UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended September 30, 2015
Commission File Number: 001-34084
POPULAR, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
Incorporation or organization)
(IRS Employer
Identification Number)
(787) 765-9800
(Registrant’s telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
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. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $0.01 par value, 103,585,570 shares outstanding as of November 3, 2015.
INDEX
Part I – Financial Information
Item 1. Financial Statements
Unaudited Consolidated Statements of Financial Condition at September 30, 2015 and December 31, 2014
Unaudited Consolidated Statements of Operations for the quarters and nine months ended September 30, 2015 and 2014
Unaudited Consolidated Statements of Comprehensive Income (Loss) for the quarters and nine months ended September 30, 2015 and 2014
Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2015 and 2014
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014
Notes to Unaudited Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
Part II – Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other information
Item 6. Exhibits
Signatures
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Forward-Looking Information
The information included in this Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to Popular, Inc.’s (the “Corporation”, “Popular”, “we”, “us”, “our”) financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to the adequacy of the allowance for loan losses, delinquency trends, market risk and the impact of interest rate changes, capital markets conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Corporation’s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate”, “believe”, “continues”, “expect”, “estimate”, “intend”, “project” and similar expressions and future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, “can”, “may” or similar expressions are generally intended to identify forward-looking statements.
These statements are not guarantees of future performance and involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict.
Various factors, some of which are beyond Popular’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to:
Other possible events or factors that could cause results or performance to differ materially from those expressed in these forward-looking statements include the following: negative economic conditions that adversely affect housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of non-performing assets, charge-offs and provision expense; changes in interest rates and market liquidity which may reduce interest margins, impact funding sources and affect our ability to originate and distribute financial products in the primary and secondary markets; changes in market rates and prices which may adversely impact the value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; changes in accounting standards, rules and interpretations; our ability to grow our core businesses; decisions to downsize, sell or close units or otherwise change our business mix; and management’s ability to identify and manage these and other risks. Moreover, the outcome of legal proceedings, as discussed in “Part II, Item I. Legal Proceedings,” is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries. Investors should refer to the
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Corporation’s Annual Report on Form 10-K for the year ended December 31, 2014 as well as “Part II, Item 1A” of this Form 10-Q for a discussion of such factors and certain risks and uncertainties to which the Corporation is subject.
All forward-looking statements included in this document are based upon information available to the Corporation as of the date of this document, and other than as required by law, including the requirements of applicable securities laws, we assume no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
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CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
(In thousands, except share information)
Assets:
Cash and due from banks
Money market investments:
Securities purchased under agreements to resell
Time deposits with other banks
Total money market investments
Trading account securities, at fair value:
Pledged securities with creditors’ right to repledge
Other trading securities
Investment securities available-for-sale, at fair value:
Other investment securities available-for-sale
Investment securities held-to-maturity, at amortized cost (fair value 2015 - $84,036; 2014 - $94,199)
Other investment securities, at lower of cost or realizable value (realizable value 2015 - $176,598; 2014 - $165,024)
Loans held-for-sale, at lower of cost or fair value
Loans held-in-portfolio:
Loans not covered under loss-sharing agreements with the FDIC
Loans covered under loss-sharing agreements with the FDIC
Less – Unearned income
Allowance for loan losses
Total loans held-in-portfolio, net
FDIC loss share asset
Premises and equipment, net
Other real estate not covered under loss-sharing agreements with the FDIC
Other real estate covered under loss-sharing agreements with the FDIC
Accrued income receivable
Mortgage servicing assets, at fair value
Other assets
Goodwill
Other intangible assets
Total assets
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest bearing
Interest bearing
Total deposits
Federal funds purchased and assets sold under agreements to repurchase
Other short-term borrowings
Notes payable
Other liabilities
Liabilities from discontinued operations (Refer to Note 4)
Total liabilities
Commitments and contingencies (Refer to Note 26)
Stockholders’ equity:
Preferred stock, 30,000,000 shares authorized; 2,006,391 shares issued and outstanding
Common stock, $0.01 par value; 170,000,000 shares authorized;103,745,956 shares issued (2014 – 103,614,553) and 103,556,285 shares outstanding(2014 – 103,476,847)
Surplus
Retained earnings
Treasury stock – at cost, 189,671 shares (2014 – 137,706)
Accumulated other comprehensive loss, net of tax
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share information)
Interest income:
Loans
Money market investments
Investment securities
Trading account securities
Total interest income
Interest expense:
Deposits
Short-term borrowings
Long-term debt
Total interest expense
Net interest income
Provision for loan losses - non-covered loans
Provision (reversal) for loan losses - covered loans
Net interest income after provision for loan losses
Service charges on deposit accounts
Other service fees (Refer to Note 32)
Mortgage banking activities (Refer to Note 14)
Net gain (loss) and valuation adjustments on investment securities
Other-than-temporary impairment losses on investment securities
Trading account (loss) profit
Net gain on sale of loans, including valuation adjustments on loans held-for-sale
Adjustments (expense) to indemnity reserves on loans sold
FDIC loss share-income (expense) (Refer to Note 33)
Other operating income
Total non-interest income
Operating expenses:
Personnel costs
Net occupancy expenses
Equipment expenses
Other taxes
Professional fees
Communications
Business promotion
FDIC deposit insurance
Other real estate owned (OREO) expenses
Other operating expenses
Amortization of intangibles
Restructuring costs (Refer to Note 6)
Total operating expenses
Income (loss) from continuing operations before income tax
Income tax expense (benefit)
Income (loss) from continuing operations
(Loss) income from discontinued operations, net of tax (Refer to Note 4)
Net Income (Loss)
Net Income (Loss) Applicable to Common Stock
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Net Income (Loss) per Common Share – Basic
Net income (loss) from continuing operations
Net income (loss) from discontinued operations
Net Income (Loss) per Common Share – Diluted
Dividends Declared per Common Share
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
Net income (loss)
Other comprehensive income (loss) before tax:
Foreign currency translation adjustment
Reclassification adjustment for losses included in net income
Amortization of net losses of pension and postretirement benefit plans
Amortization of prior service cost of pension and postretirement benefit plans
Unrealized holding gains (losses) on investments arising during the period
Other-than-temporary impairment included in net income
Reclassification adjustment for gains included in net income
Unrealized net losses on cash flow hedges
Reclassification adjustment for net losses included in net income
Other comprehensive income (loss) before tax
Income tax (expense) benefit
Total other comprehensive income (loss) , net of tax
Comprehensive income (loss), net of tax
Tax effect allocated to each component of other comprehensive income (loss):
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Balance at December 31, 2013
Net loss
Issuance of stock
Tax windfall benefit on vesting of restricted stock
Repurchase of TARP-related warrants
Dividends declared:
Preferred stock
Common stock purchases
Common stock reissuance
Other comprehensive income, net of tax
Balance at September 30, 2014
Balance at December 31, 2014
Net income
Common stock
Balance at September 30, 2015
Disclosure of changes in number of shares:
Preferred Stock:
Balance at beginning and end of period
Common Stock – Issued:
Balance at beginning of period
Balance at end of the period
Treasury stock
Common Stock – Outstanding
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses
Goodwill impairment losses
Depreciation and amortization of premises and equipment
Net accretion of discounts and amortization of premiums and deferred fees
Other-than-temporary impairment on investment securities
Fair value adjustments on mortgage servicing rights
FDIC loss share (income) expense
Earnings from investments under the equity method
Deferred income tax (benefit) expense
(Gain) loss on:
Disposition of premises and equipment
Sale and valuation adjustments of investment securities
Sale of loans, including valuation adjustments on loans held-for-sale and mortgage banking activities
Sale of foreclosed assets, including write-downs
Disposal of discontinued business
Acquisitions of loans held-for-sale
Proceeds from sale of loans held-for-sale
Net originations on loans held-for-sale
Net (increase) decrease in:
Trading securities
Net increase (decrease) in:
Interest payable
Pension and other postretirement benefits obligation
Total adjustments
Net cash provided by operating activities
Cash flows from investing activities:
Net increase in money market investments
Purchases of investment securities:
Available-for-sale
Held-to-maturity
Other
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
Proceeds from sale of investment securities:
Net repayments on loans
Proceeds from sale of loans
Acquisition of loan portfolios
Acquisition of trademark
Net payments from FDIC under loss sharing agreements
Net cash received and acquired from business combination
Acquisition of servicing advances
Cash paid related to business acquisition
Net cash disbursed from disposal of discontinued business
Mortgage servicing rights purchased
Acquisition of premises and equipment
Proceeds from sale of:
Premises and equipment
Foreclosed assets
Net cash provided by (used in) used in investing activities
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Cash flows from financing activities:
Payments of notes payable
Proceeds from issuance of notes payable
Proceeds from issuance of common stock
Dividends paid
Repurchase of TARP - related warrants
Net payments for repurchase of common stock
Net cash used in financing activities
Net decrease in cash and due from banks
Cash and due from banks at beginning of period
Cash and due from banks at the end of period, including discontinued operations
Less: cash from discontinued operations
Cash and due from banks at the end of the period
The Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014 include the cash flows from operating, investing and financing activities associated with discontinued operations.
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Notes to Consolidated Financial Statements (Unaudited)
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Note 1 – Nature of Operations
Popular, Inc. (the “Corporation”) is a diversified, publicly-owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation has operations in Puerto Rico, the United States and the Caribbean. In Puerto Rico, the Corporation provides retail, including mortgage loan originations, and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as investment banking, broker-dealer, auto and equipment leasing and financing, and insurance services through specialized subsidiaries. In the U.S. mainland, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN. BPNA focuses efforts and resources on the core community banking business. BPNA operates branches in New York, New Jersey and South Florida. E-LOAN markets deposit accounts under its name for the benefit of BPNA. Refer to Note 4 for discussion of the sales of the California, Illinois and Central Florida regional operations during 2014. Note 38 to the consolidated financial statements presents information about the Corporation’s business segments.
On February 27, 2015, BPPR, in an alliance with other bidders, including BPNA, acquired certain assets and all deposits (other than certain brokered deposits) of former Doral Bank (“Doral”) from the Federal Deposit Insurance Corporation (FDIC), as receiver (the “Doral Bank Transaction”). Under the FDIC’s bidding format, BPPR was the lead bidder and party to the purchase and assumption agreement with the FDIC covering all assets and deposits acquired by it and its alliance co-bidders. BPPR entered into back to back purchase and assumption agreements with the alliance co-bidders for the transfer of certain assets and deposits. The other co-bidders that formed part of the alliance led by BPPR were First Bank Puerto Rico, Centennial Bank, and a vehicle formed by J.C. Flowers III L.P. BPPR entered into transition service agreements with each of the alliance co-bidders. Refer to Note 5 for further details on the Doral Bank Transaction.
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Note 2 – Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The consolidated interim financial statements have been prepared without audit. The consolidated statement of financial condition data at December 31, 2014 was derived from audited financial statements. The unaudited interim financial statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, all of a normal recurring nature, for a fair statement of such results.
Certain reclassifications have been made to the 2014 consolidated financial statements and notes to the financial statements to conform with the 2015 presentation. As discussed in Note 4, current and prior periods presented in the consolidated statement of operations as well as the related note disclosures covering income and expense amounts have been retrospectively adjusted for the impact of the discontinued operations for comparative purposes. The consolidated statement of financial condition and related note disclosure for prior periods do not reflect the reclassification of BPNA’s assets and liabilities to discontinued operations.
Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from the unaudited financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Corporation for the year ended December 31, 2014, included in the Corporation’s 2014 Annual Report (the “2014 Annual Report”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Business Combination
The Corporation determined that the acquisition of certain assets and assumption of certain liabilities in connection with the Doral Bank Transaction constitutes a business combination as defined by the Financial Accounting Standards Board (“FASB”) Codification (“ASC”) Topic 805 “Business Combinations”. The assets and liabilities, both tangible and intangible, were initially recorded at their estimated fair values. Fair values were determined based on the requirements of FASB Codification Topic 820 “Fair Value Measurements”. These fair value estimates are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair value becomes available. Acquisition-related costs are expensed as incurred. Refer to Note 5, Business Combination, for additional information of assets acquired and liabilities assumed in connection with this transaction.
Loans acquired as part of the Doral Bank Transaction
Loans acquired in a business acquisition are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date.
Certain residential mortgage loans and commercial loans acquired as part of the Doral Bank Transaction were considered impaired. Accordingly, the Corporation applied the guidance of ASC Subtopic 310-30. Under this guidance, the loans acquired from the FDIC were aggregated into pools based on similar characteristics, including factors such as loan type, interest rate type, accruing status, and amortization type. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Under ASC Subtopic 310-30, the difference between the undiscounted cash flows expected at acquisition and the fair value in the loans, or the “accretable yield,” is recognized as interest income using the effective yield method over the estimated life of the loan if the timing and amount of the future cash flows of the pool is reasonably estimable. The non-accretable difference represents the difference between contractually required principal and interest and the cash flows expected to be collected. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as a reduction in the allowance for loan losses, if any, and then as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. Refer to Note 11 to the consolidated financial statements for additional information with respect to the loans acquired as part of the Doral Bank Transaction that were considered impaired.
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Note 3 – New accounting pronouncements
FASB Accounting Standards Update (“ASU”) 2015-16, Business Combination - (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
The FASB issued ASU 2015-16 in September 2015, which eliminates the requirement to retrospectively adjust and revise prior period financial statements for measurement period adjustments related to a business combination. The new guidance requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The cumulative impact of measurement period adjustments on current and prior periods, including the prior period impact on depreciation, amortization, and other income statement items and their related tax effects, is now required to be recognized in the period the adjustment amount is determined and within the respective financial statement line items affected.
The new guidance requires an acquirer to disclose the nature and amount of measurement period adjustments. In addition, the amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.
The amendments of this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The amendments in this Update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this Update with earlier application permitted for financial statements that have not been issued.
The Corporation expects to early adopt this accounting pronouncement during the fourth quarter of 2015, in connection with the Doral Bank Transaction.
FASB Accounting Standards Update 2015-15, Interest- Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements
The FASB issued ASU 2015-15 in August 2015 since ASU 2015-03 does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Given the absence of authoritative guidance within ASU 2015-03, the SEC staff clarified that it would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.
The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material impact on the presentation of its consolidated statements of financial condition or on its results of operations.
FASB Accounting Standards Update 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
The FASB issued ASU 2015-14 in August 2015, which defers the effective date of ASU 2014-09 for all entities by one year. Therefore, ASU 2014-09 is now effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Earlier application is permitted only as of annual reporting periods, and interim periods within those fiscal years, beginning after December 15, 2016.
FASB Accounting Standards Update 2015-09, Insurance - (Topic 944): Disclosures about Short-Duration Contracts
In June 2015, the FASB issued Accounting Standards Update 2015-09, Disclosure about Short-Duration Contracts, which applies to all insurance entities that issue short-duration contracts. The amendment requires, among other things, additional disclosures about the liability for unpaid claims and claim adjustment expenses. The amendments also require insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including reasons for the change and the effects on the financial statements.
The amendments in this update are effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016.
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The Corporation does not anticipate that the adoption of this accounting pronouncement will have a significant impact on its consolidated financial statements.
FASB Accounting Standards Update 2015-07, Fair Value Measurement – (Topic 820): Disclosures for Investment in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (“ASU 2015-07”)
The FASB issued ASU 2015-07 in May 2015, which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. Currently, investments valued using the practical expedient are categorized within the fair value hierarchy on the basis of whether the investment is redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset value, or redeemable with the investee at a future date. For investments that are redeemable with the investee at a future date, a reporting entity must take into account the length of time until those investments become redeemable to determine the classification within the fair value hierarchy. There is diversity in practice related to how certain investment measured at net asset value with redemption dates in the future are categorized within the fair value hierarchy.
The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient.
The amendments of this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2015. Early adoption is permitted. A reporting entity should apply the amendments retrospectively to all periods presented. The retrospective approach requires that an investment for which fair value is measured using the net asset value per share practical expedient be removed from the fair value hierarchy in all periods presented in an entity’s financial statements.
The adoption of this guidance impacts presentation disclosures only and will not have an impact on the Corporation’s consolidated statement of financial condition or results of operations.
FASB Accounting Standards Update 2015-05, Intangibles – Goodwill and Other Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2015-05”)
The FASB issued ASU 2015-05 in April 2015, which provides guidance about a customer’s accounting for fees paid in a cloud computing arrangement. The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. This guidance will not change the accounting for service contracts. All software licenses within the scope of ASC Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets.
The amendments of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2015. Early adoption is permitted. An entity can adopt the amendments either prospectively to all arrangements entered into or materially modified after the effective date, or retrospectively.
The Corporation is currently evaluating the impact that the adoption of this accounting pronouncement will have on its consolidated financial statements.
FASB Accounting Standards Update 2015-04, Compensation – Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets (“ASU 2015-04”)
The FASB issued ASU 2015-04 in April 2015, which simplifies the measurement of benefit plan assets and obligations. For an entity with a fiscal year-end that does not coincide with a month-end, the amendments in this ASU provides a practical expedient that permits the entity to measure defined benefit plan assets and obligations using the month-end that is closest to the entity’s fiscal year-end and apply that practical expedient from year to year. The practical expedient should be applied consistently to all plans if an entity has more than one plan.
For an entity that has a significant event in an interim period that calls for a remeasurement of defined benefit plan assets and obligation, the amendments in this ASU also provide a practical expedient that permits the entity to remeasure define plan assets and obligations using the month-end that is closest to the date of the significant event.
An entity is required to disclose the accounting policy election and the date used to measure defined benefit plan assets and obligations in accordance with the amendments of this ASU. Employee benefit plans are not within the scope of these amendments.
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The amendments of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2015. Early adoption is permitted. The amendments in this ASU should be applied prospectively.
The Corporation does not expect that the adoption of this accounting pronouncement will have a significant impact on its financial statements.
FASB Accounting Standards Update 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”)
The FASB issued ASU 2015-03 in April 2015, which simplifies the presentation of debt issuance costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. Having different balance sheet presentation requirements for debt issuance costs and debt discount and premium creates unnecessary complexity. The recognition and measurement guidance for debt issuance costs are not affected by the amendments of this Update.
The amendments of this Update are effective for financial statements issued for fiscal years beginning after December 31, 2015, and interim periods within fiscal years beginning after December 31, 2016. Early adoption is permitted for financial statements that have not been previously issued.
An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle.
The Corporation‘s current policy is to record debt issuance costs as a deferred asset, and accordingly, it will need to reclassify this balance upon adoption. However, this balance sheet reclassification is not expected to have a material impact in the Corporation’s consolidated financial statements.
FASB Accounting Standards Update 2015-02, Consolidation (Topic 810): Amendment to the Consolidation Analysis (“ASU 2015-02”)
The FASB issued ASU 2015-02 in February 2015, which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments:
The amendments of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2015. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustment should be reflected as of the beginning of the fiscal year of that includes that interim period.
The amendments may be applied using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. A reporting entity may also apply the amendments of this ASU retrospectively.
FASB Accounting Standards Update 2015-01, Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (“ASU 2015-01”)
The FASB issued ASU 2015-01 in January 2015, which eliminates from GAAP the concept of extraordinary items. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports the classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity is also required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item.
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Eliminating the concept of extraordinary items will save time and reduce costs for preparers because they will not have to assess whether a particular event or transaction event is extraordinary. This will alleviate uncertainty for preparers, auditors, and regulators because auditors and regulators no longer will need to evaluate whether a preparer treated an unusual and/or infrequent item appropriately.
The presentation and disclosure guidance for items that are unusual in nature and occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring.
The amendments of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2015. The amendments may be applied prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided is applied from the beginning of the fiscal year of adoption.
The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material effect on its consolidated statements of financial condition, results of operations or presentation and disclosures.
FASB Accounting Standards Update 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is more Akin to Debt or to Equity (“ASU 2014-16”)
The FASB issued ASU 2014-16 in November 2014, which intends to eliminate the use of different methods in practice and thereby reduce existing diversity under GAAP in the accounting for hybrid financial instruments issued in the form of a share. An entity should determine the nature of the host contract by considering the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. In evaluating the stated and implied substantive terms and features, the existence or omission of any single term or feature does not necessarily determine the economic characteristics and risks of the host contract. Although an individual term or feature may weigh more heavily in the evaluation on the basis of facts and circumstances, an entity should use judgment based on an evaluation of all relevant terms and features.
The amendment in this ASU does not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. An entity will continue to evaluate whether the economic characteristics and risks of the embedded derivative feature are clearly and closely related to those of the host contract, among other relevant criteria.
The amendments in the ASU are effective for annual periods, and interim periods within those annual periods, beginning in the first quarter of 2016. Early adoption is permitted. The effects of initially adopting the amendments of this ASU should be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendments are effective. Retrospective application is permitted to all relevant prior periods.
The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material effect on its consolidated statements of financial condition or results of operations.
FASB Accounting Standards Update 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability as a Going Concern (“ASU 2014-15”)
The FASB issued ASU 2014-15 in August 2014, which provides guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide the related footnote disclosures. These amendments should reduce diversity in the timing and content of footnote disclosures.
In connection with preparing financial statements for each annual and interim reporting period, an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable).
When management identifies conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern, management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. The mitigating effect of management’s plans should be considered only to the extent that (1) it is probable that the plans will be effectively implemented and, if so, (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.
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The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.
The Corporation does not anticipate that the adoption of this guidance will have a material effect on its consolidated statements of financial condition, results of operations or presentation and disclosures.
FASB Accounting Standards Update 2014-13, Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financial Entity (“ASU 2014-13”)
The FASB issued ASU 2014-13 in August 2014, which intends to clarify that when a reporting entity that consolidates a collateralized financing entity may elect to measure the financial assets and the financial liabilities of that collateralized financing entity using either the measurement alternative included in this Update or Topic 820 on fair value measurement. When the measurement alternative is not elected, the amendments of this Update clarify that the fair value of the financial assets and the fair value of the financial liabilities of the consolidated collateralized financing entity should be measured using the requirements of Topic 820 and any differences in the fair value of the financial assets and the fair value of the financial liabilities of that entity should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income.
When a reporting entity elects the measurement alternative included in this Update for a collateralized financing entity, the reporting entity should measure both the financial assets and the financial liabilities of that entity in its consolidated financial statements using the more observable of the fair value of the financial assets and the fair value of the financial liabilities.
The amendments in the ASU are effective in the first quarter of 2016. Early adoption is permitted as of the beginning of an annual period. The amendments of this ASU can be applied using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the annual period of adoption. A reporting entity also may apply the amendments retrospectively to all relevant prior periods beginning with the annual period in which the amendments of ASU 2009-17 were initially adopted.
The Corporation does not anticipate that the adoption of this accounting pronouncement guidance will have a material effect on its consolidated statements of financial condition or results of operations.
FASB Accounting Standards Update 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”)
The FASB issued ASU 2014-12 in June 2014, which intends to resolve the diverse accounting treatment of awards with a performance target that could be achieved after an employee completes the requisite service period. That is, the employee would be eligible to vest in the award regardless of whether the employee is rendering service on the date the performance target is achieved.
The amendments of the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award.
Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period.
The amendments in the ASU are effective in the first quarter of 2016. Early adoption is permitted. The amendments of this ASU can be applied (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets outstanding at the beginning of the period of adoption and to all new or modified awards thereafter.
The Corporation does not anticipate that the adoption of this guidance will have a material effect on its consolidated statements of financial condition or results of operations.
FASB Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606); (“ASU 2014-09”)
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The FASB issued ASU 2014-09 in May 2014, which clarifies the principles for recognizing revenue and develop a common revenue standard that would (1) remove inconsistencies and weaknesses in revenue requirements, (2) provide a more robust framework for addressing revenue issues, (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (4) provide more useful information to users of financial statement through improved disclosure requirements and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. ASU 2014-09 amends the ASC Codification and creates a new Topic 606, Revenue from Contracts with Customers.
The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
In addition, the new guidance requires disclosures to enable users of financial statements to understand the nature, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required about contract with customers, significant judgments and changes in judgments, and assets recognized from the cost to obtain or fulfill a contract.
The amendments in this ASU were originally effective in the first quarter of 2017. However, in August 2015, the FASB issued ASU 2015-14, which defers the effective date until January 1, 2018.
The Corporation is currently evaluating the impact that the adoption of this guidance will have on the presentation and disclosures in its consolidated financial statements.
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Note 4 – Discontinued operations
During the year ended December 31, 2014, the Corporation completed the sale of its California, Illinois and Central Florida regional operations to three different buyers.
The regional operations sold constituted a business, as defined in ASC 805-10-55. Accordingly, the decision to sell these businesses resulted in the discontinuance of each of their respective operations and classification as held-for-sale. For financial reporting purposes, the results of the discontinued operations are presented as “Assets / Liabilities from discontinued operations” in the consolidated statement of condition and “(Loss) income from discontinued operations, net of tax” in the consolidated statement of operations. As required by ASC 205-20, current and prior periods presented in the consolidated statement of operations as well as the related note disclosures covering income and expense amounts have been retrospectively adjusted for the impact of the discontinued operations for comparative purposes.
During the quarter ended June 30, 2014, the Corporation recorded non-cash impairment charge of $187 million related to the goodwill allocated, on a relative fair value basis, to these operations. However, this non-cash charge had no impact on the Corporation’s tangible capital or regulatory capital ratios.
After the sale of these three regions, at September 30, 2015, there were no assets held within the discontinued operations. As of September 30, 2015, liabilities within discontinued operations amounted to approximately $1.8 million, mainly comprised of the indemnity reserve related to the California regional sale.
The following table provides the components of net income from the discontinued operations for the quarters and nine months ended September 30, 2015 and 2014.
Provision (reversal) for loan losses
Net gain on sale of regions
Other non-interest income
Goodwill impairment charge
Net (loss) income from discontinued operations
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Note 5 – Business combination
On February 27, 2015, BPPR, the Corporation’s Puerto Rico banking subsidiary, in an alliance with co-bidders, including BPNA, the Corporation’s U.S. mainland banking subsidiary, acquired certain assets and all deposits (other than certain brokered deposits) of former Doral Bank from the Federal Deposit Insurance Corporation (FDIC), as receiver (the “Doral Bank Transaction”).
Under the FDIC’s bidding format, BPPR was the lead bidder and party to the purchase and assumption agreement with the FDIC covering all assets and deposits acquired by it and its alliance co-bidders. BPPR entered into back to back purchase and assumption agreements with the alliance co-bidders for the transfer of certain assets and deposits. The other co-bidders that formed part of the alliance led by BPPR were FirstBank Puerto Rico, Centennial Bank, and a vehicle formed by J.C. Flowers III LP. BPPR entered into transition service agreements with each of the alliance co-bidders.
After taking into account the transfers to the unaffiliated alliance co-bidders, BPPR and BPNA assumed an aggregate of approximately $2.2 billion in deposits and acquired an aggregate of approximately $1.7 billion in commercial and residential loans.
BPPR assumed approximately $574 million in deposits associated with eight Puerto Rico branches of Doral Bank and approximately $425 million from its online deposit platform, and approximately $827 million in Puerto Rico residential and commercial loans.
BPNA assumed approximately $1.2 billion in deposits in three New York branches of Doral Bank, and acquired approximately $891 million in commercial loans primarily in the New York metropolitan area.
There is no loss-sharing arrangement with the FDIC on the acquired assets.
On February 27, 2015, the FDIC, as receiver for Doral Bank, accepted BPPR’s bid for the purchase of the mortgage servicing rights on three pools of residential mortgage loans of approximately $5.0 billion in unpaid principal balance for a purchase price initially estimated at $48.6 million. As of February 27, 2015, the transfers of the mortgage servicing rights were subject to a number of specified closing conditions, including the consent of each of Ginnie Mae, Fannie Mae and Freddie Mac in a form acceptable to BPPR, and other customary closing conditions. Therefore, the fair value as of March 31, 2015 was recorded as a contingent asset as part of other assets in the Consolidated Statement of Condition. During the second quarter of 2015, BPPR completed the acquisition of the mortgage servicing rights pools on the three pools for an aggregate purchase price of $56.2 million, including certain servicing advances purchased. As a result of the completion of these transactions, during the second quarter of 2015 BPPR reclassified the contingent asset from other assets to mortgage servicing rights.
During the second and third quarters of 2015, retrospective adjustments were made to the estimated fair values of certain assets and liabilities assumed with the Doral Bank Transaction to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the acquisition-date fair value measurements. The retrospective adjustments resulted in a decrease of $2.1 million to the initial fair value estimate of the mortgage servicing rights, a decrease in other liabilities assumed of $0.5 million and, an increase of $2.6 million in the receivable from the FDIC related to the acquisition cost of deposits, all of which were adjusted against goodwill.
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The following table presents the fair values of major classes of identifiable assets acquired and liabilities assumed by the Corporation as of February 27, 2015, which includes updated fair value adjustments of the mortgage servicing rights initially recorded as a contingent asset and of the deposits.
Investment in available-for-sale securities
Investments in FHLB stock
Receivable from the FDIC
Core deposit intangible
Advances from the Federal Home Loan Bank
Excess of liabilities assumed over assets acquired
Aggregate fair value adjustments
Additional consideration
Goodwill on acquisition
The fair values assigned to the assets acquired and liabilities assumed are preliminary and subject to refinement for up to one year after the closing date of the acquisition as new information relative to closing date fair values becomes available. The Corporation continues to analyze its estimates of fair value on loans and other assets acquired as well as the deposits and other liabilities assumed. As the Corporation finalizes its analyses of these assets and liabilities, there may be additional adjustments to the recorded carrying values, and thus the recognized goodwill may increase or decrease.
The following is a description of the methods used to determine the fair values of significant assets acquired and liabilities assumed on the Doral Bank Transaction:
Fair values of loans were based on a discounted cash flow methodology. Certain loans were valued individually, while other loans were valued as pools. Aggregation into pools considered characteristics such as loan type, payment term, rate type and accruing status. Principal and interest projections considered prepayment rates and credit loss expectations. The discount rates were developed based on the relative risk of the cash flows, taking into account principally the loan type, market rates as of the valuation date, liquidity expectations, and the expected life of the loans.
Mortgage Servicing Rights (recorded as Contingent Asset at February 27, 2015)
The Corporation uses a discounted cash flow model to estimate the fair value of mortgage servicing rights. The discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. The mortgage servicing rights from the Doral Bank Transaction were recorded at the BPPR reportable segment.
The amount of goodwill is the residual difference in the fair value of liabilities assumed and net consideration paid to the FDIC over the fair value of the assets acquired. The goodwill created by this transaction is driven by the deployment of capital with meaningful earnings accretion and significant cost savings opportunities. In addition to strengthening the Corporation’s Puerto Rico franchise,
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the transaction grows the U.S. business through the addition of an attractive commercial platform. The goodwill is deductible for income tax purposes. The goodwill from the Doral Bank Transaction was assigned to the BPPR and BPNA reportable segments based on the relative fair value of the assets acquired and liabilities assumed.
This intangible asset represents the value of the relationships that Doral Bank had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the core deposit base, interest costs, and the net maintenance cost attributable to customer deposits, and the cost of alternative funds. The core deposit intangible asset will be amortized over a period of ten years.
The fair values used for the demand deposits that comprise the transaction accounts acquired, which have no stated maturity and include non-interest bearing demand deposits, savings, NOW, and money market accounts, by definition equal the amount payable on demand at the reporting date. The fair values for time deposits were estimated using a discounted cash flow calculation that applies interest rates currently offered to comparable time deposits with similar maturities, and also accounts for the non-performance risk by using internally-developed models that consider, where applicable, the remaining term and the credit premium of the institution.
Deferred taxes
Deferred taxes relate to a difference between the financial statement and tax basis of the assets acquired and assumed liabilities assumed in the transaction. Deferred taxes were reported based upon the principles in ASC Topic 740 “Income Taxes”, and were measured using the enacted statutory income tax rate to be in effect for BPPR and BPNA at the time the deferred tax is expected to reverse.
For income tax purposes, the Doral Bank Transaction was accounted for as an asset purchase and the tax bases of assets acquired were allocated based on fair values using a modified residual method. Under this method, the purchase price was allocated among the assets in order of liquidity (the most liquid first) up to its fair market value.
The operating results of the Corporation for the quarter and nine months periods ended on September 30, 2015 include the operating results produced by the acquired assets and assumed liabilities. This includes approximately $30.9 million and $79.3 million in gross revenues and approximately $19.1 million and $60.3 million in operating expenses for the quarter and nine months periods ended on September 30, 2015, respectively. The Corporation believes that given the amount of assets and liabilities assumed, the size of the operations acquired in relation to Popular’s operations and the significant amount of fair value adjustments, the historical results of Doral Bank are not meaningful to Popular’s results, and thus no pro forma information is presented.
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Note 6 – Restructuring plan
As discussed in Note 4, in connection with the sale of the operations of the California, Illinois and Central Florida regions, the Corporation has relocated certain back office operations, previously conducted in these regions, to Puerto Rico and New York. The Corporation has undertaken a restructuring plan (the “PCB Restructuring Plan”) to eliminate and re-locate employment positions, terminate contracts and incur other costs associated with moving the operations to Puerto Rico and New York. The Corporation has incurred restructuring charges of approximately $44.1 million, of which approximately $26.7 million were incurred during 2014 and $17.4 million during the nine months ended September 30, 2015. As of September 30, 2015, the restructuring related to the U.S. operations has been substantially completed. The Corporation does not anticipate any significant restructuring expenses to be incurred prospectively.
The following table details the expenses recorded by the Corporation that were associated with the PCB Restructuring Plan:
Total restructuring costs
The following table presents the activity in the reserve for the restructuring costs associated with the PCB Restructuring Plan:
Balance at January 1, 2015
Charges expensed during the period
Payments made during the period
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Note 7 - Restrictions on cash and due from banks and certain securities
The Corporation’s banking subsidiaries, BPPR and BPNA, are required by federal and state regulatory agencies to maintain average reserve balances with the Federal Reserve Bank of New York (the “Fed”) or other banks. Those required average reserve balances amounted to $ 1.1 billion at September 30, 2015 (December 31, 2014 - $ 1.0 billion). Cash and due from banks, as well as other short-term, highly liquid securities, are used to cover the required average reserve balances.
At September 30, 2015, the Corporation held $32 million in restricted assets in the form of funds deposited in money market accounts, trading account securities and investment securities available for sale (December 31, 2014 - $45 million). The amounts held in trading account securities and investment securities available for sale consist primarily of restricted assets held for the Corporation’s non-qualified retirement plans and fund deposits guaranteeing possible liens or encumbrances over the title of insured properties.
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Note 8 – 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, derivative positions, and loan servicing agreements. The classification and carrying amount of the Corporation’s pledged assets, in which the secured parties are not permitted to sell or repledge the collateral, were as follows:
Investment securities available-for-sale, at fair value
Investment securities held-to-maturity, at amortized cost
Loans held-in-portfolio covered under loss sharing agreements with the FDIC
Loans held-in-portfolio not covered under loss sharing agreements with the FDIC
Total pledged assets
Pledged securities that the creditor has the right by custom or contract to repledge are presented separately on the consolidated statements of financial condition.
At September 30, 2015, the Corporation had $ 1.5 billion in investment securities available-for-sale and $ 0.5 billion in loans that served as collateral to secure public funds (December 31, 2014 - $ 0.7 billion and $ 0.7 billion, respectively).
At September 30, 2015, the Corporation’s banking subsidiaries had short-term and long-term credit facilities authorized with the Federal Home Loan Bank system (the “FHLB”) aggregating to $3.6 billion (December 31, 2014 - $3.7 billion). Refer to Note 20 to the consolidated financial statements for borrowings outstanding under these credit facilities. At September 30, 2015, the credit facilities authorized with the FHLB were collateralized by $ 4.8 billion in loans held-in-portfolio (December 31, 2014 - $ 4.5 billion). Also, at September 30, 2015, the Corporation’s banking subsidiaries had a borrowing capacity at the Federal Reserve (“Fed”) discount window of $1.5 billion, which remained unused as of such date (December 31, 2014 - $2.1 billion). The amount available under these credit facilities with the Fed is dependent upon the balance of loans and securities pledged as collateral. At September 30, 2015, the credit facilities with the Fed discount window were collateralized by $ 2.7 billion in loans held-in-portfolio (December 31, 2014 - $ 4.1 billion). These pledged assets are included in the above table and were not reclassified and separately reported in the consolidated statements of financial condition.
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Note 9 – Investment securities available-for-sale
The following tables present the amortized cost, gross unrealized gains and losses, approximate fair value, weighted average yield and contractual maturities of investment securities available-for-sale at September 30, 2015 and December 31, 2014.
U.S. Treasury securities
Within 1 year
After 1 to 5 years
Total U.S. Treasury securities
Obligations of U.S. Government sponsored entities
After 5 to 10 years
After 10 years
Total obligations of U.S. Government sponsored entities
Obligations of Puerto Rico, States and political subdivisions
Total obligations of Puerto Rico, States and political subdivisions
Collateralized mortgage obligations - federal agencies
Total collateralized mortgage obligations - federal agencies
Mortgage-backed securities
Total mortgage-backed securities
Equity securities (without contractual maturity)
Total other
Total investment securities available-for-sale
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The weighted average yield on investment securities available-for-sale is based on amortized cost; therefore, it does not give effect to changes in fair value.
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 may be called by the issuer.
During the nine months ended September 30, 2015 the Corporation sold U.S. agency securities and obligations from the Puerto Rico government and its political subdivisions. The proceeds from these sales were $ 96.8 million. The Corporation realized a gain of $ 141 thousand on these transactions. During the nine months ended September 30, 2014 the Corporation sold approximately $94.2 million in mortgage backed securities and collateralized mortgage obligations at the BPNA segment. The proceeds from this sale were $91.3 million. The Corporation realized a loss of $1.8 million on this transaction.
The following tables present the Corporation’s fair value and gross unrealized losses 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 September 30, 2015 and December 31, 2014.
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Equity securities
Total investment securities available-for-sale in an unrealized loss position
As of September 30, 2015, the available-for-sale investment portfolio reflects gross unrealized losses of approximately $31 million, driven by U.S. Agency Collateralized Mortgage Obligations, Mortgage-backed securities and obligations of the Puerto Rico Government and its political subdivisions. As part of its analysis for all US Agencies’ securities, management considers the U.S. Agency guarantee. The portfolio of obligations of the Puerto Rico Government is mostly comprised of securities with specific sources of income or revenues identified for repayments. The Corporation performs periodic credit quality reviews on these issuers.
Management evaluates investment securities for other-than-temporary (“OTTI”) declines in fair value on a quarterly basis. Once a decline in value is determined to be other-than-temporary, the value of a debt security is reduced and a corresponding charge to earnings is recognized for anticipated credit losses. Also, for equity securities that are considered other-than-temporarily impaired, the excess of the security’s carrying value over its fair value at the evaluation date is accounted for as a loss in the results of operations. The OTTI analysis requires management to consider various factors, which include, but are not limited to: (1) the length of time and the extent to which fair value has been less than the amortized cost basis, (2) the financial condition of the issuer or issuers, (3) actual collateral attributes, (4) the payment structure of the debt security and the likelihood of the issuer being able to make payments, (5) any rating changes by a rating agency, (6) adverse conditions specifically related to the security, industry, or a geographic area, and (7) management’s intent to sell the debt security or whether it is more likely than not that the Corporation would be required to sell the debt security before a forecasted recovery occurs. At September 30, 2015, management performed its quarterly analysis of all debt securities in an unrealized loss position.
During the second quarter of 2015, the Corporation recognized an other-than-temporary impairment charge of $14.4 million on its portfolio of investment securities available-for-sale classified as obligations from the Puerto Rico government and its political subdivisions. At June 30, 2015 these securities were rated Caa2 and CCC- by Moody’s and S&P, respectively. Notwithstanding the payment priorities established by the Puerto Rico Constitution for these securities, Puerto Rico’s fiscal and economic situation, together with the Government’s announcements regarding its ability to pay its debt and its intention to pursue a comprehensive debt restructuring, led management to conclude that the unrealized losses on these government securities were other-than-temporary. The Corporation determined that the entire balance of the unrealized loss carried by these securities was attributed to estimated credit losses. Accordingly, the other-than-temporary impairment was recognized in its entirety in the accompanying consolidated statement of operations and no amount remained recognized in the accompanying statement of other
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comprehensive income related to these specific securities. These securities, for which an other-than-temporary impairment was recorded, were sold during the third quarter of 2015, resulting in a realized gain of $0.1 million. The proceeds from this sale were $26.8 million.
Further negative evidence impacting the liquidity and sources of repayment of the obligations of Puerto Rico and its political subdivisions, could result in a further charge to earnings to recognize estimated credit losses determined to be other-than-temporary. At September 30, 2015, the Corporation did not have the intent to sell debt securities in an unrealized loss position and it is not more likely than not that the Corporation will have to sell the investment securities prior to recovery of their amortized cost basis.
The following table states the name of issuers, and the aggregate amortized cost and fair value of the securities of such issuer (includes available-for-sale and held-to-maturity securities), in which the aggregate amortized cost of such securities exceeds 10% of stockholders’ equity. This information excludes securities backed by the full faith and credit of the U.S. Government. Investments in obligations issued by a state of the U.S. and its political subdivisions and agencies, which are payable and secured by the same source of revenue or taxing authority, other than the U.S. Government, are considered securities of a single issuer.
FNMA
FHLB
Freddie Mac
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Note 10 – Investment securities held-to-maturity
The following tables present the amortized cost, gross unrealized gains and losses, approximate fair value, weighted average yield and contractual maturities of investment securities held-to-maturity at September 30, 2015 and December 31, 2014.
Total investment securities held-to-maturity
Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations and certain other securities may differ from their contractual maturities because they may be subject to prepayments or may be called by the issuer.
The following tables present the Corporation’s fair value and gross unrealized losses 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 September 30, 2015 and December 31, 2014.
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Total investment securities held-to-maturity in an unrealized loss position
As indicated in Note 9 to these consolidated financial statements, management evaluates investment securities for OTTI declines in fair value on a quarterly basis.
The “Obligations of Puerto Rico, States and political subdivisions” classified as held-to-maturity at September 30, 2015 are primarily associated with securities issued by municipalities of Puerto Rico and are generally not rated by a credit rating agency. This includes $57 million of securities issued by three municipalities of Puerto Rico that are payable from the real and personal property taxes collected within such municipalities. These bonds have seniority to the payment of operating cost and expenses of the municipality. The portfolio also includes approximately $42 million in securities for which the underlying source of payment is not the central government, but in which it provides a guarantee in the event of default.
The Corporation performs periodic credit quality reviews on these issuers. The Corporation does not have the intent to sell securities held-to-maturity and it is not more likely than not that the Corporation will have to sell these investment securities prior to recovery of their amortized cost basis.
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Note 11 – Loans
Loans acquired in the Westernbank FDIC-assisted transaction, except for lines of credit with revolving privileges, are accounted for by the Corporation in accordance with ASC Subtopic 310-30. Under ASC Subtopic 310-30, the acquired loans were aggregated into pools based on similar characteristics. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. The loans which are accounted for under ASC Subtopic 310-30 by the Corporation are not considered non-performing and will continue to have an accretable yield as long as there is a reasonable expectation about the timing and amount of cash flows expected to be collected. The Corporation measures additional losses for this portfolio when it is probable the Corporation will be unable to collect all cash flows expected at acquisition plus additional cash flows expected to be collected arising from changes in estimates after acquisition. Lines of credit with revolving privileges that were acquired as part of the Westernbank FDIC-assisted transaction are accounted for under the guidance of ASC Subtopic 310-20, which requires that any differences between the contractually required loan payment receivable in excess of the Corporation’s initial investment in the loans be accreted into interest income. Loans accounted for under ASC Subtopic 310-20 are placed in non-accrual status when past due in accordance with the Corporation’s non-accruing policy and any accretion of discount is discontinued.
The risks on loans acquired in the FDIC-assisted transaction are significantly different from the risks on loans not covered under the FDIC loss sharing agreements because of the loss protection provided by the FDIC. Accordingly, the Corporation presents loans subject to the loss sharing agreements as “covered loans” in the information below and loans that are not subject to the FDIC loss sharing agreements as “non-covered loans”. The FDIC loss sharing agreements expired on June 30, 2015 for commercial (including construction) and consumer loans, and expires on June 30, 2020 for single-family residential mortgage loans, as explained in Note 13.
As a result of the expiration of the shared-loss arrangement under the commercial loss share agreement on June 30, 2015, approximately $1.5 billion in loans and $18 million in OREOs were reclassified as “non-covered” in the accompanying statement of financial condition during the quarter ended June 30, 2015, because they are no longer subject to the shared-loss payments by the FDIC. However, included in these balances were loans with carrying amount at June 30, 2015 of approximately $248.7 million that are subject to the resolution of several arbitration proceedings currently ongoing with the FDIC related primarily to (i) the FDIC’s denial of reimbursements for certain charge-offs claimed by BPPR with respect to certain loans and the treatment of those loans as “shared-loss assets” under the commercial loss share agreement; and (ii) the denial by the FDIC of portfolio sale proposals submitted by BPPR pursuant to the applicable commercial shared loss agreement provision governing portfolio sales. Until the disputes described above are finally resolved, the terms of the commercial loss share agreement will remain in effect with respect to any such items under dispute. Refer to additional information of these disputes on Note 26, Commitment and Contingencies.
For a summary of the accounting policy related to loans, interest recognition and allowance for loan losses refer to the summary of significant accounting policies included in Note 2 to the consolidated financial statements included in 2014 Annual Report.
Change in non-accrual accounting policy for guaranteed residential mortgage loans
During the quarter ended September 30, 2015, the Corporation changed its policy on interest income recognition for residential mortgage loans guaranteed by the Federal Housing Administration (“FHA”) or the Veterans Administration (“VA”). Previously, the Corporation discontinued the recognition of interest income on these loans when they were 18-months delinquent as to principal or interest. The Corporation modified its policy to discontinue the recognition of interest when 15-months delinquent as to principal or interest. This change in estimate was based on an analysis of historical collections from these agencies. This change in policy resulted in the reversal of previously accrued interest amounting to approximately $1.9 million during the quarter ended September 30, 2015.
The following table presents the composition of non-covered loans held-in-portfolio (“HIP”), net of unearned income, at September 30, 2015 and December 31, 2014.
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Commercial multi-family
Commercial real estate non-owner occupied
Commercial real estate owner occupied
Commercial and industrial
Construction
Mortgage
Leasing
Legacy[2]
Consumer:
Credit cards
Home equity lines of credit
Personal
Auto
Total loans held-in-portfolio[1]
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The following table presents the composition of covered loans at September 30, 2015 and December 31, 2014.
Commercial real estate
Consumer
Total covered loans held-in-portfolio
The following table provides a breakdown of loans held-for-sale (“LHFS”) at September 30, 2015 and December 31, 2014 by main categories.
Commercial
Legacy
Total loans held-for-sale
Excluding the impact of the Doral Bank Transaction, during the quarter and nine months ended September 30, 2015, the Corporation recorded purchases (including repurchases) of mortgage loans amounting to $91 million and $495 million, respectively (September 30, 2014 - $139 million and $470 million, respectively). The Corporation did not record purchases of consumer loans during the quarter and nine months ended September 30, 2015 (September 30, 2014 - $92 million). In addition, during the nine months ended September 30, 2015, the Corporation did not record purchases of commercial loans (during the quarter and nine months ended September 30, 2014 - $21 million). The Corporation recorded purchases amounting to $762 thousand and $926 thousand of lease financing during the quarter and nine months ended September 30, 2015, respectively, and none during the nine months ended September 30, 2014.
The Corporation sold approximately $19 million and $82 million of residential mortgage loans (on a whole loan basis) during the quarter and nine months ended September 30, 2015, respectively (September 30, 2014 - $56 million and $126 million, respectively). Also, the Corporation securitized approximately $ 251 million and $ 651 million of mortgage loans into Government National Mortgage Association (“GNMA”) mortgage-backed securities during the quarter and nine months ended September 30, 2015, respectively (September 30, 2014 - $ 172 million and $ 522 million, respectively). Furthermore, the Corporation securitized approximately $ 57 million and $ 174 million of mortgage loans into Federal National Mortgage Association (“FNMA”) mortgage-backed securities during the quarter and nine months ended September 30, 2015, respectively (September 30, 2014 - $ 51 million and $ 174 million, respectively). The Corporation sold commercial and construction loans with a book value of approximately $9 million during the nine months ended September 30, 2015 (during the quarter and nine months ended September 30, 2014 - $96 million and $157 million, respectively).
Non-covered loans
The following tables present non-covered loans held-in-portfolio by loan class that are in non-performing status or are accruing interest but are past due 90 days or more at September 30, 2015 and December 31, 2014. Accruing loans past due 90 days or more consist primarily of credit cards, FHA / VA and other insured mortgage loans, and delinquent mortgage loans which are included in the Corporation’s financial statements pursuant to GNMA’s buy-back option program. Servicers of loans underlying GNMA mortgage-backed securities must report as their own assets the defaulted loans that they have the option (but not the obligation) to repurchase, even when they elect not to exercise that option. Residential conventional loans purchased from another financial institution, which are in the process of foreclosure, are classified as non-performing mortgage loans.
36
At September 30, 2015
Mortgage[3]
Total[2]
At December 31, 2014
37
The following tables present loans by past due status at September 30, 2015 and December 31, 2014 for non-covered loans held-in-portfolio (net of unearned income), including loans previously covered by the commercial FDIC loss sharing agreements.
September 30, 2015
Puerto Rico
Total
U.S. mainland
38
Popular, Inc.
December 31, 2014
39
The following table provides a breakdown of loans held-for-sale (“LHFS”) in non-performing status at September 30, 2015 and December 31, 2014 by main categories.
40
The following table presents loans acquired as part of the Doral Bank Transaction accounted for under ASC subtopic 310-20 as of the February 27, 2015 acquisition date:
Fair value of loans accounted under ASC Subtopic 310-20
Gross contractual amounts receivable (principal and interest)
Estimate of contractual cash flows not expected to be collected
Covered loans
The following table presents covered loans in non-performing status and accruing loans past-due 90 days or more by loan class at September 30, 2015 and December 31, 2014.
Total[1]
The following tables present loans by past due status at September 30, 2015 and December 31, 2014 for covered loans held-in-portfolio. The information considers covered loans accounted for under ASC Subtopic 310-20 and ASC Subtopic 310-30.
Total covered loans
41
The Corporation accounts for lines of credit with revolving privileges under the accounting guidance of ASC Subtopic 310-20, which requires that any differences between the contractually required loans payment receivable in excess of the initial investment in the loans be accreted into interest income over the life of the loans, if the loan is accruing interest. Covered loans accounted for under ASC Subtopic 310-20 amounted to $10 million at September 30, 2015 (December 31, 2014 - $0.1 billion).
Loans acquired with deteriorated credit quality accounted for under ASC 310-30
The following provides information of loans acquired with evidence of credit deterioration as of the acquisition date, accounted for under the guidance of ASC 310-30.
Loans acquired from Westernbank as part of an FDIC-assisted transaction
The carrying amount of the Westernbank loans consisted of loans determined to be impaired at the time of acquisition, which are accounted for in accordance with ASC Subtopic 310-30 (“credit impaired loans”), and loans that were considered to be performing at the acquisition date, accounted for by analogy to ASC Subtopic 310-30 (“non-credit impaired loans”), as detailed in the following table.
Carrying amount
Carrying amount, net of allowance
The outstanding principal balance of Westernbank loans accounted pursuant to ASC Subtopic 310-30, amounted to $2.5 billion at September 30, 2015 (December 31, 2014 - $3.1 billion). At September 30, 2015, none of the acquired loans from the Westernbank FDIC-assisted transaction accounted for under ASC Subtopic 310-30 were considered non-performing loans. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, was recognized on all acquired loans.
42
Changes in the carrying amount and the accretable yield for the Westernbank loans accounted pursuant to the ASC Subtopic 310-30, for the quarters ended September 30, 2015 and 2014, were as follows:
Beginning balance
Accretion
Change in expected cash flows
Ending balance
Collections and charge-offs
ASC 310-30 Westernbank loans
Ending balance, net of ALLL
43
Collections and charge offs
Other loans acquired with deteriorated credit quality
The outstanding principal balance of other acquired loans accounted pursuant to ASC Subtopic 310-30, amounted to $707 million at September 30, 2015 (December 31, 2014 - $243 million). At September 30, 2015, none of the other acquired loans accounted under ASC Subtopic 310-30 were considered non-performing loans. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, was recognized on all acquired loans.
Changes in the carrying amount and the accretable yield for the other acquired loans accounted pursuant to the ASC Subtopic 310-30, for the quarters ended September 30, 2015 and 2014 were as follows:
Activity in the accretable yield - other acquired loans ASC 310-30
Additions
44
Carrying amount of other acquired loans accounted for pursuant to ASC 310-30
Allowance for loan losses ASC 310-30 other acquired loans
During the quarter ended September 30 2015, the Corporation reclassified loans with a carrying value as of the acquisition date of February 27, 2015, of approximately $269.5 million to be accounted for under ASC 310-30. Based on new information obtained about facts and circumstances that existed as of the acquisition date, in accordance with ASC 805, the Corporation determined that these loans had evidence of deteriorated credit quality as of the acquisition date. These balances are reflected as an addition of $270.9 million to the carrying value of loans and $21.8 million to the accretable discount of loans accounted for under ASC 310-30 in the tables above.
The following table presents loans acquired as part of the Doral Bank Transaction accounted for pursuant to ASC Subtopic 310-30 at the February 27, 2015 acquisition date.
Contractually-required principal and interest
Non-accretable difference
Cash flows expected to be collected
Accretable yield
Fair value of loans accounted for under ASC Subtopic 310-30
45
Note 12 – Allowance for loan losses
The Corporation follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as current economic conditions, portfolio risk characteristics, prior loss experience and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on this methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses.
The Corporation’s assessment of the allowance for loan losses is determined in accordance with the guidance of loss contingencies in ASC Subtopic 450-20 and loan impairment guidance in ASC Section 310-10-35. Also, the Corporation determines the allowance for loan losses on purchased impaired loans and purchased loans accounted for under ASC Subtopic 310-30 by analogy, by evaluating decreases in expected cash flows after the acquisition date.
The accounting guidance provides for the recognition of a loss allowance for groups of homogeneous loans. The determination for general reserves of the allowance for loan losses includes the following principal factors:
For the period ended September 30, 2015, 18% (September 30, 2014- 33%) of the ALLL for BPPR non-covered loan portfolios utilized the recent loss trend adjustment instead of the base loss. The effect of replacing the base loss with the recent loss trend adjustment was mainly concentrated in the mortgage and commercial multi-family loan portfolios for 2015, and in the commercial multi-family, commercial and industrial, personal and auto loan portfolios for 2014.
For the period ended September 30, 2015, 17% (September 30, 2014 - 12%) of the ALLL for BPNA loan portfolios utilized the recent loss trend adjustment instead of the base loss. The effect of replacing the base loss with the recent loss trend adjustment was concentrated in the consumer loan portfolio for 2015 and in the commercial multi-family, commercial and industrial and legacy loan portfolios for 2014.
During the second quarter of 2015, management completed the annual review of the components of the ALLL models. As part of this review management updated core metrics and revised certain components related to the estimation process for evaluating the adequacy of the general reserve of the allowance for loan losses. These enhancements to the ALLL methodology, which are described in the paragraphs below, were implemented as of June 30, 2015 and resulted in a net decrease to the allowance for loan losses of $ 1.9 million for the non-covered portfolio. The effect of the aforementioned enhancements was immaterial for the covered loans portfolio.
Management made the following principal enhancements to the methodology during the second quarter of 2015:
46
The combined effect of the aforementioned enhancements to the base loss rates resulted in an increase to the allowance for loan losses of $19.6 million at June 30, 2015, of which $17.9 million related to the non-covered BPPR segment and $1.7 million related to the BPNA segment.
The combined effect of the aforementioned recalibration and enhancements to the environmental factors adjustment resulted in a decrease to the allowance for loan losses of $21.5 million at June 30, 2015, of which $20.5 million related to the non-covered BPPR segment and $1 million related to the BPNA segment.
The following tables present the changes in the allowance for loan losses for the quarters ended September 30, 2015 and 2014.
For the quarter ended September 30, 2015
Puerto Rico - Non-covered loans
Allowance for credit losses:
Provision (reversal of provision)
Charge-offs
Recoveries
Puerto Rico - Covered loans
U.S. Mainland
47
For the nine months ended September 30, 2015
Net write-downs related to loans transferred to held-for-sale
Allowance transferred from covered loans
Allowance transferred to non-covered loans
U.S. Mainland - Continuing Operations
Net recovery (write-down) related to loans transferred to held-for-sale
48
Net (write-down) recovery related to loans transferred to held-for-sale
For the quarter ended September 30, 2014
Puerto Rico - Covered Loans
Net (write-down) recovery related to loans transferred to LHFS
49
For the nine months ended September 30, 2014
Allowance transferred from discontinued operations
50
U.S. Mainland - Discontinued Operations
Allowance transferred to continuing operations
Net write-downs related to loans transferred to discontinued operations
Net write-down related to loans transferred to LHFS
The following table provides the activity in the allowance for loan losses related to Westernbank loans accounted for pursuant to ASC Subtopic 310-30.
Net charge-offs
Balance at end of period
The following tables present information at September 30, 2015 and December 31, 2014 regarding loan ending balances and the allowance for loan losses by portfolio segment and whether such loans and the allowance pertains to loans individually or collectively evaluated for impairment.
51
Specific ALLL non-covered loans
General ALLL non-covered loans
ALLL - non-covered loans
Specific ALLL covered loans
General ALLL covered loans
ALLL - covered loans
Total ALLL
Impaired non-covered loans
Non-covered loans held-in-portfolio excluding impaired loans
Non-covered loans held-in-portfolio
Impaired covered loans
Covered loans held-in-portfolio excluding impaired loans
Covered loans held-in-portfolio
Total loans held-in-portfolio
Specific ALLL
General ALLL
Impaired loans
Loans held-in-portfolio, excluding impaired loans
52
53
Loans held-in-portfolio,excluding impaired loans
excluding impaired loans
54
The following tables present loans individually evaluated for impairment at September 30, 2015 and December 31, 2014.
Total Puerto Rico
HELOCs
Total U.S. mainland
Credit Cards
Total Popular, Inc.
55
The following tables present the average recorded investment and interest income recognized on impaired loans for the quarter and nine months ended September 30, 2015 and 2014.
56
Helocs
57
Modifications
Troubled debt restructurings related to non-covered loan portfolios amounted to $ 1.2 billion at September 30, 2015 (December 31, 2014 - $ 1.1 billion). The amount of outstanding commitments to lend additional funds to debtors owing receivables whose terms have been modified in troubled debt restructurings amounted $3 million related to the commercial loan portfolio and none in the construction loan portfolio at September 30, 2015 (December 31, 2014 - $5 million and $1 million, respectively).
A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession.
Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting evergreen revolving credit lines to long-term loans. Commercial real estate (“CRE”), which includes multifamily, owner-occupied and non-owner occupied CRE, and construction loans modified in a TDR often involve reducing the interest rate for a limited period of time or the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or reductions in the payment plan. Construction loans modified in a TDR may also involve extending the interest-only payment period.
Residential mortgage loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs for a period of time, normally five years to ten years. After the lowered monthly payment period ends, the borrower reverts back to paying principal and interest per the original terms with the maturity date adjusted accordingly.
Home equity loans modifications are made infrequently and are not offered if the Corporation also holds the first mortgage. Home equity loans modifications are uniquely designed to meet the specific needs of each borrower. Automobile loans modified in a TDR are primarily comprised of loans where the Corporation has lowered monthly payments by extending the term. Credit cards modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs for a period of time, normally up to 24 months.
As part of its NPL reduction strategy and in order to expedite the resolution of delinquent construction and commercial loans, commencing in 2012, the Corporation routinely enters into liquidation agreements with borrowers and guarantors through the regular legal process, bankruptcy procedures and in certain occasions, out of court transactions. These liquidation agreements, in general, contemplate the following conditions: (1) consent to judgment by the borrowers and guarantors; (2) acknowledgement by the borrower of the debt, its liquidity and maturity; and (3) acknowledgment of the default in payments. The contractual interest rate is not reduced and continues to accrue during the term of the agreement. At the end of the period, the borrower is obligated to remit all amounts due or be subject to the Corporation’s exercise of its foreclosure rights and further collection efforts. Likewise, the borrower’s failure to make stipulated payments will grant the Corporation the ability to exercise its foreclosure rights. This strategy tends to expedite the foreclosure process, resulting in a more effective and efficient collection process. Although in general, these liquidation agreements do not contemplate the forgiveness of principal or interest as debtor is required to cover all outstanding
58
amounts when the agreement becomes due, it could be construed that the Corporation has granted a concession by temporarily accepting a payment schedule that is different from the contractual payment schedule. Accordingly, loans under these program agreements are considered TDRs.
Loans modified in a TDR that are not accounted pursuant to ASC Subtopic 310-30 are typically already in non-accrual status at the time of the modification and partial charge-offs have in some cases already been taken against the outstanding loan balance. The TDR loan continues in non-accrual status until the borrower has demonstrated a willingness and ability to make the restructured loan payments (generally at least six months of sustained performance after the modification (or one year for loans providing for quarterly or semi-annual payments)) and management has concluded that it is probable that the borrower would not be in payment default in the foreseeable future.
Loans modified in a TDR may have the financial effect to the Corporation of increasing the specific allowance for loan losses associated with the loan. Consumer and residential mortgage loans modified under the Corporation’s loss mitigation programs that are determined to be TDRs are individually evaluated for impairment based on an analysis of discounted cash flows.
For consumer and mortgage loans that are modified with regard to payment terms and which constitute TDRs, the discounted cash flow value method is used as the impairment valuation is more appropriately calculated based on the ongoing cash flow from the individuals rather than the liquidation of the asset. The computations give consideration to probability of defaults and loss-given-foreclosure on the related estimated cash flows.
Commercial and construction loans that have been modified as part of loss mitigation efforts are evaluated individually for impairment. The vast majority of the Corporation’s modified commercial loans are measured for impairment using the estimated fair value of the collateral, as these are normally considered as collateral dependent loans. The Corporation may also measure commercial loans at their estimated realizable values determined by discounting the expected future cash flows. Construction loans that have been modified are also accounted for as collateral dependent loans. The Corporation determines the fair value measurement dependent upon its exit strategy for the particular asset(s) acquired in foreclosure.
The following tables present the non-covered and covered loans classified as TDRs according to their accruing status at September 30, 2015 and December 31, 2014.
Leases
59
The following tables present the loan count by type of modification for those loans modified in a TDR during the quarters and nine months ended September 30, 2015 and 2014.
60
61
The following tables present by class, quantitative information related to loans modified as TDRs during the quarters and nine months ended September 30, 2015 and 2014.
(Dollars in thousands)
62
63
64
65
During the nine months ended September 30, 2015 and 2014, eleven loans with an aggregate unpaid principal balance of $10.8 million and four loans of $3.1 million, respectively, were restructured into multiple notes (“Note A / B split”). The Corporation recorded $747 thousand charge-offs as part of those loan restructurings during the nine months ended September 30, 2015 (September 30, 2014 - $14 thousand). The restructuring of those loans was made after analyzing the borrowers’ capacity to repay the debt, collateral and ability to perform under the modified terms. The recorded investment on those commercial TDRs amounted to approximately $10.2 million at September 30, 2015 (September 30, 2014 - $3.4 million) with a related allowance for loan losses amounting to approximately $309 thousand (September 30, 2014 - $111 thousand).
The following tables present by class, TDRs that were subject to payment default and that had been modified as a TDR during the twelve months preceding the default date. Payment default is defined as a restructured loan becoming 90 days past due after being modified, foreclosed or charged-off, whichever occurs first. The recorded investment at September 30, 2015 is inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported.
66
67
Commercial, consumer and mortgage loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Corporation evaluates the loan for possible further impairment. The allowance for loan losses may be increased or partial charge-offs may be taken to further write-down the carrying value of the loan.
Credit Quality
The following table presents the outstanding balance, net of unearned income, of non-covered loans held-in-portfolio based on the Corporation’s assignment of obligor risk ratings as defined at September 30, 2015 and December 31, 2014.
Puerto Rico[1]
Total Commercial
Total Consumer
68
The following table presents the weighted average obligor risk rating at September 30, 2015 for those classifications that consider a range of rating scales.
Puerto Rico:[1]
U.S. mainland:
69
70
The following table presents the weighted average obligor risk rating at December 31, 2014 for those classifications that consider a range of rating scales.
71
Note 13 – FDIC loss-share asset and true-up payment obligation
In connection with the Westernbank FDIC-assisted transaction, BPPR entered into loss-share arrangements with the FDIC with respect to the covered loans and other real estate owned. Pursuant to the terms of the loss-share arrangements, the FDIC’s obligation to reimburse BPPR for losses with respect to covered assets begins with the first dollar of loss incurred. The FDIC reimburses BPPR for 80% of losses with respect to covered assets, and BPPR reimburses the FDIC for 80% of recoveries with respect to losses for which the FDIC paid 80% reimbursement under loss-share arrangements. The loss-share agreement applicable to single-family residential mortgage loans provides for FDIC loss and recoveries sharing for ten years expiring at the end of the quarter ending June 30, 2020. The loss-share arrangements applicable to commercial (including construction) and consumer loans expired during the quarter ended June 30, 2015 and provides for reimbursement to the FDIC through the quarter ending June 30, 2018.
The following table sets forth the activity in the FDIC loss-share asset for the periods presented.
Amortization
Reversal of accelerated amortization in prior periods
Credit impairment losses (reversal) to be covered under loss-sharing agreements
Reimbursable expenses
Net payments from FDIC under loss-sharing agreements
Other adjustments attributable to FDIC loss-sharing agreements
As a result of the expiration of the shared-loss arrangement under the commercial loss-share agreement on June 30, 2015, loans with a carrying amount at June 30, 2015 of approximately $248.7 million, which were reclassified to “non-covered” in the accompanying statement of financial condition, are subject to the resolution of several arbitration proceedings currently ongoing with the FDIC related primarily to (i) the FDIC’s denial of reimbursements for certain charge-offs claimed by BPPR with respect to certain loans and the treatment of those loans as “shared-loss assets” under the commercial loss-share agreement; and (ii) the denial by the FDIC of portfolio sale proposals submitted by BPPR pursuant to the applicable commercial shared-loss agreement provision governing portfolio sales. Until the disputes described above are finally resolved, the terms of the commercial loss-share agreement will remain in effect with respect to any such items under dispute. As of September 30, 2015, losses amounting to $141.3 million related to these assets are reflected in the FDIC indemnification asset as a receivable from the FDIC. Refer to additional information of these disputes on Note 26, Commitments and Contingencies.
The weighted average life of the single family loan portfolio subject to the FDIC loss-sharing agreement at September 30, 2015 is 7.58 years.
As part of the loss-share agreements, BPPR has agreed to make a true-up payment to the FDIC on the date that is 45 days following the last day (such day, the “true-up measurement date”) of the final shared-loss month, or upon the final disposition of all covered assets under the loss-share agreements, in the event losses on the loss-share agreements fail to reach expected levels. The estimated fair value of such true-up payment obligation is recorded as contingent consideration, which is included in the caption of other liabilities in the consolidated statements of financial condition. Under the loss sharing agreements, BPPR will pay to the FDIC 50% of the excess, if any, of: (i) 20% of the intrinsic loss estimate of $4.6 billion (or $925 million) (as determined by the FDIC) less (ii) the sum of: (A) 25% of the asset discount (per bid) (or ($1.1 billion)); plus (B) 25% of the cumulative shared-loss payments (defined as the aggregate of all of the payments made or payable to BPPR minus the aggregate of all of the payments made or payable to the FDIC); plus (C) the sum of the period servicing amounts for every consecutive twelve-month period prior to and ending on the true-up measurement date in respect of each of the loss-sharing agreements during which the loss-sharing provisions of the applicable loss-sharing agreement is in effect (defined as the product of the simple average of the principal amount of shared- loss loans and shared-loss assets at the beginning and end of such period times 1%).
72
The following table provides the fair value and the undiscounted amount of the true-up payment obligation at September 30, 2015 and December 31, 2014.
Carrying amount (fair value)
Undiscounted amount
The loss-share agreements contain specific terms and conditions regarding the management of the covered assets that BPPR must follow in order to receive reimbursement on losses from the FDIC. Under the loss-share agreements, BPPR must:
Refer to Note 26, Commitment and Contingencies, for additional information on the settlement of the arbitration proceedings with the FDIC regarding the commercial loss-share agreement.
73
Note 14 – Mortgage banking activities
Income from mortgage banking activities includes mortgage servicing fees earned in connection with administering residential mortgage loans and valuation adjustments on mortgage servicing rights. It also includes gain on sales and securitizations of residential mortgage loans and trading gains and losses on derivative contracts used to hedge the Corporation’s securitization activities. In addition, lower-of-cost-or-market valuation adjustments to residential mortgage loans held for sale, if any, are recorded as part of the mortgage banking activities.
The following table presents the components of mortgage banking activities:
Mortgage servicing fees, net of fair value adjustments:
Mortgage servicing fees
Mortgage servicing rights fair value adjustments
Total mortgage servicing fees, net of fair value adjustments
Net gain on sale of loans, including valuation on loans held-for-sale
Trading account (loss) profit:
Unrealized (losses) gains on outstanding derivative positions
Realized (losses) gains on closed derivative positions
Total trading account (loss) profit
Total mortgage banking activities
74
Note 15 – Transfers of financial assets and mortgage servicing assets
The Corporation typically transfers conforming residential mortgage loans in conjunction with GNMA and FNMA securitization transactions whereby the loans are exchanged for cash or securities and servicing rights. The securities issued through these transactions are guaranteed by the corresponding agency and, as such, under seller/service agreements the Corporation is required to service the loans in accordance with the agencies’ servicing guidelines and standards. Substantially all mortgage loans securitized by the Corporation in GNMA and FNMA securities have fixed rates and represent conforming loans. As seller, the Corporation has made certain representations and warranties with respect to the originally transferred loans and, in the past, has sold certain loans with credit recourse to a government-sponsored entity, namely FNMA. Refer to Note 25 to the consolidated financial statements for a description of such arrangements.
No liabilities were incurred as a result of these securitizations during the quarters and nine months ended September 30, 2015 and 2014 because they did not contain any credit recourse arrangements. During the quarter ended September 30, 2015, the Corporation recorded a net gain $9.1 million (September 30, 2014 - $7.4 million) related to the residential mortgage loans securitized. During the nine months ended September 30, 2015, the Corporation recorded a net gain $22.8 million (September 30, 2014 - $24.4 million) related to the residential mortgage loans securitized.
The following tables present the initial fair value of the assets obtained as proceeds from residential mortgage loans securitized during the quarters and nine months ended September 30, 2015 and 2014:
Assets
Trading account securities:
Mortgage-backed securities - GNMA
Mortgage-backed securities - FNMA
Total trading account securities
Mortgage servicing rights
75
During the nine months ended September 30, 2015, the Corporation retained servicing rights on whole loan sales involving approximately $56 million in principal balance outstanding (September 30, 2014 - $71 million), with realized gains of approximately $2.2 million (September 30, 2014 - gains of $2.8 million). All loan sales performed during the nine months ended September 30, 2015 and 2014 were without credit recourse agreements.
The Corporation recognizes as assets the rights to service loans for others, whether these rights are purchased or result from asset transfers such as sales and securitizations. These mortgage servicing rights (“MSRs”) are measured at fair value.
The Corporation uses a discounted cash flow model to estimate the fair value of MSRs. The discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. Prepayment speeds are adjusted for the Corporation’s loan characteristics and portfolio behavior.
The following table presents the changes in MSRs measured using the fair value method for the nine months ended September 30, 2015 and 2014.
Residential MSRs
Fair value at beginning of period
Additions[1]
Changes due to payments on loans[2]
Reduction due to loan repurchases
Changes in fair value due to changes in valuation model inputs or assumptions
Fair value at end of period
During the second quarter of 2015, BPPR completed the acquisition of mortgage servicing rights on three pools of residence mortgage loans serviced for GNMA, FNMA and FHLMC, with an unpaid principal balance of approximately $5.0 billion, from the FDIC as a receiver for Doral Bank, as part of the Doral Bank Transaction. The aggregate purchase price for the mortgage servicing rights and related servicing advances was approximately $56.2 million.
During the third quarter of 2015, BPPR acquired mortgage servicing rights for a portfolio previously serviced by Doral Bank, with approximately $873 million in unpaid principal balance and a fair value of $4.4 million, in connection with a pre-existing backup servicing agreement. The Corporation also purchased the servicing advances related to this portfolio from the FDIC, as receiver of Doral Bank, for a price of $46.6 million.
76
Residential mortgage loans serviced for others were $20.9 billion at September 30, 2015 (December 31, 2014 - $15.6 billion).
Net mortgage servicing fees, a component of mortgage banking activities in the consolidated statements of operations, include the changes from period to period in the fair value of the MSRs, including changes due to collection / realization of expected cash flows. Mortgage servicing fees, excluding fair value adjustments, for the quarter and nine months ended September 30, 2015 amounted to $17.0 million and $44.0 million, respectively (September 30, 2014 - $11.1 million and $32.4 million, respectively). The banking subsidiaries receive servicing fees based on a percentage of the outstanding loan balance. At September 30, 2015, those weighted average mortgage servicing fees were 0.28% (September 30, 2014 – 0.27%). Under these servicing agreements, the banking subsidiaries do not generally earn significant prepayment penalty fees on the underlying loans serviced.
The section below includes information on assumptions used in the valuation model of the MSRs, originated and purchased.
Key economic assumptions used in measuring the servicing rights derived from loans securitized or sold by the Corporation during the quarters and nine months ended September 30, 2015 and 2014 were as follows:
Prepayment speed
Weighted average life
Discount rate (annual rate)
Key economic assumptions used to estimate the fair value of MSRs derived from sales and securitizations of mortgage loans performed by the banking subsidiaries and the sensitivity to immediate changes in those assumptions were as follows as of the end of the periods reported:
Fair value of servicing rights
Weighted average prepayment speed (annual rate)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Weighted average discount rate (annual rate)
The banking subsidiaries also own servicing rights purchased from other financial institutions. The fair value of purchased MSRs, their related valuation assumptions and the sensitivity to immediate changes in those assumptions were as follows as of the end of the periods reported:
77
The sensitivity analyses presented in the tables above for servicing rights are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 and 20 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the sensitivity tables included herein, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
At September 30, 2015, the Corporation serviced $1.9 billion (December 31, 2014 - $2.1 billion) in residential mortgage loans with credit recourse to the Corporation.
Under the GNMA securitizations, the Corporation, as servicer, has the right to repurchase (but not the obligation), at its option and without GNMA’s prior authorization, any loan that is collateral for a GNMA guaranteed mortgage-backed security when certain delinquency criteria are met. At the time that individual loans meet GNMA’s specified delinquency criteria and are eligible for repurchase, the Corporation is deemed to have regained effective control over these loans if the Corporation was the pool issuer. At September 30, 2015, the Corporation had recorded $116 million in mortgage loans on its consolidated statements of financial condition related to this buy-back option program (December 31, 2014 - $81 million). As long as the Corporation continues to service the loans that continue to be collateral in a GNMA guaranteed mortgage-backed security, the MSR is recognized by the Corporation. During the nine months ended September 30, 2015, the Corporation repurchased approximately $ 68 million (September 30, 2014 - $141 million) of mortgage loans under the GNMA buy-back option program. The determination to repurchase these loans was based on the economic benefits of the transaction, which results in a reduction of the servicing costs for these severely delinquent loans, mostly related to principal and interest advances. Furthermore, due to their guaranteed nature, the risk associated with the loans is minimal. The Corporation places these loans under its loss mitigation programs and once brought back to current status, these may be either retained in portfolio or re-sold in the secondary market.
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Note 16 – Other real estate owned
The following tables present the activity related to Other Real Estate Owned (“OREO”), for the quarters and nine months ended September 30, 2015 and 2014.
Write-downs in value
Sales
Other adjustments
Transfer to non-covered status[1]
During the second quarter of 2015, the Corporation completed a bulk sale of $37 million of covered OREOs.
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Note 17 – Other assets
The caption of other assets in the consolidated statements of financial condition consists of the following major categories:
Net deferred tax assets (net of valuation allowance)
Investments under the equity method
Prepaid taxes
Other prepaid expenses
Derivative assets
Trades receivable from brokers and counterparties
Others
Total other assets
Prepaid taxes at September 30, 2015 and December 31, 2014 includes a payment of $45 million in income taxes in connection with the Closing Agreement signed with the Puerto Rico Department of Treasury on June 30, 2014.
As discussed in Note 36, the corporation recorded during the quarter ended June 30, 2015 a partial reversal of the valuation allowance on its deferred tax assets from its U.S. operations for approximately $545 million.
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Note 18 – Goodwill and other intangible assets
The changes in the carrying amount of goodwill for the nine months ended September 30, 2015 and 2014, allocated by reportable segments, were as follows (refer to Note 38 for the definition of the Corporation’s reportable segments):
2015
Banco Popular de Puerto Rico
Banco Popular North America
2014
The goodwill acquired during 2015 in the reportable segments of Banco Popular de Puerto Rico and Banco Popular North America of $2.9 million, after considering purchase accounting adjustments, and $38.7 million, respectively, was related to the Doral Bank Transaction. During the nine months ended September 30, 2015, the Corporation recorded adjustments to its initial fair value estimates resulting in a net reduction of the goodwill recorded in connection with the Doral Bank Transaction of approximately $1.0 million. Refer to Note 5, Business Combination, for additional information. In addition, the Corporation recorded purchase accounting adjustments to reduce the goodwill related to the acquisition of an insurance benefits business during the year ended December 31, 2014 by approximately $2.4 million.
Other Intangible Assets
At September 30, 2015 and December 31, 2014, the Corporation had $ 6 million of identifiable intangible assets, with indefinite useful lives, mostly associated with E-LOAN’s trademark.
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The following table reflects the components of other intangible assets subject to amortization:
Core deposits
Other customer relationships
Total other intangible assets
During the first quarter of 2015, the Corporation also acquired $23.6 million in core deposit intangibles related to the Doral Bank Transaction. During the second quarter of 2015, the Corporation acquired the Doral Insurance Agency portfolio, as part of a separate bidding process after Doral Financial Corporation filed for bankruptcy. As a result of this acquisition, the Corporation recorded $17.3 million in customer relationship intangibles.
During the quarter ended September 30, 2015, the Corporation recognized $ 3.5 million in amortization expense related to other intangible assets with definite useful lives (September 30, 2014 - $ 2.0 million). During the nine months ended September 30, 2015, the Corporation recognized $ 8.5 million in amortization related to other intangible assets with definite useful lives (September 30, 2014 - $ 6.1 million).
The following table presents the estimated amortization of the intangible assets with definite useful lives for each of the following periods:
Remaining 2015
Year 2016
Year 2017
Year 2018
Year 2019
Year 2020
Results of the Annual Goodwill Impairment Test
The Corporation’s goodwill and other identifiable intangible assets having an indefinite useful life are tested for impairment, at least annually and on a more frequent basis if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit.
Under applicable accounting standards, goodwill impairment analysis is a two-step test. The first step of the goodwill impairment test involves comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed. The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangibles (including any unrecognized intangible assets, such as unrecognized core deposits and trademark) as if the reporting unit was being acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The Corporation estimates the fair values of the assets and liabilities of a reporting unit, consistent with the requirements of the fair value measurements accounting standard, which defines fair value as the price that would be received to
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sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of the assets and liabilities reflects market conditions, thus volatility in prices could have a material impact on the determination of the implied fair value of the reporting unit goodwill at the impairment test date. The adjustments to measure the assets, liabilities and intangibles at fair value are for the purpose of measuring the implied fair value of goodwill and such adjustments are not reflected in the consolidated statement of condition. If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment. If the goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted under applicable accounting standards.
The Corporation performed the annual goodwill impairment evaluation for the entire organization during the third quarter of 2015 using July 31, 2015 as the annual evaluation date. The reporting units utilized for this evaluation were those that are one level below the business segments, which are the legal entities within the reportable segment. The Corporation follows push-down accounting, as such all goodwill is assigned to the reporting units when carrying out a business combination.
In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, including market price multiples of comparable companies and transactions, as well as discounted cash flow analysis. Management evaluates the particular circumstances of each reporting unit in order to determine the most appropriate valuation methodology. The Corporation evaluates the results obtained under each valuation methodology to identify and understand the key value drivers in order to ascertain that the results obtained are reasonable and appropriate under the circumstances. Elements considered include current market and economic conditions, developments in specific lines of business, and any particular features in the individual reporting units.
The computations require management to make estimates and assumptions. Critical assumptions that are used as part of these evaluations include:
For purposes of the market comparable approach, valuations were determined by calculating average price multiples of relevant value drivers from a group of companies that are comparable to the reporting unit being analyzed and applying those price multiples to the value drivers of the reporting unit. Multiples used are minority based multiples and thus, no control premium adjustment is made to the comparable companies market multiples. While the market price multiple is not an assumption, a presumption that it provides an indicator of the value of the reporting unit is inherent in the valuation. The determination of the market comparables also involves a degree of judgment.
For purposes of the discounted cash flows (“DCF”) approach, the valuation is based on estimated future cash flows. The financial projections used in the DCF valuation analysis for each reporting unit are based on the most recent (as of the valuation date) financial projections presented to the Corporation’s Asset / Liability Management Committee (“ALCO”). The growth assumptions included in these projections are based on management’s expectations for each reporting unit’s financial prospects considering economic and industry conditions as well as particular plans of each entity (i.e. restructuring plans, de-leveraging, etc.). The cost of equity used to discount the cash flows was calculated using the Ibbotson Build-Up Method and ranged from 11.64% to 15.52% for the 2015 analysis. The Ibbotson Build-Up Method builds up a cost of equity starting with the rate of return of a “risk-free” asset (20-year U.S. Treasury note) and adds to it additional risk elements such as equity risk premium, size premium and industry risk premium. The resulting discount rates were analyzed in terms of reasonability given the current market conditions and adjustments were made when necessary.
For BPNA reporting unit, the average estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPNA’s equity value by approximately $92 million in the July 31, 2015 annual test and by $205 million in the July 31, 2014 annual test. Accordingly, there is no indication of impairment on the goodwill recorded in BPNA at July 31, 2015 and there is no need for a Step 2 analysis.
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For the BPPR reporting unit, the average estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPPR’s equity value by approximately $180 million in the July 31, 2015 annual test as compared with approximately $337 million at July 31, 2014. This result indicates there is no indication of impairment on the goodwill recorded in BPPR at July 31, 2015. The goodwill balance of BPPR and BPNA, as legal entities, represented approximately 96% of the Corporation’s total goodwill balance as of the July 31, 2015 valuation date.
Furthermore, as part of the analyses, management performed a reconciliation of the aggregate fair values determined for the reporting units to the market capitalization of Popular, Inc. concluding that the fair value results determined for the reporting units in the July 31, 2015 annual assessment were reasonable.
The goodwill impairment evaluation process requires the Corporation to make estimates and assumptions with regard to the fair value of the reporting units. Actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Corporation’s results of operations and the reporting units where the goodwill is recorded. Declines in the Corporation’s market capitalization could increase the risk of goodwill impairment in the future.
Management monitors events or changes in circumstances between annual tests to determine if these events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The following table presents the gross amount of goodwill and accumulated impairment losses by reportable segments.
Goodwill Impairment Test – U.S. Regional Sales
As discussed in Note 4, Discontinued Operations, on April 22, 2014, BPNA entered into definitive agreements to sell its regional operations in California, Illinois and Central Florida to three different buyers. In connection with the transactions, the Corporation has centralized certain back office operations in Puerto Rico and New York. During the second quarter of 2014, the assets and liabilities for those regions were reclassified as held-for-sale in accordance with ASC 360-10-45. As a result of the reclassification, and in accordance with ASC 350-20-40, BPNA allocated a proportionate share of the goodwill balance to the discontinued businesses on a relative fair value basis and performed an impairment test for the goodwill allocated to each of the discontinued operations as well as for retained business, each as a separate reporting unit. This allocation of goodwill and related impairment analysis resulted in an impairment charge of $186.5 million during the second quarter of 2014. The goodwill impairment charge is a non-cash charge that did not have an impact on the Corporation’s tangible capital or regulatory capital ratios. The goodwill impairment analysis of the retained portion of the BPNA operations resulted in no impairment as of June 30, 2014.
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The methodology used to determine the relative value of the regions sold and the retained portion of the BPNA reporting unit for purpose of the goodwill allocation among these reporting units takes into consideration the fair value estimates resulting from a combination of: (1) the average price to tangible book multiple based on a regression analysis of the projected return on equity for comparable companies, (2) the average price to revenue multiple based on a regression analysis of the projected revenue margin for comparable companies, and (3) the average price to earnings multiple based on comparable companies. After allocating the carrying amount of goodwill to the regions sold and the retained portion, the Corporation performed the goodwill impairment test of ASC 350-20 to each region sold and to the retained business reporting unit. The fair value of each region was based on the transaction price agreed with the buyers as part of the Step 2 of the goodwill impairment analysis. This fair value was compared to the fair value of the assets and liabilities sold including any unrecognized intangible asset. The goodwill impairment analysis of the regions sold indicated that all the goodwill allocated to each region sold was impaired, and accordingly, the Corporation recorded an impairment charge of $186.5 million during the second quarter of 2014.
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Note 19 – Deposits
Total interest bearing deposits as of the end of the periods presented consisted of:
Savings accounts
NOW, money market and other interest bearing demand deposits
Total savings, NOW, money market and other interest bearing demand deposits
Certificates of deposit:
Under $100,000
$100,000 and over
Total certificates of deposit
Total interest bearing deposits
A summary of certificates of deposit by maturity at September 30, 2015 follows:
2016
2017
2018
2019
2020 and thereafter
At September 30, 2015, the Corporation had brokered deposits amounting to $ 1.6 billion (December 31, 2014 - $ 1.9 billion).
The aggregate amount of overdrafts in demand deposit accounts that were reclassified to loans was $13 million at September 30, 2015 (December 31, 2014 - $9 million).
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Note 20 – Borrowings
The following table presents the composition of fed funds purchased and assets sold under agreements to repurchase at September 30, 2015 and December 31, 2014.
Federal funds purchased
Assets sold under agreements to repurchase
Total federal funds purchased and assets sold under agreements to repurchase
The following table presents information related to the Corporation’s repurchase transactions accounted for as secured borrowings that are collateralized with investment securities available-for-sale, other assets held-for-trading purposes or which have been obtained under agreements to resell. It is the Corporation’s policy to maintain effective control over assets sold under agreements to repurchase; accordingly, such securities continue to be carried on the consolidated statements of financial condition.
Repurchase agreements accounted for as secured borrowings
U.S. Treasury Securities
Within 30 days
After 90 days
Total U.S. Treasury Securities
Obligations of U.S. government sponsored entities
Overnight
After 30 to 90 days
Total obligations of U.S. government sponsored entities
Obligations of Puerto Rico, states and political subdivisions
Total Obligations of Puerto Rico, states and political subdivisions
Collateralized mortgage obligations
Total collateralized mortgage obligations
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Repurchase agreements in portfolio are generally short-term, often overnight and Popular acts as borrowers transferring assets to the counterparty. As such our risk is very limited. We manage the liquidity risks arising from secured funding by sourcing funding globally from a diverse group of counterparties, providing a range of securities collateral and pursuing longer durations, when appropriate.
The following table presents the composition of other short-term borrowings at September 30, 2015 and December 31, 2014.
Advances with the FHLB paying interest at maturity
Total other short-term borrowings
Note: Refer to the Corporation’s 2014 Annual Report for rates information at December 31, 2014.
The following table presents the composition of notes payable at September 30, 2015 and December 31, 2014.
Advances with the FHLB with maturities ranging from 2015 through 2029 paying interest at monthly fixed rates ranging from 0.41% to 4.19%
Unsecured senior debt securities maturing on 2019 paying interest semiannually at a fixed rate of 7.00%
Junior subordinated deferrable interest debentures (related to trust preferred securities) with maturities ranging from 2027 to 2034 with fixed interest rates ranging from 6.125% to 8.327% (Refer to Note 22)
Total notes payable
A breakdown of borrowings by contractual maturities at September 30, 2015 is included in the table below.
Year
Later years
Total borrowings
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Note 21 – Offsetting of financial assets and liabilities
The following tables present the potential effect of rights of setoff associated with the Corporation’s recognized financial assets and liabilities at September 30, 2015 and December 31, 2014.
As of September 30, 2015
Derivatives
Reverse repurchase agreements
Repurchase agreements
As of December 31, 2014
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The Corporation’s derivatives are subject to agreements which allow a right of set-off with each respective counterparty. In addition, the Corporation’s Repurchase Agreements and Reverse Repurchase Agreements have a right of set-off with the respective counterparty under the supplemental terms of the Master Repurchase Agreements. In an event of default each party has a right of set-off against the other party for amounts owed in the related agreement and any other amount or obligation owed in respect of any other agreement or transaction between them.
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Note 22 – Trust preferred securities
At September 30, 2015 and December 31, 2014, statutory trusts established by the Corporation (BanPonce Trust I, Popular Capital Trust I, Popular North America Capital Trust I and Popular Capital Trust II) had issued trust preferred securities (also referred to as “capital securities”) to the public. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts (the “common securities”), were used by the trusts to purchase junior subordinated deferrable interest debentures (the “junior subordinated debentures”) issued by the Corporation.
The sole assets of the trusts consisted of the junior subordinated debentures of the Corporation and the related accrued interest receivable. These trusts are not consolidated by the Corporation pursuant to accounting principles generally accepted in the United States of America.
The junior subordinated debentures are included by the Corporation as notes payable in the consolidated statements of financial condition, while the common securities issued by the issuer trusts are included as other investment securities. The common securities of each trust are wholly-owned, or indirectly wholly-owned, by the Corporation.
The following table presents financial data pertaining to the different trusts at September 30, 2015 and December 31, 2014.
Issuer
Capital securities
Distribution rate
Common securities
Junior subordinated debentures aggregate liquidation amount
Stated maturity date
Reference notes
The Basel III Capital Rules require that capital instruments such as trust preferred securities be phased-out of Tier 1 capital. The Corporation’s capital components at September 30, 2015 included $ 427 million of trust preferred securities that are subject to the phase-out provisions of the Basel III Capital Rules. The Corporation is allowed to include only 25% of such trust preferred securities in Tier I capital as of January 1, 2015 and would be allowed 0% as of January 1, 2016 and thereafter. The Basel III Capital Rules also permanently grandfathers as Tier 2 capital such trust preferred securities.
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Note 23 – Stockholders’ equity
During the quarter ended September 30, 2015 the Corporation declared a cash dividend of $0.15 per share on its outstanding common stock, which was paid on October 7, 2015 to shareholders of record at the close of business on September 29, 2015. This represents a payout of approximately $15.5 million and is the first cash dividend the Corporation pays to its shareholders since April 2009.
BPPR statutory reserve
The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of 10% of BPPR’s net income for the year be transferred to a statutory reserve account until such statutory reserve equals the total of paid-in capital on common and preferred stock. Any losses incurred by a bank must first be charged to retained earnings and then to the reserve fund. Amounts credited to the reserve fund may not be used to pay dividends without the prior consent of the Puerto Rico Commissioner of Financial Institutions. The failure to maintain sufficient statutory reserves would preclude BPPR from paying dividends. BPPR’s statutory reserve fund amounted to $469 million at September 30, 2015 (December 31, 2014 - $469 million). There were no transfers between the statutory reserve account and the retained earnings account during the quarters and nine months ended September 30, 2015 and September 30, 2014.
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Note 24 – Other comprehensive loss
The following table presents changes in accumulated other comprehensive loss by component for the quarters and nine months ended September 30, 2015 and 2014.
Changes in Accumulated Other Comprehensive Loss by Component [1]
Foreign currency translation
Beginning Balance
Other comprehensive (loss) income before reclassifications
Amounts reclassified from accumulated other comprehensive loss
Net change
Adjustment of pension and postretirement benefit plans
Amounts reclassified from accumulated other comprehensive loss for amortization of net losses
Amounts reclassified from accumulated other comprehensive loss for amortization of prior service cost
Unrealized net holding gains (losses) on investments
Other comprehensive income (loss) before reclassifications
Other-than-temporary impairment amount reclassified from accumulated other comprehensive income (loss)
Amounts reclassified from accumulated other comprehensive income (loss)
Other comprehensive loss before reclassifications
Amounts reclassified from accumulated other comprehensive (loss) income
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The following table presents the amounts reclassified out of each component of accumulated other comprehensive loss during the quarters and nine months ended September 30, 2015 and 2014.
Reclassifications Out of Accumulated Other Comprehensive Loss
Consolidated Statements of Operations
Foreign Currency Translation
Cumulative translation adjustment reclassified into earnings
Amortization of net losses
Amortization of prior service cost
Realized loss on sale of securities
Forward contracts
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Note 25 – Guarantees
At September 30, 2015, the Corporation recorded a liability of $0.5 million (December 31, 2014 - $0.4 million), which represents the unamortized balance of the obligations undertaken in issuing the guarantees under the standby letters of credit. Management does not anticipate any material losses related to these instruments.
From time to time, the Corporation securitized mortgage loans into guaranteed mortgage-backed securities subject to limited, and in certain instances, lifetime credit recourse on the loans that serve as collateral for the mortgage-backed securities. The Corporation has not sold any mortgage loans subject to credit recourse since 2009. At September 30, 2015, the Corporation serviced $ 1.9 billion (December 31, 2014 - $ 2.1 billion) in residential mortgage loans subject to credit recourse provisions, principally loans associated with FNMA and FHLMC residential mortgage loan securitization programs. In the event of any customer default, pursuant to the credit recourse provided, the Corporation is required to repurchase the loan or reimburse the third party investor for the incurred loss. The maximum potential amount of future payments that the Corporation would be required to make under the recourse arrangements in the event of nonperformance by the borrowers is equivalent to the total outstanding balance of the residential mortgage loans serviced with recourse and interest, if applicable. During the quarter and nine months ended September 30, 2015, the Corporation repurchased approximately $ 14 million and $ 44 million, respectively, of unpaid principal balance in mortgage loans subject to the credit recourse provisions (September 30, 2014 - $ 21 million and $ 69 million, respectively). In the event of nonperformance by the borrower, the Corporation has rights to the underlying collateral securing the mortgage loan. The Corporation suffers ultimate losses on these loans when the proceeds from a foreclosure sale of the property underlying a defaulted mortgage loan are less than the outstanding principal balance of the loan plus any uncollected interest advanced and the costs of holding and disposing the related property. At September 30, 2015, the Corporation’s liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $ 57 million (December 31, 2014 - $ 59 million).
The following table shows the changes in the Corporation’s liability of estimated losses related to loans serviced with credit recourse provisions during the quarters and nine month periods ended September 30, 2015 and 2014.
Balance as of beginning of period
Provision for recourse liability
Balance as of end of period
The estimated losses to be absorbed under the credit recourse arrangements are recorded as a liability when the loans are sold or credit recourse is assumed as part of acquired servicing rights, and are updated by accruing or reversing expense (categorized in the line item “adjustments (expense) to indemnity reserves on loans sold” in the consolidated statements of operations) throughout the life of the loan, as necessary, when additional relevant information becomes available. The methodology used to estimate the recourse liability is a function of the recourse arrangements given and considers a variety of factors, which include actual defaults and historical loss experience, foreclosure rate, estimated future defaults and the probability that a loan would be delinquent. Statistical methods are used to estimate the recourse liability. Expected loss rates are applied to different loan segmentations. The expected loss, which represents the amount expected to be lost on a given loan, considers the probability of default and loss severity. The probability of default represents the probability that a loan in good standing would become 90 days delinquent within the following twelve-month period. Regression analysis quantifies the relationship between the default event and loan-specific characteristics, including credit scores, loan-to-value ratios, and loan aging, among others.
When the Corporation sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. The Corporation’s mortgage operations in Puerto Rico group conforming mortgage loans into pools which are exchanged for FNMA and GNMA mortgage-backed securities, which are generally sold to private investors, or are sold directly to FNMA or other private investors for cash. As required under the government agency programs, quality review procedures are performed by the Corporation to ensure that asset guideline qualifications are met. To the extent the loans do not meet specified characteristics, the Corporation may be required to repurchase such loans or indemnify for losses and bear any subsequent loss related to the loans. Repurchases under BPPR’s representation and warranty arrangements for the nine months
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ended September 30, 2015 approximated $175 thousand, in unpaid principal balance, with losses amounting to $24 thousand, and $ 2.2 million and $ 1.6 million, respectively, for the same period of 2014. A substantial amount of these loans reinstate to performing status or have mortgage insurance, and thus the ultimate losses on the loans are not deemed significant.
As discussed on Note 4 – Discontinued operations, on November 8, 2014, the Corporation completed the sale of the California regional operations. In connection with this transaction, the Corporation agreed to provide, subject to certain limitations, customary indemnification to the purchaser, including with respect to certain pre-closing liabilities and violations of representations and warranties. The Corporation also agreed to indemnify the purchaser for up to 1.5% of credit losses on transferred loans for a period of two years after the closing. Pursuant to this indemnification provision, the Corporation’s maximum exposure is approximately $16.0 million. The Corporation recognized a reserve of approximately $2.2 million, representing its best estimate of the loss that would be incurred in connection with this indemnification. This reserve is included within the liabilities from discontinued operations.
During the quarter ended June 30, 2013, the Corporation established a reserve for certain specific representation and warranties made in connection with BPPR’s sale of non-performing mortgage loans. The purchaser’s sole remedy under the indemnity clause is to seek monetary damages from BPPR, for a maximum of $16.3 million. BPPR recognized a reserve of approximately $3.0 million, representing its best estimate of the loss that would be incurred in connection with this indemnification. BPPR’s obligations under this clause end one year after the closing except to any claim asserted prior to such termination date. At September 30, 2015, the Corporation has a reserve balance of $3 million to cover claims received from the purchaser, which are currently being evaluated.
During the quarter ended March 31, 2013, the Corporation established a reserve for certain specific representations and warranties made in connection with BPPR’s sale of commercial and construction loans, and commercial and single family real estate owned. The purchaser’s sole remedy under the indemnity clause is to seek monetary damages from BPPR, for a maximum of $18.0 million. BPPR is not required to repurchase any of the assets. BPPR recognized a reserve of approximately $10.7 million, representing its best estimate of the loss that would be incurred in connection with this indemnification. During the first and second quarter of 2015, the Corporation released $3.2 million and $1.8 million, respectively, based on an evaluation of claims received under this clause. At September 30, 2015, the Corporation has a reserve balance of $0.1 million to cover claims received from the purchaser.
The following table presents the changes in the Corporation’s liability for estimated losses associated with indemnifications and representations and warranties related to loans sold by BPPR for the quarters and nine months ended September 30, 2015 and 2014.
Additions for new sales
Provision (reversal) for representation and warranties
Settlements paid
In addition, at September 30, 2015, the Corporation has reserves for customary representations and warranties related to loans sold by its U.S. subsidiary E-LOAN prior to 2009. These loans were sold to investors on a servicing released basis subject to certain representation and warranties. Although the risk of loss or default was generally assumed by the investors, the Corporation made certain representations relating to borrower creditworthiness, loan documentation and collateral, which if not correct, may result in requiring the Corporation to repurchase the loans or indemnify investors for any related losses associated with these loans. At September 30, 2015, the Corporation’s reserve for estimated losses from such representation and warranty arrangements amounted to $ 4 million, which was included as part of other liabilities in the consolidated statement of financial condition (December 31, 2014 - $ 5 million). E-LOAN is no longer originating and selling loans since the subsidiary ceased these activities in 2008 and most of the outstanding agreements with major counterparties were settled during 2010 and 2011.
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Servicing agreements relating to the mortgage-backed securities programs of FNMA and GNMA, and to mortgage loans sold or serviced to certain other investors, including FHLMC, require the Corporation to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. At September 30, 2015, the Corporation serviced $ 20.9 billion in mortgage loans for third-parties, including the loans serviced with credit recourse (December 31, 2014 - $ 15.6 billion). The Corporation generally recovers funds advanced pursuant to these arrangements from the mortgage owner, from liquidation proceeds when the mortgage loan is foreclosed or, in the case of FHA/VA loans, under the applicable FHA and VA insurance and guarantees programs. However, in the meantime, the Corporation must absorb the cost of the funds it advances during the time the advance is outstanding. The Corporation must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Corporation would not receive any future servicing income with respect to that loan. At September 30, 2015, the outstanding balance of funds advanced by the Corporation under such mortgage loan servicing agreements was approximately $102 million (December 31, 2014 - $36 million). To the extent the mortgage loans underlying the Corporation’s servicing portfolio experience increased delinquencies, the Corporation would be required to dedicate additional cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.
Popular, Inc. Holding Company (“PIHC”) fully and unconditionally guarantees certain borrowing obligations issued by certain of its wholly-owned consolidated subsidiaries amounting to $ 0.2 billion at September 30, 2015 (December 31, 2014 - $ 0.2 billion). In addition, at September 30, 2015 and December 31, 2014, PIHC fully and unconditionally guaranteed on a subordinated basis $ 0.4 billion and $ 0.4 billion, respectively, of capital securities (trust preferred securities) issued by wholly-owned issuing trust entities to the extent set forth in the applicable guarantee agreement. Refer to Note 22 to the consolidated financial statements for further information on the trust preferred securities.
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Note 26 – Commitments and contingencies
Off-balance sheet risk
The Corporation is a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financial needs of its customers. These financial instruments include loan commitments, letters of credit, and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.
The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and financial guarantees written is represented by the contractual notional amounts of those instruments. The Corporation uses the same credit policies in making these commitments and conditional obligations as it does for those reflected on the consolidated statements of financial condition.
Financial instruments with off-balance sheet credit risk, whose contract amounts represent potential credit risk as of the end of the periods presented were as follows:
Commitments to extend credit:
Credit card lines
Commercial and construction lines of credit
Other consumer unused credit commitments
Commercial letters of credit
Standby letters of credit
Commitments to originate or fund mortgage loans
At September 30, 2015, the Corporation maintained a reserve of approximately $12 million for potential losses associated with unfunded loan commitments related to commercial and consumer lines of credit, as compared to $13 million at December 31, 2014.
Other commitments
At September 30, 2015, the Corporation also maintained other non-credit commitments for approximately $9 million, primarily for the acquisition of other investments, as compared to $9 million at December 31, 2014.
Business concentration
Since the Corporation’s business activities are currently concentrated primarily in Puerto Rico, its results of operations and financial condition are dependent upon the general trends of the Puerto Rico economy and, in particular, the residential and commercial real estate markets. The concentration of the Corporation’s operations in Puerto Rico exposes it to greater risk than other banking companies with a wider geographic base. Its asset and revenue composition by geographical area is presented in Note 38 to the consolidated financial statements.
At September 30, 2015, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 635 million, of which approximately $ 579 million is outstanding ($ 1.0 billion and $ 811 million, respectively, at December 31, 2014). Of the amount outstanding, $ 498 million consists of loans and $ 81 million are securities ($ 689 million and $ 122 million at December 31, 2014). Of this amount, $ 82 million represents obligations from the Government of Puerto Rico and public corporations that have a specific source of income or revenues identified for their repayment ($ 336 million at December 31, 2014). Some of these obligations consist of senior and subordinated loans to public corporations that obtain revenues from rates charged for services or products, such as public utilities. Public corporations have varying degrees of independence from the central Government and many receive appropriations or other payments from it. The remaining $ 497 million outstanding represents obligations from various municipalities in Puerto Rico for which, in most cases, the good faith, credit and unlimited taxing power of the applicable municipality has been pledged to their repayment ($ 475 million at December 31, 2014). These municipalities are required by law to levy special property taxes in such amounts as shall be required for the payment of all of its general obligation bonds and loans. These loans have seniority to the payment of operating cost and expenses of the municipality. During the quarter ended June 30, 2015, the Corporation agreed to sell a $75 million non-accrual public sector credit at BPPR (subject among other
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conditions, to the approval of the syndicate’s agent bank, and accordingly transferred it to held-for-sale. The sale agreement was terminated on July 29, 2015 pursuant to its terms after the parties were not able to obtain the approval of the agent bank on terms acceptable to the assignee. However, at September 30, 2015, the loan remains classified as held-for-sale as the Corporation maintains its ability and intent to sell the loan.
The following table details the loans and investments representing the Corporation’s direct exposure to the Puerto Rico government according to their maturities:
Central Government
Total Central Government
Government Development Bank (GDB)
Total Government Development Bank (GDB)
Public Corporations:
Puerto Rico Aqueduct and Sewer Authority
Total Puerto Rico Aqueduct and Sewer Authority
Puerto Rico Electric Power Authority
Total Puerto Rico Electric Power Authority
Puerto Rico Highways and Transportation Authority
Total Puerto Rico Highways and Transportation Authority
Municipalities
Total Municipalities
Total Direct Government Exposure
In addition, at September 30, 2015, the Corporation had $386 million in indirect exposure to loans or securities that are payable by non-governmental entities, but which carry a government guarantee to cover any shortfall in collateral in the event of borrower default ($370 million at December 31, 2014). These included $307 million in residential mortgage loans that are guaranteed by the Puerto Rico Housing Finance Authority (December 31, 2014 - $289 million). These mortgage loans are secured by the underlying properties and the guarantees serve to cover shortfalls in collateral in the event of a borrower default. Also, the Corporation had $50 million in Puerto Rico pass-through housing bonds backed by FNMA, GNMA or residential loans CMO’s, and $29 million of commercial real estate notes ($49 million and $32 million at December 31, 2014, respectively).
Since February 2014, the three principal rating agencies (Moody’s, S&P and Fitch) have lowered their ratings on the General Obligation bonds of the Commonwealth and the bonds of several other Commonwealth instrumentalities to non-investment grade ratings. In connection with their rating actions, the rating agencies noted various factors, including high levels of public debt, the lack
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of a clear economic growth catalyst, recurring fiscal budget deficits, the financial condition of the public sector employee pension plans and, more recently, liquidity concerns regarding the Commonwealth and the GDB and their ability to access the capital markets. Currently, the Commonwealth’s general obligation ratings are as follows: S&P, ‘CC’, Moody’s, ‘Caa3’, and Fitch, ‘CC’.
During the second quarter of 2015, the Corporation recognized an other-than-temporary impairment charge of $14.4 million on its portfolio of investment securities available-for-sale classified as obligations from the Puerto Rico government and its political subdivisions.
Other contingencies
As indicated in Note 13 to the consolidated financial statements, as part of the loss sharing agreements related to the Westernbank FDIC-assisted transaction, the Corporation agreed to make a true-up payment to the FDIC on the date that is 45 days following the last day of the final shared loss month, or upon the final disposition of all covered assets under the loss sharing agreements in the event losses on the loss sharing agreements fail to reach expected levels. The fair value of the true-up payment obligation was estimated at $ 123 million at September 30, 2015 (December 31, 2014 - $ 129 million).
Legal Proceedings
The nature of Popular’s business ordinarily results in a certain number of claims, litigation, investigations, and legal and administrative cases and proceedings. When the Corporation determines it has meritorious defenses to the claims asserted, it vigorously defends itself. The Corporation will consider the settlement of cases (including cases where it has meritorious defenses) when, in management’s judgment, it is in the best interest of both the Corporation and its shareholders to do so.
On at least a quarterly basis, Popular assesses its liabilities and contingencies in connection with outstanding legal proceedings utilizing the latest information available. For matters where it is probable that the Corporation will incur a material loss and the amount can be reasonably estimated, the Corporation establishes an accrual for the loss. Once established, the accrual is adjusted on at least a quarterly basis as appropriate to reflect any relevant developments. For matters where a material loss is not probable or the amount of the loss cannot be estimated, no accrual is established.
In certain cases, exposure to loss exists in excess of the accrual to the extent such loss is reasonably possible, but not probable. Management believes and estimates that the aggregate range of reasonably possible losses (with respect to those matters where such limits may be determined, in excess of amounts accrued), for current legal proceedings ranges from $0 to approximately $27 million as of September 30, 2015. For certain other cases, management cannot reasonably estimate the possible loss at this time. Any estimate involves significant judgment, given the varying stages of the proceedings (including the fact that many of them are currently in preliminary stages), the existence of multiple defendants in several of the current proceedings whose share of liability has yet to be determined, the numerous unresolved issues in many of the proceedings, and the inherent uncertainty of the various potential outcomes of such proceedings. Accordingly, management’s estimate will change from time-to-time, and actual losses may be more or less than the current estimate.
While the final outcome of legal proceedings is inherently uncertain, based on information currently available, advice of counsel, and available insurance coverage, management believes that the amount it has already accrued is adequate and any incremental liability arising from the Corporation’s legal proceedings will not have a material adverse effect on the Corporation’s consolidated financial position as a whole. However, in the event of unexpected future developments, it is possible that the ultimate resolution of these matters, if unfavorable, may be material to the Corporation’s consolidated financial position in a particular period.
Set forth below are descriptions of the Corporation’s material legal proceedings.
PCB has been named a defendant in a putative class action complaint captioned Josefina Valle, et al. v. Popular Community Bank, filed in November 2012 in the New York State Supreme Court (New York County). Plaintiffs, existing PCB customers, allege among other things that PCB has engaged in unfair and deceptive acts and trade practices in connection with the assessment of overdraft fees and payment processing on consumer deposit accounts. The complaint further alleges that PCB improperly disclosed its consumer overdraft policies and, additionally, that the overdraft rates and fees assessed by PCB violate New York’s usury laws. The complaint seeks unspecified damages, including punitive damages, interest, disbursements, and attorneys’ fees and costs.
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PCB removed the case to federal court (S.D.N.Y.) and plaintiffs subsequently filed a motion to remand the action to state court, which the Court granted on August 6, 2013. A motion to dismiss was filed on September 9, 2013. On October 25, 2013, plaintiffs filed an amended complaint seeking to limit the putative class to New York account holders. A motion to dismiss the amended complaint was filed in February 2014. In August 2014, the Court entered an order granting in part PCB’s motion to dismiss. The sole surviving claim relates to PCB’s item processing policy. On September 10, 2014, plaintiffs filed a motion for leave to file a second amended complaint to correct certain deficiencies noted in the court’s decision and order. PCB subsequently filed a motion in opposition to plaintiff’s motion for leave to amend and further sought to compel arbitration. In June 2015, this matter was reassigned to a new judge and on July 22, 2015, such Court denied PCB’s motion to compel arbitration and granted plaintiffs’ motion for leave to amend the complaint to replead certain claims based on item processing reordering, misstatement of balance information and failure to notify customers in advance of potential overdrafts. The Court did not, however, allow plaintiffs to replead their claim for the alleged breach of the implied covenant of good faith and fair dealing. On August 12, 2015, the Plaintiffs filed a second amended complaint. On August 24, 2015, PCB filed a Notice of Appeal as to the order granting leave to file the second amended complaint and on September 17, 2015, it filed a motion to dismiss the second amended complaint. On October 7, 2015, PCB renewed its motion to compel arbitration.
BPPR has been named a defendant in a putative class action complaint captioned Neysha Quiles et al. v. Banco Popular de Puerto Rico et al., filed in December 2013 in the United States District Court for the District of Puerto Rico (USDC-PR). Plaintiffs essentially allege that they and others, who have been employed by the Defendants as “bank tellers” and other similarly titled positions, have been paid only for scheduled work time, rather than time actually worked. The Complaint seeks to maintain a collective action under the Fair Labor Standards Act (“FLSA”) on behalf of all individuals formerly or currently employed by BPPR in Puerto Rico and the Virgin Islands as hourly paid, non-exempt, bank tellers or other similarly titled positions at any time during the past three years. Specifically, the complaint alleges that Banco Popular violated FLSA by willfully failing to pay overtime premiums. Similar claims were brought under Puerto Rico law. On January 31, 2014, the Popular defendants filed an answer to the complaint. On January 9, 2015, plaintiffs submitted a motion for conditional class certification, which BPPR opposed. On February 18, 2015, the Court entered an order whereby it granted plaintiffs’ request for conditional certification of the FLSA action. Following the Court’s order, plaintiffs sent out notices to all purported class members with instructions for opting into the class. Approximately sixty potential classmembers opted into the class prior to the expiration of the opt-in period. On June 25, 2015, the Court denied with prejudice plaintiffs’ motion for class certification under Rule 23 of the Federal Rules of Civil Procedure. On October 20, 2015, the parties reached an agreement in principle to resolve the referenced action for an immaterial amount, subject to their reaching an agreement on the payment of reasonable attorneys’ fees.
BPPR and Popular Securities have also been named defendants in a putative class action complaint captioned Nora Fernandez, et al. v. UBS, et al., filed in the United States District Court for the Southern District of New York (SDNY) on May 5, 2014 on behalf of investors in 23 Puerto Rico closed-end investment companies. UBS Financial Services Incorporated of Puerto Rico, another named defendant, is the sponsor and co-sponsor of all 23 funds, while BPPR was co-sponsor, together with UBS, of nine (9) of those funds. Plaintiffs allege breach of fiduciary duty and breach of contract against Popular Securities, aiding and abetting breach of fiduciary duty against BPPR, and similar claims against the UBS entities. The complaint seeks unspecified damages, including disgorgement of fees and attorneys’ fees. On May 30, 2014, plaintiffs voluntarily dismissed their class action in the SDNY and on that same date, they filed a virtually identical complaint in the USDC-PR and requested that the case be consolidated with the matter of In re: UBS Financial Services Securities Litigation, a class action currently pending before the USDC-PR in which neither BPPR nor Popular Securities are parties. The UBS defendants filed an opposition to the consolidation request and moved to transfer the case back to the SDNY on the ground that the relevant agreements between the parties contain a choice of forum clause, with New York as the selected forum. The Popular defendants joined this opposition and motion. By order dated January 30, 2015, the court denied the plaintiffs’ motion to consolidate. By order dated March 30, 2015, the court granted defendants’ motion to transfer. On May 8, 2015, plaintiffs filed an amended complaint in the Southern District of New York containing virtually identical allegations with respect to Popular Securities and BPPR. Defendants filed motions to dismiss the amended complaint on June 18, 2015. Such motions remain pending to date.
Last, BPPR has been named a defendant in a putative class action complaint titled In re 2014 RadioShack ERISA Litigation, filed in U.S. District Court for the Northern District of Texas. The complaint alleges that certain employees of RadioShack incurred losses in their 401(k) plans because various fiduciaries elected to retain RadioShack’s company stock in the portfolio of potential investment options. The complaint further asserts that once RadioShack’s financial situation began to deteriorate in 2011, the fiduciaries of the RadioShack 401(k) Plan and the RadioShack Puerto Rico 1165(e) Plan (collectively, “the Plans”) should have removed RadioShack company stock from the portfolio of potential investment options.
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Popular was a directed trustee, and therefore a fiduciary, of the RadioShack Puerto Rico 1165(e) Plan (“P.R. Plan”). Even though the P.R. Plan directed Popular to retain RadioShack company stock within the portfolio of investment options, the complaint alleges that a trustee’s duty of prudence requires it to disregard plan documents or directives that it knows or reasonably should know would lead to an imprudent result or would otherwise harm plan participants or beneficiaries. It further alleges that Popular breached its fiduciary duties by (i) failing to take any meaningful steps to protect plan participants from losses that it knew would occur; (ii) failing to divest the P.R. Plan of Company Stock; and (iii) participating in the decisions of another trustee (Wells Fargo) to protect the Plans from inevitable losses.
Other Matters
The volatility in prices and declines in value that Puerto Rico municipal bonds and closed-end investment companies that invest primarily in Puerto Rico municipal bonds have experienced since August 2013 have led to regulatory inquiries, customer complaints and arbitrations for most broker-dealers in Puerto Rico, including Popular Securities, a wholly owned subsidiary of the Corporation. Popular Securities has received customer complaints and is named as a respondent (among other broker-dealers) in 46 arbitration proceedings with aggregate claimed damages of approximately $99 million, including one arbitration with claimed damages of $78 million in which two other Puerto Rico broker-dealers are co-defendants. The proceedings are in their early stages and it is the view of the Corporation that Popular Securities has meritorious defenses to the claims asserted. The Government’s recent announcements regarding its ability to pay its debt and intention to pursue a comprehensive debt restructuring, together with the market reaction to it, may increase the number of customer complaints (and claimed damages) against Popular Securities concerning Puerto Rico municipal bonds and closed-end investment companies that invest primarily in Puerto Rico municipal bonds. An adverse result in the matters described above or a significant increase in customer complaints could have a material and adverse effect on Popular Securities.
Other Significant Proceedings
As described under “Note 13 – FDIC loss share asset and true-up payment obligation”, in connection with the Westernbank FDIC-assisted transaction, on April 30, 2010, BPPR entered into loss share agreements with the FDIC with respect to the covered loans and other real estate owned that it acquired in the transaction. Pursuant to the terms of the loss share agreements, the FDIC’s obligation to reimburse BPPR for losses with respect to covered assets begins with the first dollar of loss incurred. The FDIC reimburses BPPR for 80% of losses with respect to covered assets, and BPPR reimburses the FDIC for 80% of recoveries with respect to losses for which the FDIC paid 80% reimbursement under those loss share agreements. The loss share agreements contain specific terms and conditions regarding the management of the covered assets that BPPR must follow in order to receive reimbursement for losses from the FDIC. BPPR believes that it has complied with such terms and conditions. The loss share agreement applicable to the commercial late stage real-estate-collateral-dependent loans described below provides for loss sharing by the FDIC through the quarter ending June 30, 2015 and for reimbursement to the FDIC through the quarter ending June 30, 2018.
For the quarters ended June 30, 2010 through March 31, 2012, BPPR received reimbursement for loss-share claims submitted to the FDIC, including charge-offs for certain commercial late stage real-estate-collateral-dependent loans and OREO calculated in accordance with BPPR’s charge-off policy for non-covered assets. When BPPR submitted its shared-loss claim in connection with the June 30, 2012 quarter, however, the FDIC refused to reimburse BPPR for a portion of the claim because of a difference related to the methodology for the computation of charge-offs for certain commercial late stage real-estate-collateral-dependent loans and OREO. In accordance with the terms of the commercial loss share agreement, BPPR applied a methodology for charge-offs for late stage real-estate-collateral-dependent loans that conforms to its regulatory supervisory criteria and is calculated in accordance with BPPR’s charge-off policy for non-covered assets. The FDIC stated that it believed that BPPR should use a different methodology for those charge-offs. Notwithstanding the FDIC’s refusal to reimburse BPPR for certain shared-loss claims, BPPR had continued to calculate shared-loss claims for quarters subsequent to June 30, 2012 in accordance with its charge-off policy for non-covered assets.
BPPR’s loss share agreements with the FDIC specify that disputes can be submitted to arbitration before a review board under the commercial arbitration rules of the American Arbitration Association. On July 31, 2013, BPPR filed a statement of claim with the American Arbitration Association requesting that the review board determine certain matters relating to the loss-share claims under
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its commercial loss share agreement with the FDIC, including that the review board award BPPR the amounts owed under its unpaid quarterly certificates. The statement of claim also included requests for reimbursement of certain valuation adjustments for discounts to appraised values, costs to sell troubled assets and other items. The review board was comprised of one arbitrator appointed by BPPR, one arbitrator appointed by the FDIC and a third arbitrator selected by agreement of those arbitrators.
On October 17, 2014, BPPR and the FDIC settled all claims and counterclaims that had been submitted to the review board. The settlement provides for an agreed valuation methodology for reimbursement of charge-offs for late stage real-estate-collateral-dependent loans and resulting OREO. BPPR applied this valuation methodology to charge-offs claimed on late stage real-estate-collateral-dependent loans and resulting OREO during the remaining term of the commercial loss-sharing agreement which expired on June 30, 2015.
On November 25, 2014, the FDIC notified BPPR that it (a) would not reimburse BPPR under the commercial loss share agreement for a $66.6 million loss claim on eight related real estate loans that BPPR restructured and consolidated (collectively, the “Disputed Asset”), and (b) would no longer treat the Disputed Asset as a “Shared-Loss Asset” under the commercial loss share agreement. The FDIC alleged that BPPR’s restructure and modification of the underlying loans did not constitute a “Permitted Amendment” under the commercial loss share agreement, thereby causing the bank to breach Article III of the commercial loss share agreement. BPPR disagrees with the FDIC’s determinations relating to the Disputed Asset, and accordingly, on December 19, 2014, delivered to the FDIC a notice of dispute under the commercial loss share agreement.
On March 19, 2015, BPPR filed a statement of claim with the American Arbitration Association requesting that a review board determine BPPR and the FDIC’s disputes concerning the Disputed Asset. The statement of claim requests a declaration that the Disputed Asset is a “Shared-Loss Asset” under the commercial loss share agreement, a declaration that the restructuring is a “Permitted Amendment” under the commercial loss share agreement, and an order that the FDIC reimburse the Bank for approximately $53.3 million for the Charge-Off of the Disputed Asset, plus interest at the applicable rate. On April 1, 2015, the FDIC notified BPPR that it was clawing back approximately $1.7 million in reimbursable expenses relating to the Disputed Asset that the FDIC had previously paid to BPPR. Thus, on April 13, 2015, BPPR notified the American Arbitration Association and the FDIC of an increase in the amount of its damages by approximately $1.7 million. The review board in the arbitration concerning the Disputed Asset is comprised of one arbitrator appointed by BPPR, one arbitrator appointed by the FDIC and a third arbitrator selected by agreement of those arbitrators. The arbitration hearing date has been set for August 2016.
In addition, in November and December 2014, BPPR proposed separate portfolio sales of Shared-Loss Assets to the FDIC. The FDIC refused to consent to either sale, stating that those sales did not represent best efforts to maximize collections on Shared-Loss Assets under the commercial loss share agreement. In March 2015, BPPR proposed a third portfolio sale to the FDIC, and in May 2015, BPPR proposed a fourth portfolio sale to the FDIC.
BPPR disagrees with the FDIC’s characterization of the November and December 2014 portfolio sale proposals and with the FDIC’s interpretation of the commercial loss share agreement provision governing portfolio sales. Accordingly, on March 13, 2015, BPPR delivered to the FDIC a notice of dispute under the commercial loss share agreement. On June 8, 2015, BPPR filed a statement of claim with the American Arbitration Association requesting that a review board resolve the disputes concerning those proposed portfolio sales. On June 15, 2015, BPPR amended its statement of claim to include a claim for the FDIC-R’s refusal to timely concur in the third sale proposed in March 2015. On June 29, 2015, the FDIC informed BPPR that it would reimburse the Bank for losses arising from the primary portfolio of the third proposed sale, but only subject to conditions to which BPPR objects. The FDIC also informed BPPR that it would not concur in the secondary portfolio of the third proposed sale or in the fourth proposed sale. On September 4, 2015, BPPR filed a second amended statement of claim concerning the FDIC’s refusal to concur in the third and fourth portfolio sales as proposed by BPPR. The review board in the arbitration concerning the proposed portfolio sales is comprised of one arbitrator appointed by BPPR, one arbitrator appointed by the FDIC and a third arbitrator selected by agreement of those arbitrators. The arbitration hearing is scheduled to be held in the fall of 2016.
The shared-loss arrangement described above expired on June 30, 2015. As of September 30, 2015, BPPR had unreimbursed loss claims related to the commercial loss-sharing arrangement amounting to $232 million, reflected in the FDIC indemnification asset as a receivable from the FDIC, which include approximately $90 million related to losses claimed during the second quarter of 2015 and approximately $142 million which are subject to the arbitration proceedings described above. This last figure may continue to increase to the extent that the assets that are the subject of the portfolio sales arbitration further decline in value. Until these disputes are finally resolved, the terms of the commercial loss share agreement will remain in effect with respect to any such items under dispute. No assurance can be given that we will receive reimbursement from the FDIC with respect to the foregoing items, which could require us to make a material adjustment to the value of our loss share asset and the related true up payment obligation to the FDIC and could have a material adverse effect on our financial results for the period in which such adjustment is taken.
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The loss sharing agreement applicable to single-family residential mortgage loans provides for FDIC loss sharing and BPPR reimbursement to the FDIC for ten years (ending on June 30, 2020), and the loss sharing agreement applicable to commercial and other assets provides for FDIC loss sharing and BPPR reimbursement to the FDIC for five years (ending on June 30, 2015), with additional recovery sharing for three years thereafter. As of September 30, 2015, the carrying value of covered loans approximated $0.7 billion, mainly comprised of single-family residential mortgage loans. To the extent that estimated losses on covered loans are not realized before the expiration of the applicable loss sharing agreement, such losses would not be subject to reimbursement from the FDIC and, accordingly, would require us to make a material adjustment in the value of our loss share asset and the related true up payment obligation to the FDIC and could have a material adverse effect on our financial results for the period in which such adjustment is taken.
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Note 27 – Non-consolidated variable interest entities
The Corporation is involved with four statutory trusts which it established to issue trust preferred securities to the public. These trusts are deemed to be variable interest entities (“VIEs”) since the equity investors at risk have no substantial decision-making rights. The Corporation does not hold any variable interest in the trusts, and therefore, cannot be the trusts’ primary beneficiary. Furthermore, the Corporation concluded that it did not hold a controlling financial interest in these trusts since the decisions of the trusts are predetermined through the trust documents and the guarantee of the trust preferred securities is irrelevant since in substance the sponsor is guaranteeing its own debt.
Also, the Corporation is involved with various special purpose entities mainly in guaranteed mortgage securitization transactions, including GNMA and FNMA. These special purpose entities are deemed to be VIEs since they lack equity investments at risk. The Corporation’s continuing involvement in these guaranteed loan securitizations includes owning certain beneficial interests in the form of securities as well as the servicing rights retained. The Corporation is not required to provide additional financial support to any of the variable interest entities to which it has transferred the financial assets. The mortgage-backed securities, to the extent retained, are classified in the Corporation’s consolidated statements of financial condition as available-for-sale or trading securities. The Corporation concluded that, essentially, these entities (FNMA and GNMA) control the design of their respective VIEs, dictate the quality and nature of the collateral, require the underlying insurance, set the servicing standards via the servicing guides and can change them at will, and can remove a primary servicer with cause, and without cause in the case of FNMA. Moreover, through their guarantee obligations, agencies (FNMA and GNMA) have the obligation to absorb losses that could be potentially significant to the VIE.
ASU 2009-17 requires that an ongoing primary beneficiary assessment should be made to determine whether the Corporation is the primary beneficiary of any of the VIEs it is involved with. The conclusion on the assessment of these trusts and guaranteed mortgage securitization transactions has not changed since their initial evaluation. The Corporation concluded that it is still not the primary beneficiary of these VIEs, and therefore, these VIEs are not required to be consolidated in the Corporation’s financial statements at September 30, 2015.
The Corporation holds variable interests in these VIEs in the form of agency mortgage-backed securities and collateralized mortgage obligations, including those securities originated by the Corporation and those acquired from third parties. Additionally, the Corporation holds agency mortgage-backed securities, agency collateralized mortgage obligations and private label collateralized mortgage obligations issued by third party VIEs in which it has no other form of continuing involvement. Refer to Note 29 to the consolidated financial statements for additional information on the debt securities outstanding at September 30, 2015 and December 31, 2014, which are classified as available-for-sale and trading securities in the Corporation’s consolidated statements of financial condition. In addition, the Corporation may retain the right to service the transferred loans in those government-sponsored special purpose entities (“SPEs”) and may also purchase the right to service loans in other government-sponsored SPEs that were transferred to those SPEs by a third-party. Pursuant to ASC Subtopic 810-10, the servicing fees that the Corporation receives for its servicing role are considered variable interests in the VIEs since the servicing fees are subordinated to the principal and interest that first needs to be paid to the mortgage-backed securities’ investors and to the guaranty fees that need to be paid to the federal agencies.
The following table presents the carrying amount and classification of the assets related to the Corporation’s variable interests in non-consolidated VIEs and the maximum exposure to loss as a result of the Corporation’s involvement as servicer with non-consolidated VIEs at September 30, 2015 and December 31, 2014.
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Servicing assets:
Total servicing assets
Other assets:
Servicing advances
Maximum exposure to loss
The size of the non-consolidated VIEs, in which the Corporation has a variable interest in the form of servicing fees, measured as the total unpaid principal balance of the loans, amounted to $12.9 billion at September 30, 2015 (December 31, 2014 - $9.0 billion).
Maximum exposure to loss represents the maximum loss, under a worst case scenario, that would be incurred by the Corporation, as servicer for the VIEs, assuming all loans serviced are delinquent and that the value of the Corporation’s interests and any associated collateral declines to zero, without any consideration of recovery. The Corporation determined that the maximum exposure to loss includes the fair value of the MSRs and the assumption that the servicing advances at September 30, 2015 and December 31, 2014, will not be recovered. The agency debt securities are not included as part of the maximum exposure to loss since they are guaranteed by the related agencies.
In September of 2011, BPPR sold construction and commercial real estate loans with a fair value of $148 million, and most of which were non-performing, to a newly created joint venture, PRLP 2011 Holdings, LLC. The joint venture is majority owned by Caribbean Property Group (“CPG”), Goldman Sachs & Co. and East Rock Capital LLC. The joint venture was created for the limited purpose of acquiring the loans from BPPR; servicing the loans through a third-party servicer; ultimately working out, resolving and/or foreclosing the loans; and indirectly owning, operating, constructing, developing, leasing and selling any real properties acquired by the joint venture through deed in lieu of foreclosure, foreclosure, or by resolution of any loan.
BPPR provided financing to the joint venture for the acquisition of the loans in an amount equal to the sum of 57 % of the purchase price of the loans, or $84 million, and $2 million of closing costs, for a total acquisition loan of $86 million (the “acquisition loan”). The acquisition loan has a 5-year maturity and bears a variable interest at 30-day LIBOR plus 300 basis points and is secured by a pledge of all of the acquiring entity’s assets. In addition, BPPR provided the joint venture with a non-revolving advance facility (the “advance facility”) of $68.5 million to cover unfunded commitments and costs-to-complete related to certain construction projects, and a revolving working capital line (the “working capital line”) of $20 million to fund certain operating expenses of the joint venture. Cash proceeds received by the joint venture are first used to cover debt service payments for the acquisition loan, advance facility, and the working capital line described above which must be paid in full before proceeds can be used for other purposes. The distributable cash proceeds are determined based on a pro-rata basis in accordance with the respective equity ownership percentages. BPPR’s equity interest in the joint venture ranks pari-passu with those of other parties involved. As part of the transaction executed in September 2011, BPPR received $ 48 million in cash and a 24.9 % equity interest in the joint venture. The Corporation is not required to provide any other financial support to the joint venture.
BPPR accounted for this transaction as a true sale pursuant to ASC Subtopic 860-10 and thus recognized the cash received, its equity investment in the joint venture, and the acquisition loan provided to the joint venture and derecognized the loans sold.
The Corporation has determined that PRLP 2011 Holdings, LLC is a VIE but the Corporation is not the primary beneficiary. All decisions are made by CPG (or an affiliate thereof) (the “Manager”), except for certain limited material decisions which would require the unanimous consent of all members. The Manager is authorized to execute and deliver on behalf of the joint venture any and all documents, contracts, certificates, agreements and instruments, and to take any action deemed necessary in the benefit of the joint venture.
The Corporation holds variable interests in this VIE in the form of the 24.9 % equity interest (the “Investment in PRLP 2011 Holdings, LLC”) and the financing provided to the joint venture. The equity interest is accounted for under the equity method of accounting pursuant to ASC Subtopic 323-10.
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The initial fair value of the Corporation’s equity interest in the joint venture was determined based on the fair value of the loans and real estate owned transferred to the joint venture of $148 million which represented the purchase price of the loans agreed by the parties and was an arm’s-length transaction between market participants in accordance with ASC Topic 820, reduced by the acquisition loan provided by BPPR to the joint venture, for a total net equity of $63 million. Accordingly, the 24.9% equity interest held by the Corporation was valued at $16 million. Thus, the fair value of the equity interest is considered a Level 2 fair value measurement since the inputs were based on observable market inputs.
The following table presents the carrying amount and classification of the assets and liabilities related to the Corporation’s variable interests in the non-consolidated VIE, PRLP 2011 Holdings, LLC, and its maximum exposure to loss at September 30, 2015 and December 31, 2014.
Advances under the working capital line
Advances under the advance facility
Accrued interest receivable
Investment in PRLP 2011 Holdings LLC
Total net assets
The Corporation determined that the maximum exposure to loss under a worst case scenario at September 30, 2015 would be not recovering the carrying amount of the acquisition loan, the advances on the advance facility and working capital line, if any, and the equity interest held by the Corporation, net of the deposits.
On March 25, 2013, BPPR completed a sale of assets with a book value of $509.0 million, of which $500.6 million were in non-performing status, comprised of commercial and construction loans, and commercial and single family real estate owned, with a combined unpaid principal balance on loans and appraised value of other real estate owned of approximately $987.0 million to a newly created joint venture, PR Asset Portfolio 2013-1 International, LLC. The joint venture is majority owned by Caribbean Property Group LLC (“CPG”) and certain affiliates of Perella Weinberg Partners’Asset Based Value Strategy. The joint venture was created for the limited purpose of acquiring the loans from BPPR; servicing the loans through a third-party servicer; ultimately working out, resolving and/or foreclosing the loans; and indirectly owning, operating, constructing, developing, leasing and selling any real properties acquired by the joint venture through deed in lieu of foreclosure, foreclosure, or by resolution of any loan.
BPPR provided financing to the joint venture for the acquisition of the assets in an amount equal to the sum of 57 % of the purchase price of the assets, and closing costs, for a total acquisition loan of $182.4 million (the “acquisition loan”). The acquisition loan has a 5-year maturity and bears a variable interest at 30-day LIBOR plus 300 basis points and is secured by a pledge of all of the acquiring entity’s assets. In addition, BPPR provided the joint venture with a non-revolving advance facility (the “advance facility”) of $35.0 million to cover unfunded commitments and costs-to-complete related to certain construction projects, and a revolving working capital line (the “working capital line”) of $30.0 million to fund certain operating expenses of the joint venture. Cash proceeds received by the joint venture are first used to cover debt service payments for the acquisition loan, advance facility, and the working capital line described above which must be paid in full before proceeds can be used for other purposes. The distributable cash proceeds are determined based on a pro-rata basis in accordance with the respective equity ownership percentages. BPPR’s equity interest in the joint venture ranks pari-passu with those of other parties involved. As part of the transaction executed in March 2013, BPPR received $92.3 million in cash and a 24.9 % equity interest in the joint venture. The Corporation is not required to provide any other financial support to the joint venture.
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BPPR accounted for this transaction as a true sale pursuant to ASC Subtopic 860-10 and thus recognized the cash received, its equity investment in the joint venture, and the acquisition loan provided to the joint venture and derecognized the loans and real estate owned sold.
The Corporation has determined that PR Asset Portfolio 2013-1 International, LLC is a VIE but the Corporation is not the primary beneficiary. All decisions are made by CPG (or an affiliate thereof) (the “Manager”), except for certain limited material decisions which would require the unanimous consent of all members. The Manager is authorized to execute and deliver on behalf of the joint venture any and all documents, contracts, certificates, agreements and instruments, and to take any action deemed necessary in the benefit of the joint venture. Also, the Manager delegates the day-to-day management and servicing of the loans to PR Asset Portfolio Servicing International, LLC, an affiliate of CPG.
The initial fair value of the Corporation’s equity interest in the joint venture was determined based on the fair value of the loans and real estate owned transferred to the joint venture of $306 million which represented the purchase price of the loans agreed by the parties and was an arm’s-length transaction between market participants in accordance with ASC Topic 820, reduced by the acquisition loan provided by BPPR to the joint venture, for a total net equity of $124 million. Accordingly, the 24.9% equity interest held by the Corporation was valued at $31 million. Thus, the fair value of the equity interest is considered a Level 2 fair value measurement since the inputs were based on observable market inputs.
The Corporation holds variable interests in this VIE in the form of the 24.9 % equity interest (the “Investment in PR Asset Portfolio 2013-1 International, LLC”) and the financing provided to the joint venture. The equity interest is accounted for under the equity method of accounting pursuant to ASC Subtopic 323-10.
The following table presents the carrying amount and classification of the assets and liabilities related to the Corporation’s variable interests in the non-consolidated VIE, PR Asset Portfolio 2013-1 International, LLC, and its maximum exposure to loss at September 30, 2015 and December 31, 2014.
Acquisition loan
Investment in PR Asset Portfolio 2013-1 International, LLC
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Note 28 – Related party transactions with affiliated company / joint venture
EVERTEC
The Corporation has an investment in EVERTEC, Inc. (“EVERTEC”), which provides various processing and information technology services to the Corporation and its subsidiaries and gives BPPR access to the ATH network owned and operated by EVERTEC. As of September 30, 2015, the Corporation’s stake in EVERTEC was 15.31%.The Corporation continues to have significant influence over EVERTEC. Accordingly, the investment in EVERTEC is accounted for under the equity method and is evaluated for impairment if events or circumstances indicate that a decrease in value of the investment has occurred that is other than temporary. Refer to Note 34 “Related party transactions” to the consolidated financial statements included in the Corporation’s 2014 Annual Report for details.
The Corporation received $ 3.5 million in dividend distributions during the nine months ended September 30, 2015 from its investments in EVERTEC’s holding company (September 30, 2014 - $ 3.5 million). The Corporation’s equity in EVERTEC is presented in the table which follows and is included as part of “other assets” in the consolidated statements of financial condition.
Equity investment in EVERTEC
The Corporation had the following financial condition balances outstanding with EVERTEC at September 30, 2015 and December 31, 2014. Items that represent liabilities to the Corporation are presented with parenthesis.
Accounts receivable (Other assets)
Accounts payable (Other liabilities)
Net total
The Corporation’s proportionate share of income or loss from EVERTEC is included in other operating income in the consolidated statements of operations. The following table presents the Corporation’s proportionate share of EVERTEC’s income (loss) and changes in stockholders’ equity for the quarters and nine months ended September 30, 2015 and 2014.
Share of income from the investment in EVERTEC
Share of other changes in EVERTEC’s stockholders’ equity
Share of EVERTEC’s changes in equity recognized in income
The following tables present the transactions and service payments between the Corporation and EVERTEC (as an affiliate) and their impact on the results of operations for the quarters and nine months ended September 30, 2015 and 2014. Items that represent expenses to the Corporation are presented with parenthesis.
109
Category
Interest expense on deposits
ATH and credit cards interchange income from services to EVERTEC
Rental income charged to EVERTEC
Processing fees on services provided by EVERTEC
Other services provided to EVERTEC
EVERTEC has a letter of credit issued by BPPR, for an amount of $ 4.2 million at September 30, 2015 (December 31, 2014 - $ 3.6 million). The Corporation agreed to maintain outstanding this letter of credit for a 5-year period that originally expired on September 30, 2015 and was subsequently extended through February 10, 2016. EVERTEC and the Corporation entered into a Reimbursement Agreement, in which EVERTEC will reimburse the Corporation for any losses incurred by the Corporation in connection with the performance bonds and the letter of credit. Possible losses resulting from these agreements are considered insignificant.
PRLP 2011 Holdings LLC
As indicated in Note 27 to the consolidated financial statements, the Corporation holds a 24.9 % equity interest in PRLP 2011 Holdings LLC and currently provides certain financing to the joint venture as well as holds certain deposits from the entity.
The Corporation’s equity in PRLP 2011 Holdings, LLC is presented in the table which follows and is included as part of “other assets” in the consolidated statements of financial condition.
Equity investment in PRLP 2011 Holdings, LLC
The Corporation had the following financial condition balances outstanding with PRLP 2011 Holdings, LLC at September 30, 2015 and December 31, 2014.
Deposits (non-interest bearing)
110
The Corporation’s proportionate share of income or loss from PRLP 2011 Holdings, LLC is included in other operating income in the consolidated statements of operations. The following table presents the Corporation’s proportionate share of income (loss) from PRLP 2011 Holdings, LLC for the quarters and nine months ended September 30, 2015 and 2014.
Share of loss from the equity investment in PRLP 2011 Holdings, LLC
The following table presents transactions between the Corporation and PRLP 2011 Holdings, LLC and their impact on the Corporation’s results of operations for the quarters and nine months ended September 30, 2015 and 2014.
Interest income on loan to PRLP 2011 Holdings, LLC
PR Asset Portfolio 2013-1 International, LLC
As indicated in Note 27 to the consolidated financial statements, effective March 2013 the Corporation holds a 24.9 % equity interest in PR Asset Portfolio 2013-1 International, LLC and currently provides certain financing to the joint venture as well as holds certain deposits from the entity.
The Corporation’s equity in PR Asset Portfolio 2013-1 International, LLC is presented in the table which follows and is included as part of “other assets” in the consolidated statements of financial condition.
Equity investment in PR Asset Portfolio 2013-1 International, LLC
The Corporation had the following financial condition balances outstanding with PR Asset Portfolio 2013-1 International, LLC, at September 30, 2015 and December 31, 2014.
111
The Corporation’s proportionate share of income or loss from PR Asset Portfolio 2013-1 International, LLC is included in other operating income in the consolidated statements of operations. The following table presents the Corporation’s proportionate share of income (loss) from PR Asset Portfolio 2013-1 International, LLC for the quarter and nine months ended September 30, 2015 and 2014.
Share of loss from the equity investment in PR Asset Portfolio 2013-1 International, LLC
Share of (loss) income from the equity investment in PR Asset Portfolio 2013-1 International, LLC
The following table presents transactions between the Corporation and PR Asset Portfolio 2013-1 International, LLC and their impact on the Corporation’s results of operations for the quarters and nine months ended September 30, 2015 and 2014.
Interest income on loan to PR Asset Portfolio 2013-1 International, LLC
Servicing fee paid by PR Asset Portfolio 2013-1 International, LLC
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Note 29 – Fair value measurement
ASC Subtopic 820-10 “Fair Value Measurements and Disclosures” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels in order to increase consistency and comparability in fair value measurements and disclosures. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the observable inputs be used when available. Fair value is based upon quoted market prices when available. If listed prices or quotes are not available, the Corporation employs internally-developed models that primarily use market-based inputs including yield curves, interest rates, volatilities, and credit curves, among others. Valuation adjustments are limited to those necessary to ensure that the financial instrument’s fair value is adequately representative of the price that would be received or paid in the marketplace. These adjustments include amounts that reflect counterparty credit quality, the Corporation’s credit standing, constraints on liquidity and unobservable parameters that are applied consistently. There have been no changes in the Corporation’s methodologies used to estimate the fair value of assets and liabilities since December 31, 2014. Refer to the Critical Accounting Policies / Estimates in the 2014 Annual Report for additional information on the accounting guidance and the Corporation’s policies or procedures related to fair value measurements.
The estimated fair value may be subjective in nature and may involve uncertainties and matters of significant judgment for certain financial instruments. Changes in the underlying assumptions used in calculating fair value could significantly affect the results.
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Fair Value on a Recurring and Nonrecurring Basis
The following fair value hierarchy tables present information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014 and on a nonrecurring basis in periods subsequent to initial recognition for the nine months ended September 30, 2015 and 2014:
RECURRING FAIR VALUE MEASUREMENTS
Investment securities available-for-sale:
Trading account securities, excluding derivatives:
Mortgage-backed securities - federal agencies
Total assets measured at fair value on a recurring basis
Liabilities
Contingent consideration
Total liabilities measured at fair value on a recurring basis
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The fair value information included in the following tables is not as of period end, but as of the date that the fair value measurement was recorded during the nine month period ended September 30, 2015 and 2014, and excludes nonrecurring fair value measurements of assets no longer held by the Corporation.
Nine months ended September 30, 2015
NONRECURRING FAIR VALUE MEASUREMENTS
Loans[1]
Loans held-for-sale[2]
Other real estate owned[3]
Other foreclosed assets[3]
Total assets measured at fair value on a nonrecurring basis
Nine months ended September 30, 2014
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The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters and nine months ended September 30, 2015 and 2014.
Quarter ended September 30, 2015
Balance at June 30, 2015
Gains (losses) included in earnings
Gains (losses) included in OCI
Settlements
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2015
Quarter ended September 30, 2014
Balance at June 30, 2014
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2014
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Balance at January 1, 2014
There were no transfers in and / or out of Level 1, Level 2, or Level 3 for financial instruments measured at fair value on a recurring basis during the quarters and nine months ended September 30, 2015 and 2014.
Gains and losses (realized and unrealized) included in earnings for the quarter and nine months ended September 30, 2015 and 2014 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:
Interest income
FDIC loss share (expense) income
Mortgage banking activities
Trading account profit (loss)
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The following table includes quantitative information about significant unobservable inputs used to derive the fair value of Level 3 instruments, excluding those instruments for which the unobservable inputs were not developed by the Corporation such as prices of prior transactions and/or unadjusted third-party pricing sources.
Valuation technique
Unobservable inputs
Weighted average (range)
CMO’s - trading
Other - trading
5.5 years
12.2%
10.8%
7.4% (0.5% - 26.7%)
6.3 years (0.1 - 17.4 years) 11.3% (9.5% - 15.0%)
4.7% (0.0% - 100.0%)
5.7%
Loans held-in-portfolio
Other real estate owned
Other foreclosed assets
The significant unobservable inputs used in the fair value measurement of the Corporation’s collateralized mortgage obligations and interest-only collateralized mortgage obligation (reported as “other”), which are classified in the “trading” category, are yield, constant prepayment rate, and weighted average life. Significant increases (decreases) in any of those inputs in isolation would result in significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the constant prepayment rate will generate a directionally opposite change in the weighted average life. For example, as the average life is reduced by a higher constant prepayment rate, a lower yield will be realized, and when there is a reduction in the constant prepayment rate, the average life of these collateralized mortgage obligations will extend, thus resulting in a higher yield. These particular financial instruments are valued internally by the Corporation’s investment banking and broker-dealer unit utilizing internal valuation techniques. The unobservable inputs incorporated into the internal discounted cash flow models used to derive the fair value of collateralized mortgage obligations and interest-only collateralized mortgage obligation (reported as “other”), which are classified in the “trading” category, are reviewed by the Corporation’s Corporate Treasury unit on a quarterly basis. In the case of Level 3 financial instruments which fair value is based on broker quotes, the Corporation’s Corporate Treasury unit reviews the inputs used by the broker-dealers for reasonableness utilizing information available from other published sources and validates that the fair value measurements were developed in accordance with ASC Topic 820. The Corporate Treasury unit also substantiates the inputs used by validating the prices with other broker-dealers, whenever possible.
The significant unobservable inputs used in the fair value measurement of the Corporation’s mortgage servicing rights are constant prepayment rates and discount rates. Increases in interest rates may result in lower prepayments. Discount rates vary according to products and / or portfolios depending on the perceived risk. Increases in discount rates result in a lower fair value measurement. The Corporation’s Corporate Comptroller’s unit is responsible for determining the fair value of MSRs, which is based on discounted cash flow methods based on assumptions developed by an external service provider, except for prepayment speeds, which are adjusted internally for the local market based on historical experience. The Corporation’s Corporate Treasury unit validates the economic assumptions developed by the external service provider on a quarterly basis. In addition, an analytical review of prepayment speeds is performed quarterly by the Corporate Comptroller’s unit. The Corporation’s MSR Committee analyzes changes in fair value measurements of MSRs and approves the valuation assumptions at each reporting period. Changes in valuation assumptions must also be approved by the MSR Committee. The fair value of MSRs are compared with those of the external service provider on a quarterly basis in order to validate if the fair values are within the materiality thresholds established by management to monitor and investigate material deviations. Back-testing is performed to compare projected cash flows with actual historical data to ascertain the reasonability of the projected net cash flow results.
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Note 30 – Fair value of financial instruments
The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information. Many of these estimates involve various assumptions and may vary significantly from amounts that could be realized in actual transactions.
The information about the estimated fair values of financial instruments presented hereunder excludes all nonfinancial instruments and certain other specific items.
For those financial instruments with no quoted market prices available, fair values have been estimated using present value calculations or other valuation techniques, as well as management’s best judgment with respect to current economic conditions, including discount rates, estimates of future cash flows, and prepayment assumptions.
The fair values reflected herein have been determined based on the prevailing interest rate environment at September 30, 2015 and December 31, 2014, as applicable. In different interest rate environments, fair value estimates can differ significantly, especially for certain fixed rate financial instruments. In addition, the fair values presented do not attempt to estimate the value of the Corporation’s fee generating businesses and anticipated future business activities, that is, they do not represent the Corporation’s value as a going concern. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation.
Following is a description of the Corporation’s valuation methodologies and inputs used to estimate the fair values for each class of financial assets and liabilities not measured at fair value, but for which the fair value is disclosed. The disclosure requirements exclude certain financial instruments and all non-financial instruments. Accordingly, the aggregate fair value amounts of the financial instruments disclosed do not represent management’s estimate of the underlying value of the Corporation. For a description of the valuation methodologies and inputs used to estimate the fair value for each class of financial assets and liabilities measured at fair value, refer to Note 29.
Cash and due from banks include cash on hand, cash items in process of collection, and non-interest bearing deposits due from other financial institutions. The carrying amount of cash and due from banks is a reasonable estimate of its fair value. Cash and due from banks are classified as Level 1.
Investments in money market instruments include highly liquid instruments with an average maturity of three months or less. For this reason, they carry a low risk of changes in value as a result of changes in interest rates, and the carrying amount approximates their fair value. Money market investments include federal funds sold, securities purchased under agreements to resell, time deposits with other banks, and cash balances, including those held at the Federal Reserve. These money market investments are classified as Level 2, except for cash balances which generate interest, including those held at the Federal Reserve, which are classified as Level 1.
Investment securities held-to-maturity
119
Other investment securities
Loans held-for-sale
The fair value of certain impaired loans held-for-sale was based on a discounted cash flow model that assumes that no principal payments are received prior to the effective average maturity date, that the outstanding unpaid principal balance is reduced by a monthly net loss rate, and that the remaining unpaid principal balance is received as a lump sum principal payment at the effective average maturity date. The remaining unpaid principal balance expected to be received, which is based on the prior 12-month cash payment experience of these loans and their expected collateral recovery, was discounted using the interest rate currently offered to clients for the origination of comparable loans. These loans were classified as Level 3. As of September 30, 2015, no loans were valued under this methodology. For loans held-for-sale originated with the intent to sell in the secondary market, its fair value was determined using similar characteristics of loans and secondary market prices assuming the conversion to mortgage-backed securities. Given that the valuation methodology uses internal assumptions based on loan level data, these loans are classified as Level 3. The fair value of certain other loans held-for-sale is based on bids received from potential buyers; binding offers; or external appraisals, net of internal adjustments and estimated costs to sell. Loans held-for-sale based on binding offers are classified as Level 2. Loans held-for-sale based on indicative offers and/or external appraisals are classified as Level 3.
The fair values of the loans held-in-portfolio have been determined for groups of loans with similar characteristics. Loans were segregated by type such as commercial, construction, residential mortgage, consumer, and credit cards. Each loan category was further segmented based on loan characteristics, including interest rate terms, credit quality and vintage. Generally, fair values were estimated based on an exit price by discounting expected cash flows for the segmented groups of loans using a discount rate that considers interest, credit and expected return by market participant under current market conditions. Additionally, prepayment, default and recovery assumptions have been applied in the mortgage loan portfolio valuations. Generally accepted accounting principles do not require a fair valuation of the lease financing portfolio, therefore it is included in the loans total at its carrying amount. Loans held-in-portfolio are classified as Level 3.
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Fair value of the FDIC loss share asset was estimated using projected net losses related to the loss sharing agreements, which are expected to be reimbursed by the FDIC. The projected net losses were discounted using the U.S. Government agency curve. The loss share asset is classified as Level 3.
The carrying amount of other short-term borrowings approximate fair value because of the short-term maturity of those instruments or because they carry interest rates which approximate market. Thus, these other short-term borrowings are classified as Level 2.
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Commitments to extend credit and letters of credit
Commitments to extend credit were valued using the fees currently charged to enter into similar agreements. For those commitments where a future stream of fees is charged, the fair value was estimated by discounting the projected cash flows of fees on commitments. Since the fair value of commitments to extend credit varies depending on the undrawn amount of the credit facility, fees are subject to constant change, and cash flows are dependent on the creditworthiness of borrowers, commitments to extend credit are classified as Level 3. The fair value of letters of credit was based on fees currently charged on similar agreements. Given that the fair value of letters of credit constantly vary due to fees being subject to constant change and whether the fees are received depends on the creditworthiness of the account parties, letters of credit are classified as Level 3.
The following tables present the carrying or notional amounts, as applicable, and estimated fair values for financial instruments with their corresponding level in the fair value hierarchy.
Financial Assets:
Trading account securities, excluding derivatives[1]
Investment securities available-for-sale[1]
Investment securities held-to-maturity:
Collateralized mortgage obligation-federal agency
Other investment securities:
FHLB stock
FRB stock
Trust preferred securities
Other investments
Total other investment securities
Loans not covered under loss sharing agreement with the FDIC
Loans covered under loss sharing agreements with the FDIC
122
Financial Liabilities:
Demand deposits
Time deposits
Assets sold under agreements to repurchase:
Securities sold under agreements to repurchase
Total assets sold under agreements to repurchase
Other short-term borrowings[2]
Notes payable:
FHLB advances
Unsecured senior debt securities
Junior subordinated deferrable interest debentures (related to trust preferred securities)
19,227
$
—
125,895
Commitments to extend credit
1,154
Letters of credit
734
[1] Refer to Note 29 to the consolidated financial statements for the fair value by class of financial asset and its hierarchy level.
[2] Refer to Note 20 to the consolidated financial statements for the composition of short-term borrowings.
123
Unsecured senior debt
124
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Note 31 – Net income (loss) per common share
The following table sets forth the computation of net income (loss) per common share (“EPS”), basic and diluted, for the quarters and nine months ended September 30, 2015 and 2014:
Preferred stock dividends
Net income (loss) applicable to common stock
Average common shares outstanding
Average potential dilutive common shares
Average common shares outstanding - assuming dilution
Basic EPS from continuing operations
Basic EPS from discontinued operations
Total Basic EPS
Diluted EPS from continuing operations
Diluted EPS from discontinued operations
Total Diluted EPS
Potential common shares consist of common stock issuable under the assumed exercise of stock options, restricted stock and performance shares awards 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 is added as incremental shares to the actual number of shares outstanding to compute diluted earnings per share. Warrants, stock options, restricted stock and performance shares awards 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 common share.
For the quarter and nine months ended September 30, 2015, there were no stock options outstanding (September 30, 2014 – 44,797 and 45,343).
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Note 32 – Other service fees
The caption of other services fees in the consolidated statements of operations consists of the following major categories:
Debit card fees
Insurance fees
Credit card fees
Sale and administration of investment products
Trust fees
Other fees
Total other services fees
127
Note 33 – FDIC loss share income (expense)
The caption of FDIC loss-share income (expense) in the consolidated statements of operations consists of the following major categories:
Amortization of loss-share indemnification asset
80% mirror accounting on credit impairment losses (reversal)[1]
80% mirror accounting on reimbursable expenses
80% mirror accounting on recoveries on covered assets, including rental income on OREOs, subject to reimbursement to the FDIC
Change in true-up payment obligation
Total FDIC loss-share income (expense)
The negative amortization of the FDIC’s Indemnification Asset for the nine months ended September 30, 2015 includes a $10.9 million expense related to losses incurred by the corporation that were not claimed to the FDIC before the expiration of the loss-share portion of the agreement on June 30, 2015, and that are not subject to the ongoing arbitrations.
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Note 34 – Pension and postretirement benefits
The Corporation has a non-contributory defined benefit pension plan and supplementary pension benefit restoration plans for regular employees of certain of its subsidiaries. The accrual of benefits under the plans is frozen to all participants.
The components of net periodic pension cost for the periods presented were as follows:
Pension Plan
Quarters ended September 30,
Interest cost
Expected return on plan assets
Amortization of net loss
Total net periodic pension cost (benefit)
Pension Plans
Nine months ended September 30,
Interest Cost
During the quarter ended September 30, 2015 the Corporation made a contribution to the benefit restoration plans of $43 thousand. The total contributions expected to be paid during the year 2015 for the pension and benefit restoration plans amount to approximately $173 thousand.
The Corporation also provides certain postretirement health care benefits for retired employees of certain subsidiaries. The table that follows presents the components of net periodic postretirement benefit cost.
Service cost
Total net periodic postretirement benefit cost
Contributions made to the postretirement benefit plan for the quarter ended September 30, 2015 amounted to approximately $1.4 million. The total contributions expected to be paid during the year 2015 for the postretirement benefit plan amount to approximately $5.8 million.
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Note 35 - Stock-based compensation
The Corporation maintained a Stock Option Plan (the “Stock Option Plan”), which permitted the granting of incentive awards in the form of qualified stock options, incentive stock options, or non-statutory stock options of the Corporation. In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan (the “Incentive Plan”), which replaced and superseded the Stock Option Plan. The adoption of the Incentive Plan did not alter the original terms of the grants made under the Stock Option Plan prior to the adoption of the Incentive Plan.
Stock Option Plan
Employees and directors of the Corporation or any of its subsidiaries were eligible to participate in the Stock Option Plan. The Board of Directors or the Compensation Committee of the Board had the absolute discretion to determine the individuals that were eligible to participate in the Stock Option Plan. This plan provided for the issuance of Popular, Inc.’s common stock at a price equal to its fair market value at the grant date, subject to certain plan provisions. The shares are to be made available from authorized but unissued shares of common stock or treasury stock. The Corporation’s policy has been to use authorized but unissued shares of common stock to cover each grant. The maximum option term is ten years from the date of grant. Unless an option agreement provides otherwise, all options granted are 20% exercisable after the first year and an additional 20% is exercisable after each subsequent year, subject to an acceleration clause at termination of employment due to retirement.
There was no intrinsic value of options outstanding and exercisable at September 30, 2015 and 2014. As of September 30, 2015 all options outstanding expired.
The following table summarizes the stock option activity and related information:
(Not in thousands)
Outstanding at December 31, 2013
Granted
Exercised
Forfeited
Expired
Outstanding at December 31, 2014
Outstanding at September 30, 2015
There was no stock option expense recognized for the quarters and nine months ended September 30, 2015 and 2014.
Incentive Plan
The Incentive Plan permits the granting of incentive awards in the form of Annual Incentive Awards, Long-term Performance Unit Awards, Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Units or Performance Shares. Participants in the Incentive Plan are designated by the Compensation Committee of the Board of Directors (or its delegate as determined by the Board). Employees and directors of the Corporation and/or any of its subsidiaries are eligible to participate in the Incentive Plan.
Under the Incentive Plan, the Corporation has issued restricted shares, which become vested based on the employees’ continued service with Popular. Unless otherwise stated in an agreement, the compensation cost associated with the shares of restricted stock is determined based on a two-prong vesting schedule. The first part is vested ratably over five years commencing at the date of
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grant and the second part is vested at termination of employment after attainment of 55 years of age and 10 years of service. The five-year vesting part is accelerated at termination of employment after attaining 55 years of age and 10 years of service. The vesting schedule for restricted shares granted on 2014 and thereafter was modified as follows, the first part ratably over four years commencing at the date of the grant and the second part is vested at termination of employment after attaining the earlier of 55 years of age and 10 years of service or 60 years of age and 5 years of service. The four year vesting part is accelerated at termination of employment after attaining the earlier of 55 years of age and 10 years of service or 60 years of age and 5 years of service. The restricted shares granted consistent with the requirements of the TARP Interim Final Rule vest in two years from grant date.
The following table summarizes the restricted stock and performance shares activity under the Incentive Plan for members of management.
Non-vested at December 31, 2013
Vested
Non-vested at December 31, 2014
Non-vested at September 30, 2015
During the quarter ended September 30, 2015 and 2014 no shares of restricted stock were awarded to management under the Incentive Plan. For the nine-month period ended September 30, 2015, 231,830 shares of restricted stock (September 30, 2014 – 235,112) were awarded to management under the Incentive Plan, from which no shares (September 30, 2014 – 162,332) were awarded to management consistent with the requirements of the TARP Interim Final Rule.
Beginning in 2015, the Corporation authorized the issuance of performance shares, in addition to restricted shares, under the Incentive Plan. The performance share awards consist of the opportunity to receive shares of Popular, Inc.’s common stock provided that the Corporation achieves certain goals during a three-year performance cycle. The goals will be based on two metrics weighted equally: the Relative Total Shareholder Return (“TSR”) and the Absolute Earnings per Share (“EPS”) goals. The TSR metric is considered to be a market condition under ASC 718. For equity settled awards based on a market condition, the fair value is determined as of the grant date and is not subsequently revised based on actual performance. The EPS performance metric is considered to be a performance condition under ASC 718. The fair value is determined based on the probability of achieving the EPS goal as of each reporting period. The TSR and EPS metrics are equally weighted and work independently. The performance shares vest at the end of the three-year performance cycle. The vesting is accelerated at termination of employment after attaining the earlier of 55 years of age and 10 years of service or 60 years of age and 5 years of service. For the quarter ended September 30, 2015 no performance shares were granted. For the nine-month period ended September 30, 2015, 91,984 performance shares were granted under this plan.
During the quarter ended September 30, 2015, the Corporation recognized $ 1.9 million of restricted stock expense related to management incentive awards, with a tax benefit of $ 0.3 million (September 30, 2014 - $ 1.6 million, with a tax benefit of $ 0.2 million). For the nine-month period ended September 30, 2015, the Corporation recognized $ 9.4 million of restricted stock expense related to management incentive awards, with a tax benefit of $ 1.4 million (September 30, 2014 - $ 4.7 million, with a tax benefit of $ 0.7 million). For the nine-month period ended September 30, 2015, the fair market value of the restricted stock vested was $5.3 million at grant date and $6.4 million at vesting date. This triggers a windfall, net of shortfalls, of $0.4 million of which $0.2 million was recorded as a windfall pool in additional paid in capital. No windfall pool was recorded for the remaining $0.2 million due to the
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valuation allowance of the deferred tax asset. During the quarter ended September 30, 2015 the Corporation recognized $95 thousand of performance shares expense, with a tax benefit of $6 thousand. For the nine-month period ended September 30, 2015, the Corporation recognized $2.1 million of performance shares expense, with a tax benefit of $0.2 million. The total unrecognized compensation cost related to non-vested restricted stock awards and performance shares to members of management at September 30, 2015 was $ 8.9 million and is expected to be recognized over a weighted-average period of 2.2 years.
The following table summarizes the restricted stock activity under the Incentive Plan for members of the Board of Directors:
During the quarter ended September 30, 2015, the Corporation granted 1,994 shares of restricted stock to members of the Board of Directors of Popular, Inc., which became vested at grant date (September 30, 2014 – 2,318). During this period, the Corporation recognized $0.1 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $24 thousand (September 30, 2014 - $0.1 million, with a tax benefit of $14 thousand). For the nine-month period ended September 30, 2015, the Corporation granted 20,023 shares of restricted stock to members of the Board of Directors of Popular, Inc., which became vested at grant date (September 30, 2014 – 21,051). During this period, the Corporation recognized $0.4 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $59 thousand (September 30, 2014 - $0.4 million, with a tax benefit of $43 thousand). The fair value at vesting date of the restricted stock vested during the nine months ended September 30, 2015 for directors was $ 0.7 million.
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Note 36 – Income taxes
The reason for the difference between the income tax expense applicable to income before provision for income taxes and the amount computed by applying the statutory tax rate in Puerto Rico, were as follows:
Computed income tax expense at statutory rates
Net benefit of tax exempt interest income
Deferred tax asset valuation allowance
Non-deductible expenses
Difference in tax rates due to multiple jurisdictions
Initial adjustment in deferred tax due to change in tax rate
Effect of income subject to preferential tax rate
Unrecognized tax benefits
Income tax (benefit) expense
Computed income tax (benefit) expense at statutory rates
Effect of income subject to preferential tax rate[1]
Income tax expense for the quarter ended September 30, 2014 was impacted by the recognition of an income tax expense of $20.0 million, related to the deferred tax liability associated with the portfolio acquired from Westernbank as a result of the increase in the income tax for capital gains from 15% to 20%.
During the second quarter of 2015, the Corporation recorded a partial reversal of the valuation allowance on the deferred tax asset from the U.S. operations amounting to $544.9 million.
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The following table presents a breakdown of the significant components of the Corporation’s deferred tax assets and liabilities.
Deferred tax assets:
Tax credits available for carryforward
Net operating loss and other carryforward available
Postretirement and pension benefits
Deferred loan origination fees
Deferred gains
Accelerated depreciation
Intercompany deferred gains
Other temporary differences
Total gross deferred tax assets
Deferred tax liabilities:
Differences between the assigned values and the tax basis of assets and liabilities recognized in purchase business combinations
FDIC-assisted transaction
Unrealized net gain on trading and available-for-sale securities
Total gross deferred tax liabilities
Valuation allowance
Net deferred tax asset
The net deferred tax asset shown in the table above at September 30, 2015 is reflected in the consolidated statements of financial condition as $1.3 billion in net deferred tax assets in the “Other assets” caption (December 31, 2014 - $813 million) and $3.2 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2014 - $34 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation.
A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The analysis considers all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years and tax-planning strategies.
During the quarter ended June 30, 2015, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that a portion of the total deferred tax asset from the U.S. operations, amounting to $1.2 billion and comprised mainly of net operating losses, will be realized. The Corporation based this determination on its estimated earnings for the remaining carryforward period of eighteen years beginning with the 2016 fiscal year, available to utilize the deferred tax asset, to reduce its income tax obligations. The recent historical level of book income adjusted by permanent differences, together with the estimated earnings after the reorganization of the U.S. operations and additional estimated earnings from the Doral Bank Transaction were objective positive evidence considered by the Corporation. As of September 30, 2015 the U.S. operations are not in a three year loss cumulative position, taking into account taxable income exclusive of reversing temporary differences. All of these factors lead management to conclude that it is more likely than not that a portion of the deferred tax asset from its U.S. operations will be realized. Accordingly, the Corporation recorded a partial reversal of the valuation allowance on the deferred tax asset from the U.S. operations amounting to $544.9 million. Management will continue to evaluate the realization of the deferred tax asset each quarter and adjust as deemed necessary.
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At September 30, 2015, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $759 million.
The Corporation’s Puerto Rico Banking operation is not in a cumulative loss position and has sustained profitability for the three year period ended September 30, 2015, exclusive of the loss generated on the sales of non performing assets that took place in 2013 which is not a continuing condition of the operations. This is considered a strong piece of objectively verifiable positive evidence that outweights any negative evidence considered by management in the evaluation of the realization of the deferred tax asset. Based on this evidence and management’s estimate of future taxable income, the Corporation has concluded that it is more likely than not that such net deferred tax asset of the Puerto Rico Banking operations will be realized.
The Holding Company operation is not in a cumulative loss position for the three year period ended September 30, 2015. However, after the payment of TARP, the interest expense that is paid on the $450 million subordinated notes which partially funded the repayment of TARP funds in 2014, bearing interest at 7%, is tax deductible contrary to the interest expense payable on the note issued to the U.S. Treasury under TARP. Based on this fact pattern the Holding Company is expecting to have losses for income tax purposes exclusive of reversing temporary differences. Since as required by ASC 740 the historical information should be supplemented by all currently available information about future years, the expected losses in future years is considered by management a strong negative evidence that will suggest that income in future years will be insufficient to support the realization of all deferred tax asset. After weighting of all positive and negative evidence management concluded, as of the reporting date, that it is more likely than not that the Holding Company will not be able to realize any portion of the deferred tax assets, considering the criteria of ASC Topic 740. Accordingly, a full valuation allowance is recorded on the deferred tax asset at the Holding Company, which amounted to $32 million as of September 30, 2015.
The reconciliation of unrecognized tax benefits was as follows:
(In millions)
Balance at January 1
Additions for tax positions - January through March
Reduction as a result of settlements - January through March
Balance at March 31
Additions for tax positions - April through June
Balance at June 30
Additions for tax positions - July through September
Reduction as a result of lapse of statute of limitations - July through September
Balance at September 30
At September 30, 2015, the total amount of interest recognized in the statement of financial condition approximated $3.0 million (December 31, 2014 - $3.1 million). The total interest expense recognized at September 2015 was $496 thousand (December 31, 2014 - $540 thousand). Management determined that at September 30, 2015 and December 31, 2014 there was no need to accrue for the payment of penalties. The Corporation’s policy is to report interest related to unrecognized tax benefits in income tax expense, whiles the penalties, if any, are reported in other operating expenses in the consolidated statements of operations.
After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico, that if recognized, would affect the Corporation’s effective tax rate, was approximately $10.8 million at September 30, 2015 (December 31, 2014 - $9.8 million).
The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.
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The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. At September 30, 2015, the following years remain subject to examination in the U.S. Federal jurisdiction: 2011 and thereafter; and in the Puerto Rico jurisdiction, 2010 and thereafter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $5.9 million.
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Note 37 – Supplemental disclosure on the consolidated statements of cash flows
Additional disclosures on cash flow information and non-cash activities for the nine months ended September 30, 2015 and September 30, 2014 are listed in the following table:
Non-cash activities:
Loans transferred to other real estate
Loans transferred to other property
Total loans transferred to foreclosed assets
Transfers from loans held-in-portfolio to loans held-for-sale
Transfers from loans held-for-sale to loans held-in-portfolio
Transfers from trading securities to available-for-sale securities
Loans securitized into investmentsecurities[1]
Trades payable to brokers and counterparties
Recognition of mortgage servicing rights on securitizations or asset transfers
As previously disclosed in Note 5, Business Combination, on February 27, 2015, the Corporation’s Puerto Rico banking subsidiary, BPPR, in an alliance with co-bidders, including the Corporation’s U.S. mainland banking subsidiary, PCB, acquired certain assets and all deposits (other than certain brokered deposits) of Doral Bank from the FDIC as receiver. As part of this transaction, BPPR received net cash proceeds of approximately $ 731 million for consideration of the assets and liabilities acquired.
During the quarter ended September 30, 2014 BPNA completed the sale of its Illinois and Central Florida regional operations. As part of these transactions, BPNA made a net cash disbursement of $234.0 million for consideration of the assets and liabilities sold, as follows:
Net liabilities sold
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Note 38 – Segment reporting
The Corporation’s corporate structure consists of two reportable segments – Banco Popular de Puerto Rico and Banco Popular North America. These reportable segments pertain only to the continuing operations of Popular, Inc. As previously indicated in Note 4 to the consolidated financial statements, the regional operations in California, Illinois and Central Florida were classified as discontinued operations in the second quarter of 2014, and the assets and liabilities of these regions were subsequently sold during the third and fourth quarters of 2014.
As indicated in Note 5 to the consolidated financial statements, Business Combination, on February 27, 2015, Banco Popular de Puerto Rico, in an alliance with co-bidders, including BPNA, acquired certain assets and all deposits of Doral Bank from the FDIC as receiver. The financial results for the quarter and nine months period ended on September 30, 2015 of both reportable segments include the results from the operations acquired as part of the Doral Bank Transaction.
Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. The segments were determined based on the organizational structure, which focuses primarily on the markets the segments serve, as well as on the products and services offered by the segments.
Banco Popular de Puerto Rico:
Given that Banco Popular de Puerto Rico constitutes a significant portion of the Corporation’s results of operations and total assets at September 30, 2015, additional disclosures are provided for the business areas included in this reportable segment, as described below:
Banco Popular North America:
Banco Popular North America’s reportable segment consists of the banking operations of BPNA, E-LOAN, Popular Equipment Finance, Inc. and Popular Insurance Agency, U.S.A. BPNA operates through a retail branch network in the U.S. mainland under the name of Popular Community Bank, while E-LOAN supports BPNA’s deposit gathering through its online platform. All direct lending activities at E-LOAN were ceased during the fourth quarter of 2008. During the third quarter of 2015, BPNA and E-LOAN completed an asset purchase and sale transaction in which E-LOAN sold to BPNA all of its outstanding loan portfolio, including residential mortgage loans and home equity lines of credit, which had a carrying value of approximately $213 million. Prior to this transaction, the Corporation provided additional disclosures for the BPNA reportable segment, related to E-LOAN. After the close of the above mentioned asset purchase and sale transaction, additional disclosures with respect to E-LOAN are no longer considered relevant to the financial statements and accordingly are not presented. Popular Equipment Finance, Inc. also holds a running-off loan portfolio as this subsidiary ceased originating loans during 2009. Popular Insurance Agency, U.S.A. offers investment and insurance services across the BPNA branch network.
The Corporate group consists primarily of the holding companies: Popular, Inc., Popular North America, Popular International Bank and certain of the Corporation’s investments accounted for under the equity method, including EVERTEC and Centro Financiero BHD, S.A. The Corporate group also includes the expenses of certain corporate areas that are identified as critical to the organization: Finance, Risk Management and Legal.
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The accounting policies of the individual operating segments are the same as those of the Corporation. Transactions between reportable segments are primarily conducted at market rates, resulting in profits that are eliminated for reporting consolidated results of operations.
The tables that follow present the results of operations and total assets by reportable segments:
Non-interest income
Depreciation expense
Income tax expense
Segment assets
Net interest income (expense)
Provision (reversal of provision) for loan losses
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Income tax benefit
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Additional disclosures with respect to the Banco Popular de Puerto Rico reportable segment are as follows:
Net (loss) income
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Non-interest (expense) income
Geographic Information
(in thousands)
Revenues:
United States
Total consolidated revenues
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Selected Balance Sheet Information:
Deposits [1]
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Note 39 – Condensed consolidating financial information of guarantor and issuers of registered guaranteed securities
The following condensed consolidating financial information presents the financial position of Popular, Inc. Holding Company (“PIHC”) (parent only), Popular North America, Inc. (“PNA”) and all other subsidiaries of the Corporation at September 30, 2015 and December 31, 2014, and the results of their operations and cash flows for periods ended September 30, 2015 and 2014.
PNA is an operating, wholly-owned subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries: Equity One, Inc. and Banco Popular North America (“BPNA”), including BPNA’s wholly-owned subsidiaries Popular Equipment Finance, Inc., Popular Insurance Agency, U.S.A., and E-LOAN, Inc.
PIHC fully and unconditionally guarantees all registered debt securities issued by PNA.
A potential source of income for PIHC consists of dividends from BPPR and BPNA. Under existing federal banking regulations any dividend from BPPR or BPNA to the PIHC could be made if the total of all dividends declared by each entity during the calendar year would not 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. At September 30, 2015, BPPR could have declared a dividend of approximately $498 million (December 31, 2014 - $542 million).
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Condensed Consolidating Statement of Financial Condition (Unaudited)
Trading account securities, at fair value
Other investment securities, at lower of cost or realizable value
Investment in subsidiaries
Less - Unearned income
Liabilities from discontinued operations
145
Retained earnings (accumulated deficit)
Treasury stock, at cost
146
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Condensed Consolidating Statement of Operations (Unaudited)
Interest and dividend income:
Dividend income from subsidiaries
Total interest and dividend income
Provision (reversal) for loan losses- non-covered loans
Provision (reversal) for loan losses- covered loans
Net interest income (expense) after provision for loan losses
Other service fees
Net gain and valuation adjustments on investment securities
Trading account loss
FDIC loss-share income
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Restructuring cost
Income (loss) before income tax and equity in earnings of subsidiaries
Income (loss) before equity in earnings of subsidiaries
Equity in undistributed earnings of subsidiaries
Income from continuing operations
Loss from discontinued operations, net of tax
Equity in undistributed losses of discontinued operations
Net Income
Comprehensive income, net of tax
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Net interest (expense) income
Provision for loan losses- non-covered loans
Provision for loan losses- covered loans
Net interest (expense) income after provision for loan losses
Net loss and valuation adjustments on investment securities
Restructuring costs
(Loss) income before income tax and equity in earnings of subsidiaries
150
(Loss) income before equity in earnings of subsidiaries
Income from discontinued operations, net of tax
Equity in undistributed earnings of discontinued operations
151
Provision (reversal) for loan losses-non-covered loans
Provision for loan losses-covered loans
FDIC loss-share expense
152
153
Trading account profit
154
(Loss) income from continuing operations
Net (Loss) Income
Comprehensive (loss) income, net of tax
155
Condensed Consolidating Statement of Cash Flows (UNAUDITED)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
FDIC loss share income
Deferred income tax benefit
Sale of loans, including valuation adjustments on loans held for sale and mortgage banking activities
Net (decrease) increase in:
Pension and other postretirement benefits obligations
Net cash (used in) provided by operating activities
Net decrease (increase) in money market investments
Available for sale
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Acquisition of servicing assets
Cash paid related to business acquisitions
Net cash provided by (used in) investing activities
Dividends paid to parent company
Net cash (used in) provided by financing activities
Cash and due from banks at end of period
The Condensed Consolidating Statements of Cash Flows include the cash flows from operating, investing and financing activities associated with discontinued operations.
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Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Equity in undistributed (earnings) losses of subsidiaries
FDIC loss share expense
Deferred income tax expense
Loss (gain) on:
Net (increase) decrease in money market investments
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Capital contribution to subsidiary
Return of capital from wholly-owned subsidiaries
Return of capital to parent company
Capital contribution from parent
Net cash used in by financing activities
Cash and due from banks at end of period, including discontinued operations
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report includes management’s discussion and analysis (“MD&A”) of the consolidated financial position and financial performance of Popular, Inc. (the “Corporation” or “Popular”). All accompanying tables, financial statements and notes included elsewhere in this report should be considered an integral part of this analysis.
The Corporation is a diversified, publicly-owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation has operations in Puerto Rico, the United States (“U.S.”) mainland, and the U.S. and British Virgin Islands. In Puerto Rico, the Corporation provides retail, including residential mortgage loan originations, and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as investment banking, broker-dealer, auto and equipment leasing and financing, and insurance services through specialized subsidiaries. In the U.S. mainland, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN. BPNA focuses efforts and resources on the core community banking business. BPNA, under the name Popular Community Bank (“PCB”), operates branches in New York, New Jersey and Southern Florida. E-LOAN markets deposit accounts under its name for the benefit of BPNA. Note 38 to the consolidated financial statements presents information about the Corporation’s business segments. As of September 30, 2015, the Corporation had a 15.31% interest in the holding company of EVERTEC, which provides transaction processing services throughout the Caribbean and Latin America, including servicing many of the Corporation’s system infrastructures and transaction processing businesses. During the quarter ended September 30, 2015, the Corporation recorded $2.8 million in earnings from its investment in EVERTEC, which had a carrying amount of $30.9 million as of the end of the quarter. Also, the Corporation had a 15.84% stake in Centro Financiero BHD Leon, S.A. (“BHD Leon”), one of the largest banking and financial services groups in the Dominican Republic. During the quarter ended September 30, 2015 the Corporation recorded $6.2 million in earnings from its investment in BHD Leon, which had a carrying amount of $113.1 million, as of the end of the quarter.
OVERVIEW
Recent significant events
During the quarter ended September 30, 2015, the Corporation:
As discussed in Note 4 to the consolidated financial statements, during the year 2014 the Company completed the sale of its U.S. regional operations in California, Illinois and Central Florida. Current and prior periods’ financial information covering income and expense amounts presented in this MD&A has been retrospectively adjusted for the impact of the discontinued operations of the U.S. operations for comparative purposes. The financial information for prior periods included in this MD&A does not reflect the reclassification of certain of PCB’s assets and liabilities to discontinued operations.
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Adjusted results of operations – Non-GAAP financial measure
The Corporation prepares its Consolidated Financial Statements using accounting principles generally accepted in the U.S. (“U.S. GAAP”), the (“reported basis”). In addition to analyzing the Corporation’s results on a reported basis, management monitors the performance of the Corporation on an “adjusted basis” and excludes the impact of certain transactions on the results of its operations. Throughout this MD&A, the Corporation presents a discussion of its financial results excluding the impact of these events to arrive at the “adjusted results”. Management believes that the “adjusted results” provide meaningful information about the underlying performance of the Corporation’s ongoing operations. The “adjusted results” are a Non-GAAP financial measure. Refer to tables 53 through 58 for a reconciliation of the reported results for the quarter and nine months ended September 30, 2015 and 2014.
Non-GAAP financial measures used by the Corporation may not be comparable to similarly named non-GAAP financial measures used by other companies.
Financial highlights for the quarter ended September 30, 2015
Total non-performing assets, including covered, were $878 million at September 30, 2015, decreasing by $55 million, or 6%, from December 31, 2014, of which $74 million were related to OREO reductions. During the second quarter of 2015, the Corporation completed a bulk sale of covered OREOs with a carrying value of $37 million. Total non-performing non-covered assets were $838 million at September 30, 2015, increasing by $54 million, or 7%, from December 31, 2014. Non-covered non-performing loans held-in-portfolio were $635 million, increasing by $4, million, or 1%, from December 31, 2014. The ratio of non-performing loans to loans held-in-portfolio, excluding covered loans, decreased to 2.82% at September 30, 2015 from 3.25% at December 31, 2014, impacted by the reclassification of $1.5 billion to the non-covered category during the second quarter of 2015, pursuant to the expiration of the commercial and consumer loans loss-sharing agreement with the FDIC.
Refer to the Credit Risk Management and Loan Quality section of this MD&A for an explanation of the main factors impacting the provision for loan losses and a detailed analysis of net charge-offs, non-performing assets, the allowance for loan losses and selected loan losses statistics.
Refer to the Non-Interest Income section of this MD&A for additional information on the main variances that affected the non-interest income categories.
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Refer to the Operating Expenses section of this MD&A for additional information.
These increases were partially offset by:
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Table 1 provides selected financial data and performance indicators for the quarters ended September 30, 2015 and 2014.
As a financial services company, the Corporation’s earnings are significantly affected by general business and economic conditions. Lending and deposit activities and fee income generation are influenced by the level of business spending and investment, consumer income, spending and savings, capital market activities, competition, customer preferences, interest rate conditions and prevailing market rates on competing products.
The Corporation continuously monitors general business and economic conditions, industry-related indicators and trends, competition, interest rate volatility, credit quality indicators, loan and deposit demand, operational and systems efficiencies, revenue enhancements and changes in the regulation of financial services companies.
The Corporation operates in a highly regulated environment and may be adversely affected by changes in federal and local laws and regulations. Also, competition with other financial institutions could adversely affect its profitability.
The description of the Corporation’s business contained in Item 1 of the Corporation’s 2014 Annual Report, while not all inclusive, discusses additional information about the business of the Corporation and risk factors, many beyond the Corporation’s control that, in addition to the other information in this Form 10-Q, readers should consider.
The Corporation’s common stock is traded on the NASDAQ Global Select Market under the symbol BPOP.
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Table 1 - Financial Highlights
Financial Condition Highlights
Investment and trading securities
Earning assets
Assets from discontinued operations
Deposits*
Borrowings
Stockholders’ equity
Operating Highlights
Operating expenses
(Loss) income from discontinued operations, net of tax
Net income (loss) per Common Share – Basic
Net income (loss) per Common Share – Diluted
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Selected Statistical Information
Common Stock Data
Market price
High
Low
End
Book value per common share at period end
Profitability Ratios
Return on assets
Return on common equity
Net interest spread (taxable equivalent) - Non-GAAP
Net interest margin (taxable equivalent) - Non-GAAP
Capitalization Ratios
Average equity to average assets
Tier I capital
Total capital
Tier 1 leverage
CRITICAL ACCOUNTING POLICIES / ESTIMATES
The accounting and reporting policies followed by the Corporation and its subsidiaries conform to generally accepted accounting principles in the United States of America and general practices within the financial services industry. Various elements of the Corporation’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. These estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from those estimates.
Management has discussed the development and selection of the critical accounting policies and estimates with the Corporation’s Audit Committee. The Corporation has identified as critical accounting policies those related to: (i) Fair Value Measurement of Financial Instruments; (ii) Loans and Allowance for Loan Losses; (iii) Acquisition Accounting for Loans and Related Indemnification Asset; (iv) Income Taxes; (v) Goodwill, and (vi) Pension and Postretirement Benefit Obligations. For a summary of these critical accounting policies and estimates, refer to that particular section in the MD&A included in Popular, Inc.’s 2014 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, 2014 (the “2014 Annual Report”). Also, refer to Note 2 to the consolidated financial statements included in the 2014 Annual Report for a summary of the Corporation’s significant accounting policies.
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Certain residential mortgage and commercial loans acquired as part of the Doral Bank Transaction were considered impaired. Accordingly, the Corporation applied the guidance of ASC Subtopic 310-30. Under this guidance, the loans acquired from the FDIC were aggregated into pools based on similar characteristics, including factors such as loan type, interest rate type, accruing status, and amortization type. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Under ASC Subtopic 310-30, the difference between the undiscounted cash flows expected at acquisition and the fair value in the loans, or the “accretable yield,” is recognized as interest income using the effective yield method over the estimated life of the loan if the timing and amount of the future cash flows of the pool is reasonably estimable. The non-accretable difference represents the difference between contractually required principal and interest and the cash flows expected to be collected. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. Refer to Note 11 to the consolidated financial statements for additional information with respect to the loans acquired as part of the Doral Bank Transaction that were considered impaired.
For the period ended September 30, 2015, 18% (September 30, 2014 - 33%) of the ALLL for BPPR non-covered loan portfolios utilized the recent loss trend adjustment instead of the base loss. The effect of replacing the base loss with the recent loss trend adjustment was mainly concentrated in the mortgage and commercial multi-family loan portfolios for 2015, and in the commercial multi-family, commercial and industrial, personal and auto loan portfolios for 2014.
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NET INTEREST INCOME
Net interest income on a taxable equivalent basis-Non-GAAP financial measure
Net interest income, on a taxable equivalent basis, is presented with its different components on Table 2 for the quarter ended September 30, 2015 as compared with the same period in 2014, segregated by major categories of interest earning assets and interest bearing liabilities.
The interest earning assets include investment securities and loans that are exempt from income tax, principally in Puerto Rico. The main sources of tax-exempt interest income are certain investments in obligations of the U.S. Government, its agencies and sponsored entities, and certain obligations of the Commonwealth of Puerto Rico and its agencies and assets held by the Corporation’s international banking entities. To facilitate the comparison of all interest related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates for each period. The taxable equivalent computation considers the interest expense and other related expense disallowances required by the Puerto Rico tax law. Under this law, the exempt interest can be deducted up to the amount of taxable income. Net interest income on a taxable equivalent basis is a Non-GAAP financial measure. Management believes that this presentation provides meaningful information since it facilitates the comparison of revenues arising from taxable and exempt sources.
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Average outstanding securities balances are based on amortized cost excluding any unrealized gains or losses on securities available-for-sale. Non-accrual loans have been included in the respective average loans and leases categories. Loan fees collected and costs incurred in the origination of loans are deferred and amortized over the term of the loan as an adjustment to interest yield. Prepayment penalties, late fees collected and the amortization of premiums / discounts on purchased loans are also included as part of the loan yield. Excluding the discount accretion on loans acquired in the Westernbank FDIC-assisted transaction (“WB loans”) accounted for under Subtopic ASC 310-30, the impact to interest income from these fees and amortizations for the quarter and nine months ended September 30, 2015 were of $6.9 million and $13.4 million, respectively, compared with a favorable impact of $1.5 million and $4.1 million in the same periods in 2014. The increase in fees and amortizations relates mostly to loans acquired in the Doral transaction.
Net interest income from continued operations, on a taxable equivalent basis, for the third quarter of 2015 was $368.0 million compared to $345.7 million in the same quarter of 2014. Net interest margin, on a taxable equivalent basis, for the third quarter of 2015 was 4.60% compared to 4.62% in the same quarter of 2014, a decrease of 2 basis points. Excluding the impact of the $20.7 million in fees related to the structured repo refinancing in BPNA in the third quarter of 2014, adjusted net interest income on a taxable equivalent basis was $366.4 million and the adjusted net interest margin was 4.90%.
The most important variances were:
These positive variances were partially offset by:
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Table 2 - Analysis of Levels & Yields on a Taxable Equivalent Basis for Continuing Operations
VarianceAttributable to
Total money market, investment and trading securities
Loans:
Sub-total loans
WB loans
Total loans
Total earning assets
Interest bearing deposits:
NOW and money market [1]
Savings
Short-term borrowings [2]
TARP funds [3]
Other medium and long-term debt
Total interest bearing liabilities
Non-interest bearing demand deposits
Other sources of funds
Total source of funds
Adjusted net interest margin/income on a taxable equivalent basis
Adjusted net interest spread
Impact of fees related to BPNA repo refinancing
Net interest margin/income on a taxable equivalent basis
Taxable equivalent adjustment
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Note: The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of the change in each category.
Net interest income from continuing operations on a taxable equivalent basis for the nine-month period ended September 30, 2015 was $1.1 billion compared to $675.9 million for the same period in 2014. Excluding the impact of the $20.7 million in fees related to the refinancing of structured repos at BPNA and the $414.1 million of accelerated amortization of the discount and deferred costs related to the TARP repayment in the second quarter of 2014, the adjusted net interest income on a taxable equivalent basis for the same period in 2014 was $1.1 billion. The adjusted net interest margin for the nine-month period ended September 30, 2015 was 4.75% compared to 4.92% for the same period in 2014, a decrease of 17 basis points. The most important variances were:
Table 3 - Analysis of Levels & Yields on a Taxable Equivalent Basis from Continuing Operations (Non-GAAP)
Average Volume
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Adjusted net interest margin/ income on a taxable equivalent basis
Accelerated amortization of TARP discount and BPNA repo refinancing fees
Net interest margin/ income on a taxable equivalent basis
Provision for Loan Losses
The Corporation’s total provision for loan losses was $66.7 million for the quarter ended September 30, 2015, compared to $80.6 million for the same quarter of the previous year, a decrease of $13.9 million.
The provision for loan losses for the non-covered loan portfolio totaled $69.6 million, compared to $68.2 million for the same quarter in 2014. The provision for the third quarter of 2015 included $10.1 million impairment on Westernbank loans that the Corporation has the intent to sell and are subject to the ongoing arbitration with the FDIC. The provision for the third quarter of 2014 included $12.0 million related to certain classified and legacy loans sold or transferred to loans held-for-sale as part of the U.S. reorganization. Excluding these effects, the provision for the third quarter amounted to $59.5 million, relatively flat when compared to $56.2 million in the third quarter of 2014.
The provision for loan losses for the non-covered loan portfolio at the BPPR segment increased by $6.9 million, compared to the third quarter of 2014. The provision for the third quarter of 2015 included the $10.1 million impairment on Westernbank loans stated above. Excluding the impact of the $10.1 million, the provision for the third quarter amounted to $58.7 million, a decrease of $3.2 million when compared to the third quarter of 2014.
The provision for loan losses for the BPNA segment was $813 thousand, compared to $6.3 million for the same quarter in 2014, as the provision for the third quarter of 2014 included $12.0 million related to loan sales, as mentioned above. Notwithstanding, a low provision level is reflective of BPNA’s improvements in credit quality and low levels of net charge-offs during 2015.
For the covered portfolio, the Corporation recorded a reserve release of $2.9 million in the third quarter of 2015, compared to $12.5 million provision expense for the same quarter in 2014, mostly reflecting the reclassification to non-covered loans of non -single family loans that were previously covered by the commercial loss agreement with the FDIC in the second quarter of 2015.
For the nine months ended September 30, 2015, the Corporation’s total provision for loan losses totaled $182.9 million, compared with $222.1 million for the same period in 2014, decreasing by $39.2 million mostly driven by lower provision in the BPPR segment. The provision for the nine months ended September 30, 2015 includes the above mentioned $10.1 million impairment on
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Westernbank loans, compared to $12.0 million in the third quarter of 2014 related to BPNA loans sales. In addition, the provision includes a reserve release of $1.9 million as part of the annual recalibration and enhancements of the allowance for loans losses completed during the second quarter of 2015, compared to a reserve release of $17.9 million from the 2014 annual recalibration process.
For the nine months period ended September 30, 2015, the provision for loan losses for the non-covered loan portfolio decreased by $12.6 million when compared to the same period of 2014. The provision for the BPPR segment non-covered loan portfolio decreased by $29.4 million, as the same period in 2014 included the impact of higher reserves to account for the macroeconomic conditions in Puerto Rico. The nine month period ended September 30, 2015, included the impact of the annual recalibration and enhancements to the allowance for loan losses methodology during the second quarter, as mentioned above. The review of the ALLL methodology resulted in a net decrease of $2.6 million for the BPPR segment, compared to a reserve release of $14.9 million in 2014. The BPNA segment reflected a reserve release of $1.5 million, compared to a reserve release of $18.3 million for the same period of 2014. The annual review of the ALLL methodology resulted in a net increase of approximately $0.7 million, compared to a $3.8 million reserve release in the same quarter in 2014. Refer to the Critical Accounting Policies section of this MD&A for further details of these revisions.
The provision for the covered portfolio was $23.2 million for the nine month period ended September 30, 2015, compared to $49.8 million for same period of last year. This decrease was mainly due to lower impairment losses on commercial loan pools accounted for under ASC 310-30 until the second quarter of 2015 and consequently to reclassification of these loans to non-covered loans In the second quarter of 2015, the effect of the aforementioned enhancements to the allowance for loan losses methodology was immaterial for the covered loans portfolio. The 2014 annual recalibration and enhancements of the ALLL models resulted in an increase of $0.8 million to the provision for the covered portfolio.
Refer to the Credit Risk Management and Loan Quality sections of this MD&A for a detailed analysis of net charge-offs, non-performing assets, the allowance for loan losses and selected loan losses statistics.
NON-INTEREST INCOME
Refer to Table 4 for a breakdown on non-interest income by major categories for the quarters and nine months ended September 30, 2015 and 2014.
Table 4 - Non-Interest Income
Other service fees:
Total other service fees
Net gain (loss) and valuation adjustments of investment securities
Net gain on sale of loans, including valuation adjustment on loans held-for-sale
Adjustment (expense) to indemnity reserves on loans sold
FDIC loss share income (expense)
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Table 5 - Mortgage Banking Activities
Non-interest income increased by $6.8 million during the quarter ended September 30, 2015, compared with the same quarter of the previous year. Excluding the impact of certain events detailed in Tables 53 to 55 Adjusted Results (Non-GAAP), non-interest income increased $16.6 million. The increase in adjusted non-interest income was principally due to a positive variance in the FDIC loss share income (expense) of $21.1 million, mostly driven by lower amortization of the indemnification asset, partially offset by lower mirror accounting on credit impairment losses and lower mirror accounting on reimbursable expenses. Refer to Table 6 for a breakdown of FDIC loss share income (expenses) by major categories.
For the nine months ended September 30, 2015, non-interest income increased by $104.0 million, compared with the same period of the previous year. Excluding the impact of certain events detailed in Tables 56 to 58 Adjusted Results (Non-GAAP), non-interest income increased $116.9 million. The increase in adjusted non-interest income was principally due to:
The results for the nine months ended September 30, 2015 include an other-than-temporary impairment charge on the portfolio of Puerto Rico government investment securities available-for-sale of $14.4 million. These securities had an amortized cost of approximately $41.1 million and a market value of $26.6 million. Based on the fiscal and economic situation in Puerto Rico, together with the government’s announcements regarding its ability to pay its debt and its intention to pursue a comprehensive debt restructuring, the Corporation determined that the unrealized loss, a portion of which had been in an unrealized loss for a period exceeding twelve months, was other-than-temporary.
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The following table provides a summary of the revenues and expenses derived from the assets acquired in the FDIC-assisted transaction during the quarters and nine months period ended September 30, 2015 and 2014.
Table 6 - Financial Information - Westernbank FDIC-Assisted Transaction
Interest income on WB loans
FDIC loss-share income (expense) :
80% mirror accounting on amortization of contingent liability on Change in true-up payment obligation
Total revenues
Provision for loan losses[2]
Total revenues less provision for loan losses
Average balances
WB Loans
FDIC loss-share asset
Operating Expenses
Operating expenses decreased by $3.7 million for the quarter ended September 30, 2015, compared with the same quarter of the previous year. Refer to Table 7 for a breakdown of operating expenses by major categories. Excluding the impact of certain transactions, as detailed in Tables 53 through 55, operating expenses decreased by $1.6 million due mainly to the following factors:
These decreases were partially offset by:
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Operating expenses increased by $118.7 million for the nine months ended September 30, 2015, when compared to the same period in 2014. Excluding the impact of certain transactions, as detailed in Tables 56 through 58; operating expenses increased by $63.7 million due mainly to the following factors:
Table 7 - Operating Expenses
Personnel costs:
Salaries
Commissions, incentives and other bonuses
Pension, postretirement and medical insurance
Other personnel costs, including payroll taxes
Total personnel costs
Professional fees:
Collections, appraisals and other credit related fees
Programming, processing and other technology services
Other professional fees
Total professional fees
Other operating expenses:
Credit and debit card processing, volume and interchange expenses
Transportation and travel
Printing and supplies
Operational losses
All other
Total other operating expenses
INCOME TAXES
Income tax expense amounted to $22.6 million for the quarter ended September 30, 2015, compared to $26.7 million for the same quarter of 2014. Income tax expense for the quarter ended September 30, 2014 was impacted by the recognition of an income tax expense of $20.0 million, related to the deferred tax liability associated with the portfolio acquired from Westernbank as a result of the increase in the income tax for capital gains from 15% to 20%, net of the reversal of $3.6 million of reserves for uncertain tax positions due to the expiration of the statute of limitation. The income tax expense for the third quarter of 2015, reflected the impact of higher taxable income, compared to the same quarter of the previous year.
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The components of income tax expense for the quarters ended September 30, 2015 and 2014 are included in the following table:
Table 8 – Components of Income Tax (Benefit) Expense
Income tax benefit amounted to $478.3 million for the nine months ended September 30, 2015, compared with an income tax expense of $45.8 million for the same period of 2014. The increase in income tax benefit was primarily due to a tax benefit of $544.9 million recorded during the second quarter of 2015 as a result of the partial reversal of the valuation allowance on the Corporation’s deferred tax asset from the U.S. operations.
During the quarter ended June 30, 2015, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that a portion of the total deferred tax asset from the U.S. operations, amounting to $1.2 billion and comprised mainly of net operating losses, will be realized. The Corporation based this determination on its estimated earnings for the remaining carryforward period of eighteen years beginning with the 2016 fiscal year, available to utilize the deferred tax asset, to reduce its income tax obligations. The recent historical level of book income adjusted by permanent differences, together with the estimated earnings after the reorganization of the U.S. operations and additional estimated earnings from the Doral Bank Transaction were objective positive evidence considered by the Corporation. As of September 30,2015 the U.S. operations are not in a three year loss cumulative position, taking into account taxable income exclusive of reversing temporary differences. All of these factor led management to conclude that it is more likely than not that a portion of the deferred tax asset from its U.S. operations will be realized. Management will continue to evaluate the realization of the deferred tax asset each quarter and adjust as deemed necessary.
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Table 9 – Components of Income Tax (Benefit) Expense – Year-to-Date
Refer to Note 36 to the consolidated financial statements for a breakdown of the Corporation’s deferred tax assets as of September 30, 2015.
REPORTABLE SEGMENT RESULTS
The Corporation’s reportable segments for managerial reporting purposes consist of Banco Popular de Puerto Rico and Banco Popular North America. These reportable segments pertain only to the continuing operations of Popular, Inc. As previously indicated in Note 4 to the consolidated financial statements, the regional operations in California, Illinois and Central Florida were classified as discontinued operations in the second quarter of 2014, and the assets and liabilities of these regions were subsequently sold during the third and fourth quarters of 2014.
A Corporate group has been defined to support the reportable segments. For managerial reporting purposes, the costs incurred by the Corporate group are not allocated to the reportable segments.
For a description of the Corporation’s reportable segments, including additional financial information and the underlying management accounting process, refer to Note 38 to the consolidated financial statements.
The Corporate group reported a net loss of $17.6 million for the quarter and $57.8 million for the nine months ended September 30, 2015, compared with a net loss of $18.4 million for the quarter and $489.8 million for the nine months ended September 30, 2014. The favorable variance for the nine months periods was mostly due to the accelerated amortization recorded in the second quarter of 2014 of $414.1 million of the discount and deferred costs associated with the TARP funds, which were repaid in July 2, 2014.
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Highlights on the earnings results for the reportable segments are discussed below:
The Banco Popular de Puerto Rico reportable segment’s net income amounted to $81.4 million for the quarter ended September 30, 2015, compared with a net income of $62.2 million for the same quarter of the previous year. The principal factors that contributed to the variance in the financial results included the following:
The net interest margin was 4.75% for the quarter ended September 30, 2015, compared to 5.25% for the same period in 2014.
partially offset by:
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Net income for the nine months ended September 30, 2015 amounted to $228.1 million, compared to $198.5 million for the same period of the previous year. The principal factors that contributed to the variance in the financial results included the following:
The net interest margin was 4.89% for the nine months ended September 30, 2015, compared to 5.42% for the same period in 2014;
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The positive variances in non-interest income detailed above were partially offset by:
Partially offset by:
For the quarter ended September 30, 2015, the reportable segment of Banco Popular North America reported net income from continuing operations of $21.5 million, compared to a net loss of $11.4 million for the same quarter of the previous year. The principal factors that contributed to the variance in the financial results included the following:
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Net income from continuing operations for the nine months ended September 30, 2015 amounted to $585.7 million, compared to a net loss of $60.6 million for the same period of the previous year, largely due to the partial reversal of the valuation allowance of the deferred tax asset of $544.9 million. Other factors that contributed to the variance in the financial results included the following:
The BPNA reportable segment net interest margin was 3.93% for the nine months ended September 30, 2015, compared with 2.83% for the same period in 2014. Excluding the $20.7 million interest expense recorded in 2014 when refinancing the structured repos, the adjusted net interest margin was 3.29% for the nine months ended September 30, 2014.
FINANCIAL CONDITION ANALYSIS
The Corporation’s total assets were $35.5 billion at September 30, 2015 compared to $33.1 billion at December 31, 2014. Refer to the consolidated financial statements included in this report for the Corporation’s consolidated statements of financial condition as of such dates.
Money market investments, trading and investment securities
Money market investments totaled $2.4 billion at September 30, 2015, compared to $1.8 billion at December 31, 2014. The increase was mainly at BPPR by $356 million and at BPNA by $249 million.
Trading account securities amounted to $138 million at September 30, 2015, compared to $139 million at December 31, 2014. Refer to the Market Risk section of this MD&A for a table that provides a breakdown of the trading portfolio by security type.
Investment securities available-for-sale and held-to-maturity amounted to $5.6 billion at September 30, 2015, compared with $5.4 billion at December 31, 2014. Excluding the balance as of September 30, 2015 of $132 million in mortgage backed securities acquired as part of the Doral Bank Transaction, investment securities available-for-sale and held-to-maturity increased by $51 million.
Table 10 provides a breakdown of the Corporation’s portfolio of investment securities available-for-sale (“AFS”) and held-to-maturity (“HTM”) on a combined basis. Also, Notes 9 and 10 to the consolidated financial statements provide additional information with respect to the Corporation’s investment securities AFS and HTM. The portfolio of obligations of the Puerto Rico Government is
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mainly comprised of securities with specific sources of income or revenues identified for repayments. Based on the fiscal and economic situation in Puerto Rico, together with the government’s announcements regarding its ability to pay its debt, the Corporation determined during the second quarter of 2015 that certain PR Government securities with an amortized cost of approximately $41 million and a market value of $27 million have unrealized losses that are other than temporary, and accordingly recorded in earnings OTTI of $14.4 million for the estimated credit loss. These securities, for which an other-than-temporary impairment was recorded, were sold during the third quarter of 2015, resulting in a realized gain of $0.1 million. The proceeds from this sale were $26.8 million.
Table 10 - Breakdown of Investment Securities Available-for-Sale and Held-to-Maturity
Total investment securities AFS and HTM
Refer to Table 11 for a breakdown of the Corporation’s loan portfolio, the principal category of earning assets. Loans covered under the FDIC loss sharing agreements are presented separately in Table 11. The risks on covered loans are significantly different as a result of the loss protection provided by the FDIC. The loss share portion of the loss share agreement applicable to commercial (including construction) and consumer loans expired on June 30, 2015. Accordingly, loans with a carrying amount of $1.5 billion as of June 30, 2015 were reclassified from “covered” to “non-covered” because they are no longer subject to the shared-loss arrangements with the FDIC. As of September 30, 2015, the Corporation’s covered loans portfolio amounted to $665 million, comprised mainly of residential mortgage loans. Refer to Note 11 for detailed information about the Corporation’s loan portfolio composition and loan purchases and sales.
The Corporation’s total loan portfolio amounted to $23.3 billion at September 30, 2015, compared to $22.1 billion at December 31, 2014. Excluding the balance at September 30, 2015 of $1.5 billion in loans acquired as part of the Doral Bank Transaction, the total loan portfolio decreased by $282 million mainly in the covered loans portfolio. Excluding the reclassification of $1.5 billion to the non-covered category, the covered loans portfolio decreased by $362 million mostly due to the continuation of loan resolutions and the normal portfolio run-off. This decrease was partially offset by an increase in the non-covered loans portfolio of $80 million, excluding the impact of the Doral Bank Transaction, mainly from the commercial loans portfolio at BPNA.
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Table 11 - Loans Ending Balances
Loans not covered under FDIC loss sharing agreements:
Legacy[1]
Lease financing
Total non-covered loans held-in-portfolio
Loans covered under FDIC loss sharing agreements:
Loans held-for-sale:
The non-covered loans held-in-portfolio increased by $3.1 billion to $22.5 billion at September 30, 2015. Excluding the balance at September 30, 2015 of $1.5 billion loans acquired as part of the Doral Bank Transaction and the previously mentioned reclassification to non-covered loans of $1.5 billion, non-covered loans held-in-portfolio increased by $80 million, mainly due to commercial loans at BPNA.
The loans held-for-sale portfolio reflected an increase of $65 million from December 31, 2014 to September 30, 2015, mostly due to the reclassification during the second quarter of a $45 million public sector credit of BPPR public sector net of the related write-down of $30 million, for which the sale was subject, among other conditions, to the approval of the syndicate’s agent bank. The sale agreement was terminated on July 29, 2015 pursuant to its terms after the parties were not able to obtain the approval of the agent bank on terms acceptable to the assignee. However, at September 30, 2015, the loan remains classified as held-for-sale as the Corporation maintains its ability and its intent to sell the loan. Also contributing to the increase were originations of mortgage loans held-for-sale by branches acquired as part of the Doral Bank Transaction.
The covered loans portfolio amounted to $665 million at September 30, 2015, compared to $2.5 billion at December 31, 2014. Excluding the previously mentioned reclassification of $1.5 billion loans from covered to non-covered, covered loans decreased by $362 million due to loan resolutions and the normal portfolio run-off. Refer to Table 11 for a breakdown of the covered loans by major loan type categories.
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Tables 12 and 13 provide the activity in the carrying amount and outstanding discount on the Westernbank loans accounted for under ASC 310-30. The outstanding accretable discount is impacted by increases in cash flow expectations on the loan pool based on quarterly revisions of the portfolio. The increase in the accretable discount is recognized as interest income using the effective yield method over the estimated life of each applicable loan pool.
Table 12 - Activity in the Carrying Amount of Westernbank Loans Accounted for Under ASC 310-30
Collections / charge-offs
Allowance for loan losses (ALLL)
Table 13 - Activity in the Accretable Yield on Westernbank Loans Accounted for Under ASC 310-30
Accretion [1]
[1] Positive to earnings, which is included in interest income.
Table 14 sets forth the activity in the FDIC loss share asset for the quarters and nine months ended September 30, 2015 and 2014.
Table 14 – Activity of Loss Share Asset
The FDIC loss share indemnification asset is recognized on the same basis as the assets subject to the loss share protection from the FDIC, except that the amortization / accretion terms differ. Decreases in expected reimbursements from the FDIC due to improvements in expected cash flows to be received from borrowers, as compared with the initial estimates, are recognized as a reduction to non-interest income prospectively over the life of the loss share agreements. This is because the indemnification asset balance is being reduced to the expected reimbursement amount from the FDIC. Table 15 presents the activity associated with the outstanding balance of the FDIC loss share asset amortization (or negative discount) for the periods presented.
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Table 15 - Activity in the Remaining FDIC Loss-Share Asset Discount
Balance at beginning of period[1]
Amortization of negative discount[2]
Impact of lower projected losses
The Corporation revises its expected cash flows and estimated credit losses on a quarterly basis. The lowered loss estimates requires the Corporation to amortize the loss share asset to its currently lower expected collectible balance, thus resulting in negative accretion. Due to the shorter life of the indemnity asset compared with the expected life of the covered loans, this negative accretion temporarily offsets the benefit of higher cash flows accounted through the accretable yield on the loans.
Other real estate owned represents real estate property received in satisfaction of debt. At September 30, 2015, OREO decreased to $192 million from $266 million at December 31, 2014 mainly driven by higher sales, which include a bulk sale of covered commercial properties during the second quarter of 2015 of $37 million. Refer to Table 16 for the activity in other real estate owned. The amounts included as “covered other real estate” are subject to the FDIC loss sharing agreements.
Table 16 - Other Real Estate Owned Activity
Transfer to non-covered status
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Table 17 provides a breakdown of the principal categories that comprise the caption of “Other assets” in the consolidated statements of financial condition at September 30, 2015 and December 31, 2014.
Table 17 - Breakdown of Other Assets
Other assets increased by $575 million from December 31, 2014 to September 30, 2015, due largely to the partial reversal during the second quarter of 2015 of the valuation allowance on its deferred tax assets from its U.S. operations for approximately $545 million. Refer to Note 36 to the consolidated financial statements for detailed information on the Corporation’s income taxes.
Goodwill increased by $39 million from December 31, 2014 to September 30, 2015, due to $42 million of goodwill recorded as part of the Doral Bank Transaction, partially offset by a $2 million purchase accounting adjustment recorded at the Corporation’s insurance subsidiary related to the acquisition of an insurance benefits business during the year ended December 31, 2014.
The Corporation’s total liabilities were $30.5 billion at September 30, 2015 compared to $28.8 billion at December 31, 2014. Refer to the consolidated financial statements included in this Form 10-Q for the Corporation’s consolidated statements of financial condition as of such dates.
Deposits and Borrowings
The composition of the Corporation’s financing sources to total assets at September 30, 2015 and December 31, 2014 is included in Table 18.
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Table 18 - Financing to Total Assets
Non-interest bearing deposits
Interest-bearing core deposits
Other interest-bearing deposits
Fed funds purchased and repurchase agreements
The Corporation’s deposits totaled $26.7 billion at September 30, 2015 compared to $24.8 billion at December 31, 2014. Excluding the balance at September 30, 2015 of $1.5 billion in deposits acquired as part of the Doral Bank Transaction, deposits increased by $395 million due to an increase at BPNA of $450 million, partially offset by a decrease at BPPR of $56 million driven by decreases of $508 million in brokered deposits and $359 million in time deposits, partially offset by an increase in demand and savings deposits of $811 million. Refer to Table 19 for a breakdown of the Corporation’s deposits at September 30, 2015 and December 31, 2014.
Table 19 - Deposits Ending Balances
Demand deposits [1]
Savings, NOW and money market deposits (non-brokered)
Savings, NOW and money market deposits (brokered)
Time deposits (non-brokered)
Time deposits (brokered CDs)
The Corporation’s borrowings amounted to $2.8 billion at September 30, 2015, compared to $3.0 billion at December 31, 2014. Refer to Note 20 to the consolidated financial statements for detailed information on the Corporation’s borrowings. Also, refer to the Liquidity section in this MD&A for additional information on the Corporation’s funding sources.
Other liabilities remained relatively flat at $1.0 billion as of September 30, 2015, decreasing by $7 million from December 31, 2014. The decrease is mainly related to decreases of $31 million in deferred tax liabilities and $48 million in accrued expenses, including taxes and interests payable, partially offset by increases of $34 million in the GNMA repurchase option payable, $23 million in securities trades payable, and $16 million in dividends payable related to the common dividends declared in September that were paid on October 7, 2015.
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Stockholders’ Equity
Stockholders’ equity totaled $5.0 billion at September 30, 2015, compared with $4.3 billion at December 31, 2014. The increase resulted from the Corporation’s net income of $757.9 million for the nine months ended September 30, 2015 and a decrease in accumulated other comprehensive loss of $40 million, principally due to higher unrealized gains on securities available-for-sale partially offset by common and preferred dividends declared during the quarter of $15.5 million and $2.8 million. Refer to the consolidated statements of financial condition, comprehensive income and of changes in stockholders’ equity for information on the composition of stockholders’ equity.
REGULATORY CAPITAL
On January 1, 2015, the Corporation, BPPR and BPNA became subject to Basel III capital requirements, including also revised minimum and well capitalized regulatory capital ratios and compliance with the standardized approach for determining risk-weighted assets. As of September 30, 2015, the Corporation continues to exceed the well-capitalized adequacy requirements promulgated by the U.S. federal bank regulatory agencies.
Basel III capital rules require the phase out of non-qualifying Tier 1 capital instruments such as trust preferred securities. At September 30, 2015, the Corporation had $427 million in trust preferred securities outstanding, of which $320 million no longer qualify for Tier 1 capital treatment, but instead qualify for Tier 2 capital treatment. By January 1, 2016, all $427 million of its outstanding trust preferred securities will lose Tier 1 capital treatment, and will be reclassified to Tier 2 capital.
On January 1, 2015, the Corporation, as well as its banking subsidiaries, made the one-time permanent election to exclude the effects on regulatory capital computations of certain accumulated other comprehensive income (loss) (“AOCI”) items as permitted under the Basel III capital rules.
Risk-based capital ratios presented in Table 20, which include common equity tier 1, Tier 1 capital, total capital and leverage capital as of September 30, 2015, are calculated based on the Basel III regulatory transitional guidance related to the measurement of capital, risk-weighted assets and average assets. Capital ratios for December 31, 2014 were calculated based on the then applicable Basel I rules. Common equity tier 1 capital was not formally codified in the federal banking regulations in effect as of December 31, 2014; thus, common equity tier 1 capital presented in the table below as of year-end 2014 is considered a management internally-defined measurement. Since common equity tier 1 capital was not defined by GAAP or, unlike Tier 1 capital, codified in the Basel I federal banking regulations, it was considered a non-GAAP financial measure as of December 31, 2014.
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Table 20 - Capital Adequacy Data
Common equity tier 1 capital:
Common stockholders equity - GAAP basis
AOCI related adjustments due to opt-out election
Goodwill, net of associated deferred tax liability (DTL)
Intangible assets, net of associated DTLs
Deferred tax assets and other deductions
Common equity tier 1 capital
Additional tier 1 capital:
Trust preferred securities subject to phase out of additional tier 1
Other additional tier 1 capital deductions
Additional tier 1 capital
Tier 1 capital
Tier 2 capital:
Trust preferred securities subject to phase in as tier 2
Other inclusions (deductions), net
Tier 2 capital
Total risk-based capital
Minimum total capital requirement to be well capitalized
Excess total capital over minimum well capitalized
Total risk-weighted assets
Total assets for leverage ratio
Risk-based capital ratios:
Rules adopted by the federal banking agencies, as applicable to the Corporation’s banking subsidiaries as of of September 30, 2015, provide that a depository institution will be deemed to be well capitalized under prompt corrective action if it maintains a leverage ratio of at least 5%, a common equity Tier 1 ratio of at least 6.5%, a Tier 1 capital ratio of at least 8% and a total risk-based ratio of at least 10%. Management has determined that as of September 30, 2015, BPPR and BPNA were well-capitalized under the regulatory framework for prompt corrective action.
The regulatory capital ratios except for the common equity tier 1 capital ratio declined despite the increase in regulatory capital mostly because of the increase in risk-weighted assets driven by the Doral Bank acquired assets, the expiration of the commercial loans loss sharing agreement which required a higher risk-weight percentage and to particular assets and off-balance sheet items which are assigned a higher-risk-weight percentage under the Basel III rules, including, for example, certain exposures past due 90 days or more, high volatility commercial real estate loans and unused commitments with an original maturity of one year or less. The increase in the common equity tier 1 capital ratio is mainly due to higher common equity tier I capital driven by the nine months period earnings and to a favorable impact related to the transitional Basel III capital rules applicable to the deferred tax asset capital deduction as compared to the previous Basel I rules, which generally limited the amount allowed as capital for deferred tax assets that were dependable upon future taxable income.
Non-GAAP financial measures
The tangible common equity ratio, tangible assets and tangible book value per common share, which are presented in the table that follows, are non-GAAP measures. Management and many stock analysts use the tangible common equity ratio and tangible book value per common share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking
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organizations with significant amounts of goodwill or other intangible assets, typically stemming from the use of the purchase accounting method of accounting for mergers and acquisitions. Neither tangible common equity nor tangible assets or related measures should be considered in isolation or as a substitute for stockholders’ equity, total assets or any other measure calculated in accordance with generally accepted accounting principles in the United States of America (“GAAP”). Moreover, the manner in which the Corporation calculates its tangible common equity, tangible assets and any other related measures may differ from that of other companies reporting measures with similar names.
Table 21 provides a reconciliation of total stockholders’ equity to tangible common equity and total assets to tangible assets as of September 30, 2015, and December 31, 2014.
Table 21 - Reconciliation of Tangible Common Equity and Tangible Assets
(In thousands, except share or per share information)
Less: Preferred stock
Less: Goodwill
Less: Other intangibles
Total tangible common equity
Total tangible assets
Tangible common equity to tangible assets
Common shares outstanding at end of period
Tangible book value per common share
Contractual Obligations and Commercial Commitments
The Corporation has various financial obligations, including contractual obligations and commercial commitments, which require future cash payments on debt and lease agreements. Also, in the normal course of business, the Corporation enters into contractual arrangements whereby it commits to future purchases of products or services from third parties. Obligations that are legally binding agreements, whereby the Corporation agrees to purchase products or services with a specific minimum quantity defined at a fixed, minimum or variable price over a specified period of time, are defined as purchase obligations.
Purchase obligations include major legal and binding contractual obligations outstanding at September 30, 2015, primarily for services, equipment and real estate construction projects. Services include software licensing and maintenance, facilities maintenance, supplies purchasing, and other goods or services used in the operation of the business. Generally, these contracts are renewable or cancelable at least annually, although in some cases the Corporation has committed to contracts that may extend for several years to secure favorable pricing concessions. Purchase obligations amounted to $176 million at September 30, 2015 of which approximately 39% mature in 2015, 33% in 2016, 13% in 2017 and 15% thereafter.
The Corporation also enters into derivative contracts under which it is required either to receive or pay cash, depending on changes in interest rates. These contracts are carried at fair value on the consolidated statement of financial condition with the fair value representing the net present value of the expected future cash receipts and payments based on market rates of interest as of the statement of condition date. The fair value of the contract changes daily as interest rates change. The Corporation may also be required to post additional collateral on margin calls on the derivatives and repurchase transactions.
Refer to Note 20 for a breakdown of long-term borrowings by maturity.
The Corporation utilizes lending-related financial instruments in the normal course of business to accommodate the financial needs of its customers. The Corporation’s exposure to credit losses in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and commercial letters of credit is represented by the
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contractual notional amount of these instruments. The Corporation uses credit procedures and policies in making those commitments and conditional obligations as it does in extending loans to customers. Since many of the commitments may expire without being drawn upon, the total contractual amounts are not representative of the Corporation’s actual future credit exposure or liquidity requirements for these commitments.
Table 22 presents the contractual amounts related to the Corporation’s off-balance sheet lending and other activities at September 30, 2015.
Table 22 - Off-Balance Sheet Lending and Other Activities
Unfunded investment obligations
At September 30, 2015 and December 31, 2014, the Corporation maintained a reserve of approximately $12 million and $13 million, respectively, for probable losses associated with unfunded loan commitments related to commercial and consumer lines of credit. The estimated reserve is principally based on the expected draws on these facilities using historical trends and the application of the corresponding reserve factors determined under the Corporation’s allowance for loan losses methodology. This reserve for unfunded loan commitments remains separate and distinct from the allowance for loan losses and is reported as part of other liabilities in the consolidated statement of financial condition.
Refer to Note 26 to the consolidated financial statements for additional information on credit commitments and contingencies.
Guarantees associated with loans sold / serviced
At September 30, 2015, the Corporation serviced $1.9 billion in residential mortgage loans subject to lifetime credit recourse provisions, principally loans associated with FNMA and FHLMC residential mortgage loan securitization programs, compared with $2.1 billion at December 31, 2014. The Corporation has not sold any mortgage loan subject to credit recourse since 2010.
In the event of any customer default, pursuant to the credit recourse provided, the Corporation is required to repurchase the loan or reimburse the third party investor for the incurred loss. The maximum potential amount of future payments that the Corporation would be required to make under the recourse arrangements in the event of nonperformance by the borrowers is equivalent to the total outstanding balance of the residential mortgage loans serviced with recourse and interest, if applicable. In the event of nonperformance by the borrower, the Corporation has rights to the underlying collateral securing the mortgage loan. The Corporation suffers losses on these loans when the proceeds from a foreclosure sale of the property underlying a defaulted mortgage loan are less than the outstanding principal balance of the loan plus any uncollected interest advanced and the costs of holding and disposing the related property.
In the case of Puerto Rico, most claims are settled by repurchases of delinquent loans, the majority of which are greater than 90 days past due. The average time period to prepare an initial response to a repurchase request is from 30 to 120 days from the initial written notice depending on the type of repurchase request. Failure by the Corporation to respond to a request for repurchase on a timely basis could result in a deterioration of the seller/servicer relationship and the seller/servicer’s overall standing. In certain instances, investors could require additional collateral to ensure compliance with the servicer’s repurchase obligation or cancel the seller/servicer license and exercise their rights to transfer the servicing to an eligible seller/servicer.
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The following table presents the delinquency status of the residential mortgage loans serviced by the Corporation that are subject to lifetime credit recourse provisions.
Table 23 - Delinquency of Residential Mortgage Loans Subject to Lifetime Credit Recourse
Total portfolio
Days past due:
30 days and over
90 days and over
As a percentage of total portfolio:
30 days past due or more
90 days past due or more
During the quarter and nine months period ended September 30, 2015, the Corporation repurchased approximately $14 million and $44 million, respectively, in unpaid principal balance of mortgage loans subject to the credit recourse provisions, compared with $21 million and $69 million, respectively, for the same periods of 2014. There are no particular loan characteristics, such as loan vintages, loan type, loan-to-value ratio, or other criteria that denote any specific trend or concentration of repurchases on any particular segment. Based on historical repurchase experience, the loan delinquency status is the main factor which causes the repurchase request. Once the loans are repurchased, they are put through the Corporation’s loss mitigation programs.
At September 30, 2015, the Corporation’s liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $57 million, compared with $59 million at December 31, 2014.
The following table presents the changes in the Corporation’s liability for estimated losses related to loans serviced with credit recourse provisions for the quarters and nine months periods ended September 30, 2015 and 2014.
Table 24 – Changes in Liability of Estimated Losses from Credit Recourse Agreements
The provision for credit recourse liability decreased by $13.0 million during the nine months ended September 30, 2015, when compared with the same period in 2014, due to certain enhancements in the estimated losses for credit recourse methodology at BPPR during 2014.
The estimated losses to be absorbed under the credit recourse arrangements are recorded as a liability when the loans are sold or credit recourse is assumed as part of acquired servicing rights and are updated by accruing or reversing expense (categorized in the line item “adjustments (expense) to indemnity reserves on loans sold” in the consolidated statements of operations) throughout the life of the loan, as necessary, when additional relevant information becomes available. The methodology used to estimate the recourse liability is a function of the recourse arrangements given and considers a variety of factors, which include actual defaults and historical loss experience, foreclosure rate, estimated future defaults and the probability that a loan would be delinquent. Statistical methods are used to estimate the recourse liability. Expected loss rates are applied to different loan segmentations. The expected loss, which represents the amount expected to be lost on a given loan, considers the probability of default and loss severity. The probability of default represents the probability that a loan in good standing would become 90 days delinquent within the following twelve-month period. Regression analysis quantifies the relationship between the default event and loan-specific characteristics, including credit scores, loan-to-value ratios and loan aging, among others.
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Servicing agreements relating to the mortgage-backed securities programs of FNMA and GNMA, and to mortgage loans sold or serviced to certain other investors, including FHLMC, require the Corporation to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. At September 30, 2015, the Corporation serviced $20.9 billion in mortgage loans for third-parties, including the loans serviced with credit recourse, compared with $15.6 billion at December 31, 2014. The Corporation generally recovers funds advanced pursuant to these arrangements from the mortgage borrower, from liquidation proceeds when the mortgage loan is foreclosed or, in the case of FHA/VA loans, under the applicable FHA and VA insurance and guarantees programs. However, in the meantime, the Corporation must absorb the cost of the funds it advances during the time the advance is outstanding. The Corporation must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Corporation would not receive any future servicing income with respect to that loan. At September 30, 2015, the outstanding balance of funds advanced by the Corporation under such mortgage loan servicing agreements was approximately $102 million, which includes the impact of approximately $60 million in advances purchased in connection with servicing portfolios acquired, compared with $33 million at September 30, 2014. To the extent the mortgage loans underlying the Corporation’s servicing portfolio experience increased delinquencies, the Corporation would be required to dedicate additional cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.
When the Corporation sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. The Corporation’s mortgage operations in Puerto Rico conform mortgage loans into pools which are exchanged for FNMA and GNMA mortgage-backed securities, which are generally sold to private investors, or are sold directly to FNMA for cash. As required under the government agency programs, quality review procedures are performed by the Corporation to ensure that asset guideline qualifications are met. To the extent the loans do not meet specified characteristics, the Corporation may be required to repurchase such loans or indemnify for losses and bear any subsequent loss related to the loans. During the nine months period ended September 30, 2015, the Corporation repurchased $175 thousand under representation and warranty arrangements. A substantial amount of these loans reinstate to performing status or have mortgage insurance, and thus the ultimate losses on the loans are not deemed significant.
During the quarter ended June 30, 2013, the Corporation established a reserve for certain specific representation and warranties made in connection with BPPR’s sale of non-performing mortgage loans. The purchaser’s sole remedy under the indemnity clause is to seek monetary damages from BPPR, for a maximum of $16.3 million. BPPR recognized a reserve of approximately $3.0 million, representing its best estimate of the loss that would be incurred in connection with this indemnification. BPPR’s obligations under this clause end one year after the closing except with respect to any claim asserted prior to such termination date. At September 30, 2015, the Corporation has a reserve balance of $3.0 million to cover claims received from the purchaser, which are currently being evaluated.
During the quarter ended March 31, 2013, the Corporation established a reserve for certain specific representation and warranties made in connection with BPPR’s sale of commercial and construction loans, and commercial and single family real estate owned. The purchaser’s sole remedy under the indemnity clause is to seek monetary damages from BPPR, for a maximum of $18.0 million. BPPR is not required to repurchase any of the assets. BPPR recognized a reserve of approximately $10.7 million, representing its best estimate of the loss that would be incurred in connection with this indemnification. During the quarter ended March 31, 2015, the Corporation released $3.2 million. In addition, during the quarter ended June 30, 2015, the Corporation and the purchaser agreed to amend the Portfolio Purchase Agreement and a settlement amount of $2.3 million was paid, and $1.8 million of the reserve was released. At September 30, 2015, the Corporation has a reserve balance of $0.1 million to cover pending claims received from the purchaser.
The following table presents the changes in the Corporation’s liability for estimated losses associated with indemnifications and customary representations and warranties related to loans sold by BPPR during the quarters and nine month periods ended September 30, 2015 and 2014.
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Table 25 – Changes in Liability of Estimated Losses from Indemnifications and Customary Representations and Warranties Agreements
In addition, at September 30, 2015, the Corporation has reserves for customary representations and warranties related to loans sold by its U.S. subsidiary E-LOAN prior to 2009. Loans were sold to investors on a servicing released basis subject to certain representations and warranties. Although the risk of loss or default was generally assumed by the investors, the Corporation made certain representations relating to borrower creditworthiness, loan documentation and collateral, which if not correct, may result in requiring the Corporation to repurchase the loans or indemnify investors for any related losses associated with these loans. At September 30, 2015 and December 31, 2014, the Corporation’s reserve for estimated losses from such representation and warranty arrangements amounted to $4 million and $5 million, respectively. E-LOAN is no longer originating and selling loans since the subsidiary ceased these activities in 2008 and most of the outstanding agreements with major counterparties were settled during 2010 and 2011.
MARKET RISK
The financial results and capital levels of the Corporation are constantly exposed to market risk. Market risk represents the risk of loss due to adverse movements in market rates or financial asset prices, which include interest rates, foreign exchange rates, and bond and equity security prices; the failure to meet financial obligations coming due because of the inability to liquidate assets or obtain adequate funding; and the inability to easily unwind or offset specific exposures without significantly lowering prices because of inadequate market depth or market disruptions.
While the Corporation is exposed to various business risks, the risks relating to interest rate risk and liquidity are major risks that can materially impact future results of operations and financial condition due to their complexity and dynamic nature.
The Asset Liability Management Committee (“ALCO”) and the Corporate Finance Group are responsible for planning and executing the Corporation’s market, interest rate risk, funding activities and strategy, and for implementing the policies and procedures approved by the Corporation’s Risk Management Committee. In addition, the Risk Management Group independently monitors and reports adherence with established market and liquidity policies and recommends actions to enhance and strengthen controls surrounding interest, liquidity, and market risks. The ALCO meets mostly on a weekly basis and reviews the Corporation’s current and forecasted asset and liability levels as well as desired pricing strategies and other relevant financial management and interest rate and risks topics. Also, on a monthly basis the ALCO reviews various interest rate risk sensitivity metrics, ratios and portfolio information, including but not limited to, the Corporation’s liquidity positions, projected sources and uses of funds, interest rate risk positions and economic conditions.
Interest rate risk (“IRR”), a component of market risk, is considered by management as a predominant market risk in terms of its potential impact on profitability or market value. Management utilizes various tools to assess IRR, including simulation modeling, static gap analysis, and Economic Value of Equity (“EVE”). The three methodologies complement each other and are used jointly in the evaluation of the Corporation’s IRR. Simulation modeling is prepared for a five year period, which in conjunction with the EVE analysis, provides Management a better view of long term IRR.
Net interest income simulation analysis performed by legal entity and on a consolidated basis is a tool used by the Corporation in estimating the potential change in net interest income resulting from hypothetical changes in interest rates. Sensitivity analysis is calculated using a simulation model which incorporates actual balance sheet figures detailed by maturity and interest yields or costs. It is performed under a static balance sheet assumption, and the Corporation also runs scenarios that incorporate assumptions on balance sheet growth and expected changes in its composition, estimated prepayments in accordance with projected interest rates,
pricing and maturity expectations on new volumes and other non-interest related data. It is a dynamic process, emphasizing future performance under diverse economic conditions.
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Management assesses interest rate risk by comparing various net interest income simulations under different interest rate scenarios that differ in direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For example, the types of rate scenarios processed during the year included economic most likely scenarios, flat rates, yield curve twists, parallel ramps and parallel shocks. Management also performs analyses to isolate and measure basis and prepayment risk exposures.
The asset and liability management group performs validation procedures on various assumptions used as part of the sensitivity analysis as well as validations of results on a monthly basis. In addition, the model and processes used to assess IRR are subject to third-party validations according to the guidelines established in the Model Governance and Validation policy. Due to the importance of critical assumptions in measuring market risk, the risk models incorporate third-party developed data for critical assumptions such as prepayment speeds on mortgage loans and mortgage-backed securities, estimates on the duration of the Corporation’s deposits and interest rate scenarios. These interest rate simulations exclude the impact on loans accounted pursuant to ASC Subtopic 310-30, whose yields are based on management’s current expectation of future cash flows.
The Corporation processes net interest income simulations under interest rate scenarios in which the yield curve is assumed to rise and decline instantaneously by the same amount. The rising rate scenarios considered in these market risk simulations reflect parallel changes of 200 and 400 basis points during the twelve-month period ending September 30, 2016. Under a 200 basis points rising rate scenario, projected net interest income increases by $95 million, while under a 400 basis points rising rate scenario, projected net interest income increases by $194 million. These scenarios were compared against the Corporation’s flat or unchanged interest rates forecast scenario. Simulation analyses are based on many assumptions, including relative levels of market interest rates, interest rate spreads, loan prepayments and deposit decay. Thus, they should not be relied upon as indicative of actual results. Further, the estimates 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 may actually occur in the future.
The Corporation estimates the sensitivity of economic value of equity (“EVE”) to changes in interest rates. EVE is equal to the estimated present value of the Corporation’s assets minus the estimated present value of the liabilities. This sensitivity analysis is a useful tool to measure long-term IRR because it captures the impact of up or down rate changes in expected cash flows, including principal and interest, from all future periods.
EVE sensitivity calculated using interest rate shock scenarios is estimated on a quarterly basis. The shock scenarios consist of a +/- 200 and 400 basis point parallel shocks. Management has defined limits for the increases/decreases in EVE sensitivity resulting from the shock scenarios.
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 or market value that are caused by interest rate volatility. The market value of these derivatives is subject to interest rate fluctuations and counterparty credit risk adjustments which could have a positive or negative effect in the Corporation’s earnings.
The Corporation’s loan and investment portfolios are subject to prepayment risk, which results from the ability of a third-party to repay debt obligations prior to maturity. Prepayment risk also could have a significant impact on the duration of mortgage-backed securities and collateralized mortgage obligations, since prepayments could shorten (or lower prepayments could extend) the weighted average life of these portfolios.
Trading
The Corporation engages in trading activities in the ordinary course of business at its subsidiaries, Banco Popular de Puerto Rico (“BPPR”) and Popular Securities. Popular Securities’ trading activities consist primarily of market-making activities to meet expected customers’ needs related to its retail securities brokerage business and purchases and sales of U.S. Government and government sponsored securities with the objective of realizing gains from expected short-term price movements. BPPR’s trading activities consist primarily of holding U.S. Government sponsored mortgage-backed securities classified as “trading” and hedging the related market risk with “TBA” (to-be-announced) market transactions. The objective is to derive spread income from the portfolio and not to benefit from short-term market movements. In addition, BPPR uses forward contracts or TBAs to hedge its securitization pipeline. Risks related to variations in interest rates and market volatility is hedged with TBAs that have characteristics similar to that of the forecasted security and its conversion timeline.
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At September 30, 2015, the Corporation held trading securities with a fair value of $138 million, representing approximately 0.4% of the Corporation’s total assets, compared with $139 million and 0.4% at December 31, 2014. As shown in Table 26, the trading portfolio consists principally of mortgage-backed securities relating to BPPR’s mortgage activities described above, which at September 30, 2015 were investment grade securities. As of September 30, 2015, the trading portfolio also included $6.8 million in Puerto Rico government obligations and shares of Closed-end funds that invest primarily in Puerto Rico government obligations (December 31, 2014 - $9.9 million). Trading instruments are recognized at fair value, with changes resulting from fluctuations in market prices, interest rates or exchange rates reported in current period earnings. The Corporation recognized a net trading account loss of $398 thousand for the quarter ended September 30, 2015 and a trading account gain of $ 740 thousand for the quarter ended September 30, 2014.
Table 26 - Trading Portfolio
Puerto Rico government obligations
Interest-only strips
The Corporation’s trading activities are limited by internal policies. For each of the two subsidiaries, the market risk assumed under trading activities is measured by the 5-day net value-at-risk (“VAR”), with a confidence level of 99%. The VAR measures the maximum estimated loss that may occur over a 5-day holding period, given a 99% probability.
The Corporation’s trading portfolio had a 5-day VAR of approximately $1.4 million for the last week in September 2015. There are numerous assumptions and estimates associated with VAR modeling, and actual results could differ from these assumptions and estimates. Backtesting is performed to compare actual results against maximum estimated losses, in order to evaluate model and assumptions accuracy.
In the opinion of management, the size and composition of the trading portfolio does not represent a significant source of market risk for the Corporation.
FAIR VALUE MEASUREMENT OF FINANCIAL INSTRUMENTS
The Corporation currently measures at fair value on a recurring basis its trading assets, available-for-sale securities, derivatives, mortgage servicing rights and contingent consideration. Occasionally, the Corporation may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, impaired loans held-in-portfolio that are collateral dependent and certain other assets. These nonrecurring fair value adjustments typically result from the application of lower of cost or fair value accounting or write-downs of individual assets.
The Corporation categorizes its assets and liabilities measured at fair value under the three-level hierarchy. The level within the hierarchy is based on whether the inputs to the valuation methodology used for fair value measurement are observable.
Refer to Note 29 to the consolidated financial statements for information on the Corporation’s fair value measurement disclosures required by the applicable accounting standard. At September 30, 2015, approximately $ 5.6 billion, or 96%, of the assets measured at fair value on a recurring basis used market-based or market-derived valuation inputs in their valuation methodology and, therefore, were classified as Level 1 or Level 2. The majority of instruments measured at fair value were classified as Level 2, including U.S. Treasury securities, obligations of U.S. Government sponsored entities, obligations of Puerto Rico, States and political subdivisions, most mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”), and derivative instruments.
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At September 30, 2015, the remaining 4% of assets measured at fair value on a recurring basis were classified as Level 3 since their valuation methodology considered significant unobservable inputs. The financial assets measured as Level 3 included mostly tax-exempt GNMA mortgage-backed securities and mortgage servicing rights (“MSRs”). Additionally, the Corporation reported $162 million of financial assets that were measured at fair value on a nonrecurring basis at September 30, 2015, all of which were classified as Level 3 in the hierarchy.
Broker quotes used for fair value measurements inherently reflect any lack of liquidity in the market since they represent an exit price from the perspective of the market participants. Financial assets that were fair valued using broker quotes amounted to $19 million at September 30, 2015, of which $ 7 million were Level 3 assets and $ 12 million were Level 2 assets. Level 3 assets consisted principally of tax-exempt GNMA mortgage-backed securities. Fair value for these securities was based on an internally-prepared matrix derived from an average of two indicative local broker quotes. The main input used in the matrix pricing was non-binding local broker quotes obtained from limited trade activity. Therefore, these securities were classified as Level 3.
During the quarter and nine months ended September 30, 2015, there were no transfers in and/or out of Level 1, Level 2 and Level 3 for financial instruments measured at fair value on a recurring basis. Refer to the Critical Accounting Policies / Estimates in the 2014 Annual Report for additional information on the accounting guidance and the Corporation’s policies or procedures related to fair value measurements.
Trading Account Securities and Investment Securities Available-for-Sale
The majority of the values for trading account securities and investment securities available-for-sale are obtained from third-party pricing services and are validated with alternate pricing sources when available. Securities not priced by a secondary pricing source are documented and validated internally according to their significance to the Corporation’s financial statements. Management has established materiality thresholds according to the investment class to monitor and investigate material deviations in prices obtained from the primary pricing service provider and the secondary pricing source used as support for the valuation results. During the quarter and nine months ended September 30, 2015, the Corporation did not adjust any prices obtained from pricing service providers or broker dealers.
Inputs are evaluated to ascertain that they consider current market conditions, including the relative liquidity of the market. When a market quote for a specific security is not available, the pricing service provider generally uses observable data to derive an exit price for the instrument, such as benchmark yield curves and trade data for similar products. To the extent trading data is not available, the pricing service provider relies on specific information including dialogue with brokers, buy side clients, credit ratings, spreads to established benchmarks and transactions on similar securities, to draw correlations based on the characteristics of the evaluated instrument. If for any reason the pricing service provider cannot observe data required to feed its model, it discontinues pricing the instrument. During the quarter and nine months ended September 30, 2015, none of the Corporation’s investment securities were subject to pricing discontinuance by the pricing service providers. The pricing methodology and approach of our primary pricing service providers is concluded to be consistent with the fair value measurement guidance.
Furthermore, management assesses the fair value of its portfolio of investment securities at least on a quarterly basis, which includes analyzing changes in fair value that have resulted in losses that may be considered other-than-temporary. Factors considered include, for example, the nature of the investment, severity and duration of possible impairments, industry reports, sector credit ratings, economic environment, creditworthiness of the issuers and any guarantees.
Securities are classified in the fair value hierarchy according to product type, characteristics and market liquidity. At the end of each period, management assesses the valuation hierarchy for each asset or liability measured. The fair value measurement analysis performed by the Corporation includes validation procedures and review of market changes, pricing methodology, assumption and level hierarchy changes, and evaluation of distressed transactions.
At September 30, 2015, the Corporation’s portfolio of trading and investment securities available-for-sale amounted to $ 5.6 billion and represented 96% of the Corporation’s assets measured at fair value on a recurring basis. At September 30, 2015, net unrealized gains on the trading portfolios approximated $3 million and net unrealized gains on available-for-sale investments securities approximated $45 million. Fair values for most of the Corporation’s trading and investment securities available-for-sale were classified as Level 2. Trading and investment securities available-for-sale classified as Level 3, which were the securities that involved the highest degree of judgment, represented less than 1% of the Corporation’s total portfolio of trading and investment securities available-for-sale.
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Mortgage Servicing Rights
Mortgage servicing rights (“MSRs”), which amounted to $ 211 million at September 30, 2015, do not trade in an active, open market with readily observable prices. Fair value is estimated based upon discounted net cash flows calculated from a combination of loan level data and market assumptions. The valuation model combines loans with common characteristics that impact servicing cash flows (e.g. investor, remittance cycle, interest rate, product type, etc.) in order to project net cash flows. Market valuation assumptions include prepayment speeds, discount rate, cost to service, escrow account earnings, and contractual servicing fee income, among other considerations. Prepayment speeds are derived from market data that is more relevant to the U.S. mainland loan portfolios and, thus, are adjusted for the Corporation’s loan characteristics and portfolio behavior since prepayment rates in Puerto Rico have been historically lower. Other assumptions are, in the most part, directly obtained from third-party providers. Disclosure of two of the key economic assumptions used to measure MSRs, which are prepayment speed and discount rate, and a sensitivity analysis to adverse changes to these assumptions, is included in Note 15 to the consolidated financial statements.
Derivatives, such as interest rate swaps and indexed options, are traded in over-the-counter active markets. These derivatives are indexed to an observable interest rate benchmark, such as LIBOR or equity indexes, and are priced using an income approach based on present value and option pricing models using observable inputs. Other derivatives are liquid and have quoted prices, such as forward contracts or “to be announced securities” (“TBAs”). All of these derivatives held by the Corporation were classified as Level 2. Valuations of derivative assets and liabilities reflect the values associated with counterparty risk and nonperformance risk, respectively. The non-performance risk, which measures the Corporation’s own credit risk, is determined using internally-developed models that consider the net realizable value of the collateral posted, remaining term, and the creditworthiness or credit standing of the Corporation. The counterparty risk is also determined using internally-developed models which incorporate the creditworthiness of the entity that bears the risk, net realizable value of the collateral received, and available public data or internally-developed data to determine their probability of default. To manage the level of credit risk, the Corporation employs procedures for credit approvals and credit limits, monitors the counterparties’ credit condition, enters into master netting agreements whenever possible and, when appropriate, requests additional collateral. During the quarter ended September 30, 2015, inclusion of credit risk in the fair value of the derivatives resulted in a net loss of $465.7 thousand recorded in the other operating income and interest expense captions of the consolidated statement of operations, which consisted of a gain of $215.1 thousand from the assessment of the counterparties’ credit risk and a loss of $680.8 thousand resulting from the Corporation’s own credit standing adjustment. During the nine months ended September 30, 2015, inclusion of credit risk in the fair value of the derivatives resulted in a net loss of $614.3 thousand recorded in the other operating income and interest expense captions of the consolidated statement of operations, which consisted of a gain of $272.4 thousand resulting from assessment of the counterparties credit risk and a loss of $886.7 thousand resulting from the Corporation’s own credit standing adjustment.
Loans held-in-portfolio considered impaired under ASC Section 310-10-35 that are collateral dependent
The impairment is based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, size and supply and demand. Deterioration of the housing markets and the economy in general have adversely impacted and continue to affect the market activity related to real estate properties. These collateral dependent impaired loans are classified as Level 3 and are reported as a nonrecurring fair value measurement.
LIQUIDITY
The objective of effective liquidity management is to ensure that the Corporation has sufficient liquidity to meet all of its financial obligations, finance expected future growth and maintain a reasonable safety margin for cash commitments under both normal and stressed market conditions. The Board is responsible for establishing the Corporation’s tolerance for liquidity risk, including approving relevant risk limits and policies. The Board has delegated the monitoring of these risks to the RMC and the ALCO. The management of liquidity risk, on a long-term and day-to-day basis, is the responsibility of the Corporate Treasury Division. The Corporation’s Corporate Treasurer is responsible for implementing the policies and procedures approved by the Board and for monitoring the Corporation’s liquidity position on an ongoing basis. Also, the Corporate Treasury Division coordinates corporate
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wide liquidity management strategies and activities with the reportable segments, oversees policy breaches and manages the escalation process. The Financial and Operational Risk Management Division is responsible for the independent monitoring and reporting of adherence with established policies.
An institution’s liquidity may be pressured if, for example, its credit rating is downgraded, it experiences a sudden and unexpected substantial cash outflow, or some other event causes counterparties to avoid exposure to the institution. Factors that the Corporation does not control, such as the economic outlook, adverse ratings of its principal markets and regulatory changes, could also affect its ability to obtain funding.
Liquidity is managed by the Corporation at the level of the holding companies that own the banking and non-banking subsidiaries. It is also managed at the level of the banking and non-banking subsidiaries. The Corporation has adopted policies and limits to monitor more effectively the Corporation’s liquidity position and that of the banking subsidiaries. Additionally, contingency funding plans are used to model various stress events of different magnitudes and affecting different time horizons that assist management in evaluating the size of the liquidity buffers needed if those stress events occur. However, such models may not predict accurately how the market and customers might react to every event, and are dependent on many assumptions.
During the quarter ended September 30, 2015, the Corporation reinstated the quarterly cash dividend on its outstanding common stock. A cash dividend of $0.15 per share was paid on October 7, 2015 to shareholders of record at the close of business on September 29, 2015. This represents a quarterly payout of approximately $15.5 million.
As discussed in Note 5 - Business Combinations, on February 27, 2015 the Corporation acquired certain assets and all deposits (except brokered deposits) from Doral Bank. This included approximately $ 1.7 billion in loans, approximately $ 173 million in securities available for sale and $ 2.2 billion in deposits.
Deposits, including customer deposits, brokered deposits and public funds deposits, continue to be the most significant source of funds for the Corporation, funding 75% of the Corporation’s total assets at September 30, 2015, and December 31, 2014. The ratio of total ending loans to deposits was 87% at September 30, 2015, compared to 89% at December 31, 2014. In addition to traditional deposits, the Corporation maintains borrowing arrangements. At September 30, 2015, these borrowings consisted primarily of $ 1.1 billion in assets sold under agreement to repurchase, $765 million in advances with the FHLB, $440 million in junior subordinated deferrable interest debentures related to trust preferred securities and $450 million in term notes issued to partially fund the repayment of TARP funds. A detailed description of the Corporation’s borrowings, including their terms, is included in Note 20 to the consolidated financial statements. Also, the consolidated statements of cash flows in the accompanying consolidated financial statements provide information on the Corporation’s cash inflows and outflows.
The following sections provide further information on the Corporation’s major funding activities and needs, as well as the risks involved in these activities. A detailed description of the Corporation’s borrowings and available lines of credit, including its terms, is included in Note 20 to the consolidated financial statements. Also, the consolidated statements of cash flows in the accompanying consolidated financial statements provide information on the Corporation’s cash inflows and outflows.
Banking Subsidiaries
Primary sources of funding for the Corporation’s banking subsidiaries (BPPR and BPNA), or “the banking subsidiaries,” include retail and commercial deposits, brokered deposits, unpledged investment securities, and, to a lesser extent, loan sales. In addition, the Corporation maintains borrowing facilities with the FHLB and at the discount window of the Fed, and has a considerable amount of collateral pledged that can be used to quickly raise funds under these facilities.
The principal uses of funds for the banking subsidiaries include loan originations, investment portfolio purchases, loan purchases and repurchases, repayment of outstanding obligations (including deposits), and operational expenses. Also, the banking subsidiaries assume liquidity risk related to collateral posting requirements for certain activities mainly in connection with contractual commitments, recourse provisions, servicing advances, derivatives, credit card licensing agreements and support to several mutual funds administered by BPPR.
During the quarter ended September 30, 2015, BPPR declared a cash dividend of $17.2 million, a portion of which was used by Popular, Inc. for the payment of the cash dividend on its outstanding common stock made on October 7, 2015, as mentioned above.
Note 39 to the consolidated financial statements provides a consolidating statement of cash flows which includes the Corporation’s banking subsidiaries as part of the “All other subsidiaries and eliminations” column.
The banking subsidiaries maintain sufficient funding capacity to address large increases in funding requirements such as deposit outflows. This capacity is comprised mainly of available liquidity derived from secured funding sources, as well as on-balance sheet
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liquidity in the form of cash balances maintained at the Fed and unused secured lines held at the Fed and FHLB, in addition to liquid unpledged securities. The Corporation has established liquidity guidelines that require the banking subsidiaries to have sufficient liquidity to cover all short-term borrowings and a portion of deposits.
The Corporation’s ability to compete successfully in the marketplace for deposits, excluding brokered deposits, depends on various factors, including pricing, service, convenience and financial stability as reflected by operating results, credit ratings (by nationally recognized credit rating agencies), and importantly, FDIC deposit insurance. Although a downgrade in the credit ratings of the Corporation’s banking subsidiaries may impact their ability to raise retail and commercial deposits or the rate that it is required to pay on such deposits, management does not believe that the impact should be material. Deposits at all of the Corporation’s banking subsidiaries are federally insured (subject to FDIC limits) and this is expected to mitigate the potential effect of a downgrade in the credit ratings.
Deposits are a key source of funding as they tend to be less volatile than institutional borrowings and their cost is less sensitive to changes in market rates. Refer to Table 19 for a breakdown of deposits by major types. Core deposits are generated from a large base of consumer, corporate and institutional customers. Core deposits include all non-interest bearing deposits, savings deposits and certificates of deposit under $100,000, excluding brokered deposits with denominations under $100,000. Core deposits have historically provided the Corporation with a sizable source of relatively stable and low-cost funds. Core deposits totaled $ 21.6 billion, or 81% of total deposits, at September 30, 2015, compared with $20.6 billion, or 83% of total deposits, at December 31, 2014. Core deposits financed 68 % of the Corporation’s earning assets at September 30, 2015, compared with 69% at December 31, 2014.
Certificates of deposit with denominations of $100,000 and over at September 30, 2015 totaled $3.9 billion, or 15% of total deposits (December 31, 2014 - $3.3 billion, or 13% of total deposits). Their distribution by maturity at September 30, 2015 is presented in the table that follows:
Table 27 - Distribution by Maturity of Certificate of Deposits of $100,000 and Over
3 months or less
3 to 6 months
6 to 12 months
Over 12 months
At September 30, 2015 approximately 5 % of the Corporation’s assets were financed by brokered deposits, as compared to 6% at December 31, 2014. The Corporation had $ 1.6 billion in brokered deposits at September 30, 2015, compared with $1.9 billion at December 31, 2014. In the event that any of the Corporation’s banking subsidiaries’ regulatory capital ratios fall below those required by a well-capitalized institution or are subject to capital restrictions by the regulators, that banking subsidiary faces the risk of not being able to raise or maintain brokered deposits and faces limitations on the rate paid on deposits, which may hinder the Corporation’s ability to effectively compete in its retail markets and could affect its deposit raising efforts.
To the extent that the banking subsidiaries are unable to obtain sufficient liquidity through core deposits, the Corporation may meet its liquidity needs through short-term borrowings by pledging securities for borrowings under repurchase agreements, by pledging additional loans and securities through the available secured lending facilities, or by selling liquid assets. These measures are subject to availability of collateral.
The Corporation’s banking subsidiaries have the ability to borrow funds from the FHLB. At September 30, 2015 and December 31, 2014, the banking subsidiaries had credit facilities authorized with the FHLB aggregating to $3.6 billion and $3.7 billion, respectively, based on assets pledged with the FHLB at those dates. Outstanding borrowings under these credit facilities totaled $765 million at September 30, 2015 and $822 million at December 31, 2014. Such advances are collateralized by loans held-in-portfolio, do not have restrictive covenants and do not have any callable features. At September 30, 2015 the credit facilities authorized with the FHLB were collateralized by $ 4.8 billion in loans held-in-portfolio, compared with $4.5 billion at December 31, 2014. Refer to Note 20 to the consolidated financial statements for additional information on the terms of FHLB advances outstanding.
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At September 30, 2015 and December 31, 2014, the Corporation’s borrowing capacity at the Fed’s Discount Window amounted to approximately $1.5 billion and $2.1 billion, respectively, which remained unused as of both dates. This facility is a collateralized source of credit that is highly reliable even under difficult market conditions. The amount available under this borrowing facility is dependent upon the balance of performing loans, securities pledged as collateral and the haircuts assigned to such collateral. At September 30, 2015 and December 31, 2014, this credit facility with the Fed was collateralized by $ 2.7 billion and $4.1 billion, respectively, in loans held-in-portfolio.
At September 30, 2015, management believes that the banking subsidiaries had sufficient current and projected liquidity sources to meet their anticipated cash flow obligations, as well as special needs and off-balance sheet commitments, in the ordinary course of business and have sufficient liquidity resources to address a stress event. Although the banking subsidiaries have historically been able to replace maturing deposits and advances if desired, no assurance can be given that they would be able to replace those funds in the future if the Corporation’s financial condition or general market conditions were to deteriorate. The Corporation’s financial flexibility will be severely constrained if its banking subsidiaries are unable to maintain access to funding or if adequate financing is not available to accommodate future financing needs at acceptable interest rates. The banking subsidiaries also are required to deposit cash or qualifying securities to meet margin requirements. To the extent that the value of securities previously pledged as collateral declines because of market changes, the Corporation will be required to deposit additional cash or securities to meet its margin requirements, thereby adversely affecting its liquidity. Finally, if management is required to rely more heavily on more expensive funding sources to meet its future growth, revenues may not increase proportionately to cover costs. In this case, profitability would be adversely affected.
Westernbank FDIC-assisted Transaction and Impact on Liquidity
The effects of the loss sharing agreements on cash flows and operating results will depend primarily on the ability of the borrowers whose loans are covered by the loss sharing agreements to make payments over time and our ability to receive reimbursements for losses from the FDIC. As the loss sharing agreements are in effect for a period of ten years for one-to-four family loans and five years for commercial, construction and consumer loans (with periods commencing on April 30, 2010), changing economic conditions will likely impact the timing of future charge-offs and the resulting reimbursements from the FDIC. Management believes that any recapture of interest income and recognition of cash flows from the borrowers or received from the FDIC on the claims filed may be recognized unevenly over this period, as management exhausts its collection efforts under the Corporation’s normal practices.
BPPR’s liquidity may also be impacted by the loan payment performance and timing of claims made and receipt of reimbursements under the FDIC loss sharing agreements. Please refer to the Legal Proceedings section of Note 26 to the consolidated financial statements and to Part II, Item 1A- Risk factors herein for a discussion of the settlement of a contractual dispute between BPPR and the FDIC which has impacted the timing of the payment of claims under the loss share agreements.
Bank Holding Companies
The principal sources of funding for the holding companies include cash on hand, investment securities, dividends received from banking and non-banking subsidiaries (subject to regulatory limits and authorizations) asset sales, credit facilities available from affiliate banking subsidiaries and proceeds from potential securities offerings.
The principal use of these funds include the repayment of debt, and interest payments to holders of senior debt and junior subordinated deferrable interest (related to trust preferred securities) and capitalizing its banking subsidiaries.
During the nine months ended September 30, 2015, PIHC received $17.1 million in dividends from BPPR and $ 3.5 million in dividends from EVERTEC’s parent company. PIHC also received $9.3 million in dividends from its investment in BHD and $5.0 million in dividends from its non-banking subsidiaries.
Another use of liquidity at the parent holding company is the payment of dividends on its outstanding stock. During the quarter ended September 30, 2015, the Corporation reinstated the quarterly cash dividend on its outstanding common stock. A cash dividend of $0.15 per share was paid on October 7, 2015 to shareholders of record at the close of business on September 29, 2015. This represents a quarterly payout of approximately $15.5 million. The dividends for the Corporation’s Series A and Series B preferred stock amounted to $2.8 million for the nine months ended September 30, 2015. The preferred stock dividends paid were financed by issuing new shares of common stock to the participants of the Corporation’s qualified employee savings plans. The Corporation anticipates that any future preferred stock dividend payments would continue to be financed with the issuance of new common stock in connection with its qualified employee savings plans.
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The BHC’s have in the past borrowed in the money markets and in the corporate debt market primarily to finance their non-banking subsidiaries, however, the cash needs of the Corporation’s non-banking subsidiaries other than to repay indebtedness and interest are now minimal. These sources of funding have become more costly due to the reductions in the Corporation’s credit ratings. The Corporation’s principal credit ratings are below “investment grade” which affects the Corporation’s ability to raise funds in the capital markets. The Corporation has an automatic shelf registration statement filed and effective with the Securities and Exchange Commission, which permits the Corporation to issue an unspecified amount of debt or equity securities.
Note 39 to the consolidated financial statements provides a statement of condition, of operations and of cash flows for the two BHC’s. The loans held-in-portfolio in such financial statements is principally associated with intercompany transactions.
The outstanding balance of notes payable at the BHC’s amounted to $890 million at September 30, 2015 and December 31, 2014. The repayment of the BHC’s obligations represents a potential cash need which is expected to be met with a combination of internal liquidity resources stemming mainly from future dividend receipts and new borrowings.
The contractual maturities of the BHC’s notes payable at September 30, 2015 are presented in Table 28.
Table 28 - Distribution of BHC’s Notes Payable by Contractual Maturity
As indicated previously, the BHC did not issue new registered debt in the capital markets during the quarter ended September 30, 2015.
The BHCs liquidity position continues to be adequate with sufficient cash on hand, investments and other sources of liquidity which are expected to be enough to meet all BHCs obligations during the foreseeable future.
Non-banking subsidiaries
The principal sources of funding for the non-banking subsidiaries include internally generated cash flows from operations, loan sales, repurchase agreements, and borrowed funds from their direct parent companies or the holding companies. The principal uses of funds for the non-banking subsidiaries include repayment of maturing debt, operational expenses and payment of dividends to the BHCs. The liquidity needs of the non-banking subsidiaries are minimal since most of them are funded internally from operating cash flows or from intercompany borrowings from their holding companies, BPPR or BPNA.
Other Funding Sources and Capital
The investment securities portfolio provides an additional source of liquidity, which may be realized through either securities sales or repurchase agreements. The Corporation’s investment securities portfolio consists primarily of liquid U.S. government investment securities, sponsored U.S. agency securities, government sponsored mortgage-backed securities, and collateralized mortgage obligations that can be used to raise funds in the repo markets. The availability of the repurchase agreement would be subject to having sufficient unpledged collateral available at the time the transactions are to be consummated, in addition to overall liquidity and risk appetite of the various counterparties. The Corporation’s unpledged investment and trading securities, excluding other investment securities, amounted to $ 2.2 billion at September 30, 2015 and $2.7 billion at December 31, 2014. A substantial portion of these securities could be used to raise financing quickly in the U.S. money markets or from secured lending sources.
Additional liquidity may be provided through loan maturities, prepayments and sales. The loan portfolio can also be used to obtain funding in the capital markets. In particular, mortgage loans and some types of consumer loans, have secondary markets which the Corporation could use.
Risks to Liquidity
Total lines of credit outstanding are not necessarily a measure of the total credit available on a continuing basis. Some of these lines could be subject to collateral requirements, standards of creditworthiness, leverage ratios and other regulatory requirements, among other factors. Derivatives, such as those embedded in long-term repurchase transactions or interest rate swaps, and off-balance sheet exposures, such as recourse, performance bonds or credit card arrangements, are subject to collateral requirements. As their fair value increases, the collateral requirements may increase, thereby reducing the balance of unpledged securities.
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The importance of the Puerto Rico market for the Corporation is an additional risk factor that could affect its financing activities. In the case of a deterioration in economic conditions in Puerto Rico, the credit quality of the Corporation could be affected and result in higher credit costs. The Puerto Rico economy continues to face various challenges, including significant pressures in some sectors of the residential real estate market. Refer to the Geographic and Government Risk section of this MD&A for some highlights on the current status of the Puerto Rico economy.
Factors that the Corporation does not control, such as the economic outlook and credit ratings of its principal markets and regulatory changes, could also affect its ability to obtain funding. In order to prepare for the possibility of such scenario, management has adopted contingency plans for raising financing under stress scenarios when important sources of funds that are usually fully available are temporarily unavailable. These plans call for using alternate funding mechanisms, such as the pledging of certain asset classes and accessing secured credit lines and loan facilities put in place with the FHLB and the Fed.
The credit ratings of Popular’s debt obligations are a relevant factor for liquidity because they impact the Corporation’s ability to borrow in the capital markets, its cost and access to funding sources. Credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and the Corporation’s ability to access a broad array of wholesale funding sources, among other factors.
The Corporation’s banking subsidiaries have historically not used unsecured capital market borrowings to finance its operations, and therefore are less sensitive to the level and changes in the Corporation’s overall credit ratings. At the BHCs, the volume of capital market borrowings has declined substantially, as the non-banking lending businesses that it had historically funded have been shut down and the need to raise unsecured senior debt has been substantially reduced.
Obligations Subject to Rating Triggers or Collateral Requirements
The Corporation’s banking subsidiaries currently do not use borrowings that are rated by the major rating agencies, as these banking subsidiaries are funded primarily with deposits and secured borrowings. The banking subsidiaries had $20 million in deposits at September 30, 2015 that are subject to rating triggers.
Some of the Corporation’s derivative instruments include financial covenants tied to the bank’s well-capitalized status and certain formal regulatory actions. These agreements could require exposure collateralization, early termination or both. The fair value of derivative instruments in a liability position subject to financial covenants approximated $6 million at September 30, 2015, with the Corporation providing collateral totaling $10 million to cover the net liability position with counterparties on these derivative instruments.
In addition, certain mortgage servicing and custodial agreements that BPPR has with third parties include rating covenants. In the event of a credit rating downgrade, the third parties have the right to require the institution to engage a substitute cash custodian for escrow deposits and/or increase collateral levels securing the recourse obligations. Also, as discussed in the Guarantees section of this MD&A, the Corporation services residential mortgage loans subject to credit recourse provisions. Certain contractual agreements require the Corporation to post collateral to secure such recourse obligations if the institution’s required credit ratings are not maintained. Collateral pledged by the Corporation to secure recourse obligations amounted to approximately $75 million at September 30, 2015. The Corporation could be required to post additional collateral under the agreements. Management expects that it would be able to meet additional collateral requirements if and when needed. The requirements to post collateral under certain agreements or the loss of escrow deposits could reduce the Corporation’s liquidity resources and impact its operating results.
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CREDIT RISK MANAGEMENT AND LOAN QUALITY
Non-Performing Assets
Non-performing assets include primarily past-due loans that are no longer accruing interest, renegotiated loans, and real estate property acquired through foreclosure. A summary, including certain credit quality metrics, is presented in Table 29.
The Corporation’s non-accruing and charge-off policies by major categories of loan portfolios are as follows:
On June 30, 2015, the shared-loss arrangement under the commercial loss share agreement with the FDIC related to the loans acquired from Westernbank as part of the FDIC assisted transaction in 2010 expired. Accordingly, loans and OREO’s with balances of $1.5 billion in loans and $18 million, respectively, as of June 30, 2015, were reclassified as “non-covered” in the accompanying statement of financial condition as of June 30, 2015, because they are no longer subject to the shared-loss payments by the FDIC.
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However, included in these balances were approximately $248.7 million of loans that are subject to the resolution of several arbitration proceedings currently ongoing with the FDIC. Loans and OREO’s that remain covered under the terms of the single-family loss share agreement continue to be presented as covered assets in the accompanying tables and credit metrics as of September 30, 2015.
Because of the application of ASC Subtopic 310-30 to the Westernbank acquired loans and the loss protection provided by the FDIC which limits the risks on the covered loans, the Corporation has determined to provide certain quality metrics in this MD&A that exclude such covered loans to facilitate the comparison between loan portfolios and across periods. Given the amount of covered loans that are past due but still accruing due to the accounting under ASC Subtopic 310-30, the Corporation believes the inclusion of these loans in certain asset quality ratios in the numerator or denominator (or both) would result in a distortion to these ratios. In addition, because charge-offs related to the acquired loans are recorded against the non-accretable balance, the net charge-off ratio including the acquired loans is lower for the single-family loan portfolios that which includes covered loans. The inclusion of these loans in the asset quality ratios could result in a lack of comparability across periods, and could negatively impact comparability with other portfolios that were not impacted by acquisition accounting. The Corporation believes that the presentation of asset quality measures, excluding covered loans and related amounts from both the numerator and denominator, provides a better perspective into underlying trends related to the quality of its loan portfolio.
Despite challenging economic and fiscal conditions that persist in Puerto Rico, overall assets quality for non-covered loans remained stable in the third quarter of 2015, with moderate quarter-to-quarter volatility in certain credit metrics mostly associated with a small number of larger commercial loans in BPPR. Consistent with prior periods, credit trends for the US portfolios continued to show stability during the third quarter of 2015.
Table 29 - Non-Performing Assets
Total non-performing loans held-in- portfolio, excluding covered loans
Non-performing loans held-for-sale [2]
Other real estate owned (“OREO”), excluding covered OREO
Total non-performing assets, excluding covered assets
Covered loans and OREO [3]
Total non-performing assets
Accruing loans past due 90 days or more[5] [6]
Ratios excluding covered loans:[7]
Non-performing loans held-in-portfolio to loans held-in-portfolio
Allowance for loan losses to loans held-in-portfolio
Allowance for loan losses to non-performing loans, excluding held-for-sale
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Ratios including covered loans:
Non-performing assets to total assets
HIP = “held-in-portfolio”
Total non-performing assets, including covered, were $878 million at September 30, 2015, decreasing by $55 million, or 6%, from December 31, 2014, of which $74 million were related to OREO reductions. During the second quarter of 2015, the Corporation completed a bulk sale of covered OREO’s with a book value of $37 million.
Table 30 - Activity in Non-Performing Loans Held-in-Portfolio (Excluding Consumer and Covered Loans)
Plus:
New non-performing loans
Advances on existing non-performing loans
Reclass from covered loans
Less:
Non-performing loans transferred to OREO
Non-performing loans charged-off
Loans returned to accrual status / loan collections
Loans transferred to held-for-sale
Other transfers out of non-performing
Ending balance NPLs
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Table 31 - Activity in Non-Performing Loans Held-in-Portfolio (Excluding Consumer and Covered Loans)
Non-performing loans from discontinued operations
Reclassification to consumer loans
For the quarter ended September 30, 2015, total non-performing loan inflows, excluding consumer loans, increased by $74 million, or 58%, when compared to the inflows for the same quarter in 2014. Inflows of non-performing loans held-in-portfolio at the BPPR segment increased by $67 million, or 56%, compared to the inflows for the third quarter of 2014, mostly related to higher commercial inflows of $68 million in the BPPR segment. Refer to Table 32 for a summary of the activity in the allowance for loan losses and selected loan losses statistics for the quarters ended September 30, 2015 and 2014.
At September 30, 2015, non-performing loans secured by real estate held-in-portfolio, excluding covered loans, amounted to $535 million in the Puerto Rico operations and $21 million in the U.S. mainland operations. These figures compare to $482 million in the Puerto Rico operations and $35 million in the U.S. mainland operations at December 31, 2014. In addition to the non-performing loans included in Table 29, at September 30, 2015, there were $160 million of non-covered performing loans, mostly commercial loans, which in management’s opinion, are currently subject to potential future classification as non-performing and are considered impaired, compared with $146 million at December 31, 2014.
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Table 32 - Allowance for Loan Losses and Selected Loan Losses Statistics - Quarterly Activity
Provision for loan losses - Continuing operations
Charged-offs:
Recoveries:
Net loans charged-offs (recovered):
Net write-downs[2]
Ratios:
Annualized net charge-offs to average loans held-in-portfolio[3]
Provision for loan losses to net charge-offs[3]
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Refer to Table 33 for a summary of the activity in the allowance for loan losses and selected loan losses statistics for the nine months ended September 30, 2015 and 2014.
Table 33 - Allowance for Loan Losses and Selected Loan Losses Statistics - Year-to-date Activity
Provision for loan losses - Discontinued operations
Discontinued operations
Net loans charged-off (recovered):
Allowance transferred from covered to non-covered loans [2]
Net write-downs [3]
Annualized net charge-offs to average loans held-in-portfolio[4]
Provision for loan losses to net charge-offs[4]
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Refer to the “Allowance for Loan Losses” subsection in this MD&A for tables detailing the composition of the allowance for loan losses between general and specific reserves, and for qualitative information on the main factors driving the variances.
The following table presents annualized net charge-offs to average loans held-in-portfolio (“HIP”) for the non-covered portfolio by loan category for the quarters and nine months ended September 30, 2015 and 2014.
Table 34 - Annualized Net Charge-offs (Recoveries) to Average Loans Held-in-Portfolio (Non-covered loans)
Total annualized net charge-offs to average loans held-in-portfolio
Excluding the net write-down related to the asset sales during the third quarter of 2014.
Average loans held-in-portfolio excludes covered loans acquired in the Westernbank FDIC-assisted transaction which were recorded at fair value on date of acquisition, and thus, considered a credit discount component.
Net charge-offs, excluding covered loans, for the quarter ended September 30, 2015, increased by $5.8 million when compared to the third quarter of 2014, mainly reflective of higher commercial net charge-offs in the BPPR segment, as the third quarter of 2014 included the effect of higher recoveries. The net charge-off ratio for the third quarter includes the impact of loans reclassified from the covered portfolio in the second quarter, as well as Doral Bank’s acquired portfolio in the average loan base.
The discussions in the sections that follow assess credit quality performance for the third quarter of 2015 for most of the Corporation’s non-covered loan portfolios, including $1.5 billion in loans transferred from covered to non-covered status upon the expiration of the shared-loss arrangement under the commercial loss share agreement with the FDIC during the second quarter of 2015.
Commercial loans
Non-covered non-performing commercial loans held-in-portfolio decreased by $21 million, or 8%, from December 31, 2014, largely driven by a $22 million decline in the BPPR segment. During the second quarter, the Corporation agreed to sell a $75 million non-accrual public sector credit at BPPR and accordingly transferred it to held-for-sale. The aggregate write-down on loans transferred to held-for-sale during the second quarter was of approximately $30.5 million, of which $29.0 million was previously reserved. The sale was subject, among other conditions, to the approval of the syndicate’s agent bank. The sale agreement was terminated on July 29, 2015 pursuant to its terms after the parties were not able to obtain the approval of the agent bank on terms acceptable to the assignee. However, at September 30, 2015, the loan remains classified as held-for-sale as the Corporation maintains its ability and intent to sell the loan. This decrease was offset by the addition to non-accrual of a small number of large commercial loans during the third quarter of 2015, the most significant having a carrying value of $49 million.
The percentage of non-performing commercial loans held-in-portfolio to commercial loans held-in-portfolio decreased to 2.36% at September 30, 2015 from 3.20% at December 31, 2014.
Tables 35 and 36 present the changes in the non-performing commercial loans held-in-portfolio for the quarters and nine months ended September 30, 2015 and 2014 for the BPPR (excluding covered loans) and BPNA segments.
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Table 35 - Activity in Non-Performing Commercial Loans Held-in-Portfolio (Excluding Covered Loans)
Table 36 - Activity in Non-Performing Commercial Loans Held-in-Portfolio (Excluding Covered Loans)
Non-performing loans transferred from (to) discontinued operations
Table 37 - Non-Performing Commercial Loans and Net Charge-offs (Excluding Covered Loans)
Non-performing commercial loans
Non-performing commercial loans to commercial loans HIP
Commercial loan net charge-offs (recoveries)
Commercial loan net charge-offs (recoveries) (annualized) to average commercial loans HIP
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For the quarter ended September 30, 2015, inflows of commercial non-performing loans held-in-portfolio at the BPPR segment increased by $68 million , when compared to inflows for the same period in 2014, mostly driven by a small number of commercial loans, the largest being the abovementioned $49 million borrowing relationship. Inflows of commercial non-performing loans held-in-portfolio at the BPNA segment decreased by $2 million, compared to inflows for the same quarter in 2014. The reduction was driven by improvements in the underlying quality of the loan portfolio.
Table 37 provides information on commercial non-performing loans and net charge-offs for the BPPR (excluding the Westernbank covered loan portfolio) and BPNA segments.
There are two commercial loan relationships greater than $10 million in non-accrual status at September 30, 2015 with an outstanding aggregate balance of $61 million, compared with two commercial loan relationships with an outstanding aggregate balance of $88 million at December 31, 2014.
Commercial loan net charge-offs, excluding net charge-offs for covered loans, increased by $7.1 million, when compared to the same period in 2014, primarily the effect of higher recoveries in the third quarter of 2014. This increase was mostly driven by higher net charge-offs in the BPPR segment of $8.2 million for the quarter ended September 30, 2015, when compared with the same period in 2014. For the quarter ended September 30, 2015, the charge-offs associated with collateral dependent impaired commercial loans amounted to approximately $9.5 million at the BPPR segment. The BPNA segment continued to show low levels of charge-offs reflective of improvements in credit quality.
The Corporation’s commercial loan portfolio secured by real estate (“CRE”), excluding covered loans, amounted to $6.5 billion at September 30, 2015, of which $2.1 billion was secured with owner occupied properties, compared with $4.7 billion and $1.7 billion, respectively, at December 31, 2014. CRE non-performing loans, excluding covered loans, amounted to $162 million at September 30, 2015, compared with $129 million at December 31, 2014. The CRE non-performing loans ratios for the BPPR and BPNA segments were 3.34% and 0.05%, respectively, at September 30, 2015, compared with 3.60% and 0.07%, respectively, at December 31, 2014. The decrease in the ratio was primarily due to the impact of approximately $1.3 billion in CRE loans transferred from covered category, of which $7 million are in NPL status.
Construction loans
Non-covered non-performing construction loans held-in-portfolio decreased by $10 million when compared with December 31, 2014, mostly concentrated in the BPPR segment. This decrease was mostly related to loan resolutions. Stable credit trends in the construction portfolio are the result of de-risking strategies executed by the Corporation over the past several years. The ratio of non-performing construction loans to construction loans held-in-portfolio, excluding covered loans, decreased to 0.52% at September 30, 2015 from 5.48% at December 31, 2014. The decrease in the ratio was in part due to the impact of the Doral acquired construction portfolio on the total loan base.
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Tables 38 and 39 present changes in non-performing construction loans held-in-portfolio for the quarters and nine months ended September 30, 2015 and 2014 for the BPPR (excluding covered loans) and BPNA segments.
Table 38 - Activity in Non-Performing Construction Loans Held-in-Portfolio (Excluding Covered Loans)
Table 39 - Activity in Non-Performing Construction Loans Held-in-Portfolio (Excluding Covered Loans)
Construction loan net charge-offs (recoveries), excluding net charge-offs for covered loans, amounted to recoveries of $2.6 million for the quarter ended September 30, 2015, compared to recoveries of $1.3 million for the quarter ended September 30, 2014. For quarter ended September 30, 2015, charge-offs associated with collateral dependent impaired construction loans were $91 thousand in the BPPR segment.
Table 40 provides information on construction non-performing loans and net charge-offs for the BPPR and BPNA (excluding the covered loan portfolio) segments.
Table 40 - Non-Performing Construction Loans and Net Charge-offs (Excluding Covered Loans)
Non-performing construction loans
Non-performing construction loans to construction loans HIP
Construction loan net charge-offs (recoveries)
Construction loan net charge-offs (recoveries) (annualized) to average construction loans HIP
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Mortgage loans
Non-covered non-performing mortgage loans held-in-portfolio increased by $38 million , mainly driven by an increase of $35 million in the BPPR segment, which included the addition in the first quarter of 2015 of $17 million of loans previously guaranteed by Doral Bank under servicing agreement that required Doral to advance principal and interest payments irrespective of borrower delinquencies. The percentage of non-performing mortgage loans held-in-portfolio to mortgage loans held-in-portfolio increased to 4.79% at September 30, 2015 from 4.69% at December 31, 2014.
Tables 41 and 42 present changes in non-performing mortgage loans held-in-portfolio for the BPPR (excluding covered loans) and BPNA segments.
Table 41 - Activity in Non-Performing Mortgage Loans Held-in-Portfolio (Excluding Covered Loans)
Table 42 - Activity in Non-Performing Mortgage loans Held-in-Portfolio (Excluding Covered Loans)
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For the quarter ended September 30, 2015, inflows of mortgage non-performing loans held-in-portfolio at the BPPR segment decreased by $1 million, or 2%, when compared to inflows for the same period in 2014. Inflows of mortgage non-performing loans held-in-portfolio at the BPNA segment increased by $3 million, when compared to inflows for the same period in 2014.
Mortgage loan net charge-offs, excluding net charge-offs for covered loans, increased by $3.0 million when compared with the quarter ended September 30, 2014. Net charge-off activity derived mainly from loans in the BPPR segment. The net charge-offs in the BPNA segment continued at low levels, reflective of the improved risk profile of the portfolio, further strengthened by the sale of certain non-performing and classified assets. For the quarter ended September 30, 2015, charge-offs associated with mortgage loans individually evaluated for impairment amounted to $4.2 million in the BPPR segment.
Table 43 provides information on non-performing mortgage loans and net charge-offs for the BPPR, excluding the covered loan portfolio, and the BPNA segments.
Table 43 - Non-Performing Mortgage Loans and Net Charge-Offs (Excluding Covered Loans)
Non-performing mortgage loans
Non-performing mortgage loans to mortgage loans HIP
Mortgage loan net charge-offs
Mortgage loan net charge-offs (annualized) to average mortgage loans HIP
Consumer loans
Non-covered non-performing consumer loans held-in-portfolio decreased by $6 million when compared to December 31, 2014, primarily as a result of a decrease of $5 million in the BPPR segment, mainly related to personal loans.
For the quarter ended September 30, 2015, the BPPR segment inflows of consumer non-performing loans held-in-portfolio, decreased by $4 million, or 14%, when compared to inflows for the same period of 2014, mostly related to auto loans. Inflows of consumer non-performing loans held-in-portfolio at the BPNA segment amounted to $3 million, a decrease of $2 million, or 36% compared to inflows for 2014.
The Corporation’s consumer net charge-offs remained stable, decreasing by $1.5 million for the third quarter of 2015, when compared with the same period of 2014. For the quarter ended September 30, 2015, charge-offs associated with consumer loans individually evaluated for impairment amounted to $3.6 million in the BPPR segment.
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Table 44 provides information on consumer non-performing loans and net charge-offs by segments.
Table 44 - Non-Performing Consumer Loans and Net Charge-Offs (Excluding Covered Loans)
Non-performing consumer loans
Non-performing consumer loans to consumer loans HIP
Consumer loan net charge-offs
Consumer loan net charge-offs (annualized) to average consumer loans HIP
Troubled debt restructurings
The Corporation’s TDR loans, excluding covered loans, increased by $59 million, or 5%, from December 31, 2014. TDRs in accruing status increased by $79 million from December 31, 2014, due to sustained borrower performance, while non-accruing TDRs decreased by $20 million.
At September 30, 2015, the Corporation’s commercial loan TDRs, excluding covered loans, for BPPR amounted to $289 million of which $125 million were in non-performing status. This compares with $303 million of which $150 million were in non-performing status at December 31, 2014.
At September 30, 2015, the Corporation’s construction loan TDRs, excluding covered loans, for the BPPR segment amounted to $3 million, of which $2 million were in non-performing status. This compares with $6 million, of which $5 million were in non-performing status at December 31, 2014.
At September 30, 2015, the mortgage loan TDRs for the BPPR and BPNA segments amounted to $748 million (including $349 million guaranteed by U.S. sponsored entities) and $5 million, respectively, of which $126 million and $1 million, respectively, were in non-performing status. This compares with $669 million (including $290 million guaranteed by U.S. sponsored entities) and $4 million, respectively, of which $115 million and $987 thousand were in non-performing status at December 31, 2014.
At September 30, 2015, the consumer loan TDRs for the BPPR and BPNA segments amounted to $117 million and $2 million, respectively, of which $14 million and $176 thousand, respectively, were in non-performing status, compared with $120 million and $2 million, respectively, of which $15 million and $35 thousand, respectively, were in non-performing status at December 31, 2014.
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Refer to Note 12 to the consolidated financial statements for additional information on modifications considered troubled debt restructurings, including certain qualitative and quantitative data about troubled debt restructurings performed in the past twelve months.
Allowance for Loan Losses
Non-Covered Loan Portfolio
The allowance for loan losses, which represents management’s estimate of credit losses inherent in the loan portfolio, is maintained at a sufficient level to provide for estimated credit losses on individually evaluated loans as well as estimated credit losses inherent in the remainder of the loan portfolio. The Corporation’s management evaluates the adequacy of the allowance for loan losses on a quarterly basis. In this evaluation, management considers current economic conditions and the resulting impact on Popular Inc.’s loan portfolio, the composition of the portfolio by loan type and risk characteristics, historical loss experience, results of periodic credit reviews of individual loans, regulatory requirements and loan impairment measurement, among other factors.
The Corporation must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown, such as economic developments affecting specific customers, industries or markets. Other factors that can affect management’s estimates are the years of historical data when estimating losses, changes in underwriting standards, financial accounting standards and loan impairment measurements, among others. Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses. Consequently, the business financial condition, liquidity, capital and results of operations could also be affected. Refer to the Critical Accounting Policies / Estimates section of this MD&A for a description of the Corporation’s allowance for loan losses methodology.
The following tables set forth information concerning the composition of the Corporation’s allowance for loan losses (“ALLL”) at September 30, 2015 and December 31, 2014 by loan category and by whether the allowance and related provisions were calculated individually pursuant to the requirements for specific impairment or through a general valuation allowance.
Table 45 - Composition of ALLL
Impaired loans [1]
Specific ALLL to impaired loans [1]
Loans held-in-portfolio, excluding impaired loans [1]
General ALLL to loans held-in-portfolio, excluding impaired loans [1]
Total non-covered loans held-in-portfolio [1]
ALLL to loans held-in-portfolio [1]
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Table 46 - Composition of ALLL
Loans held-in-portfolio, excluding impairedloans [1]
At September 30, 2015, the allowance for loan losses, excluding covered loans, increased by $16 million when compared with December 31, 2014, primarily driven as a result of higher reserves for commercial loans. The ratio of the allowance for loan losses to loans held-in-portfolio decreased to 2.38% of non-covered loans held-in-portfolio at September 30, 2015, compared with 2.68% at December 31, 2014, mostly due to the impact of the Doral Bank portfolio and the loans reclassified from the covered portfolio on the total loan base. The ratio of the allowance to non-performing loans held-in-portfolio was stable at 84.42% at September 30, 2015, compared with 82.43% at December 31, 2014.
At September 30, 2015, the allowance for loan losses for non-covered loans at the BPPR segment totaled $504 million, or 2.83% of non-covered loans held-in-portfolio, compared with $489 million, or 3.07% of non-covered loans held-in-portfolio, at December 31, 2014. The increase in the allowance includes a $37 million allowance related to the Westernbank’s portfolio transferred from covered loans in the second quarter of 2015, offset by a $29 million write-down in connection with the loans transferred to held-for-sale specifically reserved in prior quarters. The ratio of the allowance to non-performing loans held-in-portfolio was 82.73% at September 30, 2015, compared with 80.00% at December 31, 2014.
The allowance for loan losses at the BPNA segment decreased slightly to $32 million, or 0.68% of loans held-in-portfolio, compared with $31 million, or 0.88% of loans held-in-portfolio, at December 31, 2014, driven by strong credit quality. The ratio of the allowance to non-performing loans held-in-portfolio was 125.01% at September 30, 2015, compared with 160.13% at December 31, 2014.
The allowance for loan losses for commercial loans held-in-portfolio, excluding covered loans, increased by $19 million from December 31, 2014. The allowance for loan losses for the commercial loan portfolio in the BPPR segment, excluding the allowance for covered loans, totaled $221 million, or 2.94% of non-covered commercial loans held-in-portfolio, at September 30, 2015, compared with $202 million, or 3.16%, at December 31, 2014. The increase of $19 million includes $29 million related to Westernbank’s non-covered portfolio. The decrease in the allowance to loans ratio was due to the impact of the reclassified covered loans. At the BPNA segment, the allowance for loan losses for the commercial loan portfolio amounted to $9 million at September 30, 2015, decreasing slightly by $1 million when compared to December 31, 2014. The allowance for loan losses for commercial loans held-in-portfolio at the BPNA segment was 0.36% of commercial loans held-in-portfolio, at September 30, 2015, compared with 0.55%, at December 31, 2014. The Corporation’s ratio of allowance to non-performing loans held-in-portfolio in the commercial loan category was 96.27% at September 30, 2015, compared with 81.18% at December 31, 2014.
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The allowance for loan losses for construction loans held-in-portfolio, excluding covered loans, increased by $8 million from December 31, 2014. The allowance for loan losses corresponding to the construction loan portfolio for the BPPR segment, excluding the allowance for covered loans, totaled $12 million, or 10.66% of non-covered construction loans held-in-portfolio, at September 30, 2015, compared with $5 million, or 3.44%, at December 31, 2014. This increase of $7 million includes $6 million related to loans from the Westernbank non-covered loan portfolio that the Corporation has the intent to sell and are subject to the ongoing dispute with the FDIC. At the BPNA segment, the allowance for loan losses of the construction loan portfolio totaled $3 million, or 0.54% of construction loans held-in-portfolio, at September 30, 2015, compared with $1 million, or 1.28%, at December 31, 2014. The Corporation’s ratio of allowance to non-performing loans held-in portfolio in the construction loan category was 409.18% at September 30, 2015, compared with 48.29% at December 31, 2014. Stable allowance levels in the construction portfolio result from the de-risking strategies executed by the Corporation over the past several years.
The allowance for loan losses for mortgage loans held-in-portfolio, excluding covered loans, increased by $11 million from December 31, 2014. The allowance for loan losses corresponding to the mortgage loan portfolio at the BPPR segment totaled $130 million, or 2.09% of mortgage loans held-in-portfolio, excluding covered loans, at September 30, 2015, compared with $121 million, or 2.22%, respectively, at December 31, 2014. The increase was consistent with current credit quality trends, including higher non-performing loans. The decrease in the ratio was due to the impact of Doral bank acquired mortgage loans in the loan base. At the BPNA segment, the allowance for loan losses corresponding to the mortgage loan portfolio increased to $4 million, or 0.47% of mortgage loans held-in-portfolio, at September 30, 2015, compared with $2 million, or 0.23%, at December 31, 2014. Low allowance levels corresponds the sale of certain classified loans, including mortgage TDRs and non-performing loans during 2014.
The allowance for loan losses for the consumer portfolio, excluding covered loans, decreased to $144 million , or 3.77% of that portfolio, at September 30, 2015, compared to $168 million , or 4.35% , at December 31, 2014. The allowance for loan losses of the non-covered consumer loan portfolio in the BPPR segment at $133 million, or 3.94% of that portfolio, at September 30, 2015, compared with $154 million, or 4.55%, at December 31, 2014. At the BPNA segment, the allowance for loan losses of the consumer loan portfolio totaled $12 million, or 2.51% of consumer loans, at September 30, 2015, compared with $14 million, or 2.98%, at December 31, 2014.
Table 47 - Impaired Loans (Non-Covered Loans) and the Related Valuation Allowance
Impaired loans:
No valuation allowance required
Total impaired loans
The following tables set forth the activity in the specific reserves for non-covered impaired loans for the quarters ended September 30, 2015 and 2014.
Provision for impaired loans
Less: Net charge-offs
Specific allowance for loan losses at September 30, 2015
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Less: Transferred to LHFS
Specific allowance for loan losses at September 30, 2014
For the quarter ended September 30, 2015, total net charge-offs for individually evaluated impaired loans amounted to approximately $17.4 million related to the BPPR segment.
The table that follows presents the approximate amount and percentage of non-covered commercial impaired loans for which the Corporation relied on appraisals dated more than one year old for purposes of impairment requirements at September 30, 2015 and December 31, 2014.
Table 50 - Non-Covered Impaired Loans with Appraisals Dated 1 year or Older
At September 30, 2015, the Corporation accounted for $3 million impaired construction loans under the “as is” value. At September 30, 2015, there were no impaired construction loans under the “as developed” value.
Costs to complete are deducted from the subject “as developed” collateral value on impaired construction loans. Impairment determinations are calculated following the collateral dependent method, comparing the outstanding principal balance of the respective impaired construction loan against the expected realizable value of the subject collateral. Realizable values of subject collaterals have been defined as the “as developed” appraised value less costs to complete, costs to sell and discount factors. Costs to complete represent an estimate of the amount of money to be disbursed to complete a particular phase of a construction project. Costs to sell have been determined as a percentage of the subject collateral value, to cover related collateral disposition costs (e.g. legal and commission fees). As discussed previously, discount factors may be applied to the appraised amounts due to age or general market conditions.
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The percentage of the Corporation’s impaired construction loans that were relied upon “as developed” and “as is” for the periods ended September 30, 2015 and December 31, 2014 are presented in Table 51.
Allowance for loan losses– Covered loan portfolio
The Corporation’s allowance for loan losses for the covered loan portfolio acquired in the Westernbank FDIC-assisted transaction amounted to $35 million at September 30, 2015, compared to $82 million at December 31, 2014. As of June 30, 2015, an allowance of $13 million was transferred from covered to non-covered category. This allowance covers the estimated credit loss exposure related to: (i) acquired loans accounted for under ASC Subtopic 310-30, which required an allowance for loan losses of $28 million at September 30, 2015, compared with $79 million at December 31, 2014; and (ii) acquired loans accounted for under ASC Subtopic 310-20, which required an allowance for loan losses of $7 million at September 30, 2015 and $3 million at December 31, 2014.
Decreases in expected cash flows after the acquisition date for loans (pools) accounted for under ASC Subtopic 310-30 are recognized by recording an allowance for loan losses in the current period. For purposes of loans accounted for under ASC Subtopic 310-20 and new loans originated as a result of loan commitments assumed, the Corporation’s assessment of the allowance for loan losses is determined in accordance with the accounting guidance of loss contingencies in ASC Subtopic 450-20 (general reserve for inherent losses) and loan impairment guidance in ASC Section 310-10-35 for loans individually evaluated for impairment. Concurrently, the Corporation records an increase in the FDIC loss share asset for the expected reimbursement from the FDIC under the loss sharing agreements.
Geographic and government risk
The Corporation is exposed to geographic and government risk. The Corporation’s assets and revenue composition by geographical area and by business segment reporting are presented in Note 38 to the consolidated financial statements. A significant portion of our financial activities and credit exposure is concentrated in Puerto Rico, which entered into a recession in the second quarter of 2006. Puerto Rico’s gross national product contracted in real terms in every year between fiscal year 2007 and fiscal year 2011 (inclusive), grew by 0.5% in fiscal year 2012 and decreased by 0.2% and 0.9% in fiscal years 2013 and 2014. The changes in the gross national product in fiscal years 2012, 2013 and 2014 also have to be analyzed in light of the large amount of governmental stimulus and deficit spending in those fiscal years. Although the forecast for fiscal years 2015 and 2016 has not been made public, gross national product for fiscal year 2015 is expected to decrease, based on available monthly economic indicators. The latest Government Development Bank for Puerto Rico (“GDB”) Economic Activity Index, which is a coincident indicator of ongoing economic activity, reflected a 1.6% reduction in the average for fiscal year 2015 (July 2014 to June 2015), compared to the prior fiscal year. For the first three months of fiscal year 2016, the Economic Activity Index remained flat when compared to the same period of the prior fiscal year.
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The Commonwealth of Puerto Rico (the “Commonwealth”) has experienced and continues to experience significant budget deficits, which have been historically covered with bond financings, loans from GDB and extraordinary one-time revenue measures. As a result of the downgrades of the Commonwealth and its instrumentalities’ obligations to below investment grade ratings and recent liquidity constraints at the Commonwealth central government level and GDB, the Commonwealth’s ability to finance future budget deficits is expected to be very limited.
The Government’s most recent estimate of the budget deficit for fiscal year 2015 is approximately $703 million. For fiscal year 2016, the Government recently approved a $9.8 billion budget, which is $235 million higher than the approved budget for fiscal year 2015 due primarily to a significant increase in debt service payments and special pension contributions. In October 2015, however, the Government revised its revenue estimate for fiscal year 2016, to $9.471 billion, which is $329 million lower than budgeted. In order to address this reduction, the Government will have to implement additional revenue raising and expense reduction measures.
The Commonwealth’s public corporations and instrumentalities are also facing financial challenges. On June 28, 2014, Governor Alejandro García Padilla signed into law the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”) which provides a framework for certain public corporations, including the Puerto Rico Electric Power Authority (“PREPA”), the Puerto Rico Aqueduct and Sewer Authority and the Puerto Rico Highways and Transportation Authority, to restructure their debt obligations in order to ensure that the services they provide to the public are not interrupted.
In July 2014, certain holders of PREPA bonds and an investment manager, on behalf of funds which hold PREPA bonds, filed separate lawsuits in the United States District Court for the District of Puerto Rico (the “District Court”) seeking a declaratory judgment that the Recovery Act violates several provisions of the United States Constitution. The District Court consolidated the actions. On February 6, 2015, the District Court issued an opinion and order declaring the Recovery Act unconstitutional and stating that it was preempted by the federal Bankruptcy Code. The District Court permanently enjoined the Commonwealth officers from enforcing the Recovery Act. The Commonwealth filed an expedited appeal before the United States Court of Appeals for the First Circuit and, on July 6, 2015, the Court of Appeals affirmed the lower court’s decision. The Commonwealth has filed a petition for certiorari in the United States Supreme Court, which is currently pending.
In August 2014, PREPA entered into forbearance agreements with certain bondholders, municipal bond insurers, and lenders (including BPPR) pursuant to which the forbearing creditors agreed to forbear from exercising certain rights and remedies under their applicable debt instruments. On November 5, 2015, PREPA announced that it had entered into a restructuring support agreement with certain creditors setting forth the economic terms of a recovery plan. Execution of the transactions set forth in the restructuring support agreement is subject to a number of material conditions, including the enactment of legislation, and there can be no assurance that those conditions will be met. PREPA’s monoline bond insurers are not party to the restructuring support agreement. At September 30, 2015, BPPR’s exposure to PREPA was $45.0 million, as shown in Table 52 below.
On February 11, 2015, the Puerto Rico Resident Commissioner introduced a bill in the U.S. House of Representatives to permit the Government of Puerto Rico to authorize Puerto Rico municipalities and public corporations to restructure their debt obligations under Chapter 9 of the United States Bankruptcy Code. On July 15, 2015, Senator Richard Blumenthal filed a companion bill in the United States Senate. The Commonwealth and GDB have expressed their support for this amendment to the United States Bankruptcy Code. On February 26, 2015, public hearings were held to consider the bill. At this time it is unclear if the bill will be approved and, if it is approved, whether its effects will be retroactive or not.
In response to the continued fiscal and economic challenges, the Government of Puerto Rico engaged a group of former IMF economists to analyze the Commonwealth’s economic and financial stability and growth prospects. The group’s final report, commonly known as the “Krueger Report,” was delivered to the Governor of Puerto Rico on June 28, 2015 and states that Puerto Rico faces an acute crisis in the face of faltering economic activity, fiscal solvency and debt sustainability, and institutional credibility. Some of the report’s principal conclusions are as follows: (i) the economic problems of Puerto Rico are structural, not cyclical, and are not going away without structural reforms, (ii) fiscal deficits are much larger than assumed and are set to deteriorate, (iii) the central government deficits (as measured in the report) over the coming years imply an unsustainable trajectory of large financing gaps, and (iv) Puerto Rico’s public debt cannot be made sustainable without growth, nor can growth occur in the face of structural obstacles and doubts about debt sustainability.
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The report concludes that, even after factoring in a substantial fiscal effort, a large residual financing gap persists into the next decade, implying a need for debt relief. To close the financing gap, the government would need to seek relief from a significant but progressively declining proportion of principal and interest falling due during fiscal years 2016-2024. The report acknowledges that any debt restructuring would be challenging as there is no precedent of this scale and scope, but concludes that, from an economic perspective, the fact remains that the central government faces large financing gaps even with substantial adjustment efforts (as there are limits to how much expenditures can be cut or taxes raised).
On June 29, 2015, the Governor of Puerto Rico issued an Executive Order to create the Puerto Rico Fiscal and Economic Recovery Working Group (the “Working Group”). The Working Group was created to consider the measures necessary, including the measures recommended in the Krueger Report, to address the fiscal crisis of the Commonwealth and to develop and recommend to the Governor of Puerto Rico a fiscal and economic adjustment plan.
On September 9, 2015, the Working Group presented a draft of the Fiscal and Economic Growth Plan (the “FEGP”). The FEGP projects that, absent further corrective action, the Commonwealth’s cumulative financing gap from fiscal years 2016 to 2020 will be approximately $27.8 billion, and that this financing gap could be reduced to approximately $14 billion through a combination of identified revenue increases, expense reduction and economic growth measures. The FEGP concludes that the remaining financing gap would have to be addressed through debt restructuring and that, unless economic growth can be achieved, the Commonwealth’s debt is not sustainable. The FEGP also reflects that, absent emergency measures, Puerto Rico’s Treasury and single cash account will each exhaust their liquidity before the end of the calendar year. The Working Group recommends that the Commonwealth begin working on a voluntary exchange offer to creditors to seek a consensual debt restructuring. The FEGP is publicly available in GDB’s website.
On October 21, 2015, the Obama Administration released a proposal to address Puerto Rico’s urgent fiscal crisis. The proposal states that Puerto Rico is in the midst of an economic and fiscal crisis that requires Congressional action and makes the following recommendations: (i) Congress should extend Chapter 9 of the U.S. Bankruptcy Code to Puerto Rico, and also provide a broader legal framework to allow for a comprehensive restructuring of Puerto Rico’s liabilities, (ii) Congress should provide independent fiscal oversight to ensure Puerto Rico adheres to its recovery plan and fully implements proposed reforms, (iii) Congress should provide a long-term solution to Puerto Rico’s historically inadequate Medicaid treatment, and (iv) Congress should extend to Puerto Rico certain proven measures to reward work and stimulate growth, such as the Earned Income Tax Credit. On October 22, 2015, the United States Senate Committee on Energy and Natural Resources held a hearing on Puerto Rico’s economy, debt and options for Congress. A senior adviser to the U.S. Secretary of the Treasury testified before Congress in support of the Obama Administration proposals.
On August 1, 2015, the Puerto Rico Public Finance Corporation (“PFC”), a subsidiary of GDB, missed substantially all of the debt service payment of $57.9 million due on such date on approximately $1.1 billion of bonds payable solely from Commonwealth legislative appropriations. The Puerto Rico Legislative Assembly had not included in the approved budget for fiscal year 2016 the funds necessary to pay principal and interest on these bonds. The Commonwealth has indicated that the non-appropriation of funds reflects serious liquidity concerns.
The Commonwealth has implemented various measures to deal with the liquidity challenges it faces during fiscal year 2016, besides not appropriating for the payment of PFC bonds mentioned above. Some of these measures include: (i) advances to the Treasury Department from the two largest government retirement systems for the payment by the Treasury Department of retirement benefits to participants (instead of the usual reimbursements for payments made by the Treasury Department on behalf of the retirement systems); (ii) placing $400 million of tax and revenue anticipation notes with certain Commonwealth instrumentalities to fund fiscal year 2016 working capital needs; (iii) suspending during fiscal year 2016 Commonwealth set-asides required by Act No. 39 of May 13, 1976, as amended, for the payment of its general obligation debt; (iv) delaying the payment of third-party payables or amounts due to public corporations; and (v) delaying the payment of income tax refunds. Some of these measures are unsustainable and have significant negative economic effects. Also, since these measures are not sufficient to address the Commonwealth’s liquidity needs, the Commonwealth has indicated it will need to implement additional measures.
On May 29, 2015, the Commonwealth enacted Act No. 72 (“Act 72-2015”), which, inter alia, increased the sales and use tax (“SUT”) rate and provided for a transition to a value added tax (“VAT”) to substitute the central government’s portion of the SUT, subject to certain conditions. Commencing on July 1, 2015, transactions that were subject to the 7% SUT are subject to an 11.5% SUT (10.5% collected by the Treasury Department, of which 0 .5% goes to a special fund for the municipalities, and 1% collected by the municipalities). The SUT will be in effect until March 31, 2016, unless the Secretary of Treasury extends the effectiveness of the SUT for an additional 60 day period.
In addition, from on October 1, 2015 and until March 31, 2016: (i) business-to-business transactions that are currently taxable are subject to an 11.5% SUT, (ii) certain business-to-business services and designated professional services that were previously exempt from SUT are subject to a Commonwealth SUT of 4% (but no municipal SUT will apply to these services), and (iii) specific services are exempt from SUT. After March 31, 2016 (or the extended sunset date provided for the SUT at the discretion of the Secretary of Treasury), all transactions subject to the SUT will be subject to a new VAT of 10.5% plus a 1% municipal SUT.
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The lingering effects of the prolonged recession are still reflected in limited loan demand, an increase in the rate of foreclosures and delinquencies on mortgage loans granted in Puerto Rico. If global or local economic conditions worsen or the Government of Puerto Rico is unable to obtain financing and manage its fiscal crisis, including the restructuring of its debt obligations, in an orderly manner while honoring its debt obligations as they come due, those adverse effects could continue or worsen in ways that we are not able to predict. Any reduction in consumer spending as a result of these issues may also adversely impact our non-interest revenues.
At September 30, 2015, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 635 million, of which approximately $ 579 million is outstanding ($ 1.0 billion and $ 811 million, respectively, at December 31, 2014). Of the amount outstanding, $ 498 million consists of loans and $ 81 million are securities ($ 689 million and $ 122 million, respectively, at December 31, 2014). Of the amount outstanding, $ 82 million represents obligations from the Government of Puerto Rico and public corporations that have a specific source of income or revenues identified for their repayment ($ 336 million at December 31, 2014). Some of these obligations consist of senior and subordinated loans to public corporations that obtain revenues from rates charged for services or products, such as public utilities. Public corporations have varying degrees of independence from the central Government and many receive appropriations or other payments from it. The remaining $ 497 million represents obligations from various municipalities in Puerto Rico for which, in most cases, the good faith, credit and unlimited taxing power of the applicable municipality has been pledged to their repayment ($ 475 million at December 31, 2014). These municipalities are required by law to levy special property taxes in such amounts as shall be required for the payment of all of its general obligation bonds and loans. These loans have seniority to the payment of operating cost and expenses of the municipality. The Corporation performs periodic credit quality reviews on these issuers. Table 52 has a summary of the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities.
Table 52 - Direct Exposure to the Puerto Rico Government
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In addition, at September 30, 2015, the Corporation had $386 million in indirect exposure to loans or securities that are payable by non-governmental entities, but which carry a government guarantee to cover any shortfall in collateral in the event of borrower default ($370 million at December 31, 2014). These included $307 million in residential mortgage loans that are guaranteed by the Puerto Rico Housing Finance Authority (December 31, 2014 - $289 million). These mortgage loans are secured by the underlying properties and the guarantees serve to cover shortfalls in collateral in the event of a borrower default. Also, the Corporation had $50 million in Puerto Rico pass-through housing bonds backed by FNMA, GNMA or residential loans CMO’s, and $29 million of industrial development notes ($49 million and $32 million, respectively, at December 31, 2014).
On October 10, 2014, GDB entered into a note purchase, revolving credit and term loan agreement with a syndicate of banks and other financial institutions providing for the issuance of up to $900 million of GDB short-term senior notes, guaranteed by the Commonwealth, the proceeds of which will be used to fund the purchase of an equal amount of TRANs of the Commonwealth. The TRANs, which also serve as collateral for the GDB notes, provide intra-year financing to the central Government to address timing differences between expected disbursements and receipts of taxes and revenues for fiscal year 2015. The GDB notes and the related Commonwealth’s tax and revenue anticipation notes matured on June 30, 2015 and were paid in full. BPPR participated in this credit facility with an aggregate commitment of $100 million in the term loan and revolving credit facilities.
During the quarter ended June 30, 2015, BPPR agreed to sell to an unaffiliated third party its $75 million loan part of a syndicated fuel line credit facility to PREPA. Accordingly, the loan was reclassified as held-for-sale and a write down of $30 million, of which $29 million was already reserved, was recorded during the second quarter of 2015. The sale was subject, among other conditions, to the approval of the syndicate’s agent bank. The sale agreement was terminated on July 29, 2015 pursuant to its terms after the parties were not able to obtain the approval of the agent bank on terms acceptable to the assignee. However, at September 30, 2015, the loan remains classified as held-for-sale as the Corporation maintains its ability and intent to sell the loan.
As further detailed in Notes 9 and 10 to the consolidated financial statements, a substantial portion of the Corporation’s investment securities represented exposure to the U.S. Government in the form of U.S. Government sponsored entities, as well as agency mortgage-backed and U.S. Treasury securities. In addition, $906 million of residential mortgages and $109 million in commercial loans were insured or guaranteed by the U.S. Government or its agencies at September 30, 2015. The Corporation does not have any exposure to European sovereign debt.
ADOPTION OF NEW ACCOUNTING STANDARDS AND ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS
Refer to Note 3, “New Accounting Pronouncements” to the consolidated financial statements.
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Adjusted results of operations – Non-GAAP Financial Measure
The Corporation prepares its Consolidated Financial Statements using accounting principles generally accepted in the U.S. (“U.S. GAAP”), the (“reported basis”). In addition to analyzing the Corporation’s results on a reported basis, management monitors the performance of the Corporation on an “adjusted basis” and excludes the impact of certain transactions on the results of its operations. Through this MD&A, the Corporations present a discussion of its financial results excluding the impact of these events to arrive at the “adjusted results”. Management believes that the “adjusted basis” provides meaningful information about the underlying performance of the Corporation’s ongoing operations. The “adjusted results” are a Non-GAAP financial measure. Refer to the following tables for a reconciliation of the reported results to the “adjusted results” for the quarters and nine months ended September 30, 2015 and 2014.
Table 53 - Adjusted Consolidated Statement of Operations for the Quarter Ended September 30, 2015 (Non-GAAP)
(Unaudited)
Provision for loan losses – non-covered loans
Provision (reversal) for loan losses – covered loans [1]
Income from continuing operations before income tax
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Table 54 - Adjusted Consolidated Statement of Operations for the Quarter Ended September 30, 2014 (Non-GAAP)
Provision for loan losses – covered loans [1]
227
Table 55 - Adjusted Consolidated Statement of Operations (Non-GAAP) - Comparative Quarters
228
Table 56 - Adjusted Consolidated Statement of Operations for the Nine Months Ended September 30,2015 (Non-GAAP)
229
230
Table 57 - Adjusted Consolidated Statement of Operations for the Nine Months Ended September 30, 2014 (Non-GAAP)
FDIC loss-share income (expense)
(Loss) income from continuing operations before income tax
Net (loss)\income
231
Table 58 - Adjusted Consolidated Statement of Operations (Non-GAAP) - Comparative Nine Months Ended
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Quantitative and qualitative disclosures for the current period can be found in the Market Risk section of this report, which includes changes in market risk exposures from disclosures presented in the Corporation’s 2014 Annual Report.
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 and such information is accumulated and communicated to management, as appropriate, to allow timely decisions regarding required disclosures.
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 quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Part II - Other Information
For a discussion of Legal Proceedings, see Note 26, “Commitments and Contingencies”, to the Consolidated Financial Statements.
In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I - Item 1A - Risk Factors” in our 2014 Annual Report. These factors could materially adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report. Also refer to the discussion in “Part I - Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report for additional information that may supplement or update the discussion of risk factors in our 2014 Annual Report.
There have been no material changes to the risk factors previously disclosed under Item 1A of the Corporation’s 2014 Annual Report, except for the risks described below.
The risks described in our 2014 Annual Report and in this report are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.
RISKS RELATING TO THE BUSINESS ENVIRONMENT AND OUR INDUSTRY
Weakness in the Puerto Rico economy and real estate market, together with the Puerto Rico government’s ongoing fiscal crisis, has adversely impacted and may continue to adversely impact us.
Popular is exposed to geographical and government risk. A significant portion of our financial activities and credit exposure is concentrated in Puerto Rico, which entered into a recession in the second quarter of 2006. Puerto Rico’s gross national product
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contracted in real terms in every year between fiscal year 2007 and fiscal year 2011 (inclusive), grew by 0.5% in fiscal year 2012 and decreased by 0.2% and 0.9% in fiscal years 2013 and 2014. The changes in the gross national product in fiscal years 2012, 2013 and 2014 also have to be analyzed in light of the large amount of governmental stimulus and deficit spending in those fiscal years. Although the forecast for fiscal years 2015 and 2016 has not been made public, gross national product for fiscal year 2015 is expected to decrease, based on available monthly economic indicators. The latest Government Development Bank for Puerto Rico (“GDB”) Economic Activity Index, which is a coincident indicator of ongoing economic activity, reflected a 1.6% reduction in the average for fiscal year 2015 (July 2014 to June 2015), compared to the prior fiscal year. For the first three months of fiscal year 2016, the Economic Activity Index remained flat when compared to the same period of the prior fiscal year.
In August 2014, PREPA entered into forbearance agreements with certain bondholders, municipal bond insurers, and lenders (including BPPR) pursuant to which the forbearing creditors agreed to forbear from exercising certain rights and remedies under their applicable debt instruments. On November 5, 2015, PREPA announced that it had entered into a restructuring support agreement with certain creditors setting forth the economic terms of a recovery plan. Execution of the transactions set forth in the restructuring support agreement is subject to a number of material conditions, including the enactment of legislation, and there can be no assurance that those conditions will be met. PREPA’s monoline bond insurers are not party to the restructuring support agreement. At September 30, 2015, BPPR’s exposure to PREPA was $45.0 million.
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For additional information regarding the Puerto Rico economy, refer to “Geographical and government risk” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Quarterly Report.
RISKS RELATED TO THE FDIC-ASSISTED TRANSACTION
Our ability to obtain reimbursement under the loss sharing agreements on covered assets depends on our compliance with the terms of the loss sharing agreements.
The loss share agreements contain specific terms and conditions regarding the management of the covered assets that BPPR must follow to receive reimbursement on losses from the FDIC. Under the loss share agreements, BPPR must:
Under the loss share agreements, BPPR is also required to maintain books and records sufficient to ensure and document compliance with the terms of the loss share agreements.
Under the terms of the loss share agreements, BPPR is also required to deliver certain certificates regarding compliance with the terms of each of the loss share agreements and the computations required there under. The required terms of the agreements are extensive and failure to comply with any of the guidelines could result in a specific asset or group of assets permanently losing their
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loss sharing coverage. BPPR believes that it has complied with such terms and conditions. The loss share agreement applicable to the commercial late stage real-estate-collateral-dependent loans described below provides for loss sharing by the FDIC through the quarter ending June 30, 2015 and for reimbursement to the FDIC through the quarter ending June 30, 2018.
BPPR’s loss share agreements with the FDIC specify that disputes can be submitted to arbitration before a review board under the commercial arbitration rules of the American Arbitration Association. On July 31, 2013, BPPR filed a statement of claim with the American Arbitration Association requesting that the review board determine certain matters relating to the loss-share claims under its commercial loss share agreement with the FDIC, including that the review board award BPPR the amounts owed under its unpaid quarterly certificates. The statement of claim also included requests for reimbursement of certain valuation adjustments for discounts to appraised values, costs to sell troubled assets and other items. The review board was comprised of one arbitrator appointed by BPPR, one arbitrator appointed by the FDIC and a third arbitrator selected by agreement of those arbitrators.
On October 17, 2014, BPPR and the FDIC settled all claims and counterclaims that had been submitted to the review board. The settlement provides for an agreed valuation methodology for reimbursement of charge-offs for late stage real-estate-collateral-dependent loans and resulting OREO. Although the terms of the settlement could delay the timing of reimbursement of certain loss-share claims from the FDIC, the settlement is not expected to have a material adverse impact on BPPR’s current estimate of expected reimbursable losses for the covered portfolio through the end of the commercial loss share agreement in the quarter ending June 30, 2015.
BPPR disagrees with the FDIC’s characterization of the November and December 2014 portfolio sale proposals and with the FDIC’s interpretation of the commercial loss share agreement provision governing portfolio sales. Accordingly, on March 13, 2015, BPPR delivered to the FDIC a notice of dispute under the commercial loss share agreement. On June 8, 2015, BPPR filed a statement of claim with the American Arbitration Association requesting that a review board resolve the disputes concerning those proposed portfolio sales. On June 15, 2015, BPPR amended its statement of claim to include a claim for the FDIC-R’s refusal to timely concur
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in the third sale proposed in March 2015. On June 29, 2015, the FDIC informed BPPR that it would reimburse the Bank for losses arising from the primary portfolio of the third proposed sale, but only subject to conditions to which BPPR objects. The FDIC also informed BPPR that it would not concur in the secondary portfolio of the third proposed sale or in the fourth proposed sale. On September 4, 2015, BPPR filed a second amended statement of claim concerning the FDIC’s refusal to concur in the third and fourth portfolio sales as proposed by BPPR. The review board in the arbitration concerning the proposed portfolio sales is comprised of one arbitrator appointed by BPPR, one arbitrator appointed by the FDIC and a third arbitrator selected by agreement of those arbitrators. The arbitration hearing is scheduled to be held in the fall of 2016.
Issuer Purchases of Equity Securities
In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan. The Corporation has to date used shares purchased in the market to make grants under the Plan. As of September 30, 2015 the maximum number of shares of common stock that may have been granted under this plan was 3,500,000.
In connection with the Corporation’s participation in the Capital Purchase Program under the Troubled Asset Relief Program, the consent of the U.S. Department of the Treasury will be required for the Corporation to repurchase its common stock other than in connection with benefit plans consistent with past practice and certain other specified circumstances. The Corporation terminated its participation in the Troubled Asset Relief Program, after the repurchase on July 23, 2014, of the outstanding warrants issued to the U.S. Treasury.
The following table sets forth the details of purchases of Common Stock during the quarter ended September 30, 2015 under the 2004 Omnibus Incentive Plan.
Not in thousands
Period
July 1- July 31
August 1- August 31
September 1- September 30
Total September 30, 2015
238
None.
Not applicable.
Item 5. Other Information
239
Exhibit No.
Exhibit Description
240
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.
(Registrant)
/s/ Carlos J. Vázquez
/s/ Jorge J. García
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