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BPOP > SEC Filings for BPOP > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for POPULAR INC


8-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 third quarter of 2012, which marks the seventh consecutive profitable quarter for the Corporation. Net income amounted to $47.2 million for the quarter ended September 30, 2012, compared with net income of $27.5 million for the same quarter of the previous year. For the nine months ended September 30, 2012, net income amounted to $161.3 million, compared with net income of $148.4 million for the same period in 2011.


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Main events for the quarter ended September 30, 2012

Credit quality metrics of the non-covered loan portfolio continued to improve during the third quarter of 2012. Non-performing assets declined by $57 million or 3% to $1.9 billion from June 30, 2012, down 22% from its peak in the third quarter of 2010, and were at their lowest level since the second quarter of 2009. This decline was primarily attributable to a decline in non-performing loans held-for-sale by $70 million or 39% from June 30, 2012. In addition, net charge-offs declined for the fourth consecutive quarter.

Taxable equivalent net interest margin increased to 4.50% for the quarter ended September 30, 2012, from 4.43% for the quarter ended June 30, 2012. The improvement in margin was driven largely by reduced funding costs. During the second quarter of 2012 BPPR canceled $350 million of structured repurchase agreements and recorded $25 million in prepayment expense. The Corporation replaced high-cost structured repurchase agreements and maturing brokered deposits with short-term borrowings at lower costs.

The discussion that follows provides highlights of the Corporation's results of operations for the quarter ended September 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 September 30, 2012

Taxable equivalent net interest income was $343.4 million for the third quarter of 2012, down $25.9 million, or 7%, from the same quarter of the prior year. The 6-basis-point decrease in the net interest margin from 4.56% to 4.50% was mainly attributable to a lower average yield in earning assets by 38 basis points primarily in covered loans due to the resolution of certain commercial loans during 2011; non-covered mortgage loans resulting mainly from purchases and originations under a lower interest rate scenario; and investment securities as a result of higher prepayment activity and reinvestments at a lower rate; partially offset by a decrease in the cost of funds by 32 basis points, mainly from deposits and other short-term borrowings as a result of the Corporation's strategy to continue to reduce its funding costs. In addition, the full repayment of the FDIC note during 2011 and the early cancellation of high-cost repurchase agreements during the second quarter contributed to the decrease in interest expense. 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.

The Corporation continued its improvement in credit quality in both the Puerto Rico and U.S. mainland operations, which was reflected in improved credit metrics, such as the level of net charge-offs and non-performing loans, during the third quarter of the current year. Net charge-offs in the third quarter were at the lowest level since the first quarter of 2008. Also, non-performing loans held-in-portfolio were 34% lower than peak levels in the third quarter of 2010.

Provision for loan losses decreased by $70.1 million or 40% for the third quarter of 2012 compared with the same quarter of the previous year, principally in the non-covered loan portfolio. The provision for loan losses for non-covered loans for the third quarter of 2012 reflected lower net charge-offs by $39.4 million in both the P.R. and U.S. mainland operations, including reductions in all non-covered loan portfolio categories except for the mortgage loan category which experienced higher reserve requirements prompted by higher loss trends and higher specific reserves for loans restructured under loss mitigation programs. During the quarter, there was also 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, which was partially offset by the previously mentioned increase in general and specific reserves in the mortgage loan portfolio. During the third quarter of 2012, the annualized net charge-offs to average non-covered loans held-in-portfolio ratio fell to 1.92% in Puerto Rico and to 1.74% in the U.S. mainland operations from 2.49% and 3.00%, respectively, during the quarter ended September 30, 2011.

In addition, the non-covered non-performing loan portfolio declined by $187 million to $1.6 billion, down 11% from December 31, 2011, mainly due to improvements in all loan categories. Non-performing loans held-for-sale, excluding covered loans, also declined by $153 million or 58% from December 31, 2011 driven principally by certain construction loans in the BPPR reportable segment which were resolved.

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 3.07% at September 30, 2012. The general and specific reserves related to non-covered loans amounted to $529 million and $107 million, respectively, at September 30, 2012, compared


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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 reserves in the residential loan portfolio of the BPPR reportable segment. The increase in the specific reserves of the residential loan portfolio of the BPPR reportable segment was mainly the result of loans restructured under loss mitigation programs.

Non-interest income decreased by $6.7 million or 5% to $115.7 million for the quarter ended September 30, 2012, compared with $122.4 million for the same quarter in the previous year. This decrease was the result of the $8.5 million gain on sale of available-for-sale FHLB notes during the third quarter of 2011 and higher trading account losses by $5.2 million on mortgage-backed securities, partially offset by higher other operating income by $6.5 million mostly resulting from lower net losses on equity-method investments, net of intra-entity eliminations. 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 $8.0 million or 3% for the third quarter of 2012, when compared with the same quarter of the previous year, principally due to higher professional fees by $4.7 million due to loan collection efforts and higher OREO expenses by $2.7 million related to higher subsequent fair value adjustments on commercial and construction properties. 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.

Income tax expense amounted to $15.4 million for the quarter ended September 30, 2012, compared with an income tax expense of $5.5 million for the same period of the previous year, primarily due to higher income recognized by the Puerto Rico operations. Refer to the Income Taxes section of this MD&A for additional factors that affected this variance.

Total assets amounted to $36.5 billion at September 30, 2012, compared with $37.3 billion at December 31, 2011. Money market investments declined by $451 million mainly as a result of a decrease in excess balances held at the Federal Reserve. In addition, total loans held-in-portfolio declined by $294 million from the end of 2011, principally due to a decline of $445 million in the covered loan portfolio. The non-covered portfolio reflected an increase of $151 million mainly in the mortgage and consumer loan portfolios driven by acquisitions, originations, and loans repurchased from the recourse portfolio during the second and third quarter of the current year, partially offset by decreases in non-covered commercial and legacy loans due to charge-offs and resolutions of non-performing loans.

Deposits amounted to $26.3 billion at September 30, 2012, compared with $27.9 billion at December 31, 2011. The decrease in time deposits of $2.0 billion was principally in brokered and non-brokered certificates of deposit of the BPPR operations. The decrease in brokered and non-brokered deposits resulted from the Corporation's substitution of maturing brokered and non-brokered deposits with short-term borrowings at lower costs. These decreases were partially offset by increases in savings, NOW, and money market deposits by $0.5 billion.

The Corporation's borrowings amounted to $5.0 billion at September 30, 2012, compared with $4.3 billion at December 31, 2011. The increase in borrowings was mainly driven by an increase in other short-term borrowings by $0.9 billion, since the Corporation replaced maturing brokered deposits and time deposits with short term FHLB NY advances at a lower cost.

Stockholders' equity amounted to $4.1 billion at September 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 16.81% at September 30, 2012, from 15.97% at December 31, 2011. Tangible common equity ratio at September 30, 2012 was 9.26%, up from 8.62% at December 31, 2011. Refer to Table 20 for capital ratios and Table 21 for Non-GAAP reconciliations.

Table 1 provides selected financial data and performance indicators for the quarters and nine months ended September 30, 2012 and 2011.

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.


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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 nine months
                                            September 30,       December 31,
(In thousands)                                  2012                2011             Variance             2012              2011            Variance
Money market investments                   $       925,663      $   1,376,174      $   (450,511 )     $  1,053,633      $  1,186,962      $   (133,329 )
Investment and trading securities                5,682,680          5,751,417           (68,737 )        5,681,022         6,355,238          (674,216 )
Loans                                           24,994,769         25,314,392          (319,623 )       24,806,342        25,756,879          (950,537 )
Earning assets                                  31,603,112         32,441,983          (838,871 )       31,540,978        33,299,079        (1,758,101 )
Total assets                                    36,503,366         37,348,432          (845,066 )       36,251,754        38,511,996        (2,260,242 )
Deposits*                                       26,319,499         27,942,127        (1,622,628 )       27,008,008        27,496,340          (488,332 )
Borrowings                                       5,017,141          4,293,669           723,472          4,318,718         6,298,514        (1,979,796 )
Stockholders' equity                             4,068,984          3,918,753           150,231          3,812,486         3,704,105           108,381

* Average deposits exclude average derivatives.

Operating Highlights                                              Third Quarter                           Nine months ended September 30,
(In thousands, except per share information)           2012           2011         Variance           2012              2011           Variance
Net interest income                                  $ 343,426      $ 369,311      $ (25,885 )     $ 1,022,208       $ 1,087,212      $  (65,004 )
Provision for loan losses-non-covered loans             83,589        150,703        (67,114 )         247,846           306,177         (58,331 )
Provision for loan losses-covered loans                 22,619         25,573         (2,954 )          78,284            89,735         (11,451 )
Non-interest income                                    115,709        122,390         (6,681 )         333,341           410,918         (77,577 )
Operating expenses                                     290,355        282,355          8,000           914,401           839,204          75,197

(Loss) income before income tax                         62,572         33,070         29,502           115,018           263,014        (147,996 )
Income tax (benefit) expense                            15,384          5,537          9,847           (46,317 )         114,664        (160,981 )

Net income                                           $  47,188      $  27,533      $  19,655       $   161,335       $   148,350      $   12,985

Net income applicable to common stock                $  46,257      $  26,602      $  19,655       $   158,543       $   145,558      $   12,985

Net income per common share-basic and diluted        $    0.45      $    0.26      $    0.19       $      1.55       $      1.42      $     0.13

                                                  Third Quarter                  Nine months ended September 30,
Selected Statistical Information               2012           2011               2012                      2011
Common Stock Data
Market price
High                                          $ 18.74        $ 28.30        $         23.00           $         35.33
Low                                             13.55          13.70                  13.55                     13.70
End                                             17.45          15.00                  17.45                     15.00
Book value per common share at period end       38.98          38.68                  38.98                     38.68

Profitability Ratios
Return on assets                                 0.52 %         0.29 %                 0.59 %                    0.52 %
Return on common equity                          4.81           2.81                   5.63                      5.33
Net interest spread (taxable equivalent)         4.25           4.30                   4.18                      4.24
Net interest margin (taxable equivalent)         4.50           4.56                   4.45                      4.49

Capitalization Ratios
Average equity to average assets                10.77 %        10.00 %                10.52 %                    9.62 %
Tier I capital to risk-weighted assets          16.81          15.79                  16.81                     15.79
Total capital to risk-weighted assets           18.09          17.07                  18.09                     17.07
Leverage ratio                                  11.40          10.56                  11.40                     10.56


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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 in the first quarter 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


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of the loan portfolio, recent and historical credit and loss trends, current and expected portfolio behavior and economic 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.

Goodwill

The Corporation's goodwill and other identifiable intangible assets having an indefinite useful life are tested for impairment. Intangibles with indefinite lives are evaluated for impairment at least annually and on a more frequent basis if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit.

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