SECURITIES AND EXCHANGE COMMISSION
FORM 10 - Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934
POPULAR, INC.
Popular Center Building209 Muñoz Rivera Avenue, Hato ReySan Juan, Puerto Rico 00918
Registrant’s telephone number, including area code (787) 765-9800
Not Applicable
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
POPULAR, INC.INDEX
Forward-Looking Information. The information included in this Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the adequacy of the allowance for loan losses, the Corporation’s market and liquidity risks and the effect of legal proceedings on Popular, Inc.’s financial condition and results of operations, among others. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may increase,” “may fluctuate,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” and “could.” These forward-looking statements involve certain risks, uncertainties, estimates and assumptions by management. Various factors such as regional and national economic conditions, competitive and regulatory factors, and legislative changes, could cause actual results to differ from those contemplated by such forward-looking statements.
With respect to the adequacy of the allowance for loan losses and market risk, these factors include, among others, the rate of growth in the economy, the relative strength and weakness in the consumer and commercial credit sectors and in the real estate markets, the performance of the stock and bond market and the magnitude of interest rate and foreign currency exchange rate changes. Moreover, the outcome of litigation, as discussed in “Part II, Item I. Legal Proceedings,” is inherently uncertain and depends on judicial interpretations of law and the findings of judges and juries. The Corporation assumes no obligation to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such Statements.
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ITEM 1. FINANCIAL STATEMENTS
The accompanying notes are an integral part of these unaudited consolidated financial statements.
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Disclosure of accumulated other comprehensive income:
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Notes to Unaudited Consolidated Financial Statements
Note 1 – Nature of operations and basis of presentation
Popular, Inc. (the “Corporation”) is a financial holding company offering a full range of financial products and services to consumer and corporate customers through its offices in Puerto Rico, the United States, the Caribbean, including the U.S. and British Virgin Islands, and Central America. The Corporation’s subsidiaries are engaged in the following businesses: commercial banking, auto loans and lease financing, mortgage and consumer lending, broker/dealer activities, retail financial services, insurance agency services and information technology, ATM and data processing services. Note 15 to the unaudited consolidated financial statements present information about the Corporation’s business segments.
The unaudited consolidated financial statements include the accounts of Popular, Inc. and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. These unaudited statements are, in the opinion of management, a fair statement of the results for the periods presented and include all necessary adjustments, of a normal recurring nature, for a fair statement of such results. Certain minor reclassifications have been made to the prior period consolidated financial statements to conform to the 2004 presentation.
Certain information and note disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to the rules and regulations of the Securities and Exchange Commission and, accordingly, these financial statements should be read in conjunction with the audited Consolidated Financial Statements of the Corporation for the year ended December 31, 2003, included in the Corporation’s Annual Report on Form 10-K.
Note 2 – Recent Accounting Developments
FIN No. 46 “Consolidation of Variable Interest Entities”
In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities.” The FASB’s stated intent in issuing FIN No. 46 was to clarify the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 requires an enterprise to consolidate a variable interest entity (as defined in FIN No. 46) if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected returns if they occur, or both.
In December 2003, the FASB issued a revised FIN No. 46 (FIN No. 46R), which attempts to clarify the guidance in the original interpretation. FIN No. 46 applies to variable interest entities created after January 31, 2003. FIN No. 46 also applies to all variable interest entities created prior to February 1, 2003 that are considered to be special-purpose entities (as defined in FIN No. 46R) as of December 31, 2003. FIN No. 46R must be applied to all variable interest entities no later than the end of the first reporting period that ends after March 15, 2004. Certain variable interest entities that are qualifying special purpose entities subject to the reporting requirements for SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” are not required to be consolidated under the provisions of FIN No. 46.
At December 31, 2003, the Corporation had two wholly-owned issuer trusts that issued trust preferred securities (also referred to as “Capital Securities”). Prior to FIN No. 46R, the issuer trusts were consolidated subsidiaries of the Corporation. In relation to these issuer trusts, the Corporation adopted the provisions of FIN No. 46R at December 31, 2003, requiring the deconsolidation of these trusts. Refer to Note 11 to the unaudited consolidated financial statements for further information of the issuer trusts and the impact in the Corporation’s consolidated financial statements. Except for the impact described above, at March 31, 2004, there was no other material impact on the Corporation’s financial condition or results of operations as a result of the adoption of FIN No. 46R.
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SAB 105 “Application of Accounting Principles to Loan Commitments”
On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105) to inform registrants of the Staff’s view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. The adoption of SAB 105 is not expected to have a material impact on the Corporation’s financial condition or results of operations.
Issue 03-1, “Meaning of Other Than Temporary Impairment”
In March 2004, the Emerging Issues Task Force reached a consensus on Issue 03-1, “Meaning of Other Than Temporary Impairment” (Issue 03-1). The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether the investment is impaired. An investment is impaired if its fair value is less than its cost. Step 2: Evaluate whether the impairment is other-than-temporary. Step 3: If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. The three-step model used to determine other-than-temporary impairments shall be applied prospectively to all current and future investments in interim or annual reporting periods beginning after June 15, 2004. The Corporation does not anticipate that the adoption of Issue 03-1 will have a material impact on its financial condition or results of operations.
FASB Staff Position No. FAS 106-1 “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”
On January 12, 2004, the FASB issued FASB Staff Position No. FAS 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (FSP 106-1). FSP 106-1 permits employers that sponsor postretirement benefit plans which provide prescription drug benefits to retirees to make a one-time election to defer accounting for any effects of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “Act”). Without the FSP 106-1, employers would be required under SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” to account for the effects of the Act in the fiscal period that includes December 8, 2003, the date the President of the United States signed the Act into law. If deferral is elected, the deferral must remain in effect until the earlier of (a) the issuance of guidance by the FASB on how to account for the federal subsidy to be provided to plan sponsors under the Act or (b) the remeasurement of plan assets and obligations subsequent to January 31, 2004. FSP 106-1 requires employers to provide certain disclosures, regardless of whether they choose to account, or defer accounting, for the effects of the Act. The Corporation expects that this legislation will eventually reduce the costs in the postretirement benefit plan for at least some of the participants. The Corporation awaits guidance from various governmental and regulatory agencies concerning the requirements that must be met to obtain these cost reductions as well as guidance on the measurement and accounting for such savings. The Corporation has elected to defer the accounting, for any effects of the Act, as permitted by FAS 106-1. Any final guidance, once issued, could require the Corporation to change previously reported information.
Note 3 - Investment Securities Available-For-Sale
The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investment securities where no market quotations are available), and contractual maturities of investment securities available-for-sale as of March 31, 2004, December 31, 2003 and March 31, 2003 were as follows:
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Securities not due on a single contractual maturity date, such as mortgage-backed securities and collateralized mortgage obligations, are classified in the period of final contractual maturity.
The expected maturities of collateralized mortgage obligations, mortgage-backed securities and certain other securities may differ from their contractual maturities because they may be subject to prepayments or callable features.
The following table shows the Corporation’s gross unrealized losses and fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2004:
Available-for-sale securities in an unrealized loss position at March 31, 2004 are primarily U.S. Agency and Treasury obligations, and to a lesser extent, U.S. Agency-issued, collateralized mortgage obligations. The vast majority of them are rated the equivalent of AAA by the major rating agencies. The investment portfolio is structured primarily with highly liquid securities which posses a large and efficient secondary market. Valuations are performed at least on a quarterly basis using third party providers and dealer quotes. Management believes that the unrealized losses in the available-for-sale portfolio at March 31, 2004 are substantially related to market interest rate fluctuations and not deterioration in the creditworthiness of the
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issuer. Also, management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments.
Note 4 - Investment Securities Held-to-Maturity
The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investment securities where no market quotations are available), and contractual maturities of investment securities held-to-maturity as of March 31, 2004, December 31, 2003 and March 31, 2003 were as follows:
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The following table shows the Corporation’s gross unrealized losses and fair value of investment securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2004:
Held-to-maturity securities in an unrealized loss position at March 31, 2004 are primarily U.S. Agency and Treasury obligations, and to a lesser extent, U.S. Agency-issued, collateralized mortgage obligations. The vast majority of them are rated the equivalent of AAA by the major rating agencies. The investment portfolio is structured primarily with highly liquid securities which posses a large and efficient secondary market. Valuations are evaluated at least on a quarterly basis using third party providers and dealer quotes. Management believes that the unrealized losses in the held-to-maturity portfolio at March 31, 2004 are substantially related to market interest rate fluctuations and not deterioration in the creditworthiness of the issuer. Also, management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments.
Note 5 – Pledged assets
Certain securities and loans were pledged to secure public and trust deposits, assets sold under agreements to repurchase, other borrowings and credit facilities available. The classification and carrying amount of the Corporation’s pledged assets, which the secured parties are not permitted to sell or repledge the collateral, were as follows:
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Pledged securities and loans that the creditor has the right by custom or contract to repledge are presented separately in the consolidated statements of condition.
Note 6 – Derivative Instruments and Hedging Activities
In managing its market risk the Corporation enters, to a limited extent, into certain derivative transactions, primarily interest rate swaps, interest rate forwards and future contracts, interest rate caps, index options, foreign exchange contracts and interest-rate caps, floors and options embedded in financial contracts. There were no significant changes in derivative instruments and hedging activities from December 31, 2003 to March 31, 2004.
For the quarters ended March 31, 2004 and March 31, 2003, the Corporation recognized losses of $137 and $10,655, respectively, as a result of the changes in fair value of the non-hedging derivatives included as part of interest expense. The losses recognized in 2003 related mostly to interest rate contracts outstanding with a notional amount of $500,000, which did not qualify as hedges in accordance with SFAS No. 133, as amended. These swap contracts were terminated during the second quarter of 2003.
Note 7 – Goodwill and Other Intangible Assets
The Corporation’s management has defined the reporting units based on legal entity, which is the way that operating decisions are made and performance is measured. For presentation purposes, these reporting units have been aggregated by reportable segments based on the provisions of SFAS No. 131 “Segment Reporting.” These segments have been defined as follows: Commercial Banking, Mortgage and Consumer Lending, Auto and Lease Financing and Other. All the operating segments and components that constitute reporting units were determined evaluating the nature of the products and services offered, types of customers, methods used to distribute their products and provide their services, and the nature of their regulatory environment, as well as other similar economic characteristics. Goodwill is assigned to each reporting unit at the time of acquisition.
The changes in the carrying amount of goodwill for the three months ended March 31, 2004, are as follows:
As of March 31, 2004, December 31, 2003 and March 31, 2003, goodwill totaled $192,174, $191,490 and $184,068, respectively. The Corporation has no other intangible assets not subject to amortization.
The following table reflects the components of other intangible assets subject to amortization as of March 31, 2004, December 31, 2003 and March 31, 2003:
Certain core deposits intangibles became fully amortized during 2003 and, as such, their gross amount and accumulated amortization were eliminated from the accounting records and the tabular disclosure presented above for December 31, 2003.
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During the quarter ended March 31, 2004, the Corporation recognized $1,802 in amortization expense related to other intangible assets with definite lives (March 31, 2003- $2,027).
The following table presents the estimated aggregate annual amortization expense of the intangible assets with definite lives for each of the following fiscal years:
No significant events or circumstances have occurred that would reduce the fair value of any reporting unit below its carrying amount.
Note 8 – Commitments and Contingencies
In the normal course of business there are commercial letters of credit and stand-by letters of credit outstanding, which contract amounts at March 31, 2004 were $17,266 and $153,206, respectively (December 31, 2003 - $13,833 and $137,290; March 31, 2003 - $28,536 and $139,551). There are also other commitments outstanding and contingent liabilities, such as commitments to extend credit and commitments to originate mortgage loans, which are not reflected in the accompanying financial statements.
At March 31, 2004 the Corporation recorded a liability of $295, which represents the fair value of the obligations undertaken in issuing the guarantees under the standby letters of credit issued or modified after December 31, 2002 (December 31, 2003 - $334; March 31, 2003 - $300). This liability was included as part of “other liabilities” in the consolidated statements of condition. The standby letters of credit were issued to guarantee the performance of various customers to third parties. The contract amounts in standby letters of credit outstanding represent the maximum potential amount of future payments the Corporation could be required to make under the guarantees in the event of nonperformance by the customers. These standby letters of credit are used by the customer as a credit enhancement and typically expire without being drawn upon. The Corporation’s standby letters of credit are generally secured, and in the event of nonperformance by the customers, the Corporation has rights to the underlying collateral provided, which normally includes cash and marketable securities, real estate, receivables and others.
At March 31, 2004, the Corporation had various outstanding commitments to purchase mortgage loans from other institutions at market. In 2003, the Corporation entered into loan commitments to purchase an aggregate amount of $275,000 of mortgage loans with the option of purchasing $125,000 in additional loans. The commitments expire completely by June 30, 2005. As of March 31, 2004, $125,000 in loans had been purchased under these agreements.
The Corporation fully and unconditionally guarantees certain borrowing obligations issued by certain of its wholly-owned subsidiaries approximating $3,485,960 at March 31, 2004 (December 31, 2003 - $3,623,787; March 31, 2003 - $3,491,505). In addition, at March 31, 2004, the Corporation fully and unconditionally guaranteed $444,000 of Capital Securities issued by two wholly-owned issuing trust entities that have been deconsolidated based on FIN No. 46R (December 31, 2003 - $444,000; March 31, 2003 - $144,000). Also, at March 31, 2004, Popular North America, Inc. fully and unconditionally guaranteed $400,144 of certain borrowing obligations issued by one of its non-banking subsidiaries (December 31, 2003 - $403,131).
The Corporation is a defendant in a number of legal proceedings arising in the normal course of business. Based on the opinion of legal counsel, management believes that the final disposition of these matters will not have a material
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adverse effect on the Corporation’s financial position or results of operations. Refer to Item 1 – Legal Proceedings in Part II – Other Information in this Form 10-Q for further information.
Note 9 – Stock Option Plan
During the quarter ended March 31, 2004, the Corporation recognized $679 in stock option expense (March 31, 2003 — $727).
The following table presents information on stock options at March 31, 2004:
(Not in thousands)
The following table summarizes the stock option activity and related information:
The stock options exercisable at March 31, 2004 totaled 257,836 (March 31, 2003 - - 116,930).
The fair value of the options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The weighted average assumptions used for the grants issued during 2004 and 2003 were:
Note 10 – Pension and Other Benefits
The Corporation has noncontributory defined benefit pension plans and supplementary pension plans for regular employees of certain of its subsidiaries.
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The components of net periodic pension cost for the quarters ended March 31, 2004 and 2003 were as follows:
The Corporation expects to contribute $1,528 to the pension plans and $769 to the benefit restoration plans during 2004. As of March 31, 2004, no contributions have been made to the pension and restoration plans.
The Corporation also provides certain health care benefits for retired employees of certain subsidiaries. The components of net periodic postretirement benefit cost for the quarters ended March 31, 2004 and 2003 were as follows:
As of March 31, 2004, contributions made to the postretirement benefit plan approximated $1,400. The Corporation presently expects to contribute $6,900 to the postretirement benefit plan during 2004.
During March 2004, the Corporation received authorization from the Federal Reserve Bank of New York on the proposed reorganization to consolidate the information processing and technology functions of both Banco Popular de Puerto Rico and GM Group, Inc. into one organization, EVERTEC, INC. The effective date for the transaction was April 1, 2004. As part of this reorganization, the Corporation incurred certain curtailment gains / losses on the pension and postretirement plans related with the employees that were transferred to the new company and whose benefits were frozen. Also, the Corporation incurred certain costs related to employees of Banco Popular de Puerto Rico who elected early retirement effective March 31, 2004, as part of this reorganization.
Subordinated notes of $125,000 consist of notes issued by the Corporation on December 12, 1995, maturing on December 15, 2005, with interest payable semi-annually at 6.75%.
On October 31, 2003, Popular Capital Trust I, a statutory business trust created under the laws of the State of Delaware that is wholly-owned by the Corporation, sold to institutional and retail investors $300,000 of its 6.70% Cumulative Monthly Income Trust Preferred Securities (liquidation amount twenty-five dollars per Capital Security) (“6.70% Capital Securities”) through certain underwriters. The proceeds of the issuance, together with the proceeds of the purchase by the Corporation of $9,279 of Popular Capital Trust I’s 6.70% common securities (liquidation amount twenty-five dollars per common security) were used to purchase $309,279 aggregate principal amount of the Corporation’s 6.70% Junior Subordinated Deferrable Interest Debentures (the “6.70% Junior Subordinated Debentures”). The 6.70% Capital Securities are fully and unconditionally guaranteed by the Corporation. The assets of Popular Capital Trust I consisted of $309,279 of 6.70% Junior Subordinated Debentures at March 31, 2004 and the related accrued interest receivable. The 6.70% Junior Subordinated Debentures mature on November 1, 2033;
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however, under certain circumstances, the maturity of the Junior Subordinated Debentures may be shortened (which shortening would result in a mandatory redemption of the 6.70% Capital Securities). The 6.70% Capital Securities are traded on the NASDAQ under the symbol “BPOPN”.
On February 5, 1997, BanPonce Trust I, a statutory business trust created under the laws of the State of Delaware that is wholly-owned by Popular North America (PNA) and indirectly wholly-owned by the Corporation, sold to institutional investors $150,000 of its 8.327% Capital Securities Series A (liquidation amount one thousand dollars per Capital Security) (“8.327% Capital Securities”) through certain underwriters. The proceeds of the issuance, together with the proceeds of the purchase by PNA of $4,640 of BanPonce Trust I’s 8.327% common securities (liquidation amount one thousand dollars per common security) were used to purchase $154,640 aggregate principal amount of PNA’s 8.327% Junior Subordinated Deferrable Interest Debentures, Series A (the “8.327% Junior Subordinated Debentures”). As of March 31, 2004, the Corporation had reacquired $6,000 of the 8.327% Capital Securities. The obligations of PNA under the 8.327% Junior Subordinated Debentures and its guarantees of the obligations of BanPonce Trust I are fully and unconditionally guaranteed by the Corporation. The assets of BanPonce Trust I consisted of $148,640 of 8.327% Junior Subordinated Debentures at March 31, 2004 (December 31, 2003 — $148,640; March 31, 2003 — $148,640) and the related accrued interest receivable. The 8.327% Junior Subordinated Debentures mature on February 1, 2027; however, under certain circumstances, the maturity of the 8.327% Junior Subordinated Debentures may be shortened (which shortening would result in a mandatory redemption of the 8.327% Capital Securities).
Prior to FIN No. 46R, the issuer trusts described above were consolidated subsidiaries of the Corporation. The 8.327% Capital Securities were included in the consolidated statement of condition at March 31, 2003 under the caption “Preferred beneficial interest in Popular North America’s junior subordinated deferrable interest debentures guaranteed by the Corporation,” and the retained common capital securities of the issuer trusts were eliminated against the Corporation’s investment in the issuer trust. Distributions on the Capital Securities were recorded as interest expense on the consolidated statements of income.
As a result of the adoption of FIN No. 46R, the Corporation deconsolidated these issuer trusts effective December 31, 2003. The Junior Subordinated Debentures issued by Popular, Inc. and PNA to the issuer trusts, totaling $457,919 are reflected in the Corporation’s consolidated statement of condition at March 31, 2004 and December 31, 2003 under the caption of notes payable. The Corporation recognizes interest expense on the corresponding junior subordinated debentures in the consolidated statement of income. The Corporation also recorded in the caption of other investment securities in the consolidated statement of condition at March 31, 2004 and December 31, 2003, the common securities issued by the issuer trusts.
Note 12 - Stockholders’ Equity
The authorized shares of preferred stock are nonconvertible and are redeemable solely at the option of the Corporation beginning on March 31, 2008. The redemption price per share is $25.50 from March 31, 2008 through March 30, 2009, $25.25 from March 31, 2009 through March 30, 2010 and $25.00 from March 31, 2010 and thereafter. Dividends on the Series A preferred stock are noncumulative and are payable monthly at an annual rate of 6.375% of the liquidation preference value of $25.00 per share.
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Note 13 - Earnings per Common Share
A computation of earnings per common share and diluted earnings per common share follows:
Potential common shares consist of common stock issuable under the assumed exercise of stock options granted under the Corporation’s stock option plan, using the treasury stock method. This method assumes that the potential common shares are issued and the proceeds from exercise in addition to the amount of compensation cost attributed to future services are used to purchase common stock at the exercise date. The difference between the number of potential shares issued and the shares purchased will be added as incremental shares to the actual number of shares outstanding to compute diluted earnings per share. Stock options that result in lower potential shares issued than shares purchased under the treasury stock method are not included in the computation of dilutive earnings per share since their inclusion would have an antidilutive effect in earnings per share.
During the quarter ended March 31, 2004, there were 435,542 weighted average antidilutive stock options outstanding (March 31, 2003 - 425,268).
Note 14 - Supplemental Disclosure on the Consolidated Statements of Cash Flows
During the quarter ended March 31, 2004, the Corporation paid interest and income taxes amounting to $163,210 and $3,420 respectively (2003 – $206,466 and $16,604). In addition, loans receivable transferred to other real estate and other property for the quarter ended March 31, 2004 amounted to $22,007 and $7,283, respectively (2003 - $19,882 and $6,918).
Note 15 - Segment Reporting
Popular, Inc. operates the following reportable segments: commercial banking, mortgage and consumer lending, auto and lease financing, and other. Management has determined its reporting units based on legal entity, which is the way that operating decisions are made and performance is measured. These reporting units have then been aggregated into segments by products, services and markets with similar characteristics.
The Corporation’s commercial banking segment includes all banking subsidiaries, which provide individuals, corporations and institutions with commercial and retail banking services, including loans and deposits, trust, mortgage banking and servicing, asset management, credit cards and other financial services. These services are offered through a delivery system of branches throughout Puerto Rico, the U.S. and British Virgin Islands and the United States.
The Corporation’s mortgage and consumer lending segment includes those non-banking subsidiaries whose principal activity is originating mortgage and consumer loans such as Popular Mortgage, Popular Finance, Equity One, Levitt Mortgage and Popular FS, LLC.
The Corporation’s auto and lease financing segment provides financing for vehicles and equipment through Popular Auto in Puerto Rico and Popular Leasing, USA in the U.S. mainland. The “Other” category includes all holding companies and non-banking subsidiaries which provide insurance agency services, retail financial services, broker/dealer activities, as well as those providing ATM processing services, electronic data processing and consulting services, sale and rental of electronic data processing equipment and selling and maintenance of
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computer software.
The accounting policies of the segments are the same as those followed by the Corporation in the ordinary course of business and conform with generally accepted accounting principles and with general practices within the financial industry. Following are the results of operations and selected financial information by operating segment for the quarters ended March 31, 2004 and 2003.
During the quarter ended March 31, 2004, the Corporation’s parent holding company realized gains on the sale of marketable equity securities of approximately $10,500 ($9,200 after-tax). These gains are included in “other income” within the “other” reportable segment category.
Intersegment Revenues *
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Geographic Information
The following condensed consolidating financial information presents the financial position of Popular, Inc. Holding Company (PIHC) (parent only), Popular International Bank, Inc. (PIBI), Popular North America, Inc. (PNA) and all other subsidiaries of the Corporation as of March 31, 2004, December 31, 2003 and March 31, 2003, and the results of their operations and cash flows for the periods ended March 31, 2004 and 2003. PIBI, PNA, and their wholly-owned subsidiaries, except Banco Popular North America (BPNA) and Banco Popular, National Association (BP, N.A.), have a fiscal year that ends on November 30. Accordingly, the consolidated financial information of PIBI and PNA as of February 29, 2004, November 30, 2003 and February 28, 2003, corresponds to their financial information included in the consolidated financial statements of Popular, Inc. as of March 31, 2004, December 31, 2003 and March 31, 2003, respectively.
PIHC, PIBI and PNA are authorized issuers of debt securities and preferred stock under shelf registrations filed with the SEC.
PIBI is an operating subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries, ATH Costa Rica, CreST, S.A., Popular Insurance V.I., Inc. and PNA.
PNA is an operating subsidiary of PIBI and is the holding company of its wholly-owned subsidiaries, Popular Cash Express, Inc., Equity One, Inc., BPNA, including its wholly-owned subsidiaries Popular Leasing, U.S.A., Popular Insurance Agency, U.S.A. and Popular FS, LLC, and BP, N.A., including its wholly-owned subsidiary Popular Insurance, Inc.
PIHC fully and unconditionally guarantees all registered debt securities and preferred stock issued by PIBI and PNA. The principal source of cash flows for PIHC consists of dividends from Banco Popular de Puerto Rico (BPPR).
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As a member subject to the regulations of the Federal Reserve Board, BPPR must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared by it during the calendar year would exceed the total of its net income for that year, as defined by the Federal Reserve Board, combined with its retained net income for the preceding two years, less any required transfers to surplus or to a fund for the retirement of any preferred stock. The payment of dividends by BPPR may also be affected by other regulatory requirements and policies, such as the maintenance of certain minimum capital levels. At March 31, 2004, BPPR could have declared a dividend of approximately $186,495 without the approval of the Federal Reserve Board.
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONMARCH 31, 2004(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONDECEMBER 31, 2003(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONMARCH 31, 2003(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE QUARTER ENDED MARCH 31, 2004(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE QUARTER ENDED MARCH 31, 2003(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFOR THE QUARTER ENDED MARCH 31, 2004(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFOR THE QUARTER ENDED MARCH 31, 2003(UNAUDITED)
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE AFinancial Highlights
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This financial review contains an analysis of the consolidated financial position and financial performance of Popular, Inc. and its subsidiaries (the Corporation). 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 financial holding company, which offers a wide range of products and services to consumer and corporate customers in Puerto Rico, the United States, the Caribbean and Central America. The Corporation’s subsidiaries are engaged in the following businesses:
2004 FIRST QUARTER HIGHLIGHTS
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CRITICAL ACCOUNTING POLICIES
The accounting policies followed by the Corporation and its subsidiaries, and the methods of applying these policies, conform with generally accepted accounting principles in the United States and to general practices within the financial services industry. The preparation of consolidated financial statements requires management to make judgments in the application of certain of its accounting policies that involve significant estimates and assumptions about the effect of matters that are inherently uncertain and that involve a high degree of subjectivity. These estimates and assumptions 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. The Corporation has identified as critical accounting policies those related to securities’ classification and related values, loans and allowance for loan losses, income taxes, goodwill and other intangible assets, and pension and postretirement benefit obligations. For a summary of the corporation’s critical accounting policies, refer to that particular section in the Management’s Discussion and Analysis included in Popular, Inc.’s 2003 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, 2003. Also, refer to Note 1 to the consolidated financial statements included in said report for a summary of the Corporation’s significant accounting policies, as well as to the accompanying notes to the unaudited consolidated financial statements included in this Form 10-Q. No significant changes in critical accounting policies have occurred since year-end 2003, except for the matter described herein.
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Effective for the quarter ended March 31, 2004, the Corporation adopted the standard industry practice of placing commercial and construction loans on non-accrual status when payments of principal or interest are delinquent 90 days rather than 60 days, its prior practice. Had the Corporation continued reporting commercial and construction loans in non-performing status when delinquent 60 days, non-performing assets would have been $30 million higher than reported in this Form 10-Q for the quarter ended March 31, 2004. The estimated impact of the new adopted practice in the Corporation’s interest income for the quarter ended March 31, 2004 approximated $0.3 million. Refer to the Credit Risk Management and Loan Quality section for a more detailed analysis of the impact of the change in the non-accruing policy for commercial and construction loans.
NET INTEREST INCOME
Net interest income for the quarter ended March 31, 2004 reached $330.7 million, an 11% increase compared with $299.1 million for the same quarter of 2003. On a taxable equivalent basis, net interest income increased to $358.4 million, from $327.0 million in the same quarter of 2003, an improvement of $31.4 million, or 10%.
Table B presents the different components of the Corporation’s net interest income for the quarters ended March 31, 2004 and 2003, segregated by major categories of earning assets and interest bearing liabilities. Some of the assets, mostly investments in obligations of the U.S. Government and the Puerto Rico Commonwealth and its agencies, generate interest, which is partially exempt for income tax purposes, principally in Puerto Rico. Therefore, to facilitate the comparison of all interest data related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates (in Puerto Rico the statutory tax rate is 39%).
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TABLE BANALYSIS OF LEVELS & YIELDS ON A TAXABLE EQUIVALENT BASISQuarter ended March 31, 2004
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.
The improvement in net interest income, on a taxable equivalent basis, for the first quarter of 2004 was attributable mostly to a $3.4 billion increase in average earning assets, compared with the same quarter in 2003. This rise was motivated mainly by an increase of $3.4 billion in the average loan portfolio, principally related to mortgage loans. The increase of $2.5 billion in the average mortgage loan portfolio, compared with the quarter ended March 31, 2003, was mostly due to an increase in loans acquired, which is part of the Corporation’s strategy to grow earning assets prudently and use its capital effectively. Commercial loans also grew on average by $533 million, or 7%. Consumer loans increased by $187 million, mainly in auto loans, while the lease financing portfolio increased on average by 22%, or $197 million, both rises related to campaigns to attract customers and sales efforts. Investment securities rose on average by $116 million, mostly in U.S. Treasury securities and obligations of U.S. agencies and Puerto Rico, states and political subdivisions, partly offset by declines in collateralized mortgage obligations due in part to higher prepayment activity. The trading portfolio increased on average by $71 million, mainly in mortgage-
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backed securities, while money market investments decreased on average by $216 million, mostly in the form of federal funds sold and resale agreements.
The average yield on earning assets, on a taxable equivalent basis, declined 51 basis points from 6.80% in the first quarter of 2003 to 6.29% for the same period in 2004. The average yield on the investment portfolio decreased by 68 basis points, due to prepayments of collateralized mortgage obligations and to the maturities of securities with higher yields that were replaced during a declining interest rate scenario. On the other hand, the yield in the trading portfolio increased by 31 basis points, mainly due to a higher proportion of mortgage-backed securities in the portfolio. The average yield on the loan portfolio decreased by 65 basis points. The commercial loans yield, including construction loans, fell by 51 basis points due to new loan growth and repricing in a declining rate environment. As of March 31, 2004, approximately 57% of the commercial and construction loan portfolios had floating or adjustable rates. The average yield on mortgage loans also declined 66 basis points, mainly due to the current interest rate scenario, higher loan prepayments of high rate mortgages and refinancing at current rates, while the consumer loans yield declined 61 basis points, due in part to the interest rate scenario, coupled with promotional campaigns with lower rates for auto and personal loans. The lease financing yield declined 160 basis points, associated with the rate scenario and with the purchase of approximately $138 million in equipment leases by the Corporation in mid-year 2003, which has a lower average yield than that of the Corporation’s remaining lease financing portfolio.
Interest-bearing liabilities for the first quarter of 2004, increased on average by $2.8 billion, or 10%, compared with the same quarter in 2003. Average interest-bearing deposits increased by $315 million, or 2%, while average borrowings rose by $2.5 billion, or 20%. Savings deposits increased on average by $204 million, while NOW and money market deposits increased by $79 million and time deposits increased by $32 million. Within this latter category, brokered deposits declined on average by $142 million.
Average short-term borrowings, comprised mostly of repurchase agreements and federal funds, decreased by $221 million in the first quarter of 2004, compared with the same quarter in the previous year, while longer-term borrowings increased by $2.7 billion, or 61%. The increase in long-term debt, which is debt with an original maturity of more than one year, was principally due to the issuance of asset-backed securities supported by residential mortgage loans, and to the issuance during 2003 of $1.1 billion in fixed-rate five-year notes and of $300 million in junior subordinated debentures.
The average cost of interest-bearing liabilities for the quarter ended March 31, 2004 declined by 53 basis points, compared with the same quarter of 2003. The principal factors to the decrease were revisions made to interest rates on interest-bearing deposits, and the impact of the low interest rate environment on the repricing of borrowed funds. Also, the first quarter of 2003 was impacted by higher losses related to derivative transactions. Following the guidance in EITF Issue No. 03-11, “Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133 and Not Held for Trading Purposes,” the Corporation included as part of interest expense, $0.1 million and $10.7 million in derivative losses, for the quarters ended March 31, 2004 and 2003, respectively.
The Corporation’s net interest margin, on a taxable equivalent basis, for the first quarter of 2004 decreased by 5 basis points to 4.12%, compared with 4.17% for the same quarter in the previous year. The net interest margin is determined by dividing taxable equivalent net interest income by average earning assets. The net interest spread, which is the difference between the yield on earning assets and the interest rate paid on interest-bearing liabilities, increased by 2 basis points, from 3.74% in the first quarter of 2003 to 3.76% in the same quarter of 2004. The increase in net interest spread, resulted in part from a decrease in the cost of interest-bearing liabilities, partially offset by a reduction in the yield on earning assets. The contraction in the net interest margin for the quarter ended March 31, 2004 was partly attributed to a reduction in the contribution of non-interest bearing funding, which was reduced to 36 basis points in the first quarter of 2004, from 43 basis points in the quarter ended March 31, 2003, despite the benefits of a $0.4 billion increase in average demand deposits and a $0.2 billion increase in other sources of non-interest bearing funds, which include the issuance of preferred stock in 2003.
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PROVISION FOR LOAN LOSSES
The provision for loan losses is the charge to earnings necessary to maintain the allowance for loan losses at a level that reflects management’s assessment of the adequacy to absorb probable losses inherent in the loan portfolio taking into account loan impairment and net charge-offs. The Corporation’s provision for loan losses for the quarter ended March 31, 2004 was $44.7 million, compared with $48.2 million in the first quarter of 2003, a decrease of $3.5 million, or 7%. The provision for loan losses represented 112% of net charge-offs for the quarter ended March 31, 2004, compared with 125% in the first quarter of 2003. Net charge-offs for the first quarter of 2004 were $40.0 million, or 0.70% of average loans, compared with $38.4 million, or 0.79% for the same quarter in 2003. Refer to the Credit Risk Management and Loan Quality section for a more detailed analysis of the allowance for loan losses, net charge-offs, non-performing assets and credit quality statistics.
NON-INTEREST INCOME
Non-interest income amounted to $145.2 million for the first quarter of 2004, an increase of $2.4 million, or 2%, compared with $142.8 million for the first quarter of 2003. Service charges on deposit accounts reached $41.1 million for the quarter ended March 31, 2004, an increase of $1.2 million, or 3%, over the same quarter of 2003. This rise was mostly derived from commercial accounts, particularly commercial account analysis fees, along with charges related to returned checks and ATM services, partially offset by lower fees on accounts with non-sufficient funds.
Other service fees totaled $69.6 million for the first quarter of 2004, an increase of $0.2 million from the same quarter of 2003. Refer to Table C for a breakdown of other service fees by major categories. Debit and credit card fees rose by $1.1 million, or 4%, mostly driven by higher transactional volume. Processing income reached $10.5 million, an increase of 8%, associated in part with services that include analysis, design and implementation of new technologies to support telecommunications infrastructure and information systems of certain major clients and higher ATM network fees. Income derived from the sale and administration of investment products rose by $0.8 million, or 17%, mostly related to assets under management. Insurance agency commissions increased $0.8 million, or 12%, attributed to new strategic business initiatives which intent to capitalize on the Corporation’s broad delivery channels and client base, which have resulted in higher premium volume. Other fees amounted to $7.6 million for the quarter ended March 31, 2004, a decrease of $3.8 million, or 33%, compared with the same period in 2003. This decline was partly associated with lower mortgage brokered services and lower origination and late payment fees.
TABLE COther Service Fees
Trading losses amounted to $2.2 million for the quarter ended March 31, 2004, compared with trading losses of $0.9 million in the same quarter of 2003. The losses incurred during 2004 resulted mostly from increased prices on forward sales hedges to protect the trading portfolio and to changes in the market value of certain mortgage-backed securities held for trading purposes.
Gains on sale of investment securities totaled $13.0 million for the quarter ended March 31, 2004, compared with gains of $1.4 million for the first quarter of 2003. The gains realized during 2004 were mainly attributed to the sale
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of marketable equity securities, while the gains in 2003 were mostly associated with the sale of mortgage-backed securities.
Gain on sale of loans, including loans held-for-sale, totaled $6.3 million in the first quarter of 2004, a decrease of $10.3 million, or 62%, compared with $16.6 million in the same quarter of 2003. This decrease was mostly related to lower volume of loans sold.
For the quarter ended March 31, 2004, other operating income amounted to $17.5 million, compared with $16.6 million in the same period of 2003, an increase of $0.9 million, or 5%. The increase in other operating income was mostly associated with a $1.6 million gain realized on the cancellation of certain collateralized mortgage obligations in which the Corporation was the owner of the residual certificates outstanding. Also, the favorable variance in other operating income was derived from higher revenues in the daily auto rental business and higher income earned from the bank-owned life insurance program. This favorable variance was partially offset by lower management fees and dividend income received from the Corporation’s investment in Telecomunicaciones de Puerto Rico, lower investment banking fees as a result of lower volume of new transactions in the Puerto Rico market and a $1.4 million write-down related to interest-only strips, in which the decline in the fair value was considered other than temporary.
OPERATING EXPENSES
For the first quarter of 2004, the Corporation’s operating expenses amounted to $279.7 million, an increase of $16.1 million, or 6%, compared with $263.6 million in the same period of 2003.
Personnel costs, which represented approximately 50% of total operating expenses, amounted to $140.6 million in the first quarter of 2004, an increase of $8.3 million, or 6%, compared with $132.3 million in the same period last year. The increase in personnel costs was due to higher total salaries, resulting mostly from annual merit increases, higher bonuses and increased headcount. Full-time equivalent employees totaled 11,457 at March 31, 2004, an increase of 310 employees from March 31, 2003. Also, contributing to the increase in personnel costs were $2.4 million in early-retirement window costs and net curtailment gains associated with the realignment of the Corporation’s processing and technology operations. This realignment resulted in certain plan amendments and the transfer of employees from BPPR to EVERTEC, the new processing subsidiary.
Other operating expenses, excluding personnel costs, amounted to $139.2 million for the first quarter of 2004, an increase of $7.9 million, or 6%, compared with the same period in 2003. This rise was mainly reflected in the categories of other operating expenses, professional fees and equipment expenses. The increase in other operating expenses of $4.5 million, or 24%, was mostly associated with higher real estate costs related to foreclosed residential mortgage properties, insurance costs due to increased premium costs, and provisions to strengthen the reserve for sundry losses. Professional fees increased by $1.3 million, mainly due to higher collection expenses and computer services fees, partially offset by lower legal expenses. Equipment expenses rose by $0.8 million, mainly due to higher software packages expenses to support business processes.
INCOME TAX
Income tax expense for the quarter ended March 31, 2004 amounted to $33.0 million, an increase of $2.1 million, or 7%, from $30.9 million in the same quarter of 2003. The increase was primarily due to higher pretax earnings for the current period, partially offset by higher benefits from net tax-exempt interest income. The effective tax rate for the quarter ended March 31, 2004 was 21.80%, compared with 23.76% in the same quarter of the previous year. The first quarter of 2004 was also impacted by an increase in gains on the sale of securities which are subject to a preferential tax rate on capital gains.
BALANCE SHEET COMMENTS
The Corporation’s total assets at March 31, 2004 reached $38.1 billion, an increase of $4.4 billion, or 13%, compared with $33.7 billion a year earlier. At December 31, 2003, total assets were $36.4 billion. Earning assets
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totaled $36.0 billion at March 31, 2004, compared with $31.8 billion and $34.5 billion at March 31, 2003 and December 31, 2003, respectively.
The investment portfolio, excluding trading securities, totaled $10.7 billion at March 31, 2004, an increase of $0.2 billion, or 2%, compared with $10.5 billion at December 31, 2003. Total investment securities at March 31, 2003 were $10.3 billion. Notes 3 and 4 to the consolidated financial statements presents the breakdown of the Corporation’s available-for-sale and held-to-maturity investment portfolios.
At March 31, 2004, loans, including loans held-for-sale, totaled $23.7 billion, an increase of $1.1 billion, or 5%, from December 31, 2003. The breakdown of the Corporation’s loan portfolio by major loan categories is presented in Table D. Mortgage loans rose $0.8 billion, or 8%, from the end of 2003, mainly in the form of portfolio acquisitions. Consumer loans rose $161 million, or 5%, from December 31, 2003, mostly in personal and auto loans which resulted from promotional campaigns with competitive rates and sales efforts. The lease financing and commercial, including construction, loan portfolios increased by $48 million and $92 million, respectively, from the end of 2003. Total loans at March 31, 2003 were $19.9 billion. The increase of $2.7 billion in mortgage loans from March 31, 2003 to the same date in 2004 represented 70% of the growth in total loans in that period. Commercial and construction loans accounted for 17% of the total growth.
TABLE DLoans Ending Balances
* Includes loans held-for-sale.
Other assets totaled $839 million at March 31, 2004, an increase of $70 million, or 9%, from December 31, 2003, and $149 million, or 22%, from March 31, 2003. The growth in other assets since December 31, 2003 was mostly associated with deferred tax assets, increased participation in certain equity investments, securitization advances and other related assets. The increase since March 31, 2003 was also related to the securitization advances and other related assets, equity investments and assets associated with the bank-owned life insurance program.
At March 31, 2004, total deposits amounted to $18.6 billion, compared with $18.1 billion a December 31, 2003, an increase of $505 million, or 3%. Demand and savings deposits increased $140 million, or 4%, and $115 million, or 1%, respectively, when compared with December 31, 2003. Time deposits increased by $250 million, or 4%, which include a rise of $119 million, or 19%, in brokered certificates of deposit. Total deposits at March 31, 2003 were $17.6 billion. Since March 31, 2003 to the same date in 2004, demand, savings and time deposits rose $413 million, $267 million and $285 million, respectively. Included in the latter category were lower brokered certificates of deposit by $43 million.
Borrowed funds, including subordinated notes and capital securities, increased $1.0 billion, or 7%, from $14.9 billion at December 31, 2003 to $15.9 billion at March 31, 2004. The increase in borrowed funds since the end of 2003 was mainly in the form of secured borrowings, supported by residential mortgage loans, and short-term borrowings. During the quarter ended March 31, 2004, Equity One tapped the asset-backed securities market with an offering of approximately $0.9 billion. The transaction was accounted for as a secured borrowing since it did not qualify as a sale of loans under the criteria of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” Borrowed funds totaled $12.8 billion at March 31, 2003. The increase in borrowed funds of $3.1 billion since March 31, 2003 to the same date in 2004 included secured borrowings, medium-term notes, junior subordinated debentures derived from the issuance of trust preferred securities and short-term sources of funds, including term funds and funds raised through available lines of credit.
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At March 31, 2004, the Corporation’s stockholders’ equity was $2.9 billion, compared with $2.8 billion at December 31, 2003. The increase since the end of 2003 was related to earnings retention, coupled with a $112 million increase in accumulated other comprehensive income, mainly associated with higher unrealized gains on the available-for-sale investment portfolio. Also, included in accumulated other comprehensive income was an unfavorable increase in the foreign currency translation adjustment of $16 million, associated with the Corporation’s equity investments in the Dominican Republic, which have been impacted by a devaluation of the Dominican peso. Stockholders’ equity at March 31, 2003 totaled $2.7 billion. The increase in stockholders’ equity since March 31, 2003, reflects earnings retention, partially offset by lower accumulated other comprehensive income of $75 million, mostly associated with lower unrealized gains on the securities available-for-sale portfolio and an increase in the foreign currency translation adjustment.
The Corporation continues to exceed the well-capitalized guidelines under the federal banking regulations. Ratios and amounts of total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage as of March 31, 2004 and 2003, and December 31, 2003 are presented on Table E. Also, as of such dates, BPPR, BPNA and BP, N.A. were all well-capitalized.
Book value per common share was $20.78 at March 31, 2004, compared with $18.75 at March 31, 2003 and $19.32 at December 31, 2003. The Corporation’s market capitalization at March 31, 2004 was $5.7 billion, compared with $4.5 billion at March 31, 2003 and $6.0 billion at December 31, 2003.
The Corporation’s common and preferred stocks are traded on the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System under the symbols BPOP and BPOPO, respectively. The closing sales price of the common stock at March 31, 2004 and 2003 was $43.10 and $33.99 per share, respectively.
TABLE ECapital Adequacy Data
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CREDIT RISK MANAGEMENT AND LOAN QUALITY
NON-PERFORMING ASSETS
Non-performing assets consist of past-due loans that are no longer accruing interest, renegotiated loans and real estate property acquired through foreclosure.
During the quarter ended March 31, 2004, the Corporation adopted the standard industry practice of placing commercial and construction loans on non-accrual status if payments of principal or interest are delinquent 90 days rather than 60 days, its previous practice. Lease financing, conventional mortgages and closed-end consumer loans are placed on non-accrual status if payments are delinquent 90 days or four scheduled payments in arrears. Closed-end consumer loans are charged-off when payments are delinquent 120 days, while open-end (revolving credit) consumer loans are charged-off when payments are delinquent 180 days. Certain loans, which would be treated as non-accrual loans pursuant to the foregoing policy, are treated as accruing loans if they are considered well-secured and in the process of collection. Unsecured retail loans to borrowers who declare bankruptcy are charged-off within 60 days of receipt of notification of filing from the bankruptcy court. Under the standard industry practice, closed-end consumer loans are charged-off when delinquent 120 days, but are not customarily placed on non-accrual status prior to being charged-off.
A summary of non-performing assets by loan categories and related ratios is presented in Table F.
TABLE FNon-Performing Assets
Had the Corporation continued reporting commercial and construction loans in non-performing status when delinquent 60 days, the Corporation’s non-performing assets at March 31, 2004 would have been $639 million, or 2.70% of loans and 1.68% of total assets.
The increase in non-performing assets since March 31, 2003 was primarily associated with non-performing mortgage loans, which rose by $65 million, or 22%. Non-performing mortgage loans represented 60% of total non-performing assets and 4% of total mortgage loans at March 31, 2004, compared with 51% of total non-performing assets and 4% of total mortgage loans at March 31, 2003. As of December 31, 2003, non-performing mortgage loans were $345 million or 56% of total non-performing assets and 4% of total mortgage loans. The increase in non-performing mortgage loans was primarily driven by increased delinquencies. This growth in mortgage non-performing loans was mostly reflected in the Corporation’s consumer and mortgage-banking subsidiary in the United States, Equity One. Of the total mortgage non-performing loans at March 31, 2004, 74% or $274 million pertained to Equity One, compared with 68% or $206 million at March 31, 2003, and 72% or $248 million at December 31, 2003. The Corporation has experienced a low level of losses in its mortgage portfolio, historically, both in Puerto Rico and the U.S. mainland. Mortgage loans net charge-offs as a percentage of the average mortgage loan portfolio was 0.25% in the first quarter of 2004, compared with 0.24% in the first quarter 2003.
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Non-performing commercial and construction loans represented 1.68% of that loan portfolio at March 31, 2004, compared with 2.54% at March 31, 2003, and 1.96% at December 31, 2003. Had the Corporation continued reporting commercial and construction loans in non-performing status when delinquent 60 days, the Corporation’s non-performing commercial and construction loans at March 31, 2004 would have been $176 million or 2.03% of that loan portfolio. The decrease in non-performing commercial and construction loans of $22 million, or 13%, since December 31, 2003 was mostly due to the aforementioned change in the Corporation’s policy for non-accrual commercial and construction loans. The decline of $57 million, or 28%, from March 31, 2003 was also due to intensified credit management efforts and loan reclassifications to other property upon certain foreclosures.
Non-performing consumer loans were 0.99% of consumer loans at March 31, 2004, compared with 1.18% at March 31, 2003 and 1.11% at December 31, 2003. The decline was principally the result of a better credit quality mix, coupled with improved collection strategies that have improved the consumer delinquency levels.
Non-performing financing leases represented 0.56% of the lease financing portfolio at March 31, 2004, compared with 0.93% at March 31, 2003, and 0.71% at December 31, 2003. The decline in non-performing leases was the result of lower delinquency levels, due to a better portfolio credit quality and enhanced collection strategies.
Other real estate assets, which are recorded at the lower of cost or fair value less estimated costs to sell, reached $55 million at March 31, 2004, or 9% of non-performing assets, compared with $46 million, or 8%, at March 31, 2003, and $54 million, or 9%, at December 31, 2003. The increase in other real estate assets was associated with the growth in the non-performing mortgage loan portfolio, coupled with strengthened and more dynamic foreclosure procedures.
Assuming the standard industry practice of placing commercial loans on non-accrual status when payments of principal and interest are past due 90 days or more and excluding the closed-end consumer loans from non-accruing, at March 31, 2003 and December 31, 2003, adjusted non-performing assets would have been $516 million or 2.60% of loans and $547 million or 2.42% of loans, respectively. The allowance to non-performing loans would have been 81.64% and 82.91% at March 31, 2003 and December 31, 2003, respectively. Excluding the closed-end consumer loans from non-accruing at March 31, 2004, adjusted non-performing assets would have been $575 million or 2.43% of loans and the allowance to non-performing loans would have been 80.19%.
In addition to the non-performing loans discussed earlier, there were $31 million of loans at March 31, 2004, which in management’s opinion are currently subject to potential future classification as non-performing, and therefore are considered impaired under SFAS No. 114. At December 31, 2003 and March 31, 2003, these potential problem loans approximated $34 million and $46 million, respectively.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses totaled $417 million at March 31, 2004, or 1.76% of loans, compared with $384 million, or 1.93% of loans, at the same date in 2003, and $409 million, or 1.81% at December 31, 2003. The Corporation’s management considers the allowance for loan losses to be at a level sufficient to provide for inherent losses based on current economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses.
The allowance for loan losses as a percentage of non-performing loans was 75.27% at March 31, 2004, compared with 69.58% at March 31, 2003 and 73.34% at December 31, 2003. The higher allowance to non-performing loans ratio at March 31, 2004 reflects the Corporation’s adoption of the standard industry practice of placing commercial and construction loans in non-accrual status when payments of principal or interest are delinquent 90 days. Had the Corporation continued reporting commercial and construction loans in non-performing status when delinquent 60 days, the allowance as a percentage of non-performing loans would have been 71.43%.
The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluations of inherent risks in the loan portfolio. The Corporation’s management evaluates the adequacy of the allowance for loan losses on a monthly basis. In determining the allowance, management considers current economic conditions, loan portfolio risk characteristics, prior loss experience, results of periodic credit reviews of individual loans and loan impairment measurement, among other factors.
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The Corporation considers a loan to be impaired when interest and/or principal is past due 90 days or more, or, when based on current information and events, it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. An allowance for loan impairment is recognized to the extent that the carrying value of an impaired loan exceeds the present value of the expected future cash flows discounted at the loan’s effective rate, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. The allowance for impaired loans is part of the Corporation’s overall allowance for loan losses. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment based on past experience adjusted for current conditions. Larger balance commercial loans are evaluated on a loan-by-loan basis. Once a specific measurement methodology is chosen, it is consistently applied unless there is a significant change in the financial position of the borrower. For more information regarding the Corporation’s allowance for loan losses methodology refer to the Credit Risk and Loan Quality section in the Management’s Discussion and Analysis included in Popular, Inc.’s 2003 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, 2003.
The following table shows the Corporation’s recorded investment in impaired loans and the related valuation allowance calculated under SFAS No. 114 at March 31, 2004, December 31, 2003 and March 31, 2003.
Average impaired loans during the first quarter of 2004 and 2003 were $133 million and $150 million, respectively. The Corporation recognized interest income on impaired loans of $0.8 million for both quarters ended March 31, 2004 and 2003.
Table G summarizes the movement in the allowance for loan losses and presents several loan loss statistics for the quarters ended March 31, 2004 and 2003.
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TABLE GAllowance for Loan Losses and Selected Loan Losses Statistics
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Also, Table H presents annualized net charge-offs to average loans by loan category for the quarters ended March 31, 2004 and 2003.
TABLE HAnnualized Net Charge-offs to Average Loans
The increase in consumer loans net charge-offs is mostly the result of portfolio growth coupled with increased delinquency, mainly associated with a small consumer loan portfolio acquired by the end of 2003.
Additionally, the Corporation experienced an increase of $1.7 million, or 37%, in mortgage loans net charge-offs for the quarter ended March 31, 2004, compared with the same period in the previous year, mostly as a result of increased delinquencies. Equity One, the Corporation’s mortgage and consumer lending subsidiary in the United States, which caters to non-prime mortgage borrowers, experienced an increase of $1.3 million in mortgage net charge-offs for quarter ended March 31, 2004, as compared with the same period in 2003.
Lease financing net charge-offs declined primarily as a result of lower delinquency levels, due to better portfolio credit quality and collection strategies.
The decrease in commercial and construction loans net charge-offs for the quarter ended March 31, 2004, compared with the same period of 2003, was mostly associated with better portfolio credit quality, coupled with collection efforts. The decrease in the net charge-offs to average loan ratio was also influenced by the continuing identification and monitoring of potential problem loans.
OFF-BALANCE SHEET ACTIVITIES
The Corporation conducts asset securitizations that involve the transfer of mortgage loans to a qualifying special purpose entity (QSPE), which in turn transferred these assets and their titles, to different trusts, thus isolating those loans from the Corporation’s assets. These transactions, which were conducted prior to 2001, qualified for sale accounting based on the provisions of SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” and as such, these trusts are not consolidated in the Corporation’s financial statements. The investors and the securitization trusts have no recourse to the Corporation’s assets. At March 31, 2004, these trusts held approximately $140 million in assets in the form of mortgage loans. Their liabilities in the form of debt principal due to investors approximated $132 million at the end of the first quarter of 2004. The Corporation retained servicing responsibilities and certain subordinated interests in these securitizations in the form of interest-only securities. The servicing rights and interest-only securities retained by the Corporation are recorded in the statement of condition at the lower of cost or market, and fair value, respectively. During the quarter ended March 31, 2004 the Corporation recorded approximately $1.4 million of write-downs related to interest-only strips, in which the decline in the fair value was considered other than temporary.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
Market risk refers to the impact of changes in interest rates on the Corporation’s net interest income, market value of equity and trading operations. It also arises from fluctuations in the value of some foreign currencies against the U.S. dollar. Despite the varied nature of market risks, the primary source of this risk at the Corporation is the impact of changes in interest rates on net interest income. Depending on the duration and repricing characteristics of the Corporation’s assets, liabilities and off-balance sheet items, changes in interest rates could either increase or decrease the level of net interest income. The Corporation maintains a formal asset and liability management process
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to quantify, monitor and control interest rate risk (IRR) and to assist management in maintaining stability in the net interest margin under varying interest rate environments.
An interest rate sensitivity analysis performed at the Corporation level is the primary tool used in expressing the potential loss in future earnings resulting from selected hypothetical changes in interest rates. Sensitivity analysis is calculated on a monthly basis using a simulation model, which incorporates actual balance sheet figures detailed by maturity and interest yields or costs, the expected balance sheet dynamics, reinvestments, and other non-interest related data. Simulations are processed using various interest rate scenarios to determine potential changes to the future earnings of the Corporation.
Computations of the prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, loan prepayments and deposit decay. Thus, they should not be relied upon as indicative of actual results. Further, the computations do not contemplate actions that management could take to respond to changes in interest rates. By their nature, these forward-looking computations are only estimates and may be different from what actually may occur in the future.
Based on the results of the sensitivity analyses as of March 31, 2004, the Corporation’s net interest income for the next twelve months, on a hypothetical 200 basis points rising rate scenario, is estimated to increase by $0.3 million, and the change for the same period, utilizing a hypothetical 100 basis points declining rate scenario, is an estimated increase of $16.1 million. The 100 basis point downward interest rate scenario is used in place of a 200 basis points declining rate scenario due to the current low interest rate environment. It should be mentioned that some short-term rates are below 1% at March 31, 2004. In the scenario of interest rates decreasing 100 basis points, rates were not permitted to fall below 0.1%, which is presumed to be highly unlikely. Both hypothetical rate scenarios consider the gradual change to be achieved during a twelve-month period from the prevailing rates at March 31, 2004. These estimated changes are within the policy guidelines established by the Board of Directors.
The Corporation maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in net interest income that are caused by interest rate volatility. Refer to Note 6 to the consolidated financial statements for further information on the Corporation’s limited involvement in derivative instruments and hedging activities. The Corporation has not experienced a significant change in its involvement in derivative activities since December 31, 2003.
The Corporation conducts business in certain Latin American markets through several of its processing and information technology services and products subsidiaries. Also, it holds interests in Consorcio de Tarjetas Dominicanas, S.A. and Centro Financiero BHD, S.A. in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s particular foreign currency. At March 31, 2004, the Corporation had $40 million in an unfavorable foreign currency translation adjustment as part of accumulated other comprehensive income, compared with $24 million at December 31, 2003. The increase was mostly associated with a devaluation of the Dominican peso. The Corporation is currently monitoring the economic environment in the Dominican Republic, which could suggest the possible future classification of the economy as highly inflationary, if current inflationary trends and particular economic factors continue, and which could trigger the remeasurement of the Corporation’s interests in the Dominican Republic in accordance with the provisions of SFAS No. 52 “Foreign Currency Translation.” Under SFAS No. 52, the effect of currency translation on investments in a company operated in a highly inflationary environment is reflected in earnings instead of accumulated other comprehensive income.
The Corporation believes that there have been no significant changes in market risk compared with the disclosures in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003.
LIQUIDITY
Liquidity refers to the ability to fund current operations, including the cash flow requirements of depositors and borrowers as well as future growth. Liquidity management involves maintaining ample and diverse funding capacity, liquid assets and other sources of cash to accommodate fluctuations in asset and liability levels due to customer behavior, capital market conditions or unanticipated events. Liquidity risk may arise whenever the Corporation’s ability to raise cash and the runoff of its assets are substantially less than the runoff of its liabilities.
The Corporation has contingency plans for raising financing under stress scenarios, where important sources of funds that are usually fully available are temporarily not willing to lend to the Corporation. These plans call for using alternate funding mechanisms such as the pledging or securitization of certain asset classes, committed credit
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lines, and loan facilities implemented with the Federal Reserve Bank of New York. The Corporation has a substantial amount of assets available for raising funds through non-traditional channels and is confident that it has adequate alternatives to rely on, under a scenario where some primary funding sources are temporarily unavailable.
The Corporation’s liquidity position is closely monitored on an ongoing basis. Management believes that available sources of liquidity are adequate to meet the funding needs in the normal course of business.
The composition of the Corporation’s financing to total assets at March 31, 2004 and December 31, 2003 were as follows:
The Corporation’s core deposits, which consist of demand, savings, money markets, and time deposits under $100 thousand, constituted 82% of total deposits at March 31, 2004. Certificates of deposit with denominations of $100 thousand and over at March 31, 2004 totaled $3.4 billion, or 18% of total deposits. Their distribution by maturity was as follows:
The Corporation diversifies the sources and the maturities of borrowings in order to avoid undue reliance on any singly source and maintain an orderly volume of borrowings maturing in the future. The Corporation has established borrowing relationships with the Federal Home Loan Bank (FHLB), the Federal Reserve Bank of New York and other correspondent banks, which further support and enhance liquidity.
The Corporation has a shelf registration with the Securities and Exchange Commission, which is intended to permit the Corporation to raise funds through sales of preferred stock, senior debt or other debt securities with a relatively short lead-time. At March 31, 2004, the Corporation had available approximately $2.5 billion under this shelf registration.
There have been no significant changes in the Corporation’s funding activities and strategy disclosed in the Management Discussion and Analysis included in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003. Also, there have been no significant changes in the Corporation’s off-balance sheet arrangements and aggregate contractual obligations since the end of 2003. Refer to note 8 to the unaudited consolidated financial statements for the Corporation’s involvement in certain commitments at March 31, 2004.
Risks to Liquidity
The Corporation’s ability to compete successfully in the marketplace for deposits depends on various factors, including service, convenience and financial stability as reflected by operating results and credit ratings (by nationally recognized credit rating agencies). Although a downgrade in the credit rating of the Corporation may impact its ability to raise deposits, management does not believe that the impact should be material. Deposits at all of the Corporation’s banking subsidiaries are federally insured and this is expected to mitigate the effect of a downgrade in credit ratings.
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Institutional lenders tend to be sensitive to the perceived credit risk of the entities to which they lend, and this exposes the Corporation to the possibility of having its access to funding affected by how the market perceives its credit quality; this in part, may be due to factors beyond its control.
Changes in the credit rating of the Corporation or any of its subsidiaries to a level below “investment grade” may affect the Corporation’s access to the capital markets. The Corporation’s counterparties are sensitive to the risk of a rating downgrade. In the event of a downgrade, it may be expected that the cost of borrowing funds in the institutional market would increase. In addition, the ability of the Corporation to raise new funds or renew maturing debt may be more difficult.
The Corporation and BPPR’s debt ratings at March 31, 2004 were as follows:
The ratings above are subject to revisions or withdrawal at any time by the assigning rating agency. Each rating should be evaluated independently of any other rating.
Some of the Corporation’s borrowings and deposits are subject to “rating triggers”, contractual provisions that accelerate the maturity of the underlying obligations in the case of a change in rating. Therefore, the need for the Corporation to raise funding in the marketplace could increase more than usual in the case of a rating downgrade. The amount of obligations subject to rating triggers that could accelerate the maturity of the underlying borrowings was $231 million at March 31, 2004.
In the course of borrowing from institutional lenders, the Corporation has entered into contractual agreements to maintain certain levels of debt, capital and non-performing loans, among other financial covenants. If the Corporation were to fail to comply with those agreements, it may result in an event of default. Such failure may accelerate the repayment of the related borrowings. An event of default could also affect the ability of the Corporation to raise new funds or renew maturing borrowings. The Corporation is currently in full compliance with all financial covenants in effect and expects to remain so in the future. At March 31, 2004, the Corporation had outstanding $853 million in obligations subject to covenants, including those which are subject to rating triggers and those outstanding under the commercial paper program.
The Corporation believes that there have been no significant changes in liquidity risk compared with the disclosures in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act.
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Internal Control Over Financial Reporting
There have been no changes in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the first quarter of 2004 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
On January 16, 2004, the U.S. District Court for the District of Puerto Rico approved a request filed by the U.S. Department of Justice to dismiss the one-count information filed against Banco Popular on January 16, 2003, and proceeded to dismiss it, effective immediately. The United States noted that the period of twelve months had expired and Banco Popular was in full compliance with all of its obligations under the Deferred Prosecution Agreement. The course of action taken by the Court follows the terms of a Deferred Prosecution Agreement among Banco Popular, the U.S. Department of Justice, the Federal Reserve System, and the Financial Crimes Enforcement Network of the U.S. Department of Treasury (FinCEN), approved on January 16, 2003. The Agreement stipulated the U.S. Department of Justice would request the dismissal of one-count information within 30 days after the 12-month period following the settlement, provided Banco Popular complied with its obligations under the Agreement over the course of one year.
The Corporation and its subsidiaries are defendants in various lawsuits arising in the ordinary course of business. Management believes, based on the opinion of legal counsel, that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the financial position and results of operations of the Corporation.
Item 2. Changes in Securities , Use of Proceeds and Issuer Purchases of Equity Securities
Effective April 30, 2004, the Corporation’s Restated Certificate of Incorporation was amended to increase the number of authorized shares of Common Stock from 180,000,000 to 470,000,000 and the number of authorized shares of Preferred Stock from 10,000,000 to 30,000,000 shares. For additional information regarding the increased number of authorized shares of Common and Preferred Stock, refer to the Corporation’s definitive proxy statement, dated March 17, 2004, filed with the Securities and Exchange Commission.
The following table sets forth the details of purchases of Common Stock during the quarter ended March 31, 2004 under a deferred compensation plan of Popular Securities, Inc.
Issuer Purchases of Equity Securities
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Item 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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