/year and the average of the last couple of years. So that’s what we’re trying to say when we mention slightly lower growth in the U.S. If you look at the pace where we have been running, ‘17 and ‘18, was 6%, 7% per quarter. We’re still growing healthily but at a slower pace than that.

[Brett Rabatin, Piper Jaffray]

Okay. Appreciate the color there. And then just around the margin. Carlos, you gave the guidance, $4 million to $5 million for 25 basis points. But you’ve also got – to continue to elevate government deposits, and you’ve obviously taken some action on the securities portfolio. One, can you walk through what you did in the securities book this quarter? And then just maybe give us some thoughts on the margin itself. Like are you going to try and manage that to flattish with balance sheet actions? Are you more trying to grow NII? What’s your thoughts on how you’re going to manage the balance sheet relative to what we’re seeing with rates?

[Carlos Vázquez, Chief Financial Officer]

Yes. You can see this quarter, there was a shift from cash to investments. That is in big part driven by our tax strategy. It is actually a lot more tax effective for us to hold treasury security and government security than it is to hold cash. So we did move some cash to investments. It should not be assumed that, that move implies a significant extension in our investment portfolio because it doesn’t allow that. It’s still in shorter-term, a term instrument. So it was a shift that, more than anything, responded to our tax position as opposed to a change in view. We have since the perception of future rate change a few months back, we actually started last year as the perception of rates started changing last year. We have been reducing our asset sensitivity over time slowly. But we tend not to make big bets in any of directions. So it is our path. We’re moving to a – closer to a neutral position, but we tend to do that through our business, right, instead of – as you know, we are not a big derivative house. We don’t have a big trading portfolio. So we just manage that through our business, and that means that it might take a bit more time.

[Brett Rabatin, Piper Jaffray]

Okay. And then maybe just lastly, from a macro perspective, it looks like the government might resign this week and maybe the Justice Secretary as well, which would make the Education Secretary Governor. Can you just talk about what you’re seeing in terms of the macro environment? And then you mentioned that you had confidence there wouldn’t be any reduction in the flows to the island. Can you just walk us through that?

[Ignacio Alvarez, Chief Executive Officer]

Oh, yes. This is Ignacio. I mean, obviously, we’ve lived through a lot of political uncertainty in the last 2 weeks in Puerto Rico. We do not believe that it should have a permanent impact on the macro environment of Puerto Rico. We haven’t seen it yet. Obviously, there have been some short-term disruptions, especially in old San Juan, where some of the cruise ships have not been able to dock. And obviously, the – people have not gone to old San Juan as they normally go because of the disruption. I think that as long – there’s a lot of rumors circulating. I think we are in the beginning of a transition period. I think what’s important is that, that transition be orderly, it’d be done according with our constitutional norms and that we cooperate to make sure that in an uncertain – this is a new playing ground for all of us. This is new ground for us that we try to stick to the constitutional norms and do it as an orderly process as possible. I believe if we do so, the economy will not suffer permanent damage. I believe that most people in the U.S. and the Congress in the U.S. government do not want to punish the Puerto Rico people. So not withstanding the, perhaps, the deficiencies of our – some of our leadership, I don’t believe there is a will in Congress to hurt the Puerto Rico people. We will see more oversight. That oversight may cause some delays, but at least I have not heard anyone saying we’re going to cut off recovery funds to Puerto Rico.

[Brett Rabatin, Piper Jaffray]

Okay, great. Thanks for all the commentary

[Operator]

And our next question today comes from Alex Twerdahl of Sandler O’Neill.

[Alex Twerdahl, Sandler O’Neill]

Hey good morning guys.

[Carlos Vázquez, Chief Financial Officer]

Morning

[Alex Twerdahl, Sandler O’Neill]

Just first off, I wanted to ask about capital and capital return and a couple of sort of notable events that happened during the quarter. One is the CCAR banks released their results, and it seems like the ask in granting of capital return is bigger this year than in past years. And the other being the big merger of 2 other banks on the island that brought – it’s going to bring, I guess, pro forma of the Common Equity Tier 1 ratio of the bank that will be the ongoing entity down to around 11.5%. So I am just wondering if those 2 items, either taken together or separately, change your guided outlook on your capital return ask or the thought process or methodology in any way?

[Carlos Vázquez, Chief Financial Officer]

Yes. Alex. This is Carlos. A couple of things. First of all, we have described before what we think is going to be our timing with regards to capital return. And at this point in time, we have no reason to change our expectation on that. And that, as you’ll recall, is that we are wrapping up our stress testing models. We will then engage with our regulators in the next few weeks. And we would hope that, as it has been in the past, in the last couple of years, take out the hurricane of course, that we can be in a position to announce something in the first part of next year. So we don’t expect the timetable to change at this point in time. We are sitting at a healthy capital position, CET1 of 16.8%, as we discussed in the call. Our view also has not changed that we have hurdles before. It would be our goal over time for our capital ratios to move in the direction of our mainland peer banks. But that will happen over time. We will probably always operate at a cushion above our mainland peer banks because we do have unique characteristics to our business, including geographic concentration. So if you think our peer banks are 11 or 12 or whatever you think that number is, we’ll probably always operate at a cushion over that. So we still hope to over time move in the direction of our mainland peers. Now we do suffer a little bit of a rich man’s problem that we keep adding a lot of capital to our capital every quarter. So it’s actually not easy for us to move our capital in that direction. But that will be our intent. And to achieve that, we will have to use all levers. We will have to hopefully keep and increase our capital return, both dividends and buybacks over time. We hopefully can get some organic growth. That will be the best deployment of capital possible. We will hopefully continue to get opportunities to purchase assets. And at some point of time, we may actually also look at [indiscernible] opportunities as well. So, all the levers will need to be put to work for us to achieve our goal to move in the direction of our mainland peers.

[Alex Twerdahl, Sandler O’Neill]

Okay. And then a question for Lidio, just as it kind of relates to all the macro commentary in Puerto Rico, it seems like a lot of the metrics that you guys are citing are moving in the right direction and improving. Can you just talk about for the general reserve, for the methodology and sort of the pieces tied to the economy, when does that get updated? And has there been enough improvement in the outlook to potentially reduce the component associated with the economy at some point in the near future?

[Lidio Soriano, Chief Risk Officer]

It gets updated on a quarterly basis. If you see the trend, I mean, we are, to a certain extent, looking at a provision that is residual, the allowance to certain extent. We’re back to a level that we have prior to the hurricane. We had – there was a dislocation during the hurricane, which was significant increase of reserve given what we thought was going to be some of the aftermath of the hurricane. We draw down that – most of our reserve into 2018. And you’ve seen the first 2 quarters of 2019, the provision that is similar to provision that we have prior to the hurricane. The allowance was draw down as a result of that process. This quarter, we saw a slight decrease in allowance driven by continued improvement in the loss trends of the mortgage portfolio. So I think on a going forward basis...

[Technical Difficulty]

[Operator]

Thank you for holding everyone. We have reconnected the speaker location. Mr. Twerdahl, if you can now continue with your question, sir?

[Lidio Soriano, Chief Risk Officer]

I hope you got all of that, Alex.

[Ignacio Alvarez, Chief Executive Officer]

It might be something you said, Alex. [indiscernible]

[Alex Twerdahl, Sandler O’Neill]

I have to but literally you’re in the middle of talking about the reserve methodology and what you’re seeing. And I think you kind of left off with the levels today or back to where they were pre-hurricane?

[Lidio Soriano, Chief Risk Officer]

I think I said that when looking at this quarter specifically, there was a small decrease in the provision related to continued improvement in the loss trends in the mortgage portfolio. In the Puerto Rico, I think, on a going forward basis that is going to what’s going to drive, more than anything, the performance of our portfolio. Although the future is rather short because then we have the beautiful CECL to account for in early 2020.

[Alex Twerdahl, Sandler O’Neill]

Okay thanks for that. And then just one final for me, could you guys estimate or give us some sort of ballpark in terms of the size of the total Puerto Rico government deposits that are currently on the balance sheet? And while we’ve been on this call, a headline has come across saying that the Puerto Rico judge imposes a 120-day hault to the bankruptcy litigation. Is that going to, do you think, extend the time at which those deposits would, therefore, be on your balance sheet?

[Ignacio Alvarez, Chief Executive Officer]

Well, maybe. I think the uncertainty in Puerto Rico and the fact they were going to have a transition may result in some delay in some of these proceedings. It’s hard for us to predict it, certainly not going to accelerate the process. Yes, I think I’m getting here some information from our general counsel. They’ve basically said the hault is a call for the judge to try to mediate for the party to voluntarily mediates some of the disputes, which is not which is normally something judges do.

[Carlos Vázquez, Chief Financial Officer]

And answering the other part of your question, Alex, the second quarter is, tends to be the peak level of deposits for Puerto Rico government. So that is when the vast majority of tax receipts occur. And that was true that seems to be true this year as well. So, our balance is going up slightly. I think there were about $9 billion at the end of the first quarter. There are probably about $10 billion now. At this, we would expect, as we mentioned before that through this year, those balances will come down. Exactly the rate on which they come down is hard to figure out, but that continues to be our expectations.

[Alex Twerdahl, Sandler O’Neill]

Thanks for taking my questions.

[Operator]

And our next question today comes from Scott Valentin of Compass Point. Please go ahead.

[Scott Valentin, Compass Point]

Good morning everyone. Thanks for taking my question. Just wondering in terms of loan growth, I think in the past you’ve cited Puerto Rico mortgage demand or originations as being a key indicator for the health of the economy. I think the numbers you guys provided earlier showed pretty good growth in year-over-year originations. I mean, do you think we finally turned the corner in terms of the mortgage loan growth for Puerto Rico?

[Carlos Vázquez, Chief Financial Officer]

Yes. I mean, I think I’m not sure I would hone in on the mortgage, originations or loan as an indicator because that’s a complex record system and the present mortgage rates and home prices and employment, a bunch of other things. I think I would sort of step backwards a little bit and look at the overall portfolio. As I mentioned earlier, we are seeing nice, healthy demand and increase in our portfolio. It will not necessarily be in any given segment, any given quarter. There is even seasonality in the mortgage demand and tends to be slow in some quarters and better in others. So, I will probably look at the summation of the pieces as opposed to any one piece as an indicator.

[Scott Valentin, Compass Point]

Okay. And then regarding the two commercial verticals you called out, the healthcare and the condo. Can you go into more detail about exactly where in health care you guys are finding opportunities? Is it, commercial real estate or is it C&I? And then the condo, maybe the geography and maybe types of credits you guys are doing?

[Ignacio Alvarez, Chief Executive Officer]

No. I think in the condo, we are basically, in our biggest estate is Florida, obviously. And that’s where our condo association business is located, our team. But we operate in over 22 or 23 states. So, we have businesses across the U.S. And most of these are loans to the associations to make repairs. So, they usually have a term. And the business is a very good business because it’s self-funded. We have more deposits than we I think we the last time I checked, we had close to $1 billion deposits, and our loans were about $600 million I think, around there, $600 million, $700 million. So, it’s a very good business. And basically, our health care business is basically, I guess, what we call assisted facilities where you come out of rehab, you go to the hospital and you get your knee operated, you have to spend some time in between. So that’s mostly we do. Those are classified as commercial real estate loans because normally the operator and the owner of the property are different. But really the risk is very different. And that business is a national business, mostly in New York, I would say, but we do have national facility.

[Scott Valentin, Compass Point]

Okay. Thanks for that color.

[Operator]

And our next question today comes from Glen Manna of Keefe, Bruyette & Woods. Please go ahead.

[Glen Manna, Keefe, Bruyette, & Woods]

Hi good morning.

[Ignacio Alvarez, Chief Executive Officer]

Good morning.

[Glen Manna, Keefe, Bruyette, & Woods]

I know late in the cycle, the public deposit, the betas had reached a point where they were 100%. You were passing through all the rate hikes. If we’re on the cusp of an easing cycle, what can we expect for the beta on the downside in the first couple of cuts?

[Carlos Vázquez, Chief Financial Officer]

Yes. I mean, I think the beta in public deposits continues to be close to 1. So those will move very close to moving rate. We have other deposits mostly in our U.S. operation that also have recently high betas. But I expect probably those to move with some lag. So, the movement in the rest of our higher beta deposit books will probably be less obvious because those will move with lags as rates come down.

[Glen Manna, Keefe, Bruyette, & Woods]

And given the Reliable acquisition and accretable yield, do you have the number of what was in accreatable yields for the second quarter?

[Carlos Vázquez, Chief Financial Officer]

You mean the amortization and the discount in the second quarter?

[Glen Manna, Keefe, Bruyette, & Woods]

Yes, the accretion into NII?

[Carlos Vázquez, Chief Financial Officer]

Around $10 million.

[Glen Manna, Keefe, Bruyette, & Woods]

Okay. And just last question. I guess, it’s kind of bigger picture. We’re past the point where, I guess, some of your commercial customers probably had to send in their financial statements to pay for their lending files. When you talk to your commercial lenders, what do they say the commercial customers’ balance sheets look like? We’re a year after the storm, and presumably there’s some kind of stimulus going on. What are they saying about the condition of those customers?

[Ignacio Alvarez, Chief Executive Officer]

Yes. I’ll let Lidio put more color, but obviously it depends on the sector. I think you, say, if you’re in the building and the construction sector, they’re doing better. I think the tourism sector in general is doing better. Many of the service industry is doing better. [indiscernible] retail, it’s probably, although retail sales have picked up, retail, like everywhere in the world, is tough. So, I think really depends around the sector. I mean, in general, the macroeconomic situation is better. People have better balance sheets, but it really depends on the sector and the particular client. And now Lidio is going to add some color.

[Lidio Soriano, Chief Risk Officer]

I would say that on general terms, the classification of our commercial portfolio has improved over time. And that reflects the improvement in the financials of our clients. So generally, it will show improvements.

[Glen Manna, Keefe, Bruyette, & Woods]

Okay thank you for taking my questions.

[Operator]

And our next question today comes from Joe Gladue of Alden Securities. Please go ahead.

[Joe Gladue, Alden Securities]

Hi good morning. I just wondered if you could comment on pending further consolidation in the banking market in Puerto Rico. Does it bring any significant opportunities in any particular areas? And does it change some of the any of the competitive pricing environment on the island?

[Ignacio Alvarez, Chief Executive Officer]

No. I think Puerto Rico is a competitive market, and I think that the Oriental was a very competitive player before. And I think they’ll continue to be competitive. Obviously, consolidations always bring opportunities. As 2 institutions meet, there may be reasons why clients who were at one institution that don’t want to stay at the other institution. So, we’re always looking to pick up new clients and new business. But we think Puerto Rico remain a very competitive market. I think the consolidation is good for Puerto Rico. It’s good to have perhaps less banks but stronger banks that are committed to the market. And so, I think it will be good. We’ll be looking out for the opportunities, the consolidated, and you may want to [indiscernible] some assets, there is always these kinds of things always bring opportunities, and we’ll be looking to see what they bring. But I think in general, it will be good for the market.

[Joe Gladue, Alden Securities]

Okay alright. Thank you.

[Operator]

And our next question is a follow-up from Brett Rabatin of Piper Jaffray. Please go ahead.

[Brett Rabatin, Piper Jaffray]

Hi. Just wanted to follow-up on the fee income and particularly insurance and card were strong this quarter. Can you give us some thoughts on the outlook for those in the back half of the year? I know insurance is somewhat seasonal, but just give us some thoughts on fee income and but just also thinking mortgage might perform better. Obviously, the results were negative or impacted by the MSR. But just wanted to talk about fee income a little bit and how you think about the outlook for the back half of the year.

[Carlos Vázquez, Chief Financial Officer]

If you look at the different mortgage lines in our press release and you skip for a moment the MSR one, you will see they are quite consistent. Most of the mortgage lines are actually very consistent as we go along. But that will probably continue to be the case. The MSR is going to be whatever it is. That is pretty tougher one to manage obviously. A lot of the fee income will be transactional. So, as transactions keep growing, those lines will continue to have positive variances. On the insurance specifically as you mentioned, there is some seasonality there because we receive contingent commissions a couple of times a year, and those tend to happen in the second and the fourth quarter. So that specific one, nothing else changes, we’re probably going to be a bit lower in the third quarter. And there is a reasonable chance that if the insurance portfolios are performing well, the fourth quarter may be a little bit better again.

[Brett Rabatin, Piper Jaffray]

Okay. And then Carlos, absent finding pools of loans or things to purchase, if your payout ratio isn’t going to approach 100%, how do you think about capital if it builds over the next year? What levers might you pull to deploy the capital or the balance sheet or other?

[Carlos Vázquez, Chief Financial Officer]

I think we’re going to try to use all of it, as I mentioned earlier, from capital distribution to asset purchases. Hopefully, the one that we are most hopeful on is organic growth. We can get organic growth, especially in Puerto Rico. That is by far the best deployment of capital because it’s our highest-margin business. But it’s going to have to be all of the above. Again, we have a little bit of rich man’s problem that we keep adding to the pool of capital held every quarter. So, it makes our challenge to move with the direction of our mainland peers a tough challenge.

[Brett Rabatin, Piper Jaffray]

Okay. And then maybe just one other one, I think last quarter we asked Lidio about provisioning and how we thought about it and if there was anything that he saw that might change the path that we’ve seen for Q1. And it didn’t happen in 2Q like you said it wouldn’t. Is there anything in the back half of the year that might change the provisioning a little?

[Lidio Soriano, Chief Risk Officer]

It’s tough to predict what will happen in the future. But given what we see in terms of NPL formation, early delinquency, we don’t see anything that could change the recent trend.

[Brett Rabatin, Piper Jaffray]

Okay great. Thanks for additional color.

[Operator]

And ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks.

[Ignacio Alvarez, Chief Executive Officer]

Thank you for joining us today and for your questions. The second quarter was another strong one for us, and we are very pleased with our results. We will build on that momentum and update you on our progress in October. Thank you for joining the call.

[Carlos Vázquez, Chief Financial Officer]

Thank you.

[Operator]

And thank you, sir. We thank everyone for their attendance today. You may now disconnect your lines, and have a wonderful day.