UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended September 30, 2017
Commission File Number: 001-34084
POPULAR, INC.
(Exact name of registrant as specified in its charter)
Popular Center Building
209 Muñoz Rivera Avenue
(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. ☒ 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). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒ 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, 102,059,726 shares outstanding as of November 6, 2017.
INDEX
Part I – Financial Information
Item 1. Financial Statements
Unaudited Consolidated Statements of Financial Condition at September 30, 2017 and December 31, 2016
Unaudited Consolidated Statements of Operations for the quarters and nine months ended September 30, 2017 and 2016
Unaudited Consolidated Statements of Comprehensive Income for the quarters and nine months ended September 30, 2017 and 2016
Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2017 and 2016
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016
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
Item 4. Mine Safety Disclosures
Item 5. Other information
Item 6. Exhibits
Signatures
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Forward-Looking Information
This Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 about Popular, Inc.’s (the “Corporation,” “Popular,” “we,” “us,” “our”), including without limitation statements about Popular’s business, financial condition, results of operations, plans, objectives and future performance. These statements are not guarantees of future performance, are based on management’s current expectations and, by their nature, involve risks, uncertainties, estimates and assumptions. Potential factors, some of which are beyond the Corporation’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Risks and uncertainties include without limitation the effect of competitive and economic factors, and our reaction to those factors, 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, the effect of legal proceedings and new accounting standards on the Corporation’s financial condition and results of operations, and the impact of Hurricanes Irma and María on the Corporation. 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.
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:
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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:
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/or juries. Investors should refer to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016 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 Form 10-Q are based upon information available to Popular as of the date of this Form 10-Q 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 or information which speak as of their respective dates.
.
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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 securitiesavailable-for-sale, at fair value:
Other investment securitiesavailable-for-sale
Investment securitiesheld-to-maturity, at amortized cost (fair value 2017 - $74,512; 2016 - $75,576)
Other investment securities, at lower of cost or realizable value (realizable value 2017 - $177,141; 2016 - $170,890)
Loansheld-for-sale, at lower of cost or fair value
Loansheld-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 loansheld-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
Assets sold under agreements to repurchase
Other short-term borrowings
Notes payable
Other liabilities
Total liabilities
Commitments and contingencies (Refer to Note 22)
Stockholders’ equity:
Preferred stock, 30,000,000 shares authorized; 2,006,391shares issued and outstanding
Common stock, $0.01 par value; 170,000,000 shares authorized; 104,197,524 shares issued (2016 - 104,058,684) and 102,026,417 shares outstanding (2016 - 103,790,932)
Surplus
Retained earnings
Treasury stock - at cost, 2,171,107 shares (2016 - 267,752)
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 28)
Mortgage banking activities (Refer to Note 11)
Net gain on sale of investment securities
Other-than-temporary impairment losses on investment securities
Trading account profit (loss)
Net (loss) gain on sale of loans, including valuation adjustments on loans held-for-sale
Adjustments (expense) to indemnity reserves on loans sold
FDIC loss-share expense (Refer to Note 29)
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
Goodwill impairment charge
Total operating expenses
Income before income tax
Income tax (benefit) expense
Net Income
Net Income Applicable to Common Stock
Net Income per Common Share – Basic
Net Income per Common Share – Diluted
Dividends Declared per Common Share
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Net income
Other comprehensive income (loss) before tax:
Foreign currency translation adjustment
Amortization of net losses of pension and postretirement benefit plans
Amortization of prior service credit 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
Total other comprehensive income (loss), net of tax
Comprehensive income, 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, 2015
Issuance of stock
Tax shortfall expense on vesting of restricted stock
Dividends declared:
Common stock
Preferred stock
Common stock purchases
Common stock reissuance
Other comprehensive income, net of tax
Balance at September 30, 2016
Balance at December 31, 2016
Balance at September 30, 2017
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 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 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
Impairment losses on long-lived assets
Other-than-temporary impairment on investment securities
Fair value adjustments on mortgage servicing rights
FDIC loss share expense
Earnings from investments under the equity method
Deferred income tax expense
Loss (gain) on:
Disposition of premises and equipment and other productive assets
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
Acquisitions of loansheld-for-sale
Proceeds from sale of loansheld-for-sale
Net originations on loansheld-for-sale
Net decrease (increase) in:
Trading securities
Net (decrease) increase 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
Other
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
Held-to-maturity
Proceeds from sale of investment securities:
Net disbursements on loans
Proceeds from sale of loans
Acquisition of loan portfolios
Net payments (to) from FDIC under loss sharing agreements
Return of capital from equity method investments
Acquisition of premises and equipment
Proceeds from sale of:
Premises and equipment and other productive assets
Foreclosed assets
Net cash used in investing activities
Cash flows from financing activities:
Net increase (decrease) in:
Federal funds purchased and assets sold under agreements to repurchase
Payments of notes payable
Proceeds from issuance of notes payable
Proceeds from issuance of common stock
Dividends paid
Net payments for repurchase of common stock
Payments related to tax withholding for share-based compensation
Net cash provided by financing activities
Net increase (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 the period
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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, mortgage, 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”). BPNA focuses efforts and resources on the core community banking business. BPNA operates branches in New York, New Jersey and South Florida under the name of Popular Community Bank.
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Note 2 – Hurricanes impact
During September 2017, Hurricanes Irma and Maria (the “hurricanes”), impacted Puerto Rico, the U.S. and British Virgin Islands, causing extensive damage and disrupting the markets in which Banco Popular de Puerto Rico (“BPPR”) does business.
On September 6, 2017, Hurricane Irma made landfall in the USVI and the BVI as a Category 5 hurricane on the Saffir-Simpson scale, causing catastrophic wind and water damage to the islands’ infrastructure, homes and businesses. Hurricane Irma’s winds and resulting flooding also impacted certain municipalities of Puerto Rico, causing the failure of electricity infrastructure in a significant portion of the island. While hurricane Irma also struck Popular’s operations in Florida, neither our operations nor those of our clients in the region were materially impacted.
Two weeks later, on September 20, 2017, Hurricane Maria, made landfall in Puerto Rico as a Category 4 hurricane, causing extensive destruction and flooding throughout Puerto Rico. Following the passage of Hurricane Maria, all Puerto Rico was left without electrical power, other basic utility and infrastructure services (such as water, communications, ports and other transportation networks) were severely curtailed and the government imposed a mandatory curfew. The hurricanes caused a significant disruption to the island’s economic activity. Most business establishments, including retailers and wholesalers, financial institutions, manufacturing facilities and hotels, were closed for several days.
Puerto Rico and the USVI were declared disaster zones by President Trump due to the impact of the hurricanes, thus making them eligible for Federal assistance. Notwithstanding the significant recovery operation that is underway by the Federal, state and local governments, as of the date of this report, most businesses and homes in Puerto Rico and the USVI remain without power, other basic utility and infrastructure remains significantly impacted, and many businesses are partially operating or remain closed. Electronic transactions, a significant source of revenue for the bank, have also declined significantly as a result of the lack of power and telecommunication services. Several reports indicate that the hurricanes have also accelerated the outmigration trends that Puerto Rico was experiencing, with many residents moving to the mainland United States, either on a temporary or permanent basis.
While it is too early to assess and quantify the full extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity, the damages are substantial and have, at least in the short-term, had a material adverse impact on economic activity, as reflected by, among other things, the slowdown in production and sales activity and the reduction in the government’s tax revenues. Employment levels are also expected to decrease at least in the short-term. The speed at which the government is able to restore power and other basic services throughout Puerto Rico, which we are not able to predict, will be a critical variable in determining the extent of the impact on economic activity. Furthermore, the hurricanes severely damaged or destroyed buildings, homes and other structures, impacting the value of such properties, some of which may serve as collateral to our loans. While our collateral is generally insured, the value of such insured structures, as well as other structures unaffected by the hurricanes, may be significantly impacted. Although some of the impact of the hurricanes, including its short-term impact on economic activity, may be offset by recovery and reconstruction activity and the influx of Federal emergency funds and private insurance proceeds, it is too early to know the amount of Federal and private insurance money to be received and whether such transfers will significantly offset the negative economic, fiscal and demographic impact of the hurricanes.
Prior to the hurricanes, the Corporation had implemented its business continuity action program. Although the Corporation’s business critical systems experienced minimal outages as a result of the storms, the Corporation’s physical operations in Puerto Rico, the USVI and the BVI, including its branch and ATM networks, were materially disrupted by the storms mostly due to lack of electricity and communication as well as limited accessibility. Reconstruction of the island’s electric infrastructure and restoration of the telecommunications network remain the most critical challenges for Puerto Rico’s recovery from the hurricanes.
The following summarizes the estimated impact on the Corporation’s earnings for the quarter ended September 30, 2017 as a result of the impact caused by Hurricanes Irma and Maria, net of estimated insurance receivables of $7.5 million. We expect the hurricanes to continue to impact the Corporation’s earnings for the quarter ending December 31, 2017 and future periods.
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Provision for loan losses[1]
Donations
Other sponsorship and promotions expenses
Total business promotion
OREO expenses
Other expenses
Write-down of premises and equipment
Other operating expense
Total other expenses
Total pre-tax hurricane expenses
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Provision for Loan Losses
Damages associated with Hurricanes Irma and Maria impacted certain of the Corporation’s asset quality measures, including higher delinquencies and non-performing loans. Payment channels, collection efforts and loss mitigation operations were interrupted during the last month of the quarter as a result of the hurricanes. An incremental provision expense of $69.9 million was made to the allowance for loan losses based on management’s best estimate of the impact of the hurricanes as of September 30, 2017 on the Corporation’s loan portfolios and the ability of borrowers to repay their loans, taking into consideration currently available information and the already challenging economic environment in Puerto Rico prior to the hurricanes.
Management has initially estimated that the effects of the hurricanes could result in loan losses in the range of $70 to $160 million. However, since the Corporation’s base allowance for loan losses already incorporated reserves for environmental factors such as unemployment and deterioration in economic activity of approximately $57.9 million, management increased the environmental factors reserve by $64.3 million to $122.2 million using the near mid-range as the best estimate. The $69.9 million provision also includes $5.6 million for the portfolio of purchased credit impaired loans, accounted for under ASC 310-30, for which the estimated cash flows were adjusted to reflect a three-month payment moratorium offered to certain eligible borrowers. Since there is significant uncertainty with respect to the full extent of the impact due to the unprecedented nature of Hurricane María, the estimate is judgmental and subject to change as conditions evolve. Management will continue to carefully assess and review the exposure of the portfolios to hurricane-related factors, economic trends and their effect on credit quality and that assessment and review could result in further loan loss provisions in future periods.
Operating Expenses
The results for the quarter include $6.6 million in expenses, net of $7.5 million in insurance receivables, from structural damages caused by the hurricanes to branches, buildings and repossessed properties as a result of the hurricanes. An additional $2.9 million in other operating expenses are reflected for costs such as donations, debris removal, fuel for backup generators and other ancillary costs associated with hurricane recovery efforts.
The Corporation has over 200 branches and office buildings and over 2,000 repossessed properties in the areas affected by the hurricanes. While the Corporation has completed a preliminary estimate of the physical damages to these properties, it has been unable to individually examine each of these properties. As the Corporation continues to evaluate the extent of the damage, additional adjustments may be necessary. However, the Corporation believes that given its level of insurance coverage, the estimated impact of damages to these properties should not vary materially.
Revenue Reduction
In addition to the previously mentioned incremental provision and direct operating expenses, results for the three months ended September 30, 2017 were impacted by the hurricanes in the form of a reduction in revenue resulting from reduced merchant transaction activity, the waiver of certain late fees and service charges, including ATM transaction fees, to businesses and consumers in hurricane-affected areas, as well as the economic and operational disruption in the Corporation’s mortgage origination, servicing and loss mitigation activities due to the hurricanes’ operational and economic impact. The impact on transactional and collection based revenues has continued into the fourth quarter and the amount will depend on the speed at which electricity, telecommunications and general merchant services can be restored across the region.
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Note 3 – 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, 2016 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 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, 2016, included in the Corporation’s 2016 Form 10-K. 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.
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Note 4 – New accounting pronouncements
Recently Issued Accounting Standards Updates
FASB Accounting Standards Update (“ASU”) 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities
The FASB issued ASU 2017-12 in August 2017, which makes more financial and nonfinancial hedging strategies eligible for hedge accounting and changes how companies assess effectiveness by, among other things, eliminating the requirement for entities to recognize hedge ineffectiveness each reporting period for cash flow hedges and requiring presentation of the changes in fair value of cash flow hedges in the same income statement line item(s) as the earnings effect of the hedged items when the hedged item affects earnings.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The amendments in this Update should be applied using a modified retrospective approach as of the adoption date.
The Corporation will be impacted by the simplified application of hedge accounting. The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material effect on its consolidated statements of financial condition and results of operations since hedge ineffectiveness has been immaterial to the Corporation and the earnings effect of the hedges and the hedged items are already presented in the same income statement line item.
FASB Accounting Standards Update (“ASU”) 2017-11, Earnings per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): Part I: Accounting for Certain Financial Instruments with Down Round Features; Part II: Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception
The FASB issued ASU 2017-11 in July 2017, which changes the classification analysis of certain equity-linked financial instruments with down round features. When determining whether these instruments should be classified as liabilities or equity, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. For EPS purposes, the effect of the down round feature should be recognized as a dividend when triggered.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The amendments in this Update may be applied using either a modified retrospective approach or a full retrospective approach.
The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material effect on its consolidated statements of financial condition and results of operations since it does not have any outstanding equity-linked financial instruments with a down round feature.
FASB Accounting Standards Update (“ASU”) 2017-09, Compensation– Stock Compensation (Topic 718): Scope of Modification Accounting
The FASB issued ASU 2017-09 in May 2017, which clarifies that modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date.
The Corporation does not anticipate that the adoption of this accounting pronouncement will have a material effect on its consolidated statements of financial condition and results of operations since it is not customary for the Corporation to modify the terms or conditions of its share-based payment awards.
FASB Accounting Standards Update (“ASU”) 2017-08, Receivables– Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities
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The FASB issued ASU 2017-08 in March 2017, which amends the amortization period for certain callable debt securities held at a premium by shortening such period to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The amendments in this Update should be applied on a modified retrospective basis with a cumulative-effect adjustment to retained earnings as of the beginning of the period 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 and results of operations since the premium of purchased callable debt securities is not significant.
FASB Accounting Standards Update (“ASU”) 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
The FASB issued ASU 2017-07 in March 2017, which requires that an employer disaggregate the service cost component from the other components of net benefit cost. The amendments also provide guidance on how to present the service cost component and the other components of net benefit cost in the income statement and allow only the service cost component of net benefit cost to be eligible for capitalization.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The amendments in this Update should be applied retrospectively for the presentation of the service cost component and other components of net benefit cost and prospectively for the capitalization of the service cost component.
The Corporation does not expect that the limitation to capitalize only the service cost component of the net periodic benefit cost will have a material impact on its consolidated statement of operations. Upon adoption, the Corporation will segregate the presentation of the service cost from the other components of net periodic benefit costs, all which are currently reported within personnel costs in its accompanying consolidated statement of operations.
FASB Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
The Corporation has continued its evaluation and implementation efforts for ASU 2016-13, Financial Instruments – Credit Losses, and has established a cross-discipline governance structure. A Current Expected Credit Losses (“CECL”) Working Group, with members from different areas within the organization, has been created and assigned the responsibility of assessing the impact of the standard, evaluating interpretative issues, evaluating the current credit loss models against the new guidance to determine any changes necessary and other related implementation activities. The Working Group provides periodic updates to the CECL Steering Committee, which has oversight responsibilities for the implementation efforts.
The Corporation plans to adopt ASU 2016-13 on January 1, 2020 using a modified retrospective approach. Although early adoption is permitted beginning in the first quarter of 2019, the Corporation does not expect to make that election. The Corporation expects an increase in its allowance for loan and lease losses due to the consideration of lifetime credit losses as part of the calculation. For additional information on ASU2016-13 and other recently issued Accounting Standards Updates not yet effective, refer to Note 3 to the Consolidated Financial Statements included in the 2016 Form10-K.
FASB Accounting Standards Updates (“ASUs”), Revenue from Contracts with Customers (Topic 606)
The Corporation’s implementation efforts regarding ASU 2014-09, Revenue from Contracts with Customers, have included a scoping analysis of revenue streams and related costs, reviewing the associated contracts, evaluating the timing of when revenues are currently being recognized in light of when the performance obligations are fulfilled and assessing principal vs. agent considerations. The Corporation does not expect material changes in the timing of when revenues are recognized upon the adoption of this standard. Nonetheless, the Corporation continues to evaluate certain costs, including card interchange transactions, to determine if these should be presented on a gross basis or as an offset to the corresponding revenues. Although the Corporation expects changes on the presentation of certain costs related to its brokerage, underwriting and valuation services in its broker-dealer subsidiary, it does not anticipate these changes in presentation to be material to the Corporation’s financial statements. The Corporation will adopt this guidance on January 1, 2018 using the modified retrospective approach.
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Note 5 – 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 $ 1.2 billion at September 30, 2017 (December 31, 2016 - $ 1.2 billion). Cash and due from banks, as well as other highly liquid securities, are used to cover the required average reserve balances.
At September 30, 2017, the Corporation held $38 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, 2016 - $31 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 6 – 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, 2017 and December 31, 2016.
U.S. Treasury securities
Within 1 year
After 1 to 5 years
Total U.S. Treasury securities
Obligations of U.S. Government sponsored entities
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
After 5 to 10 years
After 10 years
Total collateralized mortgage obligations—federal agencies
Mortgage-backed securities
Total mortgage-backed securities
Equity securities (without contractual maturity)
Total other
Total investment securitiesavailable-for-sale[1]
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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 based on 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, 2017, the Corporation sold equity securities and obligations from Puerto Rico government and its political subdivisions with a realized gain of $284 thousand. The proceeds from these sales were $14.9 million. There were no securities sold during the nine months ended September 30, 2016.
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, 2017 and December 31, 2016.
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Total investment securitiesavailable-for-sale in an unrealized loss position
As of September 30, 2017, theavailable-for-sale investment portfolio reflects gross unrealized losses of approximately $85 million, driven by U.S. Treasury Securities, Collateralized Mortgage Obligations, and Mortgage Backed Securities.
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.
During the third quarter of 2017, management performed its quarterly analysis of all debt securities in an unrealized loss position. Based on the analysis performed, management concluded that no individual debt security was other-than-temporarily-impaired as such date. During the quarter ended on June 30, 2017, the Corporation recognized an other-than-temporary impairment charge of $8.3 million on Puerto Rico Sales Tax Financing Corporation (“COFINA”) bonds classified as available-for-sale. These were subsequently sold by the Corporation during the third quarter of 2017, at a gain of approximately $0.1 million.
At September 30, 2017, the Corporation did not have the intent to sell debt securities in an unrealized loss position and it was not more likely than not that the Corporation would have to sell the investments securities prior to recovery of their amortized cost basis.
During the third quarter of 2016, management performed its quarterly analysis of all debt securities in an unrealized loss position. Based on the analysis performed, management concluded that no individual debt security was other-than-temporarily-impaired as such date. During the quarter ended on June 30, 2016 the Corporation recognized an other-temporary-impairment charge of $209 thousand on an investment security available-for-sale classified as obligations from Puerto Rico government and its political subdivisions. The security was sold during the fourth quarter of 2016.
21
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
Freddie Mac
22
Note 7 – 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, 2017 and December 31, 2016.
Collateralized mortgage obligations - federal agencies
Total collateralized mortgage obligations - federal agencies
Total investment securitiesheld-to-maturity[1]
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, 2017 and December 31, 2016.
23
Total investment securitiesheld-to-maturity in an unrealized loss position
As indicated in Note 6 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, 2017 are primarily associated with securities issued by municipalities of Puerto Rico and are generally not rated by a credit rating agency. This includes $49 million of general and special obligation bonds issued by three municipalities of Puerto Rico, which are payable primarily from, and have a lien on, certain property taxes imposed by the issuing municipality. In the case of general obligations, they also benefit from a pledge of the full faith, credit and unlimited taxing power of the issuing municipality and issuing municipalities are required by law to levy property taxes in an amount sufficient for the payment of debt service on such general obligations bonds.
The portfolio also includes approximately $43 million in securities for which the underlying source of payment is not the central government, but in which a government instrumentality provides a guarantee in the event of default. The Corporation performs periodic credit quality reviews on these issuers. Based on the quarterly analysis performed, management concluded that no individual debt security held-to-maturity was other-than-temporarily impaired at September 30, 2017. Further deterioration of the fiscal crisis of the Government of Puerto Rico or of Puerto Rico’s economy could further affect the value of these securities, resulting in losses to the Corporation. The Corporation does not have the intent to sell securities held-to-maturity and it is more likely than not that the Corporation will not have to sell these investment securities prior to recovery of their amortized cost basis.
Refer to Note 22 for additional information on the Corporation’s exposure to the Puerto Rico Government.
24
Note 8 – 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 310-20are 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 10.
For a summary of the accounting policies related to loans, interest recognition and allowance for loan losses refer to Note 2—Summary of significant accounting policies of the 2016 Form 10-K.
During the quarter and nine months ended September 30, 2017, the Corporation recorded purchases (including repurchases) of mortgage loans amounting to $104 million and $364 million, respectively; consumer loans of $133 million and $283 million, respectively; and leases of $2 million, for the nine months ended September 30, 2017. During the quarter and nine months ended September 30, 2016, the Corporation recorded purchases (including repurchases) of mortgage loans amounting to $118 million and $358 million, respectively; consumer loans of $164 million and commercial loans amounting to $51 million during the nine months ended September 30, 2016.
The Corporation performed whole-loan sales involving approximately $9 million and $63 million of residential mortgage loans during the quarter and nine months ended September 30, 2017, respectively (September 30, 2016—$13 million and $53 million, respectively). Excluding the bulk sale of Westernbank loans with a carrying value of approximately $100 million, the Corporation sold commercial and construction loans with a carrying value of approximately $38 million and $39 million during the quarter and nine months ended September 30, 2016, respectively. Also, the Corporation securitized approximately $ 86 million and $ 369 million of mortgage loans into Government National Mortgage Association (“GNMA”) mortgage-backed securities during the quarter and nine months ended September 30, 2017, respectively (September 30, 2016—$ 161 million and $ 465 million, respectively). Furthermore, the Corporation securitized approximately $ 21 million and $ 86 million of mortgage loans into Federal National Mortgage Association (“FNMA”) mortgage-backed securities during the quarter and nine months ended September 30, 2017, respectively (September 30, 2016 - $ 50 million and $ 129 million, respectively). The disruption in our operations over the last 10 days of the quarter impacted the volume of loan sales and securitizations.
Non-covered loans
The following table presents the composition of non-covered loans held-in-portfolio (“HIP”), net of unearned income, by past due status at September 30, 2017 and December 31, 2016, including loans previously covered by the commercial FDIC loss sharing agreements.
25
September 30, 2017
Puerto Rico
Commercial multi-family
Commercial real estate non-owner occupied
Commercial real estate owner occupied
Commercial and industrial
Construction
Mortgage
Leasing
Consumer:
Credit cards
Home equity lines of credit
Personal
Auto
Total
U.S. mainland
Legacy
26
Popular, Inc.
Legacy[3]
December 31, 2016
27
The level of delinquencies as of September 30, 2017 was impacted by the disruptions caused by Hurricanes Irma and Maria. The Corporation’s payment channels, collection efforts and loss mitigation operations were interrupted and mostly unavailable for the last 10 days of the quarter.
The following tables present non-covered loansheld-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, 2017 and December 31, 2016. Accruing loans past due 90 days or more consist primarily of credit cards, Federal Housing Administration (“FHA”) / U.S. Department of Veterans Affairs (“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.
28
At September 30, 2017
Mortgage[3]
Total[2]
At December 31, 2016
29
Covered loans
The following tables present the composition of loans by past due status at September 30, 2017 and December 31, 2016 for covered loans held-in-portfolio. The information considers covered loans accounted for under ASC Subtopic 310-20 and ASC Subtopic 310-30.
Consumer
Total covered loans
The following table presents covered loans in non-performing status and accruing loanspast-due 90 days or more by loan class at September 30, 2017 and December 31, 2016.
Total[1]
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, 2017 (December 31, 2016—$10 million).
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
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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.
Commercial real estate
Carrying amount [1]
Carrying amount, net of allowance
The outstanding principal balance of Westernbank loans accounted pursuant to ASC Subtopic 310-30, amounted to $1.9 billion at September 30, 2017 (December 31, 2016 - $2.1 billion). At September 30, 2017, 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.
Changes in the carrying amount and the accretable yield for the Westernbank loans accounted pursuant to the ASC Subtopic 310-30, for the quarters and nine months ended September 30, 2017 and 2016, were as follows:
Beginning balance
Accretion
Change in expected cash flows
Ending balance
31
Collections / loan sales / charge-offs
Ending balance[1]
Allowance for loan losses ASC 310-30 Westernbank loans
Ending balance, net of ALLL
Collections / loan sales / charge-offs[1]
Ending balance[2]
Other loans acquired with deteriorated credit quality
The outstanding principal balance of other acquired loans accounted pursuant to ASC Subtopic310-30, amounted to $598 million at September 30, 2017 (December 31, 2016 - $700 million). At September 30, 2017, 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.
32
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 and nine months ended September 30, 2017 and 2016 were as follows:
Activity in the accretable yield - other acquired loans ASC 310-30
Additions
Carrying amount of other acquired loans accounted for pursuant to ASC 310-30
Collections and charge-offs
Allowance for loan losses ASC 310-30 other acquired loans
Purchase accounting adjustments related to the Doral Bank Transaction (Refer to Note 15)
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Note 9 – 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 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, 2017, 45% (September 30, 2016 - 49%) of the ALLL for non-covered BPPR segment 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 leasing, credit cards, personal, auto and other consumer loan portfolios for 2017 and in the leasing, auto, other consumer loan and mortgage loan portfolios for 2016.
For the period ended September 30, 2017, 5% (September 30, 2016 - 4 %) of our BPNA segment 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 portfolios for 2017 and 2016.
As discussed in Note 2, Hurricanes impact, during the quarter ended September 30, 2017, an incremental provision expense of $69.9 million was made to the allowance for loan losses based on management’s best estimate of the impact of the hurricanes on the Corporation’s loan portfolios and the ability of borrowers to repay their loans, taking into consideration currently available information and the already challenging economic environment in Puerto Rico prior to the hurricanes. Refer to Note 2 for additional information.
The following tables present the changes in the allowance for loan losses, loan ending balances and whether such loans and the allowance pertain to loans individually or collectively evaluated for impairment for the quarters and nine months ended September 30, 2017 and 2016.
34
For the quarter ended September 30, 2017
Puerto Rico -Non-covered loans
Allowance for credit losses:
Provision (reversal of provision)
Charge-offs
Recoveries
Specific ALLL
General ALLL
Impaired non-covered loans
Non-covered loans held-in-portfolio excluding impaired loans
Total non-covered loans held-in-portfolio
Puerto Rico - Covered loans
Impaired covered loans
Covered loansheld-in-portfolio excluding impaired loans
Total covered loansheld-in-portfolio
U.S. Mainland
Impaired loans
Loansheld-in-portfolio excluding impaired loans
Total loansheld-in-portfolio
35
For the nine months ended September 30, 2017
36
For the quarter ended September 30, 2016
37
Puerto Rico - Covered Loans
U.S. Mainland - Continuing Operations
38
For the nine months ended September 30, 2016
Net recoveries (write-downs)
39
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 recoveries (charge-offs)
The following tables present loans individually evaluated for impairment at September 30, 2017 and December 31, 2016.
Total Puerto Rico
40
HELOCs
Total U.S. mainland
Credit Cards
Total Popular, Inc.
41
The following tables present the average recorded investment and interest income recognized on impaired loans for the quarters and nine months ended September 30, 2017 and 2016.
Helocs
42
Modifications
Troubled debt restructurings (“TDRs”) related to non-covered loan portfolios amounted to $ 1.3 billion at September 30, 2017 (December 31, 2016 - $ 1.2 billion). The amount of outstanding commitments to lend additional funds to debtors owing receivables whose terms have been modified in troubled debt restructurings amounted $8 million related to the commercial loan portfolio at September 30, 2017 (December 31, 2016 - $8 million).
At September 30, 2017, the mortgage loan TDRs include $444 million guaranteed by U.S. sponsored entities at BPPR, compared to $407 million at December 31, 2016.
A modification of a loan constitutes a troubled debt restructuring when a borrower is experiencing financial difficulty and the modification constitutes a concession. For a summary of the accounting policy related to TDRs, refer to the summary of significant accounting policies included in Note 2 of the 2016 Form 10-K.
The following tables present the non-covered and covered loans classified as TDRs according to their accruing status and the related allowance at September 30, 2017 and December 31, 2016.
43
Commercial
Leases
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, 2017 and 2016. Loans modified as TDRs for the U.S. operations are considered insignificant to the Corporation.
44
The following tables present by class, quantitative information related to loans modified as TDRs during the quarters and nine months ended September 30, 2017 and 2016.
(Dollars in thousands)
45
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, 2017 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.
46
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, 2017 and December 31, 2016.
47
Puerto Rico[1]
Total Commercial
Total Consumer
48
The following table presents the weighted average obligor risk rating at September 30, 2017 for those classifications that consider a range of rating scales.
49
50
The following table presents the weighted average obligor risk rating at December 31, 2016 for those classifications that consider a range of rating scales.
51
Note 10 – FDIC loss-share asset andtrue-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 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 following table sets forth the activity in the FDIC loss-share asset for the periods presented.
Accretion (amortization)
Credit impairment losses (reversal) to be covered under loss-sharing agreements
Reimbursable expenses
Net payments from FDIC under loss-sharing agreements
Arbitration award expense
Other adjustments attributable to FDIC loss-sharing agreements
Balance due to the FDIC for recoveries on covered assets [1]
The loss-share component of the arrangements applicable to commercial (including construction) and consumer loans expired during the quarter ended June 30, 2015. The agreement provides for reimbursement of recoveries to the FDIC to continue through the quarter ending June 30, 2018, and for the single family mortgage loss-share component of such agreement to expire on April 30, 2020.
The weighted average life of the single family loan portfolio accounted for under ASC 310-30 subject to the FDIC loss-sharing agreement at September 30, 2017 is 7.1 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-upmeasurement 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%).
Of the four components used to estimate the true-up payment obligation (intrinsic loss estimate, asset discount, cumulative shared-loss payments, and period servicing amounts) only the cumulative shared-loss payments and the period servicing amounts will change on a quarterly basis. These two variables are the main drivers of changes in the undiscounted true-up payment obligation. In
52
order to estimate the true-up obligation, actual and expected portfolio performance for loans under both the commercial and residential loss sharing agreement are contemplated. The cumulative shared loss payments and cumulative servicing amounts are derived from our quarterly loss reassessment process for covered loans accounted for under ASC 310-30.
Once the undiscounted true-up payment obligation is determined, the fair value is estimated based on the contractual remaining term to settle the obligation and a discount rate that is composed of the sum of the interpolated U.S. Treasury Note (“T Note”), defined by the remaining term of the true-up payment obligation, and a risk premium determined by the spread of the Corporation’s outstanding senior unsecured debt over the equivalent T Note.
The following table provides the fair value and the undiscounted amount of the true-up payment obligation at September 30, 2017 and December 31, 2016.
Carrying amount (fair value)
Undiscounted amount
The increase in the fair value of the true-up payment obligation was principally driven by a decrease in the discount rate from 5.97% in 2016 to 4.47% in 2017 due to a lower risk premium. The estimated fair value of the true-up payment obligation corresponds to the difference between the initial estimated losses to be reimbursed by the FDIC and the revised estimate of reimbursable losses. As the amount of estimated reimbursable losses decreases, the value of the true-up payment obligation increases.
As described above, the estimate of the true-up payment obligation is determined by applying the provisions of the loss sharing agreements and will change on a quarterly basis. The amount of the estimate of the true-up payment obligation is expected to change in future periods and may be subject to the interpretation of provisions 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 in order to receive reimbursement on losses from the FDIC. Under the loss-share agreements, BPPR must:
53
Note 11 – 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:
Unrealized (losses) gains on outstanding derivative positions
Realized losses on closed derivative positions
Total trading account loss
Total mortgage banking activities
54
Note 12 – 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. 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 21 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, 2017 and 2016 because they did not contain any credit recourse arrangements. During the quarter ended September 30, 2017, the Corporation recorded a net gain of $3.9 million (September 30, 2016 - $8.4 million) related to the residential mortgage loans securitized. During the nine months ended September 30, 2017, the Corporation recorded a net gain of $15.0 million (September 30, 2016 - $22.6 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, 2017 and 2016:
Assets
Investments securities available for sale:
Mortgage-backed securities—FNMA
Total investment securitiesavailable-for-sale
Trading account securities:
Mortgage-backed securities—GNMA
Total trading account securities
Mortgage servicing rights
55
During the nine months ended September 30, 2017, the Corporation retained servicing rights on whole loan sales involving approximately $49 million in principal balance outstanding (September 30, 2016 - $46 million), with realized gains of approximately $1.8 million (September 30, 2016 - gains of $1.9 million). All loan sales performed during the nine months ended September 30, 2017 and 2016 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, 2017 and 2016.
56
Residential MSRs
Fair value at beginning of period
Changes due to payments on loans[1]
Reduction due to loan repurchases
Changes in fair value due to changes in valuation model inputs or assumptions
Other disposals
Fair value at end of period
Residential mortgage loans serviced for others were $17.1 billion at September 30, 2017 (December 31, 2016 - $18.0 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. The banking subsidiaries receive servicing fees based on a percentage of the outstanding loan balance. These servicing fees are recognized as income when they are collected. At September 30, 2017, those weighted average mortgage servicing fees were 0.29% (September 30, 2016 – 0.29%). 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, 2017 and 2016 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 servicing rights purchased from other financial institutions, and the sensitivity to immediate changes in those assumptions, were as follows as of the end of the periods reported:
57
Fair value of servicing rights
Weighted average life (in years)
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 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, 2017, the Corporation serviced $1.5 billion (December 31, 2016 - $1.7 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, 2017, the Corporation had recorded $92 million in mortgage loans on its Consolidated Statements of Financial Condition related to this buy-back option program (December 31, 2016 - $49 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, 2017, the Corporation repurchased approximately $ 113 million (September 30, 2016 - $67 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 13 – 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, 2017 and 2016.
Write-downs in value(1)
Sales
Other adjustments
Write-downs in value
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Note 14 – 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
Receivables from investments maturities
Principal, interest and escrow servicing advances
Guaranteed mortgage loan claims receivable
Others
Total other assets
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Note 15 – Goodwill and other intangible assets
There were no changes in the carrying amount of goodwill for the quarter and nine months ended September 30, 2017. The changes in the carrying amount of goodwill for the nine months ended September 30, 2016, allocated by reportable segments, were as follows (refer to Note 34 for the definition of the Corporation’s reportable segments):
2016
Banco Popular de Puerto Rico
Banco Popular North America
On February 27, 2015, BPPR, in alliance with other co-bidders, including BPNA, 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”). During the quarter ended June 30, 2016, the Corporation recorded purchase accounting adjustments of $4.7 million, resulting in a total goodwill of $167.8 million recognized related to the Doral Bank Transaction.
Other Intangible Assets
At September 30, 2017 and December 31, 2016, the Corporation had $ 6.1 million of identifiable intangible assets, with indefinite useful lives, mostly associated with the E-LOAN trademark.
The following table reflects the components of other intangible assets subject to amortization:
Core deposits
Other customer relationships
Total other intangible assets
During the quarter ended September 30, 2017, the Corporation recognized $ 2.3 million in amortization expense related to other intangible assets with definite useful lives (September 30, 2016 - $ 3.1 million). During the nine months ended September 30, 2017, the Corporation recognized $ 7.0 million in amortization related to other intangible assets with definite useful lives (September 30, 2016 - $ 9.3 million).
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The following table presents the estimated amortization of the intangible assets with definite useful lives for each of the following periods:
Remaining 2017
Year 2018
Year 2019
Year 2020
Year 2021
Year 2022
Later years
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 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 2017 using July 31, 2017 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:
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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 11.58% to 14.49% for the 2017 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.
BPPR passed Step 1 in the annual test as of July 31, 2017. The results indicated that the average estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPPR’s equity value by approximately $871 million or 26%. Accordingly, there was no indication of impairment on the goodwill recorded in BPPR at July 31, 2017 and there was no need for a Step 2 analysis. As indicated in Note 2, during the month of September Hurricanes Irma and Maria made landfall and subsequently caused extensive destruction in the U.S. and British Virgin Islands and Puerto Rico, disrupting the markets in which BPPR does business. The hurricanes have and may continue to impact the Corporation’s financial results, as detailed in Note 2, which may have an effect on BPPR’s estimated fair value. However, given the excess of BPPR’s fair value over its carrying amount, the Corporation has determined, based on the information currently available, that there is no indication of impairment of goodwill. The Corporation will continue monitoring the impact of the hurricanes as new information becomes available.
BPNA passed Step 1 in the annual test as of July 31, 2017. The results indicated that the average estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPNA’s equity value by approximately $183 million or 11%. Accordingly, there was no indication of impairment on the goodwill recorded in BPNA at July 31, 2017 and there was no need for a Step 2 analysis.
The goodwill balance of BPPR and BPNA, as legal entities, represented approximately 98% of the Corporation’s total goodwill balance as of the July 31, 2017 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, 2017 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 tables present the gross amount of goodwill and accumulated impairment losses by reportable segments.
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Note 16 – 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, 2017 follows:
2017
2018
2019
2020
2021
2022 and thereafter
At September 30, 2017, the Corporation had brokered deposits amounting to $ 0.6 billion (December 31, 2016 - $ 0.6 billion).
The aggregate amount of overdrafts in demand deposit accounts that were reclassified to loans was $16 million at September 30, 2017 (December 31, 2016 - $6 million).
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Note 17 – Borrowings
The following table presents the composition of assets sold under agreements to repurchase at September 30, 2017 and December 31, 2016.
Total 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 assetsheld-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 30 to 90 days
After 90 days
Total U.S. Treasury Securities
Obligations of U.S. government sponsored entities
Total obligations of U.S. government sponsored entities
Collateralized mortgage obligations
Total collateralized mortgage obligations
Repurchase agreements in portfolio are generally short-term, often overnight. 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 information related to the Corporation’s other short-term borrowings for the periods ended September 30, 2017 and December 31, 2016.
Advances with the FHLB paying interest at maturity with fixed rates ranging from 1.32% to 1.44%
Total other short-term borrowings
Note: Refer to the Corporation’s 2016 Form 10-K for rates information at December 31, 2016.
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The following table presents the composition of notes payable at September 30, 2017 and December 31, 2016.
Advances with the FHLB with maturities ranging from 2017 through 2029 paying interest at monthly fixed rates ranging from 0.81% to 4.19 %
Advances with the FHLB with maturities ranging from 2018 through 2019 paying interest monthly at a floating rate ranging from 0.22% to 0.34% over the 1 month LIBOR
Advances with the FHLB with maturities ranging from 2018 through 2019 paying interest quarterly at a floating rate from 0.09% to 0.24% over the 3 month LIBOR
Unsecured senior debt securities maturing on 2019 paying interest semiannually at a fixed rate of 7.00%, net of debt issuance costs of $3,648 (2016 - $5,212)
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%, net of debt issuance costs of $456 (2016 - $476)
Total notes payable
A breakdown of borrowings by contractual maturities at September 30, 2017 is included in the table below.
Year 2017
Total borrowings
At September 30, 2017 and December 31, 2016, the Corporation had FHLB borrowing facilities whereby the Corporation could borrow up to $3.9 billion and $3.8 billion, respectively, of which $868 million and $673 million, respectively, were used. In addition, at September 30, 2017 and December 31, 2016, the Corporation had placed $200 million of the available FHLB credit facility as collateral for a municipal letter of credit to secure deposits. The FHLB borrowing facilities are collateralized with loansheld-in-portfolio, and do not have restrictive covenants or callable features.
Also, at September 30, 2017, the Corporation has a borrowing facility at the discount window of the Federal Reserve Bank of New York amounting to $1.2 billion (2016 - $1.2 billion), which remained unused at September 30, 2017 and December 31, 2016. The facility is a collateralized source of credit that is highly reliable even under difficult market conditions.
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Note 18 – 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, 2017 and December 31, 2016.
As of September 30, 2017
Derivatives
Repurchase agreements
As of December 31, 2016
Reverse repurchase agreements
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The Corporation’s derivatives are subject to agreements which allow a right ofset-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 19 – Stockholders’ equity
On January 23, 2017, the Corporation’s Board of Directors approved an increase in the Company’s quarterly common stock dividend from $0.15 per share to $0.25 per share. During the nine months ended September 30, 2017, the Corporation declared dividends on its common stock of $ 76.6 million. The quarterly dividend declared to shareholders of record as of the close of business on September 14, 2017, which amounted to $25.5 million, was paid on October 2, 2017. Also, during the first quarter of 2017, the Corporation completed a $75 million privately negotiated accelerated share repurchase transaction (“ASR”). As part of this transaction, the Corporation received 1,847,372 shares and recognized $79.5 million in treasury stock, based on the stock’s spot price, offset by a $4.5 million adjustment to capital surplus, resulting from the decline in the Corporation’s stock price during the term of the ASR.
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 $513 million at September 30, 2017 (December 31, 2016 - $513 million). There were no transfers between the statutory reserve account and the retained earnings account during the quarters and nine months ended September 30, 2017 and September 30, 2016.
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Note 20 – Other comprehensive loss
The following table presents changes in accumulated other comprehensive loss by component for the quarters and nine months ended September 30, 2017 and 2016.
Changes in Accumulated Other Comprehensive Loss by Component [1]
Foreign currency translation
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 credit
Unrealized holding gains (losses) on investments
Other comprehensive income (loss) before reclassifications
Other-than-temporary impairment amount reclassified from accumulated other comprehensive (loss) income
Amounts reclassified from accumulated other comprehensive (loss) income for gains on securities
Other comprehensive loss before reclassifications
Amounts reclassified from accumulated other comprehensive income (loss)
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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, 2017 and 2016.
Reclassifications Out of Accumulated Other Comprehensive Loss
Consolidated Statements of Operations
Amortization of net losses
Amortization of prior service credit
Total before tax
Income tax benefit
Total net of tax
Other-than-temporary impairment
Other-than-temporary impairment losses on available-for-sale debt securities
Realized gains on sale of securities
Income tax (expense) benefit
Forward contracts
Mortgage banking activities
Total reclassification adjustments, net of tax
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Note 21 – Guarantees
At September 30, 2017, the Corporation recorded a liability of $0.3 million (December 31, 2016—$0.3 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, 2017, the Corporation serviced $ 1.5 billion (December 31, 2016 - $ 1.7 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, 2017, the Corporation repurchased approximately $ 7 million and $ 22 million, respectively, of unpaid principal balance in mortgage loans subject to the credit recourse provisions (September 30, 2016 - $ 11 million and $ 34 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, 2017, the Corporation’s liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $ 52 million (December 31, 2016 - $ 54 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 months ended September 30, 2017 and 2016.
Balance as of beginning of period
Provision for recourse liability
Net charge-offs
Balance as of end of period
When the Corporation sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. 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 ended September 30, 2017 and 2016, BPPR did not repurchase loans 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.
From time to time, the Corporation sells loans and agrees to indemnify the purchaser for credit losses or any breach of certain representations and warranties made in connection with the sale. 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, 2017 and 2016.
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Provision (reversal) for representation and warranties
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, 2017, the Corporation serviced $17.1 billion in mortgage loans for third-parties, including the loans serviced with credit recourse (December 31, 2016 - $18.0 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, 2017, the outstanding balance of funds advanced by the Corporation under such mortgage loan servicing agreements was approximately $71 million, including advances on the portfolio acquired from Doral Bank (December 31, 2016 - $70 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 $ 149 million at September 30, 2017 and December 31, 2016. In addition, at September 30, 2017 and December 31, 2016, PIHC fully and unconditionally guaranteed on a subordinated basis $ 427 million 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 23 to the Consolidated Financial Statements in the 2016 Form 10-K for further information on the trust preferred securities.
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Note 22 – 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 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, 2017 and December 31, 2016, the Corporation maintained a reserve of approximately $9 million for potential losses associated with unfunded loan commitments related to commercial and consumer lines of credit.
Business concentration
Since the Corporation’s business activities are 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 34 to the Consolidated Financial Statements.
Puerto Rico is in the midst of a profound fiscal and economic crisis, was recently significantly impacted by two major hurricanes and has commenced several proceedings under the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”) to restructure its outstanding obligations and those of certain of its instrumentalities.
In September 2017, Puerto Rico was impacted by Hurricanes Irma and Maria. Most relevant, Hurricane Maria made landfall on September 20, 2017, causing severe wind and flood damage to infrastructure, homes and businesses throughout Puerto Rico. Following the passage of Hurricane Maria, all Puerto Rico was left without electrical power, other basic utility and infrastructure services were severely curtailed and the government imposed a mandatory curfew. As of the date of this report, most businesses and homes in Puerto Rico remain without power, other basic utility and infrastructure remains significantly impacted, and many businesses are operating partially or remain closed. While it is too early to assess and quantify the full extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity, the damages are substantial and have, at least in the short-term, had a material adverse impact on economic activity. For a discussion of the impact of the hurricanes on the Corporation’s operations and financial results during the third quarter of 2017, refer to Note 2 - Hurricanes impact.
The U.S. Congress enacted PROMESA on June 30, 2016 in response to the Commonwealth’s ongoing fiscal and economic crisis. PROMESA, among other things, (i) established a seven-member oversight board (the “Oversight Board”) with broad powers over the finances of the Commonwealth and its instrumentalities, (ii) established an automatic stay on litigation, which expired on May 1,
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2017, that applied to all financial obligations of the Commonwealth, its instrumentalities and municipalities (including to all municipal obligations owned by the Corporation), (iii) required the Commonwealth (and any instrumentality thereof designated as a “covered entity” under PROMESA) to submit its budgets, and if the Oversight Board so requests, a fiscal plan for certification by the Oversight Board, and (iv) established two separate processes for the restructuring of the outstanding liabilities of the Commonwealth, its instrumentalities and municipalities: (a) Title VI, a largelyout-of-court process through which a government entity and its financial creditors can agree on terms to restructure such entity’s debts, and (b) Title III, a court-supervised process for a comprehensive restructuring similar to Chapter 9 of the U.S. Bankruptcy Code.
The Oversight Board has designated a number of entities as “covered entities” under PROMESA, including the Commonwealth, all of its public corporations (including COFINA) and retirement systems, and all affiliates and subsidiaries of the foregoing. While the Oversight Board has the power to designate any of the Commonwealth’s municipalities as covered entities under PROMESA, it has not done so as of the date hereof. The Oversight Board has further approved fiscal plans for certain of these “covered entities,” including the Commonwealth, the Government Development Bank for Puerto Rico (“GDB”) and several other public corporations. The Commonwealth’s fiscal plan covers various public instrumentalities with outstanding debts payable from taxes, fees or other government revenues, including COFINA. The fiscal plans were prepared and approved prior to the impact of Hurricanes Irma and Maria and are thus based on pre-hurricane assumptions of government revenues, economic activity and outmigration. The approved fiscal plans indicate based on such assumptions that the applicable government entities are unable to pay their outstanding obligations as currently scheduled, thus recognizing a need for a significant debt restructuring. On October 31, 2017, the Oversight Board requested revised fiscal plans for the Commonwealth and various public corporations to take into account the impact of Hurricanes Irma and Maria. The Oversight Board expects that the revised fiscal plans would be certified by January or February 2018.
On May 3, 2017, the Oversight Board, on behalf of the Commonwealth, filed a petition in the U.S. District Court for the District of Puerto Rico to restructure the Commonwealth’s liabilities under Title III of PROMESA. The Oversight Board has subsequently filed analogous petitions with respect to COFINA, the Employees Retirement System, the Puerto Rico Highways and Transportation Authority and the Puerto Rico Electric Power Authority. The Oversight Board has also authorized GDB to pursue a restructuring of its financial indebtedness under Title VI of PROMESA. Although as of the date hereof, these entities are the only entities for which the Oversight Board has sought to use the restructuring authority provided by PROMESA, the Oversight Board may use the restructuring authority of Title III or Title VI of PROMESA for other Commonwealth instrumentalities, including its municipalities, in the future.
At September 30, 2017, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 484 million, of which approximately $ 482 million is outstanding ($584 million and $ 529 million, respectively, at December 31, 2016). Of the amount outstanding, $ 433 million consists of loans and $ 49 million are securities ($ 459 million and $ 70 million at December 31, 2016). All of amount outstanding ($ 512 million of the total amount outstanding at December 31, 2016) 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. Such general obligation bonds and notes are payable primarily from, and have a lien on, certain special property taxes, which each municipality is required by law to levy in an amount sufficient for the payment of its outstanding general obligation bonds and notes. Those special property taxes are collected by the Municipal Revenue Collection Center (“CRIM”), or directly by some municipalities, and deposited into the Municipal Public Debt Redemption Fund (a trust for which GDB acts as trustee and which is currently held in various accounts and subaccounts at BPPR (except for the portion corresponding to repayment of municipal general obligation bonds held by GDB, which was deposited at GDB until April 2016)). Funds in the Redemption Fund are required to be used for the payment of the municipality’s general obligation bonds and notes. To the extent that a municipality’s funds in the Redemption Fund are insufficient to pay the obligations in full, CRIM is required to transfer to such Redemption Fund other property tax revenues of the applicable municipality to satisfy the insufficiency.
During the third quarter of 2017, the Corporation sold all of its COFINA bonds at a gain of approximately $0.1 million. The Corporation had recorded an other-than-temporary impairment charge of $8.3 million in respect of those bonds during the second quarter of 2017 as a result of the filing of the Title III proceeding in respect of COFINA and thenon-payment of interest on the COFINA bonds in June 2017, pursuant to a court order issued in such proceeding.
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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)
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, 2017, the Corporation had $391 million in indirect exposure to loans or securities issued or guaranteed by Puerto Rico governmental entities but whose principal source of repayment are non-governmental entities. In such obligations, the Puerto Rico government entity guarantees any shortfall in collateral in the event of borrower default ($406 million at December 31, 2016). These included $313 million in residential mortgage loans guaranteed by the Puerto Rico Housing Finance Authority (“HFA”), an entity that has been designated as a covered entity under PROMESA (December 31, 2016 - $326 million). These mortgage loans are secured by the underlying properties and the HFA guarantee serves to cover shortfalls in collateral in the event of a borrower default. Although the Governor is currently authorized by local legislation to impose a temporary moratorium on the financial obligations of the HFA, he has not exercised this power as of the date hereof. Also, the Corporation had $43 million in Puerto Rico housing bonds issued by HFA, which are secured by second mortgage loans on Puerto Rico residential properties, $6 million in pass-through securities that have been economically defeased and refunded and for which collateral including U.S. agencies and Treasury obligations has been escrowed, and $29 million of commercial real estate notes issued by government entities, but payable from rent paid by third parties ($43 million, $6 million and $31 million at December 31, 2016, respectively).
BPPR’s commercial loan portfolio also includes loans to private borrowers who are service providers, lessors, suppliers or have other relationships with the government. These borrowers could be negatively affected by the fiscal measures to be implemented to address the Commonwealth’s fiscal crisis and the ongoing Title III proceedings under PROMESA described above. Similarly, BPPR’s mortgage and consumer loan portfolios include loans to government employees which could also be negatively affected by fiscal measures such as employee layoffs or furloughs.
The Corporation has operations in the United States Virgin Islands (the “USVI”) and has approximately $82 million in direct exposure to USVI government entities. The USVI has been experiencing a number of fiscal and economic challenges that could adversely affect the ability of its public corporations and instrumentalities to service their outstanding debt obligations. In addition, in September 2017, the USVI was also severely impacted by Hurricanes Irma and Maria, which will pose additional challenges to the USVI government and could further materially adversely affect the USVI economy.
Other contingencies
As indicated in Note 10 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 $ 167 million at September 30, 2017 (December 31, 2016 - $ 153 million). For additional information refer to Note 10.
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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 (“Legal Proceedings”). When the Corporation determines that 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 relating to 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 $27.8 million as of September 30, 2017. 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 Legal Proceedings (including the fact that many of them are currently in preliminary stages), the existence of multiple defendants in several of the current Legal Proceedings whose share of liability has yet to be determined, the numerous unresolved issues in many of the Legal Proceedings, and the inherent uncertainty of the various potential outcomes of such Legal 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 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 in matters in which a loss amount can be reasonably estimated will not have a material adverse effect on the Corporation’s consolidated financial position. 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 is a description of the Corporation’s significant legal proceedings.
BANCO POPULAR DE PUERTO RICO
Hazard Insurance Commission-Related Litigation
Popular, Inc., BPPR and Popular Insurance, LLC (the “Popular Defendants”) have been named defendants in a putative class action complaint captioned Perez Díaz v. Popular, Inc., et al, filed before the Court of First Instance, Arecibo Part. The complaint seeks damages and preliminary and permanent injunctive relief on behalf of the purported class against the Popular Defendants, as well as Antilles Insurance Company and MAPFRE-PRAICO Insurance Company (the “Defendant Insurance Companies”). Plaintiffs essentially allege that the Popular Defendants have been unjustly enriched by failing to reimburse them for commissions paid by the Defendant Insurance Companies to the insurance agent and/or mortgagee for policy years when no claims were filed against their hazard insurance policies. They demand the reimbursement to the purported “class” of an estimated $400 million plus legal interest, for the “good experience” commissions allegedly paid by the Defendant Insurance Companies during the relevant time period, as well as injunctive relief seeking to enjoin the Defendant Insurance Companies from paying commissions to the insurance agent/mortgagee and ordering them to pay those fees directly to the insured. A hearing on the request for preliminary injunction and other matters was held on February 15, 2017, as a result of which plaintiffs withdrew their request for preliminary injunctive relief. A motion for dismissal on the merits, which the Defendant Insurance Companies filed shortly before hearing, was denied with a right to replead following limited targeted discovery. On March 24, 2017, the Popular Defendants filed a certiorari petition with the Puerto
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Rico Court of Appeals seeking a review of the lower court’s denial of the motion to dismiss. The Court of Appeals denied the Popular Defendant’s request, and the Popular Defendants appealed this determination to the Puerto Rico Supreme Court, which declined review. A motion for reconsideration is pending resolution. Separately, a class certification hearing was held in June and the Court requested post-hearing briefs on this issue. On October 26, 2017, the Court entered an order whereby it broadly certified the class. At a hearing held on November 2, 2017, the Court encouraged the parties to reach agreement on discovery and class notification procedures. The Court further allowed defendants until January 4, 2018 to answer the complaint. A follow-up hearing was set for March 6, 2018. BPPR is currently evaluating its next steps, which may include filing an interlocutory appeal of the class certification order.
BPPR has separately been named a defendant in a putative class action complaint captionedRamirez Torres, et al. v. Banco Popular de Puerto Rico, et al, filed before the Puerto Rico Court of First Instance, San Juan Part. The complaint seeks damages and preliminary and permanent injunctive relief on behalf of the purported class against the same Popular Defendants, as well other financial institutions with insurance brokerage subsidiaries in Puerto Rico. Plaintiffs essentially contend that in November 2015, Antilles Insurance Company obtained approval from the Puerto Rico Insurance Commissioner to market an endorsement that allowed its customers to obtain reimbursement on their insurance deductible for good experience, but that defendants failed to offer this product or disclose its existence to their customers, favoring other products instead, in violation of their duties as insurance brokers. Plaintiffs seek a determination that defendants unlawfully failed to comply with their duty to disclose the existence of this new insurance product, as well as double or treble damages (the latter subject to a determination that defendants engaged in anti-monopolistic practices in failing to offer this product). Between late March and early April, co-defendants filed motions to dismiss the complaint and opposed the request for preliminary injunctive relief. A co-defendant filed a third-party Complaint against Antilles Insurance Company. A preliminary injunction and class certification hearing originally scheduled for April 6th was subsequently postponed, pending resolution of the motions to dismiss. On July 31, 2017, the Court dismissed the complaint with prejudice. In August 2017, plaintiffs appealed this judgment.
A third putative class action also tangentially related to hazard insurance policies and captioned Morales v. Banco Popular de Puerto Rico, et al., was filed in May 2017. Plaintiffs aver that BPPR forced-placed hazard insurance on their mortgaged properties in violation of Puerto Rico’s implied covenant of good faith, BPPR’s alleged fiduciary duties as the escrow account manager of their mortgage loans, the Truth in Lending Act (TILA) and the Racketeer Influenced and Corrupt Organizations Act (RICO). Plaintiffs seek class certification, an order enjoining BPPR and other unnamed defendants from maintaining their allegedly fraudulent practices concerning forced-placed hazard insurance, unspecified compensatory damages, costs and attorneys’ fees. On July 19, 2017, BPPR filed a motion for summary judgment, which is pending resolution.
Mortgage-Related Litigation and Claims
BPPR has been named a defendant in a putative class action captioned Lilliam González Camacho, et al. v. Banco Popular de Puerto Rico, et al., filed before the United States District Court for the District of Puerto Rico on behalf of mortgage-holders who have allegedly been subjected to illegal foreclosures and/or loan modifications through their mortgage servicers. Plaintiffs essentially contend that when they sought to reduce their loan payments, defendants failed to provide them with reduced loan payments, instead subjecting them to lengthy loss mitigation processes while filing foreclosure claims against them in parallel. Plaintiffs assert that such actions violate HAMP, HARP and other loan modification programs, as well as the Puerto Rico Mortgage Debtor Assistance Act and TILA. For the alleged violations stated above, Plaintiffs request that all Defendants (over 20 separate defendants have been named, including all local banks), jointly and severally, respond in an amount of no less than $400 million. BPPR waived service of process in June and filed a motion to dismiss in August which is pending resolution.
BPPR has also been named a defendant in two separate putative class actions captioned Costa Dorada Apartment Corp., et al. v. Banco Popular de Puerto Rico, et al., and Yiries Josef Saad Maura v. Banco Popular, et al., filed by the same counsel who filed the González Camacho action referenced above, on behalf of commercial and residential customers of the defendant banks who have allegedly been subject to illegal foreclosures and/or loan modifications through their mortgage servicers. Plaintiffs essentially contend that when they sought to reduce their loan payments, defendants failed to provide them with reduced loan payments, instead subjecting them to lengthy loss mitigation processes while filing foreclosure claims against them in parallel (dual tracking), all in violation of TILA, the Real Estate Settlement Procedures Act (“RESPA”), the Equal Credit Opportunity Act (“ECOA”), the Fair Credit Reporting Act (“FCRA”), the Fair Debt Collection Practices Act (“FDCPA”) and other consumer-protection laws and regulations. They demand approximately $1 billion (inCosta Dorada) and unspecified damages (in Saad Maura). Banco Popular has not yet been served with summons in relation to either matter.
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BPPR has been named a defendant in a complaint for damages and breach of contract captioned Héctor Robles Rodriguez et al. v. Municipio de Ceiba, et al. Plaintiffs are residents of a development called Hacienda Las Lomas. Through the Doral Bank-FDIC assisted transaction, BPPR acquired a significant number of mortgage loans within in this development and is currently the primary creditor in the project. Plaintiffs claim damages against the developer, contractor, the relevant insurance companies, and most recently, their mortgage lenders, as a result of a landslide that occurred in October 2015, affecting various streets and houses within the development. Plaintiffs specifically allege that the mortgage lenders, including BPPR, should be deemed liable for their alleged failure to properly inspect the subject properties. Plaintiffs demand in excess of $30 million in damages and the annulment of their mortgage deeds. BPPR has recently engaged in preliminary settlement discussions with plaintiffs.
Mortgage-Related Investigations
The Corporation and its subsidiaries from time to time receive requests for information from departments of the U.S. government that investigate mortgage-related conduct. In particular, BPPR has received subpoenas and other requests for information from the Federal Housing Finance Agency’s Office of the Inspector General, the Civil Division of the Department of Justice, the Special Inspector General for the Troubled Asset Relief Program and the Federal Department of Housing and Urban Development’s Office of the Inspector General mainly concerning real estate appraisals and residential and construction loans in Puerto Rico. The Corporation is cooperating with these requests and is in discussions with the relevant U.S. government departments regarding the resolution of such matters. There can be no assurances as to the outcome of those discussions.
Separately, it has come to the attention of management that certain letters generated by the Corporation to comply with Consumer Financial Protection Bureau (“CFPB”) rules requiring written notification to borrowers who have submitted a loss mitigation application were not mailed to borrowers over a period of up to approximately three-years due to a systems interface error. Loss mitigation is a process whereby creditors work with mortgage loan borrowers who are having difficulties making their loan payments on their debt. The loss mitigation process applies both to mortgage loans held by the Corporation and to mortgage loans serviced by the Corporation for third parties. The Corporation has corrected the systems interface error that caused the letters not to be sent.
The Corporation has notified applicable regulators and is conducting a review of its mortgage files to assess the scope of potential customer impact. Based on currently available information, we believe that although the mailing error extended to approximately 20,000 residential mortgage loans (approximately 50% of which are serviced by the Corporation for third parties), the number of borrowers actually affected by the mailing error was substantially lower due to, among other things, the fact that more than half of all borrowers potentially subject to such error closed on a permanent loss mitigation alternative and the fact that the Corporation regularly uses means other than the mail to communicate with borrowers, including hand delivery of written notices at our mortgage servicing centers or bank branches.
The Corporation will begin outreach to potentially affected borrowers with outstanding loans that have not closed on a permanent loss mitigation alternative during the fourth quarter of 2017 and expects that it will be able to make a final determination with respect to the action it will take regarding all potentially impacted borrowers by the first quarter of 2018. At this point, we are not able to estimate the financial impact of the failure to mail the loss mitigation notices.
Other Significant Proceedings
In June 2017, a syndicate comprised of BPPR and other local banks (the “Lenders”) filed an involuntary Chapter 11 bankruptcy proceeding against Betteroads Asphalt and Betterecycling Corporation (the “Involuntary Debtors”). This filing followed attempts by the Lenders to restructure and resolve the Involuntary Debtors’ obligations and outstanding defaults under a certain credit agreement, first through good faith negotiations and subsequently, through the filing of a collection action against the Involuntary Debtors in local court. The involuntary debtors subsequently counterclaimed, asserting damages in excess of $900 million. The Lenders ultimately joined in the commencement of these involuntary bankruptcy proceedings against the Debtors in order to preserve and recover the Involuntary Debtors’ assets, having confirmed that the Involuntary Debtors were transferring assets out of their estate for little or no consideration. The Involuntary Debtors subsequently filed a motion to dismiss the proceedings and for damages against the syndicate, arguing both that this petition was filed in bad faith and that there was a bona fide dispute as to the petitioners’ claims, as set forth in the counterclaim filed by the Involuntary Debtors in local court. The court allowed limited discovery to take place prior to an evidentiary hearing (still unscheduled and to be held after the discovery cut-off date) to determine the merits of debtors’ motion to dismiss. A separate hearing will be heard in November to entertain creditors’ motion to appoint a trustee.
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POPULAR SECURITIES
Puerto Rico Bonds and Closed-End Investment Funds
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. Popular Securities has received customer complaints and is named as a respondent (among other broker-dealers) in 86 arbitration proceedings with aggregate claimed amounts of approximately $209 million, including one arbitration with claimed damages of approximately $78 million in which another Puerto Rico broker-dealer is a co-defendant. While Popular Securities believes it has meritorious defenses to the claims asserted in these proceedings, it has often determined that it is in its best interest to settle such claims rather than expend the money and resources required to see such cases to completion. The Government’s defaults and non-payment of its various debt obligations, the Commonwealth government’s and the Financial Oversight Management Board’s decision to pursue restructurings under Title III and Title VI of PROMESA have increased and may continue to increase the number of customer complaints (and claimed damages) filed against Popular Securities concerning Puerto Rico bonds, including bonds issued by COFINA and GDB, and closed-end investment companies that invest primarily in Puerto Rico bonds. An adverse result in the matters described above or a significant increase in customer complaints could have a material adverse effect on Popular.
Subpoenas for Production of Documents in connection with PROMESA Title III Proceedings
Popular Securities has, together with Popular, Inc. and BPPR (collectively, the “Popular Companies”) recently filed an appearance in connection with the Commonwealth of Puerto Rico’s pending Title III bankruptcy proceeding. Its appearance was prompted by a request by the Commonwealth’s Unsecured Creditors’ Committee (“UCC”) to allow a broad discovery program under Rule 2004 to investigate, among other things, the causes of the Puerto Rico financial crisis. The Rule 2004 request seeks broad discovery not only from the Popular Companies, but also from Banco Santander de Puerto Rico (“Santander”) and others, spanning in excess of eleven (11) years. In their respective objections, both the Popular Companies and Santander argued that these requests go substantially beyond the permissible scope of Rule 2004 discovery programs and should either be denied outright or substantially modified. A hearing before Magistrate Judge Gail Dein was held on August 9, 2017. At the hearing, the Court requested that the UCC and the Oversight Board, who opposed the UCC’s request, submit further briefing on this subject. The parties are to argue their respective positions at the upcoming omnibus hearing, to be held on November 15, 2017.
Since the August 2017 hearing, the Popular Companies have been served with additional requests for the preservation and voluntary production of certain COFINA-related documents from the UCC and the COFINA Agent in connection with the COFINA-Commonwealth adversary complaint, as well as from the Oversight Board’s Independent Investigator, Kobre & Kim. BPPR is cooperating with all such requests but has asked that such requests be submitted in the form of a subpoena to address privacy and confidentiality considerations pertaining to some of the documents involved in the production.
POPULAR COMMUNITY BANK
Josefina Valle v. Popular Community Bank
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, 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 that the overdraft rates and fees assessed by PCB violate New York’s usury laws. Plaintiffs seek unspecified damages, including punitive damages, interest, disbursements, and attorneys’ fees and costs.
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
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covenant of good faith and fair dealing. On August 12, 2015, 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 February 18, 2016, the Court granted in part and denied in part PCB’s pending motion to dismiss. The Court dismissed plaintiffs’ unfair and deceptive acts and trade practices claim to the extent it sought to recover overdraft fees incurred prior to September 2011. On March 28, 2016, PCB filed an answer to second amended complaint and on April 7, 2016, it filed a notice of appeal on the partial denial of PCB’s motion to dismiss. A mediation session held on September 21, 2016 proved unsuccessful. On January 3, 2017, PCB filed a brief with the Appellate Division in support of its appeal of the lower Court’s prior order that granted in part and denied in part PCB’s motion to dismiss plaintiffs’ second amended complaint. Oral argument was held on April 4, 2017. On April 25, 2017, the Court issued an order denying PCB’s appeal from the partial denial of our motion to dismiss. The parties have since, been engaged in settlement discussions, which are currently at an advanced stage.
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Note 23 – Non-consolidated variable interest entities
The Corporation is involved with four statutory trusts which it created 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.
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 25 to the Consolidated Financial Statements for additional information on the debt securities outstanding at September 30, 2017 and December 31, 2016, which are classified as available-for-sale and trading securities in the Corporation’s consolidated statements of financial condition. In addition, the Corporation holds variable interests in the form of servicing fees, since it retains 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.
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 of GNMA and FNMA loans at September 30, 2017 and December 31, 2016.
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 $11.9 billion at September 30, 2017 (December 31, 2016—$12.3 billion).
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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, 2017 and December 31, 2016, 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 to a newly created joint venture, PRLP 2011 Holdings, LLC. In March of 2013, BPPR completed a sale of commercial and construction loans, and commercial and single family real estate owned to a newly created joint venture, PR Asset Portfolio 2013-1 International, LLC.
These joint ventures were 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 ventures through deed in lieu of foreclosure, foreclosure, or by resolution of any loan.
BPPR provided financing to PRLP 2011 Holdings, LLC and PR Asset Portfolio 2013-1International, LLC for the acquisition of the assets in an amount equal to the acquisition loan of $86 million and $182 million, respectively. The acquisition loans have a 5-year maturity and bear a variable interest at 30-day LIBOR plus 300 basis points and are secured by a pledge of all of the acquiring entity’s assets. In addition, BPPR provided these joint ventures with a non-revolving advance facility (the “advance facility”) of $69 million and $35 million, respectively, 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 and $30 million, respectively, to fund certain operating expenses of the joint venture. As part of these transactions, BPPR received $ 48 million and $92 million, respectively, in cash and a 24.9% equity interest in each joint venture. The Corporation is not required to provide any other financial support to these joint ventures.
BPPR accounted for both transactions as a true sale pursuant to ASC Subtopic 860-10.
The Corporation has determined that PRLP 2011 Holdings, LLC and PR Asset Portfolio 2013-1 International, LLC are VIEs but it is not the primary beneficiary. All decisions are made by Caribbean Property Group (“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 ventures any and all documents, contracts, certificates, agreements and instruments, and to take any action deemed necessary in the benefit of the joint ventures.
The Corporation holds variable interests in these VIEs in the form of the 24.9% equity interests and the financing provided to these joint ventures. The equity interest is accounted for under the equity method of accounting pursuant to ASC Subtopic 323-10.
The following tables present the carrying amount and classification of the assets and liabilities related to the Corporation’s variable interests in the non-consolidated VIEs, PRLP 2011 Holdings, LLC and PR Asset Portfolio 2013-1 International, LLC, and their maximum exposure to loss at September 30, 2017 and December 31, 2016.
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Advances under the working capital line
Advances under the advance facility
Accrued interest receivable
Equity investment
Liabilities
Total net assets
The Corporation determined that the maximum exposure to loss under a worst case scenario at September 30, 2017 would be not recovering the net assets held by the Corporation as of the reporting date.
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 thesenon-consolidated VIEs 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, 2017.
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Note 24 – Related party transactions
The Corporation considers its equity method investees as related parties. The following provides information on transactions with equity method investees considered related parties.
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, 2017, the Corporation’s stake in EVERTEC was 16.10%.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.
The Corporation received $ 3.5 million in dividend distributions during the nine months ended September 30, 2017 from its investments in EVERTEC’s holding company (September 30, 2016—$ 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, 2017 and December 31, 2016. 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, 2017 and 2016.
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, 2017 and 2016. Items that represent expenses to the Corporation are presented with parenthesis.
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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
PRLP 2011 Holdings LLC
As indicated in Note 23 to the consolidated financial statements, the Corporation holds a 24.9% equity interest in PRLP 2011 Holdings LLC and currently 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, 2017 and December 31, 2016.
Deposits (non-interest bearing)
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 loss from PRLP 2011 Holdings, LLC for the quarters and nine months ended September 30, 2017 and 2016.
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Share of income (loss) from the equity investment in PRLP 2011 Holdings, LLC
During the nine months ended September 30, 2017, the Corporation received $ 1.0 million in capital distributions from its investment in PRLP 2011 Holdings, LLC (September 30, 2016—$ 3.4 million). 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 quarter and nine months ended September 30, 2016.
Interest income on loan to PRLP 2011 Holdings, LLC
PR Asset Portfolio 2013-1 International, LLC
As indicated in Note 23 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 2013-1International, LLC
The Corporation had the following financial condition balances outstanding with PR Asset Portfolio 2013-1 International, LLC, at September 30, 2017 and December 31, 2016.
The Corporation’s proportionate share of income or loss from PR Asset Portfolio2013-1 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 quarters and nine months ended September 30, 2017 and 2016.
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Share of loss from the equity investment in PR Asset Portfolio2013-1 International, LLC
During the nine months ended September 30, 2017, the Corporation received $ 7.1 million in capital distribution from its investment in PR Asset Portfolio 2013-1 International, LLC. No capital distribution was received by the Corporation during the nine months ended September 30, 2016. 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, 2017 and 2016.
Interest income on loan to PR Asset Portfolio 2013-1International, LLC
Centro Financiero BHD León
At September 30, 2017, 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 nine months ended September 30, 2017, the Corporation recorded $ 17.3 million in earnings from its investment in BHD Leon (2016 - $ 18.5 million), which had a carrying amount of $ 129.1 million at September 30, 2017 (December 31, 2016 - $ 125.5 million). As of December 31, 2016 BPPR had extended a credit facility of $ 50 million to BHD León, with an outstanding balance of $ 25 million. This credit facility expired during March 2017. The Corporation received $ 11.8 million in dividend distributions during the nine months ended September 30, 2017 from its investment in BHD Leon (September 30, 2016 - $ 12.1 million).
On June 30, 2017, BPPR extended an $8 million credit facility to Grupo Financiero Leon, S.A. Panamá (“GFL”), a shareholder of BHD Leon. The sources of repayment for this loan are the dividends to be received by GFL from its investment in BHD Leon. BPPR’s credit facility ranks pari passu with another $8 million credit facility extended to GFL by BHD International Panama, an affiliate of BHD Leon.
Puerto Rico Investment Companies
The Corporation provides advisory services to several Puerto Rico investment companies in exchange for a fee. The Corporation also provides administrative, custody and transfer agency services to these investment companies. These fees are calculated at an annual rate of the average net assets of the investment company, as defined in each agreement. Due to its advisory role, the Corporation considers these investment companies as related parties.
For the nine months ended September 30, 2017 administrative fees charged to these investment companies amounted to $ 5.8 million (2016- $ 6.0 million) and waived fees amounted to $ 1.7 million (2016 - $ 2.1 million), for a net fee of $ 4.1 million (2016 - $ 3.9 million).
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The Corporation, through its subsidiary Banco Popular de Puerto Rico, has also entered into lines of credit facilities with these companies. As of September 30, 2017, the available lines of credit facilities amounted to $357 million (December 31 2016—$357 million). The aggregate sum of all outstanding balances under all credit facilities that may be made available by BPPR, from time to time, to those Puerto Rico investment companies for which BPPR acts as investment advisor or co-investment advisor, shall never exceed the lesser of $200 million or 10% of BPPR’s capital.
Other Related Party Transactions
In April 2010, in connection with the acquisition of the Westernbank assets from the FDIC, as receiver, BPPR acquired a term loan to a corporate borrower partially owned by an investment corporation in which the Corporation’s Executive Chairman, at that time the Chief Executive Officer, as well as certain of his family members, hold an ownership interest. At the time the loan was acquired by BPPR, it had an unpaid principal balance of $40.2 million.
In May 2017, this loan was sold by BPPR to Popular, Inc., holding company (“PIHC”). At the time of sale, the loan had an unpaid principal balance of $37.9 million. PIHC paid $37.9 million to BPPR for the loan, of which $6.0 million was recognized by BPPR as a capital contribution representing the difference between the fair value and the book value of the loan at the time of transfer. Immediately upon being acquired by BHC, the loan’s maturity was extended by 90 days (under the same terms as originally contracted) to provide the BHC additional time to evaluate a refinancing or long-term extension of the loan. In August 2017, the credit facility was refinanced with a stated maturity in February 2019. As of September 30, 2017, the unpaid principal balance amounted to $37.7 million.
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Note 25 – 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 from those disclosed in the 2016 Form 10-K.
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, 2017 and December 31, 2016:
RECURRING FAIR VALUE MEASUREMENTS
Investment securitiesavailable-for-sale:
Equity securities
Trading account securities, excluding derivatives:
Mortgage-backed securities—federal agencies
Total trading account securities, excluding derivatives
Total assets measured at fair value on a recurring basis
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 quarters and nine months ended September 30, 2017 and 2016 and excludes nonrecurring fair value measurements of assets no longer outstanding as of the reporting date.
Nine months ended September 30, 2017
NONRECURRING FAIR VALUE MEASUREMENTS
Loans[1]
Other real estate owned[2] [3]
Other foreclosed assets[2]
Total assets measured at fair value on a nonrecurring basis
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Nine months ended September 30, 2016
Other real estate owned[2]
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, 2017 and 2016.
Quarter ended September 30, 2017
Balance at June 30, 2017
Gains (losses) included in earnings
Gains (losses) included in OCI
Settlements
Transfers out of Level 3
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2017
Balance at January 1, 2017
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Quarter ended September 30, 2016
Balance at June 30, 2016
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2016
Balance at January 1, 2016
During the quarter and nine months ended September 30, 2017, certain MBS and CMO’s amounting to $4.2 million and $4.3 million, respectively, were transferred from Level 3 to Level 2 due to a change in valuation technique from an internally-prepared pricing matrix and discounted cash flow model, respectively, to a bond’s theoretical value. 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 quarter and nine months ended September 30, 2016.
Gains and losses (realized and unrealized) included in earnings for the quarters and nine months ended September 30, 2017 and 2016 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:
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Interest income
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.
Weighted average (range)
CMO’s - trading
Other - trading
Loansheld-in-portfolio
Other real estate owned
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.
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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 26 – 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. 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. Many of these estimates involve various assumptions and may vary significantly from amounts that could be realized in actual transactions.
The fair values reflected herein have been determined based on the prevailing rate environment at September 30, 2017 and December 31, 2016, 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. There have been no changes in 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 from those disclosed in the 2016 Form 10-K.
The following tables present the carrying amount and estimated fair values of financial instruments with their corresponding level in the fair value hierarchy. The aggregate fair value amounts of the financial instruments disclosed do not represent management’s estimate of the underlying value of the Corporation.
Financial Assets:
Trading account securities, excluding derivatives[1]
Investment securitiesavailable-for-sale[1]
Investment securitiesheld-to-maturity:
Collateralized mortgage obligation-federal agency
Total investment securitiesheld-to-maturity
Other investment securities:
FHLB stock
FRB stock
Trust preferred securities
Other investments
Total other investment securities
Loansheld-for-sale
Loans not covered under loss sharing agreement with the FDIC
Loans covered under loss sharing agreements with the FDIC
FDIC loss share asset
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Demand deposits
Time deposits
Other short-term borrowings[2]
Notes payable:
FHLB advances
Unsecured senior debt securities
Junior subordinated deferrable interest debentures (related to trust preferred securities)
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Financial Liabilities:
Unsecured senior debt
100
The notional amount of commitments to extend credit at September 30, 2017 and December 31, 2016 is $ 7.3 billion and $ 7.8 billion, respectively, and represents the unused portion of credit facilities granted to customers. The notional amount of letters of credit at September 30, 2017 and December 31, 2016 is $ 34 million and $ 36 million, respectively, and represents the contractual amount that is required to be paid in the event of nonperformance. The fair value of commitments to extend credit and letters of credit, which are based on the fees charged to enter into those agreements, are not material to Popular’s financial statements.
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Note 27 – Net income per common share
The following table sets forth the computation of net income per common share (“EPS”), basic and diluted, for the quarters and nine months ended September 30, 2017 and 2016:
Preferred stock dividends
Net income applicable to common stock
Average common shares outstanding
Average potential dilutive common shares
Average common shares outstanding— assuming dilution
Basic EPS
Diluted EPS
As disclosed in Note 19, during the quarter ended March 31, 2017, the Corporation completed a $75 million privately negotiated accelerated share repurchase transaction. As part of this transaction, the Corporation entered into a forward contract in which the final number of shares delivered at settlement was based on the average daily volume weighted average price (“VWAP”) of its common stock, net of a discount, during the term of the ASR. Based on the discounted VWAP of $40.60, the Corporation received 1,847,372 shares of its outstanding common stock.
For the quarter and nine months ended September 30, 2017, the Corporation calculated the impact of potential dilutive common shares under the treasury method, consistent with the method used for the preparation of the financial statements for the year ended December 31, 2016. For a discussion of the calculation under the treasury stock method, refer to Note 35 of the consolidated financial statements included in the 2016 Form 10-K.
For the quarters and nine months ended September 30, 2017 and 2016, there were no stock options outstanding.
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Note 28 – 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
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Note 29 – FDIC loss share expense
The caption of FDIC loss-share expense in the consolidated statements of operations consists of the following major categories:
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 expense
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Note 30 – 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:
Interest cost
Expected return on plan assets
Amortization of net loss
Total net periodic pension cost (benefit)
Interest Cost
During the quarter ended September 30, 2017 the Corporation made a contribution to the pension and benefit restoration plans of $16.1 million. The total contributions expected to be paid during the year 2017 for the pension and benefit restoration plans amount to approximately $16.2 million.
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
Amortization of prior service cost
Total net periodic postretirement benefit cost
Contributions made to the postretirement benefit plan for the quarter ended September 30, 2017 amounted to approximately $1.4 million. The total contributions expected to be paid during the year 2017 for the postretirement benefit plan amount to approximately $6.4 million.
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Note 31 - Stock-based compensation
Incentive Plan
In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan (the “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 grant (the “graduated vesting portion”) and the second part is vested at termination of employment after attainment of 55 years of age and 10 years of service (the “retirement vesting portion”). The graduated vesting portion 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 or after 2014 was modified as follows, the first part is vested ratably over four years commencing at the date of the grant (the “graduated vesting portion”) and the second part is vested at termination of employment after attainment of the earlier of 55 years of age and 10 years of service or 60 years of age and 5 years of service (the “retirement vesting portion”). The graduated vesting portion 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 following table summarizes the restricted stock and performance shares activity under the Incentive Plan for members of management.
(Not in thousands)
Non-vested at December 31, 2015
Granted
Quantity adjusted by TSR factor
Vested
Forfeited
Non-vested at December 31, 2016
Non-vested at September 30, 2017
During the quarter ended September 30, 2017 and 2016, no shares of restricted stock were awarded to management under the Incentive Plan. For the nine months ended September 30, 2017, 138,516 shares of restricted stock (September 30, 2016 – 279,890) were awarded to management under the Incentive Plan.
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 number of shares that will ultimately vest ranges from 50% to a 150% of target based on both market (TSR) and performance (EPS) conditions. 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. During the quarters ended September 30, 2017 and 2016 no performance shares were granted. For the nine months ended September 30, 2017, 73,684 (September 30, 2016—64,598) performance shares were granted under this plan.
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During the quarter ended September 30, 2017, the Corporation recognized $ 1.0 million of restricted stock expense related to management incentive awards, with a tax benefit of $ 0.2 million (September 30, 2016—$ 1.0 million, with a tax benefit of $ 0.2 million). For the nine months ended September 30, 2017, the Corporation recognized $ 4.8 million of restricted stock expense related to management incentive awards, with a tax benefit of $ 0.9 million (September 30, 2016—$ 6.6 million, with a tax benefit of $ 1.2 million). For the nine months ended September 30, 2017, the fair market value of the restricted stock vested was $4.4 million at grant date and $6.4 million at vesting date. This triggers a windfall of $0.8 million that was recorded as a reduction on income tax expense. During the quarter ended September 30, 2017 the Corporation recognized $0.3 million of performance shares expense, with a tax benefit of $42 thousand (September 30, 2016—$0.1 million, with a tax benefit of $11 thousand). For the nine months ended September 30, 2017, the Corporation recognized $2.4 million of performance shares expense, with a tax benefit of $0.2 million (September 30, 2016—$1.3 million, with a tax benefit of $0.1 million). The total unrecognized compensation cost related to non-vested restricted stock awards and performance shares to members of management at September 30, 2017 was $ 7.9 million and is expected to be recognized over a weighted-average period of 2.5 years.
The following table summarizes the restricted stock activity under the Incentive Plan for members of the Board of Directors:
During the quarters ended September 30, 2017 and 2016, the Corporation granted no shares of restricted stock to members of the Board of Directors of Popular, Inc. During this period, the Corporation recognized $0.3 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $39 thousand (September 30, 2016—$0.3 million, with a tax benefit of $31 thousand). For the nine months ended September 30, 2017, the Corporation granted 25,771 shares of restricted stock to members of the Board of Directors of Popular, Inc., which became vested at grant date (September 30, 2016 – 40,517). During this period, the Corporation recognized $ 1.0 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $0.1 million (September 30, 2016 - $0.8 million, with a tax benefit of $84 thousand). The fair value at vesting date of the restricted stock vested during the nine months ended September 30, 2017 for directors was $ 1.0 million.
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Note 32 – 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
Difference in tax rates due to multiple jurisdictions
Effect of income subject to preferential tax rate
Unrecognized tax benefits
State and local taxes
Income tax benefit amounted to $20 million for the quarter ended September 30, 2017, compared with an income tax expense of $15.8 million for the same quarter of 2016. The reduction in income tax expense was primarily due to lower taxable income before tax and higher tax benefit on net exempt interest income.
For the nine months period ended September 30,2017, income tax expense amounted to $48.8 million compared to $80.5 million for the nine months period ended September 30,2016. The reduction in income tax expense was primarily due to lower income before tax and higher tax benefit on net exempt interest income.
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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 (loss) gains
Difference between the assigned values and the tax basis of assets and liabilities recognized in purchase business combinations
Other temporary differences
Total gross deferred tax assets
Deferred tax liabilities:
FDIC-assisted transaction
Indefinite-lived intangibles
Unrealized net gain on trading andavailable-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, 2017 is reflected in the consolidated statements of financial condition as $1.2 billion in net deferred tax assets in the “Other assets” caption (December 31, 2016—$1.2 billion) and $1.4 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2016—$1.4 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation in their respective tax jurisdiction, Puerto Rico or the United States.
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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 andtax-planning strategies.
At September 30, 2017 the net deferred tax asset of the U.S. operations amounted to $1.1 billion with a valuation allowance of approximately $616 million, for a net deferred tax asset of approximately $519 million. As of September 30, 2017, management estimated that the U.S. operations would earn enough pre-tax Income during the carryover period to realize the total amount of net deferred tax asset after valuation allowance. After weighting all available positive and negative evidence, management concluded that is more likely than not that a portion of the deferred tax asset from the U.S. operation, amounting to approximately $519 million, will be realized. Management will continue to evaluate the realization of the deferred tax asset each quarter and adjust as any changes arises.
At September 30, 2017, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $687 million.
The Corporation’s Puerto Rico Banking operation is not in a cumulative three year loss position and has sustained profitability for the three year period ended September 30, 2017. 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 Popular, Inc., holding company (“PIHC”) operation is in a cumulative loss position taking into account taxable income exclusive of reversing temporary differences, for the three year period ended September 30, 2017. Management expects these losses will be a trend in future years. This objectively verifiable negative evidence is considered by management as 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 PIHC 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 PIHC, which amounted to $62 million as of September 30, 2017.
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The reconciliation of unrecognized tax benefits, excluding interest, was as follows:
(In millions)
Balance at January 1
Additions for tax positions - January through March
Additions for tax positions taken in prior years - January through March
Balance at March 31
Additions for tax positions - April through June
Reduction as a result of settlements - April through June
Balance at June 30
Additions for tax positions - July through September
Additions for tax positions taken in prior years - July through September
Reduction as a result of lapse of statute of limitations - July through September
Balance at September 30
At September 30, 2017, the total amount of interest recognized in the statement of financial condition approximated $2.6 million (December 31, 2016—$2.9 million). The total interest expense recognized at September 30, 2017 was $458 thousand net of a reduction of $505 thousand due to settlement and $353 thousand due to the expiration of the statute of limitation (December 31, 2016—$1.2 million). Management determined that at September 30, 2017 and December 31, 2016 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 $8.5 million at September 30, 2017 (December 31, 2016—$9.0 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.
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, 2017, the following years remain subject to examination in the U.S. Federal jurisdiction: 2014 and thereafter; and in the Puerto Rico jurisdiction, 2013 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 $4.5 million.
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Note 33 – 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, 2017 and September 30, 2016 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
Financed sales of other real estate assets
Financed sales of other foreclosed assets
Total financed sales of foreclosed assets
Transfers from loans held-for-sale to loans held-in-portfolio
Loans securitized into investment securities[1]
Trades payable to brokers and counterparties
Recognition of mortgage servicing rights on securitizations or asset transfers
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Note 34 – 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.
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, 2017, 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, Inc., 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, Inc. supported BPNA’s deposit gathering through its online platform until March 31, 2017, when said operations were transferred to Popular Direct, a division of BPNA. 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, Leon. The Corporate group also includes the expenses of certain corporate areas that are identified as critical to the organization: Finance, Risk Management and Legal.
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.
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The tables that follow present the results of operations and total assets by reportable segments:
Non-interest income
Depreciation expense
Net income (loss)
Segment assets
Net interest income (expense)
Income tax expense (benefit)
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Provision (reversal) for loan losses
115
Additional disclosures with respect to the Banco Popular de Puerto Rico reportable segment are as follows:
116
Non-interest (expense) income
117
Geographic Information
(in thousands)
Revenues:
United States
Total consolidated revenues
Selected Balance Sheet Information:
Deposits [1]
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Note 35 – 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, 2017 and December 31, 2016, and the results of their operations and cash flows for periods ended September 30, 2017 and 2016.
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., andE-LOAN, Inc.
PIHC fully and unconditionally guarantees all registered debt securities issued by PNA.
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Condensed Consolidating Statement of Financial Condition (Unaudited)
Trading account securities, at fair value
Investment securitiesavailable-for-sale, at fair value
Investment securitiesheld-to-maturity, at amortized cost
Other investment securities, at lower of cost or realizable value
Investment in subsidiaries
Less - Unearned income
Retained earnings (accumulated deficit)
Treasury stock, at cost
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Condensed Consolidating Statement of Operations (Unaudited)
Interest and dividend income:
Dividend income from subsidiaries
Total interest and dividend income
Provision for loan losses- non-covered loans
Provision for loan losses- covered loans
Net interest income (expense) after provision for loan losses
Other service fees
Trading account profit
Net loss on sale of loans, including valuation adjustments on loansheld-for-sale
FDIC loss-share expense
Income (loss) before income tax and equity in earnings (losses) of subsidiaries
Income (loss) before equity in earnings (losses) of subsidiaries
Equity in undistributed earnings (losses) of subsidiaries
Net Income (Loss)
Comprehensive income (loss), net of tax
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Net gain on sale of loans, including valuation adjustments on loansheld-for-sale
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
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Provision (reversal) for loan losses- non-coveredloans
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Provision (reversal) for loan losses- covered loans
Other-than temporary impairment losses on investment securities
Other operating income (loss)
Total non-interest income (expense)
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Condensed Consolidating Statement of Cash Flows (Unaudited)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in earnings of subsidiaries, net of dividends or distributions
Deferred income tax (benefit) expense
(Gain) loss on:
Sale of loans, including valuation adjustments on loans held for sale and mortgage banking activities
Net (increase) decrease in:
Pension and other postretirement benefits obligations
Net cash provided by (used in) operating activities
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Net decrease (increase) in money market investments
Available for sale
Net repayments (disbursements) on loans
Acquisition of trademark
Capital contribution to subsidiary
Return of capital from wholly-owned subsidiaries
Net cash (used in) provided by investing activities
Dividends paid to parent company
Return of capital to parent company
Capital contribution from parent
Net cash (used in) provided by financing activities
Net (decrease) increase in cash and due from banks
Cash and due from banks at end of period
During the nine months ended September 30, 2017 there have not been any cash flows associated with discontinued operations.
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(Earnings) losses from investments under the equity method
Deferred income tax expense (benefit)
Net (increase) decrease in money market investments
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Net decrease in cash and due from banks
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, mortgage, 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. The Corporation’s mortgage origination business is conducted under the brand name Popular Mortgage, a division of BPPR. In the U.S. mainland, the Corporation operates Banco Popular North America (“BPNA”). The BPNA franchise operates under the name Popular Community Bank (“PCB”). BPNA focuses efforts and resources on the core community banking business. BPNA operates branches in New York, New Jersey and Southern Florida. Note 34 to the Consolidated Financial Statements presents information about the Corporation’s business segments.
The Corporation has several investments which it accounts for under the equity method. As of September 30, 2017, the Corporation had a 16.10% 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, 2017, the Corporation recorded $ 1.6 million in earnings from its investment in EVERTEC, which had a carrying amount of $ 46 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, 2017, the Corporation recorded $5.5 million in earnings from its investment in BHD Leon, which had a carrying amount of $129 million, as of the end of the quarter.
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HURRICANES IRMA AND MARIA
Prior to the hurricanes, the Corporation had implemented its business continuity action program. Although the Corporation’s business critical systems experienced minimal outages as a result of the storms, the Corporation’s physical operations in Puerto Rico, the USVI and the BVI, including its branch and ATM networks, were materially disrupted by the storms mostly due to lack of electricity and communication as well as limited accessibility. As of November 7, 2017, 85% of BPPR’s bank branches were open and 69% of ATMs were operating. Reconstruction of the island’s electric infrastructure and restoration of the telecommunications network remain the most critical challenges for Puerto Rico’s recovery from the hurricanes.
After the hurricanes, Popular has worked diligently to provide service to the Puerto Rico and Virgin Islands markets, including reopening retail locations and providing assistance to the communities it serves. A priority for Popular has been to maintain cash in its branches and ATM’s and to mobilize its workforce to ensure continuity of service to its customers and that of other financial institutions. Popular has implemented several initiatives to provide assistance to individuals and businesses impacted by the hurricanes. Actions taken by Popular, directly or through its affiliated P.R. and U.S.-based foundations, include:
Payment Moratoriums. Payment moratoriums for eligible customers of up to three months in mortgage, consumer, auto and commercial loans, subject to certain terms and conditions.
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Fee Waivers. The waiver of certain fees and service charges, including late-payment charges and ATM transaction fees in hurricane-affected areas.
Employee Relief. Popular increased the Employee Relief Fund to $750,000 to assist affected employees. Popular also assisted employees by providing means to obtain water, food and other supplies, child care services, orientation on how to submit claims to the Federal Emergency Management Agency (“FEMA”) and other special offers.
Other Charitable Initiatives. The Corporation’s philanthropic arms, Fundación Banco Popular and the Popular Community Bank Foundation, launched relief efforts for the victims of hurricane Irma and Maria, through the “Embracing Puerto Rico” and “Embracing the Islands” campaigns, to which Popular has donated $1.1 million. As needs unfold, the Foundations are expected to direct funding to address immediate and long-term needs arising from the impact of the hurricanes. Popular also contributed to “Unidos por Puerto Rico”, a fundraising campaign spearheaded by Puerto Rico’s First Lady and was one of two sponsors of the “Somos Una Voz” concert that has raised over $35 million for earthquake victims in Mexico and hurricane victims in Texas, Florida, Puerto Rico and the Caribbean. Fundación Banco Popular is leveraging the relationships it has developed with non-profit organizations and community leaders throughout its almost 40-year history, delivering assistance directly to those who need it most.
Financial impact of the hurricanes
During the third quarter of 2017, the Corporation recorded $79.4 million in pre-tax hurricane-related expenses, including an incremental provision for loan losses of $69.9 million. These amounts are net of amounts receivable for related insurance claims of $7.5 million related to physical damages to the Corporation’s premises, equipment and other real estate owned (“OREO”).
In addition to the incremental provision and direct operating expenses, results for the three months ended September 30, 2017 were impacted by the hurricanes in the form of a reduction in revenue resulting from reduced merchant transaction activity, the waiver of certain late fees and service charges, including ATM transaction fees, to businesses and consumers in hurricane-affected areas, as well as the economic and operational disruption in the Corporation’s mortgage origination, servicing and loss mitigation activities due to the hurricanes’ operational and economic impact. These revenue captions reflect approximately $11 million in lower income when compared to the previous quarter, primarily driven by the disruption in our operations over the last 10 days of the quarter.
The impact on transactional and collection based revenues has continued into the fourth quarter and the amount will depend on the speed at which electricity, telecommunications and general merchant services can be restored across the region.
Hurricanes impact on loan delinquencies
As noted in Note 8 to the accompanying Financial Statements, due to the disruptions caused by Hurricanes Irma and Maria, the Corporation’s payment channels, collection efforts and loss mitigation operations were interrupted and mainly unavailable for the last 10 days of the quarter. This disruption contributed to an increase in the level of loan delinquencies as of September 30, 2017, as detailed in following schedule:
Commercial and construction
The disruption in payment channels, particularly our branch network, contributed to the spike in mortgage loans past due 30-89 days. Traditionally, one third of mortgage loan payments are made by our clients directly at our branches, many of which were unavailable for the last 10 days of the quarter. While the aggregate unpaid principal balance of mortgage loans past due 30-89 days increased by approximately $346.7 million at September 30, 2017 when compared to June 30, 2017, borrowers of loans with an aggregate approximate unpaid principal balance of $304.2 million, recorded as 30-89 past due at September 30, 2017, returned to current status as of the end of October. These borrowers made their September loan payments during the month of October and either also made their scheduled October payment or benefited from the loan payment moratorium extended by Popular.
We expect the hurricanes to continue to impact the Corporation’s earnings for the quarter ending December 31, 2017 and future periods. For additional information of the financial impact associated with the hurricanes, refer to Note 2 to the accompanying Financial Statements. Also, refer to the Net Interest Income, Non-Interest Income, Operating Expenses and Credit Quality sections in this MD&A for additional discussions of the impact of the hurricanes in the Corporation’s financial statements.
OVERVIEW
Table 1 provides selected financial data and performance indicators for the quarters and nine months ended September 30, 2017 and 2016.
Adjusted results of operations – Non-GAAP financial measure
Adjusted net income
The Corporation prepares its Consolidated Financial Statements using accounting principles generally accepted in the United States (“U.S. GAAP” or the “reported basis”). In addition to analyzing the Corporation’s results on a reported basis, management monitors “Adjusted net income” of the Corporation and excludes the impact of certain transactions on the results of its operations. Adjusted net income is a non-GAAP financial measure. Management believes that Adjusted net income provides meaningful information about the underlying performance of the Corporation’s ongoing operations.
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For the quarter and nine months ended September 30, 2017, there were no adjustments identified by management to arrive at an Adjusted net income presentation. Refer to Tables 36 and 37 for a reconciliation of the reported results to the Adjusted net income for the quarter and nine months ended September 30, 2016.
Net interest income on a taxable equivalent basis
Net interest income, on a taxable equivalent basis, is presented with its different components in Tables 2 and 3 for the quarter and nine months ended September 30, 2017 as compared with the same period in 2016, 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 municipalities 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.
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, 2017
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As a financial services company, the Corporation’s earnings are significantly affected by general business and economic conditions in the markets which we serve. 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.
Hurricanes Irma and Maria have had and continue to have an impact on the people and communities in which the Corporation does business. The Corporation will continue to monitor the effects of these hurricanes on its operations and clients. Popular, as the leading financial institution in Puerto Rico, is committed to partnering with our neighbors and communities to aid in the rebuilding process.
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 2016 Form 10-K, 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. Also, refer to Item 1A—Risk Factors, of this Form10-Q for additional information.
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
Borrowings
Stockholders’ equity
Liabilities from discontinued operations
Operating Highlights
Operating expenses
Net income per Common Share – Basic
Net income per Common Share – Diluted
Dividends declared per common share – Basic
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
Net interest spread(taxable equivalent) - Non-GAAP
Net interest margin
Net interest margin (taxable equivalent) -Non-GAAP
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Capitalization Ratios
Average equity to average assets
Common equity Tier 1 capital
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 2016 Form 10-K. Also, refer to Note 2 to the Consolidated Financial Statements included in the 2016 Form 10-K for a summary of the Corporation’s significant accounting policies.
During the third quarter of 2017, the Corporation performed the annual goodwill impairment evaluation for the entire organization using July 31, 2017 as the annual evaluation date and determined that there was no indication of impairment on recorded goodwill. For additional information on the results of the goodwill impairment analysis, refer to Note 15.
OPERATING RESULTS ANALYSIS
NET INTEREST INCOME
Net interest income was $378.2 million for the third quarter of 2017, an increase of $24.5 million when compared to $353.7 million for the same quarter of 2016. Taxable equivalent net interest income was $406.6 million for the third quarter of 2017, an increase of $31.2 million when compared to $375.4 million for the same quarter of 2016. Net interest margin for the third quarter of 2017 was 3.96%, a decrease of 16 basis points when compared to 4.12% for the same quarter of the previous year. Net Interest margin, on a taxable equivalent basis, for the third quarter of 2017 was 4.26%, a decrease of 11 basis points when compared to 4.37% for the same quarter of 2016. The decrease in net interest margin is mostly related to the change in asset mix, due to a higher proportion of money market, investment and trading securities to total earning assets (38% this quarter versus 33% in the third quarter of 2016) as compared to the proportion of loans to earning assets which carry a higher yield. The main reasons for the increase in net interest income are described below:
Positive variances:
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Negative variances:
Interest income for the quarter ended September 30, 2017 included the amortization of deferred loans fees, prepayment penalties, late fees and the amortization of premium/discounts, amounting to $4.7 million, compared to $5.1 million for the same period in 2016.
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Table 2—Analysis of Levels & Yields on a Taxable Equivalent Basis for Continuing Operations (Non-GAAP)
Quarters ended September 30,
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
Other medium and long-term debt
Total interest bearing liabilities
Other sources of funds
Total source of funds
Net interest margin/ income on a taxable equivalent basis(Non-GAAP)
Net interest spread Taxable equivalent adjustment
Net interest margin/ income non-taxable equivalent basis (GAAP)
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.
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Net interest income for the nine months ended September 30, 2017 was $1.1 billion, an increase of $48 million from the same period in 2016. Taxable equivalent net interest income was $1.2 billion for the nine months ended September 30, 2017, an increase of $64.0 million when compared to the same period of 2016. The increase of $16 million on the taxable equivalent adjustment for the period is related to a higher volume of exempt investment securities in the Puerto Rico portfolio. Net interest margin was 4.02%, a decrease of 27 basis points when compared to 4.29% for the same period in 2016. Net interest margin, on a taxable equivalent basis, for the nine months ended September 30, 2017 was 4.31%, a decrease of 24 basis points when compared to the 4.55% for the same period of 2016. The variances in net interest income for the nine-month period are similar to the quarterly variances described above: positive variances in earning assets due to higher volume of investment securities and money markets and continued growth in the commercial portfolio in the U.S. and the leasing portfolio in Puerto Rico. The negative variances were due to lower volumes from WB loans, mortgage and consumer loans due to lower lending activity and the amortization of the portfolios, and the increase in interest expense on deposits due to higher volumes to fund the loan growth in the U.S. and the increase in Puerto Rico government deposits.
Interest income for the nine months ended September 30, 2017 included the amortization of deferred loans fees, prepayment penalties, late fees and the amortization of premium/discounts, amounting to $16.9 million, compared to $13.3 million for the same period in 2016.
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Table 3—Analysis of Levels & Yields on a Taxable Equivalent Basis from Continuing Operations (Non-GAAP)
Nine months ended September 30,
Taxable equivalent adjustment
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Damages associated with Hurricanes Irma and Maria impacted certain of the Corporation’s asset quality measures, including higher delinquencies and non-performing loans. Payment channels, collection efforts and loss mitigation operations were interrupted during the last month of the quarter as a result of the hurricanes. An incremental provision expense of $69.9 million was made to the allowance for loan losses based on management’s best estimate of the impact of the hurricanes on the Corporation’s loan portfolios as of September 30, 2017, and the ability of borrowers to repay their loans, taking into consideration currently available information and the already challenging economic environment in Puerto Rico prior to the hurricanes.
Management has initially estimated that the effects of the hurricanes could result in loan losses in the range of $70 to $160 million. However, since the Corporation’s base allowance for loan losses already incorporated reserves for environmental factors such as unemployment and deterioration in economic activity of approximately $57.9 million, management increased the environmental factors reserve by $64.3 million to $122.2 million using the near mid-range of the loan loss estimates as the best estimate. The $69.9 million provision also includes $5.6 million for the portfolio of purchased credit impaired loans, accounted for under ASC 310-30, for which the estimated cash flows were adjusted to reflect the three-month payment moratoriums offered to certain eligible borrowers, as discussed above. Since there is significant uncertainty with respect to the full extent of the impact due to the unprecedented nature of Hurricane María, the estimate is judgmental and subject to change as conditions evolve. Management will continue to carefully assess and review the exposure of the portfolios to hurricane-related factors, economic trends and their effect on credit quality and the assessment and review could result in further loan loss provisions in future periods.
The Corporation’s total provision for loan losses was $160.8 million for the quarter ended September 30, 2017, compared to $43.3 million for the quarter ended September 30, 2016, an increase of $117.5 million, mainly related to the $69.9 million hurricanes impact and a provision of $37.0 million on the U.S. segment for the taxi medallion portfolio.
The provision for loan losses for the non-covered loan portfolio totaled $157.7 million, compared to $42.6 million for the same quarter in 2016, an increase of $115.1 million, mostly related to the same factors previously described. The incremental provision related to the hurricanes for thenon-covered loans amounted to $66.4 million. Also, total non-covered net charge-offs increased by $17.9 million when compared with the same quarter in 2016, mainly in the mortgage and consumer portfolios at BPPR.
The provision for loan losses for the non-covered loan portfolio at the BPPR segment totaled $115.1 million, compared to $36.3 million for the same quarter in 2016. The increase was mainly related to the previously described hurricanes impact of $66.4 million. Also, net charge-offs reflected an increase of $12.3 million, driven by higher consumer net charge-offs of $14.4 million, in part due to a $7.1 million recovery in the third quarter of 2016 related to the sale of previously charged-off credit cards and personal loans.
The provision for loan losses for the BPNA segment amounted to $42.5 million, compared to $6.3 million for the same quarter in 2016. The provision increase of $36.2 million was mainly due to a provision of $37.0 million for the taxi medallion portfolio acquired from the FDIC in the Doral Bank transaction, accounted under ASC 310-30. As of September 30, 2017, the taxi medallion portfolio had an unpaid principal balance of $233 million. Net of reserves, the carrying value of this portfolio is $93 million or approximately 40% of its unpaid principal balance, representing less than 1% of the Corporation’s total loan portfolio. This portfolio is mainly concentrated in New York City, which accounts for 95% of the portfolio balance, with an average carrying loan value of $261 thousand per medallion. Credit trends at BPNA continued to be favorable, excluding the taxi medallions portfolio, with low levels ofnon-performing loans and net charge-offs. Net charge-offs remain stable when compared to the quarter ended September 30, 2016, reflecting a slight increase of $5.5 million.
For the third quarter of 2017, the covered loan portfolio reflected a provision expense of $3.1 million, compared to $750 thousand provision for the same quarter in 2016. This increase was mainly due to adjustments in the estimated cash flows of purchased credit impaired loans accounted for under ASC 310-10 to reflect the three-month payment moratoriums offered to certain eligible borrowers.
For the nine months ended September 30, 2017, the Corporation’s total provision for loan losses totaled $253.9 million, compared with $128.7 million for the same period in 2016, increasing by $125.2 million. For the nine months ended September 30, 2017, the provision for loan losses for thenon-covered loan portfolio increased by $119.5 million when compared to the same period of 2016. The provision for the covered portfolio increased by $5.8 million for the nine months ended September 30, 2017, when compared to the same period of 2016. The increase in provision was mostly driven by the hurricanes and the taxi medallion impacts, as previously described.
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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
Non-interest income increased by $24.4 million for the quarter ended September 30, 2017, compared with the same quarter of the previous year. The increase in non-interest income was principally due to:
This increase was partially offset by:
Non-interest income increased by $34.9 million for the nine months ended September 30, 2017, compared with the same period of the previous year. The increase in non-interest income was due to:
These favorable variances were partially offset by:
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The following table provides a summary of the revenues and expenses derived from the assets acquired in the Westernbank FDIC-assisted transaction during the quarters and nine months ended September 30, 2017 and 2016.
Table 4—Financial Information—Westernbank FDIC-Assisted Transaction
Interest income on WB Loans
FDIC loss-share expense:
Accretion (amortization) of loss-share indemnification asset
Arbitration award expense[2]
Total revenues
Provision (reversal of provision) for loan losses
Total revenues less provision (reversal of provision) for loan losses
Average balances
Operating expenses decreased by $6.6 million for the quarter ended September 30, 2017, compared with the same quarter of the previous year. Refer to Table 5 for a breakdown of operating expenses by major categories. The decrease in operating expenses was driven primarily by:
These decreases were partially offset by:
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Operating expenses increased by $0.5 million for the nine months ended September 30, 2017, when compared to the same period in 2016. The increase in operating expenses was driven primarily by:
These increases were partially offset by:
Table 5—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
Legal fees, excluding collections
Other professional fees
Total professional fees
Other operating expenses:
Credit and debit card processing, volume and interchange expenses
Operational losses
All other
Total other operating expenses
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INCOME TAXES
For the quarter ended September 30, 2017, the Corporation recorded income tax benefit of $20.0 million, compared to an income tax expense of $15.8 million for the same quarter of the previous year. The income tax benefit for the quarter reflects the impact of the losses related to the hurricanes, which result in a reduction of taxable income and the related effective tax rate in our Puerto Rico operations, as the level of exempt income increases in proportion to the Corporation’s taxable income.
On November 2, 2017, the House Ways and Means Committee unveiled a bill to reform the U.S. tax code. If the Tax Cuts and Jobs Act (H.R. 1) is enacted as currently proposed, the U.S. corporate tax rate will be reduced from the current 35% to 20%. This reduction would result in a reduction of the deferred tax asset and the valuation allowance pertaining to the U.S. operations with a net impact to income tax expense. If such change had occurred as of September 30, 2017, the Corporation would have recognized a one time income tax expense of approximately $190 million. This reduction in the tax rate will also result in the decrease of the effective tax rate of the Corporation in future periods. The future impact in earnings of the lower tax rate will depend on the sources and mix of the income earned in future periods. The Corporation expects that the changes to the U.S. corporate income tax rate, as currently proposed, will not have a material impact on the total deferred tax asset and the effective tax rate of the Puerto Rico operations.
The reduction in the deferred tax asset of the U.S. operations, as a result of the lower U.S. corporate income tax rate, would not have a significant impact on regulatory capital of the Corporation, since substantially all of U.S. deferred tax asset, net of the valuation allowance, is deducted from the regulatory capital calculation.
At September 30, 2017, Popular had a tangible book value per common share of $44.79. The deferred tax asset of the P.R. operations and the U.S. operations amounted to $6.73 and $5.09 of the total tangible book value per share, respectively.
Refer to Note 32 to the Consolidated Financial Statements for a reconciliation of the statutory income tax rate to the effective tax rate and additional information on income taxes.
REPORTABLE SEGMENT RESULTS
The Corporation’s reportable segments for managerial reporting purposes consist of Banco Popular de Puerto Rico and Banco Popular North America. A Corporate group has been defined to support the reportable segments. For managerial reporting purposes, the costs incurred by the Corporate group are not allocated to the reportable segments.
For a description of the Corporation’s reportable segments, including additional financial information and the underlying management accounting process, refer to Note 34 to the Consolidated Financial Statements.
The Corporate group reported a net loss of $17.9 million for the quarter ended September 30, 2017, compared with a net loss of $12.1 million for the same quarter of the previous year. The change was mostly driven by lower income from equity method investments and higher other operating expenses due to a reserve release recorded in the third quarter of 2016, partially offset by a higher income tax benefit. For the nine months ended September 30, 2017, the Corporate group reported a net loss of $48.8 million, compared with a net loss of $46.8 million for the same period of the previous year. The unfavorable variance was mainly driven by higher other operating expenses, partially offset by higher income from equity method investments.
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 $44.3 million for the quarter ended September 30, 2017, compared with net income of $49.6 million for the same quarter of the previous year. The principal factors that contributed to the variance in the financial results included the following:
Partially offset by:
The net interest margin was 4.28% for the quarter ended September 30, 2017, compared to 4.49% for the same period in 2016.
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Net income for the nine months ended September 30, 2017 amounted to $236.0 million, compared to $233.7 million for the same period of the previous year. The principal factors that contributed to the variance in the financial results included the following:
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For the quarter ended September 30, 2017, the reportable segment of Banco Popular North America reported a net loss of $6.1 million, compared to net income of $9.2 million for the same quarter of the previous year. The factors that contributed to the variance in the financial results included the following:
Net interest margin was 3.50% for the third quarter of 2017, compared to 3.61% for the same period of the previous year.
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Net income for the nine months ended September 30, 2017 amounted to $18.8 million, compared to $33.4 million for the same period of the previous year. The main factors that contributed to the variance in the financial results included the following:
FINANCIAL CONDITION ANALYSIS
The Corporation’s total assets were $42.6 billion at September 30, 2017, compared to $38.7 billion at December 31, 2016. Refer to the Consolidated Statements of Financial Condition included in this report.
Money market investments, trading and investment securities
Money market investments totaled $5.5 billion at September 30, 2017, compared to $2.9 billion at December 31, 2016. The increase was mainly at BPPR due to higher liquidity driven by an increase in deposits.
Trading account securities amounted to $46 million at September 30, 2017, compared to $60 million at December 31, 2016. 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 $9.2 billion at September 30, 2017, compared with $8.3 billion at December 31, 2016. The increase of $0.9 billion was mainly at BPPR due to purchases of U.S. Treasury securities and mortgage-backed agency pools driven by an increase in funds available to invest from increased liquidity, as discussed above.
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Table 6 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 6 and 7 to the Consolidated Financial Statements provide additional information with respect to the Corporation’s investment securities AFS and HTM.
Table 6—Breakdown of Investment Securities Available-for-Sale and Held-to-Maturity
Total investment securities AFS and HTM
Refer to Table 7 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 7. The risks on covered loans are significantly different as a result of the loss protection provided by the FDIC. 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 loans. As of September 30, 2017, the Corporation’s covered loans portfolio amounted to $525 million, comprised mainly of residential mortgage loans.
The Corporation’s total loan portfolio amounted to $ 23.8 billion at September 30, 2017, compared to $23.4 billion at December 31, 2016. Refer to Note 8 for detailed information about the Corporation’s loan portfolio composition and loan purchases and sales.
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Table 7—Loans Ending Balances
Loans not covered under FDIC loss sharing agreements:
Legacy[1]
Lease financing
Loans covered under FDIC loss sharing agreements:
Loansheld-for-sale:
Total loansheld-for-sale
The non-covered loans held-in-portfolioincreased by $400 million to $ 23.2 billion at September 30, 2017. The net increase was mainly driven by the growth of commercial loans at BPNA.
The loans held-for-sale portfolio decreased by $20 million from December 31, 2016, mainly at BPPR due to lower originations of mortgage loans held-for-sale.
The covered loans portfolio amounted to $525 million at September 30, 2017, compared to $573 million at December 31, 2016. The decrease of $48 million is due to normal portfolio run-off. Refer to Table 7 for a breakdown of the covered loans by major loan type categories.
Tables 8 and 9 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 changes in cash flow expectations on the loan pool based on quarterly revisions of the portfolio. An increase in the accretable discount is recognized as interest income using the effective yield method over the estimated life of each applicable loan pool.
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Table 8—Activity in the Carrying Amount of Westernbank Loans Accounted for Under ASC 310-30
Allowance for loan losses (ALLL)
Table 9—Activity in the Accretable Yield on Westernbank Loans Accounted for Under ASC 310-30
Accretion[1]
Table 10 sets forth the activity in the FDIC loss share asset for the quarters and nine months ended September 30, 2017 and 2016.
Table 10 – 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. The Corporation revises its expected cash flows and estimated credit losses on a quarterly basis. 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 reduced to the expected reimbursement amount from the FDIC (amortization). In contrast, an increase tonon-interest income is recognized as a result of increases in expected reimbursements due to higher loss estimates (accretion). Table 11 presents the activity associated with the outstanding balance of the FDIC loss share asset accretion (amortization) for the periods presented.
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Table 11—Activity in the Remaining FDIC Loss-Share Asset Accretion (Amortization)
Balance at beginning of period[1]
Accretion (amortization)[2]
Impact of change in projected losses
Other real estate owned represents real estate property received in satisfaction of debt. At September 30, 2017, OREO decreased to $198 million from $213 million at December 31, 2016 mainly due to a decrease in residential properties at BPPR and the write-down of $2.7 million for damages associated with Hurricane Maria. Refer to Note 13 to the Consolidated Financial Statements for the activity in other real estate owned. The amounts included as “covered other real estate” are subject to the FDIC loss sharing agreements.
Refer to Note 14 for a breakdown of the principal categories that comprise the caption of “Other Assets” in the consolidated statements of financial condition at September 30, 2017 and December 31, 2016. Other assets increased by $0.2 billion from December 31, 2016 to September 30, 2017, mainly driven by an increase in accounts receivable related to maturities of U.S. Treasury securities pending to be settled.
The Corporation’s total liabilities were $37.3 billion at September 30, 2017 compared to $33.5 billion at December 31, 2016. Refer to the Corporation’s Consolidated Statements of Financial Condition included in this Form10-Q.
Deposits and Borrowings
The composition of the Corporation’s financing sources to total assets at September 30, 2017 and December 31, 2016 is included in Table 12.
Table 12—Financing to Total Assets
September 30,
Non-interest bearing deposits
Interest-bearing core deposits
Other interest-bearing deposits
N.M.—Not meaningful.
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The Corporation’s deposits totaled $34.2 billion at September 30, 2017 compared to $30.5 billion at December 31, 2016. The deposits increase of $3.8 billion was mainly due to an increase in commercial savings and NOW deposits and demand deposits from the Puerto Rico public sector at BPPR. Refer to Table 13 for a breakdown of the Corporation’s deposits at September 30, 2017 and December 31, 2016.
Table 13—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 remained flat at $2.1 billion at September 30, 2017 and December 31, 2016. Refer to Note 17 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.
Stockholders’ Equity
Stockholders’ equity totaled $5.3 billion at September 30, 2017, compared with $5.2 billion at December 31, 2016. The increase was related to the Corporation’s net income of $209.8 million for the nine months ended September 30, 2017 and a decrease in accumulated other comprehensive loss by $29.0 million in part due to the reclassification to earnings of the entire unrealized loss of the COFINA bonds which was deemed other-than-temporary, partially offset by the declaration of dividends of $ 76.6 million on common stock ($0.25 per share) and $ 2.8 million on preferred stock and the impact of the common stock repurchase plan of $75 million completed during the first quarter of 2017. 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
The Corporation, BPPR and BPNA are subject to regulatory capital requirements established by the Federal Reserve Board. The current risk-based capital standards applicable to the Corporation, BPPR and BPNA (“Basel III capital rules”), which have been effective since January 1, 2015, are based on the final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision. As of September 30, 2017, the Corporation’s, BPPR’s and BPNA’s capital ratios continue to exceed the minimum requirements for being “well-capitalized” under the Basel III capital rules.
The risk-based capital ratios presented in Table 14, which include common equity tier 1, Tier 1 capital, total capital and leverage capital as of September 30, 2017 and December 31, 2016, are calculated based on the Basel III capital rules related to the measurement of capital, risk-weighted assets and average assets.
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Table 14 — 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:
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:
The Basel III capital rules provide that a depository institution will be deemed to be well capitalized 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, 2017, the Corporation, BPPR and BPNA continue to exceed the minimum requirements for being “well-capitalized” under the Basel III capital rules.
The increase in the common equity tier I capital ratio, tier I capital ratio and total capital ratio as of September 30, 2017 as compared to December 31, 2016 was mainly attributed to the nine months period earnings, partially offset by the common stock repurchase of $75 million completed during the first quarter of 2017, the payment of dividends on common and preferred stock and the transition period impact on deferred tax assets. The decrease in the leverage ratio was mainly attributed to the increase in average total assets. Refer to Table 1, Financial Condition Highlights, for information of average assets and to the Financial Condition Analysis section of this MD&A for a discussion of significant variances in assets.
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 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 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.
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Table 15 provides a reconciliation of total stockholders’ equity to tangible common equity and total assets to tangible assets as of September 30, 2017, and December 31, 2016.
Table 15 — Reconciliation of Tangible Common Equity and Tangible Assets
(In thousands, except share or per share information)
Less: Preferred stock
Common shares outstanding at end of period
Common equity per share
Less: Goodwill
Less: Other intangibles
Total tangible common equity
Total tangible assets
Tangible common equity to tangible assets
Tangible book value per common share
OFF-BALANCE SHEET ARRANGEMENTS AND OTHER COMMITMENTS
In the ordinary course of business, the Corporation engages in financial transactions that are not recorded on the balance sheet, or may be recorded on the balance sheet in amounts that are different than the full contract or notional amount of the transaction. As a provider of financial services, the Corporation routinely enters into commitments with off-balancesheet risk to meet the financial needs of its customers. These commitments may include loan commitments and standby letters of credit. These commitments are subject to the same credit policies and approval process used for on-balance sheet instruments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position. Other types of off-balance sheet arrangements that the Corporation enters in the ordinary course of business include derivatives, operating leases and provision of guarantees, indemnifications, and representation and warranties. Refer to Note 21 for a detailed discussion related to the Corporation’s obligations under credit recourse and representation and warranties arrangements.
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, 2017, 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 $160 million at September 30, 2017 of which approximately 30% mature in 2017, 33% in 2018, 21% in 2019 and 16% thereafter.
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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 17 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 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 16 presents the contractual amounts related to the Corporation’s off-balance sheet lending and other activities at September 30, 2017.
Table 16 — Off-Balance Sheet Lending and Other Activities
Commitments to extend credit
At September 30, 2017 and December 31, 2016, the Corporation maintained a reserve of approximately $9 million 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 22 to the Consolidated Financial Statements for additional information on credit commitments and contingencies.
RISK MANAGEMENT
Managing risk is an essential component of the Corporation’s business. Risk identification and monitoring are key elements in the overall risk management. Popular has a strong disciplined risk management culture where risk management is a shared responsibility by all employees.
Risk Management Framework
Popular’s risk management framework seeks to ensure that there is an effective process in place to manage risk across the organization. Popular’s risk management framework incorporates three interconnected dependencies: risk appetite, stress testing, and capital planning. The stress testing process incorporates key risks within the context of the Risk Appetite Statement (RAS)
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defined in our Risk Management Policy. The process analyzes and delineates how much risk Popular is prepared to assume in pursuit of its business strategy and how much capital Popular’s activities will consume in light of a forward-looking assessment of the potential impact of adverse economic conditions. The RAS includes risk tolerance, limits, and types of risks the Corporation is willing to accept, as well as processes to maintain compliance with those limits.
Principal Risk Types
Risk Governance
The Corporation’s Board of Directors (the “Board”) has established a Risk Management Committee (“RMC”) to undertake the responsibilities of overseeing and approving the Corporation’s Risk Management Program, as well as the Corporation’s Capital Plan. The Capital Plan is a plan to maintain sufficient regulatory capital at the Corporation, BPPR and BPNA, which considers current and future regulatory capital requirements, expected future profitability and credit trends and, at least, two macroeconomic scenarios, including a base and stress scenario.
The RMC, as an oversight body, monitors and approves corporate policies to identify measure, monitor and control risks while maintaining the effectiveness and efficiency of the business and operational processes. As an approval body for the Corporation, the RMC reviews and approves relevant risk management policies and critical processes. Also, it periodically reports to the Board about its activities.
The Board and RMC have delegated to the Corporation’s management the implementation of the risk management processes. This implementation is split into two separate but coordinated efforts that include (i) business and / or operational units who identify, manage and control the risks resulting from their activities, and (ii) a Risk Management Group (“RMG”). In general, the RMG is mandated with responsibilities such as assessing and reporting to the Corporation’s management and RMC the risk positions of the Corporation; developing and implementing mechanisms, policies and procedures to identify, measure and monitor risks; implementing measurement mechanisms and infrastructure to achieve effective risk monitoring; developing and implementing the necessary management information and reporting mechanisms; and monitoring and testing the adequacy of the Corporation’s policies, strategies and guidelines.
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The RMG is responsible for the overall coordination of risk management efforts throughout the Corporation and is composed of three reporting divisions: (i) Credit Risk Management, (ii) Compliance Management, and (iii) Financial and Operational Risk Management. The latter includes an Enterprise Risk Management function that facilitates, among other aspects, the identification, coordination, and management of multiple and cross-enterprise risks. The Corporation’s Model Validation and Loan Review group, which reports directly to the RMC and administratively to the Chief Risk Officer, also provides important risk management functions by validating critical models used in the Corporation and by assessing the adequacy of the Corporation’s lending risk function.
Additionally, the Internal Auditing Division provides an independent assessment of the Corporation’s internal control structure and related systems and processes. The Internal Audit Division also provides an assessment of the effectiveness of the Corporation’s risk management function.
Moreover, management oversight of the Corporation’s risk-taking and risk management activities is conducted through management committees:
There are other management committees such as the Fair Lending, Section 23A & B, New Products, Fiduciary Risk, and the BSA/Anti-Money Laundering Committees, among others, which provide oversight of specific business risks.
Market / Interest Rate Risk
The financial results and capital levels of the Corporation are constantly exposed to market, interest rate and liquidity risks. The 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 RMC and the ALCO. In addition, the Financial and Operational Risk Management Division is responsible for the independent monitoring and reporting of adherence with established policies to the Risk Management Committee, and enhancing and strengthening controls surrounding interest, liquidity and market risk. The ALCO generally meets 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 risk 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.
Market risk refers to the risk of a reduction in the Corporation’s capital due to changes in the market valuation of its assets and/or liabilities.
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Most of the assets subject to market valuation risk are securities in the investment portfolio classified as available-for-sale. Refer to Notes 6 and 7 for further information on the investment portfolio. Investment securities classified as available-for-sale amounted to $9.1 billion as of September 30, 2017. Other assets subject to market risk include loansheld-for-sale, which amounted to $69 million, mortgage servicing rights (“MSRs”) which amounted to $180 million and securities classified as “trading”, which amounted to $46 million, as of September 30, 2017.
Liabilities subject to market risk include the FDIC clawback obligation, which amounted to $ 167 million at September 30, 2017.
Management believes that market risk is currently not a material source of risk at the Corporation. A significant portion of the Corporation’s financial activities is concentrated in Puerto Rico, which has been going through a fiscal and economic crisis and was recently impacted by two major hurricanes. Refer to the Geographic and Government Risk section of this MD&A for highlights on the current status of Puerto Rico’s fiscal and economic condition.
Interest Rate Risk (“IRR’)
The Corporation’s net interest income is subject to various categories of interest rate risk, including repricing, basis, yield curve and option risks. In managing interest rate risk, management may alter the mix of floating and fixed rate assets and liabilities, change pricing schedules, adjust maturities through sales and purchases of investment securities, and enter into derivative contracts, among other alternatives.
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate rate risk position given line of business forecasts, management objectives, market expectations and policy constraints.
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.
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, and parallel rate 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 independent 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.
The Corporation processes net interest income simulations under interest rate scenarios in which the yield curve is assumed to rise and decline by the same amount. The rate scenarios considered in these market risk simulations reflect parallel changes of -200, +200 and +400 basis points during the succeeding twelve-month period. Simulation analyses are based on many assumptions, including relative levels of market interest rates across all yield curve points and indexes, interest rate spreads, loan prepayments and deposit elasticity. 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 following table presents the results of the simulations at September 30, 2017 and December 31, 2016, assuming a static balance sheet and parallel changes over flat spot rates over aone-year time horizon:
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Table 17—Net Interest Income Sensitivity (One Year Projection)
Change in interest rate
+400 basis points
+200 basis points
-200 basis points
At September 30, 2017, the simulations showed that the Corporation maintains an asset-sensitive position. This is primarily due to (i) a high level of money market investments that are highly sensitive to changes in interest rates, (ii) approximately 31% of the Corporation’s loan portfolio being comprised of Prime and Libor-based loans, and (iii) low elasticity of the Corporation’s core deposit base. The increase in sensitivity from December 31, 2016 in the +200 and +400 scenarios is mainly driven by an increase in money market investments of $2.6 billion, from $2.9 billion at December 31, 2016 to $5.5 billion at September 30, 2017, that was due to growth in public fund deposits that have low sensitivity to changes in rates. The increase in sensitivity in the -200 scenario is also driven by the increase in money market investments that reflect full changes in rates across all scenarios, combined with the increases in the Federal Funds Target Rate in March and June of 2017 by the Federal Reserve, which led to an increase in the magnitude of the -200 basis points scenario.
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 and Popular Securities. Popular Securities’ trading activities consist primarily of market-making activities to meet expected customers’ needs related to its retail 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 are hedged with TBAs that have characteristics similar to that of the forecasted security and its conversion timeline.
At September 30, 2017, the Corporation held trading securities with a fair value of $46 million, representing approximately 0.1% of the Corporation’s total assets, compared with $60 million and 0.2%, respectively, at December 31, 2016. As shown in Table 18, the trading portfolio consists principally of mortgage-backed securities relating to BPPR’s mortgage activities described above, which at September 30, 2017 were investment grade securities. As of September 30, 2017, the trading portfolio also included $1.3 million in Puerto Rico government obligations and shares of closed-end funds that invest primarily in Puerto Rico government obligations ($2.6 million as of December 31, 2016). 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 gain of $0.3 million for the quarter ended September 30, 2017, compared to a loss of $0.1 million for the quarter ended September 30, 2016. Table 18 provides the composition of the trading portfolio at September 30, 2017 and December 31, 2016.
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Table 18—Trading Portfolio
Puerto Rico government obligations
Interest-only strips
Other[2]
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 $0.3 million for the last week in September 2017. 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 loansheld-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 fair value of assets and liabilities may include market or credit related adjustments, where appropriate. During the quarter ended September 30, 2017, inclusion of credit risk in the fair value of the derivatives resulted in a net loss of $38 thousand recorded in the other operating income and interest expense captions of the Consolidated Statement of Operations, which consisted of a loss of $54 thousand resulting from the Corporation’s own credit risk standing adjustment and a gain of $16 thousand from the assessment of the counterparties’ credit risk. During the nine months ended September 30, 2017, inclusion of credit risk in the fair value of the derivatives resulted in a net loss of $140 thousand recorded in the other operating income and interest expense captions of the Consolidated Statement of Operations, which consisted of a loss of $68 thousand resulting from the Corporation’s own credit standing adjustment and a loss of $72 thousand from the assessment of the counterparties’ credit risk.
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 25 to the consolidated financial statements for information on the Corporation’s fair value measurement disclosures required by the applicable accounting standard. At September 30, 2017, approximately $ 9.1 billion, or 98%, 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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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 $ 7 million at September 30, 2017, of which $ 1 million were Level 3 assets and $ 6 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 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.
Refer to Note 34 to the consolidated financial statements in the 2016 Form 10-K for a description of the Corporation’s valuation methodologies used for the assets and liabilities measured at fair value. Also, refer to the Critical Accounting Policies / Estimates in the 2016 Form 10-K for additional information on the accounting guidance and the Corporation’s policies or procedures related to fair value measurements.
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, 2017, 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. In addition, during the quarter and nine months ended September 30, 2017, the Corporation did not adjust any prices obtained from pricing service providers or broker dealers for its trading account securities and investment securities available-for-sale.
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 fair value hierarchy for each asset or liability measured. The fair value measurement analysis performed by the Corporation includes validation procedures with alternate pricing sources when available and review of market changes, pricing methodology, assumption and level hierarchy changes, and evaluation of distressed transactions. 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.
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 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.
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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.
On January 23, 2017, the Corporation’s Board of Directors approved an increase in the Company’s quarterly common stock dividend from $0.15 per share to $0.25 per share. During the nine months ended September 30, 2017, the Corporation declared dividends on its common stock of $ 76.6 million and completed a $75 million privately negotiated accelerated share repurchase transaction. Refer to additional information on Note 19 – Stockholder’s equity.
Deposits, including customer deposits, brokered deposits and public funds deposits, continue to be the most significant source of funds for the Corporation, funding 80% of the Corporation’s total assets at September 30, 2017 and 79% at December 31, 2016. The ratio of total ending loans to deposits was 69% at September 30, 2017, compared to 77% at December 31, 2016. In addition to traditional deposits, the Corporation maintains borrowing arrangements. At September 30, 2017, these borrowings consisted primarily of $ 374 million in assets sold under agreement to repurchase, $868 million in advances with the FHLB, $439 million in junior subordinated deferrable interest debentures (net of debt issuance cost) related to trust preferred securities and $446 million in term notes (net of debt issuance cost) issued to partially fund the repayment of TARP funds. A detailed description of the Corporation’s borrowings, including their terms, is included in Note 17 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.
Given the widespread level of disruption to basic infrastructure and commercial activity in the regions impacted by the passage of hurricanes Irma and Maria, BPPR decided to adopt certain measures to assist its customers in affected areas. These measures include the waiver of certain fees and charges, such as late payment charges and ATM transaction fees, and a temporary payment moratorium of three months to eligible borrowers across most loan portfolios during which BPPR will continue to accrue interest on the loans.
These measures, while important to assist in the recovery of our customers post-hurricane, will negatively impact our results of operations and liquidity. For example, the waiver of fees and other charges impacted the Corporation’s revenues for the third quarter and revenues in the fourth quarter will also be negatively impacted by such waivers. The moratorium measures, whose ultimate effect will depend in part on the number of customers who take advantage of such plans, will also impact our liquidity not only due to principal and interest payments that BPPR will not receive during the period, but also as a result of loans serviced by the Corporation where we are required to advance to the owners the payment of principal and interest on a scheduled basis even when such payment is not collected from the borrower.
Management believes that the liquidity impact of these measures will not be significant in light of BPPR’s existing liquidity resources and that BPPR has sufficient liquidity to meet anticipated cash flow obligations. Deposits at BPPR as of September 30, 2017 were higher by approximately $1.0 billion than as of the end of the second quarter.
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 17 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, mortgage loan securitization, and, to a lesser extent, loan sales. In addition, the Corporation maintains borrowing facilities with the FHLB and at the discount window of the Federal Reserve Board (the “FRB”), 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.
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During the nine months ended September 30, 2017, BPPR declared cash dividends of $169 million, a portion of which was used by Popular, Inc. for the payments of the cash dividends on its outstanding common stock and to complete the repurchase of $75 million in treasury stock as part of the privately negotiated accelerated share repurchase transaction completed during the first quarter of 2017, as mentioned above.
During the nine months ended September 30, 2017, BPNA declared a dividend of $10.4 million to Popular North America, its holding company, who in turn declared a $10.4 million dividend to Popular, Inc.
Note 35 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 liquidity in the form of cash balances maintained at the Fed and unused secured lines held at the FRB 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 13 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-interestbearing 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 $ 29.6 billion, or 86% of total deposits, at September 30, 2017, compared with $25.8 billion, or 84% of total deposits, at December 31, 2016. Core deposits financed 77% of the Corporation’s earning assets at September 30, 2017, compared with 76% at December 31, 2016.
Certificates of deposit with denominations of $100,000 and over at September 30, 2017 totaled $ 4.1 billion, or 12% of total deposits (December 31, 2016—$4.1 billion, or 14% of total deposits). Their distribution by maturity at September 30, 2017 is presented in the table that follows:
Table 19 — 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, 2017 approximately 1% of the Corporation’s assets were financed by brokered deposits (December 31, 2016 – 2%). The Corporation had $ 0.6 billion in brokered deposits at September 30, 2017 and December 31, 2016. 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.
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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, 2017 and December 31, 2016, the banking subsidiaries had credit facilities authorized with the FHLB aggregating to $3.9 billion, based on assets pledged with the FHLB at those dates. Outstanding borrowings under these credit facilities totaled $868 million at September 30, 2017 and $673 million at December 31, 2016. Such advances are collateralized by loansheld-in-portfolio, do not have restrictive covenants and do not have any callable features. At September 30, 2017 the credit facilities authorized with the FHLB were collateralized by $5.0 billion in loans held-in-portfolio (December 31, 2016—$4.9 billion). Refer to Note 17 to the Consolidated Financial Statements for additional information on the terms of FHLB advances outstanding.
At September 30, 2017 and December 31, 2016, the Corporation’s borrowing capacity at the Fed’s Discount Window amounted to approximately $1.2 billion, which remained unused as of both dates. 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, 2017, this credit facility with the Fed was collateralized by $2.2 billion of loansheld-in-portfolio (December 31, 2016—$2.3 billion).
At September 30, 2017, 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 andoff-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, 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.
Bank Holding Companies
The principal sources of funding for the bank holding companies (the “BHC’s”), which are Popular, Inc. (holding company only) (“PIHC”) and Popular North America, Inc. (“PNA”), 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, 2017, PIHC received $169 million in dividends from BPPR, $12 million in dividends from PIBI, $10.4 million in dividends from PNA and $3.5 million in dividends from EVERTEC’s parent company. PIHC also received $0.5 million in distributions from its investment in PRB Investors LP, an equity method investment, and $10.5 million in dividends from its non-banking subsidiaries. During the quarter ended September 30, 2017, a non-banking subsidiary declared a dividend of $4.5 million to PIHC. In addition, during the nine months ended September 30, 2017 Popular International Bank received $11.8 million in dividends from its investment in BHD Leon. During the nine months ended September 30, 2017, PNA received $10.4 million in dividends from BPNA.
Another use of liquidity at the parent holding company is the payment of dividends on its outstanding stock. During the nine months ended September 30, 2017, the Corporation declared quarterly dividends on its outstanding common stock of $0.25 per share, for a total of $ 76.6 million and completed a $75 million privately negotiated accelerated share repurchase transaction. Refer to additional information on Note 19 – Stockholder’s equity. 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, 2017.
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
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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 35 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 $886 million at September 30, 2017, compared with $884 million at December 31, 2016. 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, 2017 are presented in Table 20.
Table 20—Distribution of BHC’s Notes Payable by Contractual Maturity
Year
As indicated previously, the BHC did not issue new registered debt in the capital markets during the nine months ended September 30, 2017.
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-bankingsubsidiaries
The principal sources of funding for the non-banking subsidiaries include internally generated cash flows from operations, loan sales, repurchase agreements, capital injection and borrowed funds from their direct parent companies or the holding companies. The principal uses of funds for thenon-banking subsidiaries include repayment of maturing debt, operational expenses and payment of dividends to the BHCs. The liquidity needs of the non-bankingsubsidiaries 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 $2.1 billion at September 30, 2017 and $3.7 billion at December 31, 2016. 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 and fiscal 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 and the recent impact of two major hurricanes. Refer to the Geographic and Government Risk section of this MD&A for some highlights on the current status of the Puerto Rico economy and the ongoing fiscal crisis.
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 FRB.
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, geographic concentration in Puerto Rico, 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 $12 million in deposits at September 30, 2017 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 $19 thousand at September 30, 2017, with the Corporation providing collateral totaling $95 thousand 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 Note 21 to the Consolidated Financial Statements, 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 $51 million at September 30, 2017. 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.
Credit Risk
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 34 to the Consolidated Financial Statements.
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Commonwealth of Puerto Rico
A significant portion of our financial activities and credit exposure is concentrated in the Commonwealth of Puerto Rico (the “Commonwealth” or “Puerto Rico”), which continues to be in a severe economic and fiscal crisis and was recently significantly impacted by two major hurricanes.
Hurricanes Impact
During the month of September 2017, Hurricanes Irma and Maria, two major hurricanes, caused extensive destruction in Puerto Rico, disrupting the primary market in which BPPR does business. Most relevant, Hurricane Maria made landfall on September 20, 2017, causing severe wind and flood damage to infrastructure, homes and businesses throughout Puerto Rico. Following the passage of Hurricane Maria, all Puerto Rico was left without electrical power, other basic utility and infrastructure services (such as water, communications, ports and other transportation networks) were severely curtailed and the government imposed a mandatory curfew. The hurricanes caused a significant disruption to the island’s economic activity. Most business establishments, including retailers and wholesalers, financial institutions, manufacturing facilities and hotels, were closed for several days.
Puerto Rico was declared a disaster zone by President Trump due to the impact of the hurricanes, thus making it eligible for Federal assistance. Notwithstanding the significant recovery operation that is underway by the Federal, state and local governments, as of the date of this report, most businesses and homes in Puerto Rico remain without power, other basic utility and infrastructure remains significantly impacted, and many businesses are operating partially or remain closed. Electronic transactions, a significant source of revenue for BPPR, have also declined significantly as a result of the lack of power and telecommunication services. Several reports indicate that the hurricanes have also accelerated the outmigration trends that Puerto Rico was experiencing, with many residents moving to the mainland United States, either on a temporary or permanent basis.
While it is too early to assess and quantify the full extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity, the damages are substantial and have, at least in the short-term, had a material adverse impact on economic activity, as reflected by, among other things, the slowdown in production activity and reduction in the government’s tax revenues.
For a discussion of the impact of the hurricanes on the Corporation’s operations and financial results during the third quarter of 2017, refer to Note 2—Hurricanes impact, on the accompanying financial statements. For additional discussion of risk factors related to the impact of the hurricanes, see Item 1A of this report.
Fiscal and Economic Crisis
Even before the hurricanes, the Commonwealth was experiencing a severe economic and fiscal crisis resulting from continuing economic contraction, persistent and significant budget deficits, a high debt burden, unfunded legacy obligations and lack of access to the capital markets, among other factors. Further, the Commonwealth and several of its public instrumentalities are currently in the process of restructuring their outstanding obligations in proceedings under Titles III and VI of the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”) enacted in June 2016 by the U.S. Federal Government.
The Commonwealth’s deficits were historically covered with bond financings, loans from the Government Development Bank for Puerto Rico (“GDB”) and other extraordinary one-time revenue measures, as well through the deferment of the cost of certain legacy obligations, such as pensions. The Commonwealth’s structural imbalance between revenue and expenditure and unfunded legacy obligations, coupled with the deterioration of GDB’s liquidity situation and the Commonwealth’s recent inability to access the capital markets, resulted in the government becoming unable to pay scheduled debt payments while continuing to provide government services.
Recent Economic Performance
Puerto Rico entered into recession in the fourth quarter of fiscal year 2006. Puerto Rico’s gross national product (GNP) has thereafter contracted in real terms every year between fiscal year 2007 and fiscal year 2016 (inclusive), with the exception of growth of 0.5% in fiscal year 2012 (likely as a result of the large amount of governmental stimulus and deficit spending in that fiscal year). According to Puerto Rico Planning Board estimates released in March 2017 (before the impact of the hurricanes), gross national
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product is projected to further contract by 1.7% and 1.5% during fiscal years 2017 and 2018, respectively. The latest Economic Activity Index issued by GDB, which is an indicator of general economic activity and not a direct measurement of GNP, reflected a 1.49% reduction in the average for fiscal year 2017, compared to the prior fiscal year. During the first month of fiscal year 2018 (July 2017), the Economic Activity Index reflected a 2.1% average reduction compared to the corresponding figure for fiscal year 2017. As discussed above, Hurricanes Irma and Maria have had, at least in the short-term, a material adverse impact on economic activity, that is likely to be reflected in GNP estimates and the Economic Activity Index during fiscal year 2018.
Fiscal and Liquidity Measures
The Commonwealth’s challenges have resulted in a severe fiscal and liquidity crisis, which has forced the government to implement extraordinary measures in order to continue to fund its operational expenses and provide essential services to its residents. Measures taken by the previous administration to tackle the government’s structural budgetary imbalance included (a) reforming the Commonwealth’s retirement systems, (b) enacting Act No. 66-2014, as amended (“Act 66”), a fiscal emergency law that, among other things, froze formula appropriations, salaries and benefits under collective bargaining agreements, (c) implementing certain extraordinary revenue raising measures, including an increase in the sales and use tax (“SUT”) rate from 7% to 11.5% and the implementation of a Commonwealth SUT of 4% with respect to certain business-to-business services, (d) requiring the two largest government retirement systems topre-fund the payment of retirement benefits to participants, (e) delaying the payment of third-party payables, income tax refunds and amounts due to public corporations, and (f) enacting Puerto Rico Emergency Moratorium and Rehabilitation Act (the “Moratorium Act”), pursuant to which the Commonwealth and certain of its instrumentalities suspended the payment of debt service on their respective debts and retained certain revenues assigned to particular public corporations, redirecting the same for the funding of operational expenses. The Moratorium Act also imposed significant constraints on the operations of GDB, including stringent restrictions on the withdrawal of deposits from GDB (including deposits of the Commonwealth’s municipalities).
The Administration of Governor Ricardo Rosselló Nevares, sworn in January 2017, has also implemented various measures to address the Commonwealth’s fiscal crisis and liquidity problems, including enacting legislation to (a) extend until fiscal year 2021 certain of the provisions of Act 66, (b) extend for 10 years the temporary excise tax imposed by Act No. 154-2010, (c) reduce government expenses (including by reducing payroll related-expenses, such as those related to temporary workers and certain employee benefits), (d) increase government revenues (including by increasing fines and cigarette excise taxes), and (e) authorize the Commonwealth’s central government to use funds from public corporations to cover its liquidity and budgetary needs (including, under certain circumstances, the sales-and-use tax revenue securitized through the Puerto Rico Sales Tax Financing Corporation (“COFINA”)).
On January 29, 2017, the Rosselló Administration enacted Act No. 5-2017(“Act 5”), also known as the “Financial Emergency and Fiscal Responsibility Act,” to replace certain provisions of the Moratorium Act. Among other things, Act 5, as amended, extended the Governor’s power to suspend debt service obligations until December 31, 2017 (subject to further extensions through executive orders), by prioritizing the payment of essential services over debt service. Act 5 grandfathers executive orders issued pursuant to the Moratorium Act and stipulates that the same shall continue in full force and effect until amended, rescinded or superseded.
The Government has stated that certain of these emergency liquidity measures are unsustainable and have significant negative economic effects. Also, the Commonwealth and the Oversight Board (defined below) have indicated that they expect that these measures will not be sufficient to address the Commonwealth’s fiscal and liquidity needs and that additional extraordinary fiscal and liquidity measures will need to be implemented, including those outlined in the Commonwealth’s fiscal plan (discussed below), to allow the Commonwealth to continue providing essential government services. The Commonwealth and the Oversight Board have indicated that, absent such additional measures, the Commonwealth may experience significant cash shortfalls during fiscal year 2018.
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Recent Defaults
The following entities have not made payments of principal and/or interest in full on certain of their respective bonds and notes as of the date of this report: the Commonwealth, GDB, the Puerto Rico Public Buildings Authority, the Puerto Rico Infrastructure Financing Authority, the Puerto Rico Highways and Transportation Authority (“HTA”), the Puerto Rico Public Finance Corporation, the Convention Center District Authority, the Employees Retirement System (“ERS”), the University of Puerto Rico and the Puerto Rico Electric Power Authority (“PREPA”). Further, pursuant to a court order issued in COFINA’s Title III proceeding (discussed below) on May 30, 2017, funds held by the trustee of the COFINA bonds have not been applied for the payment of such bonds pending the resolution of various disputes in respect of such funds.
Enactment of PROMESA
In general terms, PROMESA seeks to provide the Commonwealth with (i) fiscal and economic discipline through the creation of a seven-member federally-appointed oversight board (the “Oversight Board), (ii) relief from creditor lawsuits through the enactment of a temporary stay on litigation to enforce rights or remedies related to outstanding liabilities of the Commonwealth and its instrumentalities and municipalities (which expired on May 1, 2017) and (iii) two separate processes for the restructuring of the debt obligations of such entities. PROMESA also includes other miscellaneous provisions, including relief from certain wage and hour laws and regulations and provisions for identification and expedited permitting of critical infrastructure projects.
On August 31, 2016, President Obama appointed the seven voting members of the Oversight Board. Pursuant to PROMESA, the Oversight Board shall remain in place until market access is restored and balanced budgets, in accordance with modified accrual accounting, are produced for at least four consecutive years.
The Oversight Board has designated a number of entities as covered entities under PROMESA, including the Commonwealth, all of its public corporations and retirement systems, and all affiliates and subsidiaries of the foregoing. While the Oversight Board has the power to designate any of the Commonwealth’s municipalities as covered entities under PROMESA, it has not done so as of the date hereof. The designation of an entity as a covered entity has various implications under PROMESA. First, it means that the Governor will have to submit such entity’s annual budgets and, if the Oversight Board so requests, its fiscal plans, to the Oversight Board for its review and approval. Second, covered territorial instrumentalities may not issue debt or guarantee, exchange, modify, repurchase, redeem, or enter into similar transactions with respect to their debts without the prior approval of the Oversight Board. Finally, covered entities could also potentially be eligible to use the restructuring procedures provided by PROMESA. The first, Title VI, is a largelyout-of-court process through which a government entity and its financial creditors can agree on terms to restructure such entity’s debt. If a supermajority of creditors of a certain category agrees, that agreement can bind all other creditors in such category. The second, Title III, draws on the federal bankruptcy code and provides a court-supervised process for a comprehensive restructuring led by the Oversight Board. Access to either of these procedures is dependent on compliance with certain requirements established in PROMESA, including the approval of the Oversight Board.
The initial stay of litigation imposed by PROMESA expired on May 1, 2017. The automatic stay imposed by PROMESA applied to covered actions against all government instrumentalities in Puerto Rico, even those that may not be immediately within the jurisdiction and purview of the Oversight Board, such as municipalities. An automatic stay is currently in effect, however, with respect to such entities that are subject to ongoing debt restructuring proceedings under Title III of PROMESA.
Fiscal Plans
PROMESA requires the Commonwealth to submit a fiscal plan to the Oversight Board that, among other things, (i) provides for estimates of revenues and expenditures in conformance with agreed accounting standards, (ii) ensures the funding of essential services, (iii) eliminates structural deficits, (iv) provides adequate funding for public pension systems and (v) provides for a debt burden that is sustainable. Furthermore, the fiscal plan must respect the relative lawful priorities or lawful liens under local law.
On February 28, 2017, the Rosselló administration submitted its draft fiscal plan to the Oversight Board. A revised version of such fiscal plan was submitted to the Oversight Board on March 13, 2017, which the Oversight Board certified on such date, after introducing certain amendments. The Commonwealth’s fiscal plan covers, in addition to the Commonwealth itself, various public instrumentalities with outstanding debts payable from taxes, fees or other government revenues (including COFINA).
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The Commonwealth’s fiscal plan, as certified in March 2017, estimates that, absent the revenue enhancing and expense reduction measures set forth therein and assuming the payment of debt service as contracted, the Commonwealth’s 10-year budget gap would reach approximately $66.9 billion. Further, the fiscal plan projects that, assuming the successful implementation of all measures set forth therein, the Commonwealth and the entities covered by the Commonwealth’s fiscal plan will only have $7.8 billion available for the payment of debt service during said 10-year period (compared to $35 billion of contractual debt service) and thus recognizes the need for debt restructuring by the Commonwealth and the instrumentalities covered by said fiscal plan (including COFINA).
The Commonwealth’s fiscal plan does not contemplate a restructuring of the debt of Puerto Rico’s municipalities. The Commonwealth’s fiscal plan contemplates, however, as part of its expense reduction measures, the gradual elimination of budgetary subsidies provided to municipalities. Those subsidies constitute a material portion of the operating revenues of certain municipalities. The Commonwealth’s fiscal plan is publicly available in the Oversight Board’s website.
Pursuant to PROMESA, the Oversight Board has also requested and approved fiscal plans for (i) GDB, (ii) HTA, (iii) PREPA, (iv) the Puerto Rico Aqueduct and Sewer Authority and (v) the Public Corporation for the Supervision and Insurance of Cooperatives. All such fiscal plans reflect that the applicable government entity is unable to pay its financial obligations in full, thus recognizing the need for debt relief. The Oversight Board has also requested fiscal plans from certain other public corporations and instrumentalities, which are subject to ongoing review and have not been approved by the Oversight Board as of the date hereof.
PREPA’s fiscal plan assumes changes to the treatment of the municipal contribution in lieu of taxes, which could result in increased electricity expenses for municipalities. GDB’s fiscal plan contemplates the wind-down of GDB’s operations and the distribution of the cash flows of GDB’s loan portfolio among its creditors (including depositors). Pursuant to the Restructuring Support Agreement, dated May 15, 2017, entered into by and among GDB and a significant portion of its financial creditors (the “GDB RSA”), GDB noteholders and municipal depositors would be eligible to exchange their claims against GDB for one of three tranches of bonds to be issued by a new government entity and which would have varied upfront exchange ratios (ranging from 55% to 75%) and coupon rates (ranging from 3.5% to 7.5%). The new bonds would be payable from payments received in respect of certain assets to be transferred by GDB to such new government entity (consisting largely of municipal loans). The legality of the modification of GDB’s financial obligations outlined in the GDB RSA is currently being challenged in court by certain dissenting municipalities with deposits in GDB.
On August 4, 2017, the Board also released its proposal for achieving a reduction in pension benefit outlays of 10% by fiscal year 2020. The proposal, which would be pursued through a court-approved plan of adjustment under Title III of PROMESA (described below), would reduce pension benefit payments in a progressive manner, so that lower income retirees would see a lower or no reduction in benefits while those with higher benefits would see larger reductions. The Oversight Board estimates that under this proposal, 25% of retirees would see no reductions and the median retiree would receive less than a 10% reduction. The Government, however, has stated that it will seek to protect pension benefit payments to retirees in full.
On October 31, 2017, the Oversight Board requested revised fiscal plans for the Commonwealth and various public corporations to take into account the impact of Hurricanes Irma and Maria. The Oversight Board expects that the revised fiscal plans would be certified by January or February 2018.
Pending Title III and Title VI Proceedings
On May 3, 2017, the Oversight Board, on behalf of the Commonwealth, filed a petition in the U.S. District Court for the District of Puerto Rico to restructure the Commonwealth’s liabilities under Title III of PROMESA. The Oversight Board has subsequently filed analogous petitions with respect to COFINA, ERS, HTA and PREPA. As of the date of this report, the plans of adjustment for said entities’ debts have not been filed. Based on the projection of funds available for debt service under the applicable fiscal plans, however, the restructuring is expected to result in significant discounts on creditor recoveries.
On July 12, 2017, the Oversight Board conditionally authorized GDB to pursue the modification of its financial obligations outlined in the GDB RSA pursuant to Title VI of PROMESA.
Exposure of the Corporation
The credit quality of BPPR’s loan portfolio necessarily reflects, among other things, the general economic conditions in Puerto Rico and other adverse conditions affecting Puerto Rico consumers and businesses. The effects of the prolonged recession are reflected in limited loan demand, an increase in the rate of foreclosures and delinquencies on loans granted in Puerto Rico. While PROMESA provides a process to address the Commonwealth’s fiscal crisis, the length and complexity of the Title III proceedings for the Commonwealth and various of its instrumentalities, the adjustment measures required by the fiscal plans and the impact of Hurricanes Irma and Maria suggest a risk of further significant economic contraction. In addition, the measures taken to address the
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fiscal crisis and those that will have to be taken in the near future will likely affect many of our individual customers and customers’ businesses, which could cause credit losses that adversely affect us and may negatively affect consumer confidence. This, in turn, results in reductions in consumer spending that may also adversely impact our interest and non-interest revenues. If global or local economic conditions worsen or the Government of Puerto Rico and the Oversight Board are unable to adequately manage the Commonwealth’s post-hurricane recovery efforts and pre-existing fiscal crisis, including by consummating an orderly restructuring of its debt obligations while continuing to provide essential services, these adverse effects could continue or worsen in ways that we are not able to predict. For additional discussion of risk factors related to the impact of the hurricanes, see Item 1A of this report.
At September 30, 2017, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 484 million, of which approximately $ 482 million is outstanding ($584 million and $529 million, respectively, at December 31, 2016). Deterioration of the Commonwealth’s fiscal and economic situation, including any negative ratings implications, could further adversely affect the value of our Puerto Rico government obligations, resulting in losses to us. Of the amount outstanding, $ 433 million consists of loans and $ 49 million are securities ($459 million and $70 million, respectively, at December 31, 2016). All of the amount outstanding at September 30, 2017 were obligations from various Puerto Rico municipalities. In most cases, these were “general obligations” of a municipality, to which the applicable municipality has pledged its good faith, credit and unlimited taxing power, or “special obligations” of a municipality, to which the applicable municipality has pledged other revenues ($512 million at December 31, 2016). At September 30, 2017, 74% of the Corporation’s exposure to municipal loans and securities was concentrated in the municipalities of San Juan, Guaynabo, Carolina and Bayamón. Although the PROMESA Oversight Board has not designated any of the Commonwealth’s 78 municipalities as covered entities under PROMESA, it may decide to do so in the future. For a more detailed description of the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities, refer to Note 22 – Commitments and contingencies.
During the third quarter of 2017, the Corporation sold all of its COFINA bonds at a gain of approximately $0.1 million. The Corporation had recorded an other-than-temporary impairment charge of $8.3 million in respect of those bonds during the second quarter of 2017 as a result of the filing of the Title III proceeding in respect of COFINA and thenon-payment of interest on the COFINA bonds in June 2017 pursuant to a court order issued in such proceeding.
In addition, at September 30, 2017, the Corporation had $391 million in indirect exposure to loans or securities issued or guaranteed by Puerto Rico governmental entities, but whose principal source of repayment are non-governmental entities. In such obligations, the Puerto Rico governmental entity guarantees any shortfall in collateral in the event of borrower default ($406 million at December 31, 2016). These included $313 million in residential mortgage loans guaranteed by the Puerto Rico Housing Finance Authority (“HFA”), an entity that has been designated as a covered entity under PROMESA (December 31, 2016 - $326 million). These mortgage loans are secured by the underlying properties and the HFA guarantee serves to cover shortfalls in collateral in the event of a borrower default. Although the Governor is currently authorized by local legislation to impose a temporary moratorium on the financial obligations of HFA, he has not exercised this power as of the date hereof. Also, the Corporation had $43 million in Puerto Rico housing bonds issued by HFA, which are secured by second mortgage loans on Puerto Rico residential properties, $6 million in pass-through securities that have been economically defeased and refunded and for which collateral including U.S. agencies and Treasury obligations has been escrowed, and $29 million of commercial real estate notes issued by government entities, but payable from rent paid by private parties ($43 million, $6 million and $31 million December 31, 2016, respectively).
United States Virgin Islands
The Corporation has operations in the United States Virgin Islands (the “USVI”) and has credit exposure to USVI government entities.
The USVI has been experiencing a number of fiscal and economic challenges that could adversely affect the ability of its public corporations and instrumentalities to service their outstanding debt obligations, and was also severely impacted by Hurricanes Irma and María. PROMESA does not apply to the USVI and, as such, there is currently no federal legislation permitting the restructuring of the debts of the USVI and its public corporations and instrumentalities.
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To the extent that the fiscal condition of the USVI continues to deteriorate, the U.S. Congress or the Government of the USVI may enact legislation allowing for the restructuring of the financial obligations of USVI government entities or imposing a stay on creditor remedies, including by making PROMESA applicable to the USVI.
At September 30, 2017, the Corporation’s direct exposure to USVI instrumentalities and public corporations amounted to approximately $82 million, of which approximately $74 million is outstanding. Of the amount outstanding, approximately (i) $43 million represents loans to the West Indian Company LTD, a government-owned company that owns and operates a cruise ship pier and shopping mall complex in St. Thomas, (ii) $14 million represents loans to the Virgin Islands Water and Power Authority, a public corporation of the USVI that operates USVI’s water production and electric generation plants, and (iii) $17 million represents loans to the Virgin Islands Public Finance Authority, a public corporation of the USVI created for the purpose of raising capital for public projects.
U.S. Government
As further detailed in Notes 6 and 7 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, $896 million of residential mortgages and $87 million commercial loans were insured or guaranteed by the U.S. Government or its agencies at September 30, 2017.
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 21.
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. Loans and OREO’s that remain covered under the terms of the single-family loss share agreement, which expires on June 30, 2020, continue to be presented as covered assets in the accompanying tables and credit metrics as of September 30, 2017.
Because of the application of ASC Subtopic310-30 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. 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 netcharge-off ratio including the acquired loans is lower for the single-family loan portfolios 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.
Certain of the asset quality measures were impacted by the damages caused by the hurricanes, which led to higher delinquencies and nonperforming loans, as payment channels, collection efforts and loss mitigation operations were interrupted and mainly unavailable for the last 10 days of the quarter. A provision was made to the allowance for loans losses based on management’s best estimate of the impact of the hurricanes on the ability of the borrowers to repay their loans, in light of an already fragile economy in Puerto Rico prior to the hurricanes. Management will continue to carefully assess the exposure of the portfolios to hurricane-related factors, economic trends, and their effect on credit quality. The U.S. operations continued to reflect positive results with strong growth and favorable credit quality metrics.
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In response to the hurricanes’ effects on its customers, the Corporation implemented a 90-day moratorium, equal to three months of suspended payments for consumer and certain commercial borrowers that were current or less than ninety days past due in their payments as of September 30, 2017. As a result of the moratorium, eligible loans for which the borrower takes advantage of the moratorium do not affect the asset quality measures as the suspended payments are not deemed to be delinquent and the Corporation continues to accrue interest on these loans.
Non-performing assets, excluding covered loans and OREO, increased by $24 million from December 31, 2016, mostly related to higher P.R. mortgage NPLs of $20 million, affected by disruptions to payment channels, collections and loss mitigation efforts related to hurricane María. Refer to Table 21 which presents the information of non-performing assets.
At September 30, 2017,non-performing loans secured by real estate held-in-portfolio, excluding covered loans, amounted to $471 million in the Puerto Rico operations and $33 million in the U.S. operations. These figures compare to $467 million in the Puerto Rico operations and $21 million in the U.S. operations at December 31, 2016. In addition to the non-performing loans included in Table 21 at September 30, 2017, there were $159 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 $169 million at December 31, 2016.
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Table 21—Non-Performing Assets
Total non-performing loansheld-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 loansheld-in-portfolio to loans held-in-portfolio
Allowance for loan losses to loansheld-in-portfolio
Allowance for loan losses to non-performing loans, excluding held-for-sale
Ratios including covered loans:
Non-performing assets to total assets
HIP = “held-in-portfolio”
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Accruing loans past due 90 days or more are composed primarily of credit cards, residential mortgage loans insured by FHA / VA, and delinquent mortgage loans 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 to purchase, even when they elect not to exercise that option. Also, accruing loans past due 90 days or more include residential conventional loans purchased from other financial institutions that, although delinquent, the Corporation has received timely payment from the sellers / servicers, and, in some instances, have partial guarantees under recourse agreements.
The Corporation’s commercial loan portfolio secured by real estate (“CRE”), excluding covered loans, amounted to $7.4 billion at September 30, 2017, of which $2.0 billion was secured with owner occupied properties, compared with $7.2 billion and $2.0 billion, respectively, at December 31, 2016. CREnon-performing loans, excluding covered loans, amounted to $118 million at September 30, 2017, compared with $130 million at December 31, 2016. The CREnon-performing loans ratios for the BPPR and BPNA segments were 2.63% and 0.12%, respectively, at September 30, 2017, compared with 2.83% and 0.07%, respectively, at December 31, 2016.
For the quarter ended September 30, 2017, total non-performing loan inflows, excluding consumer loans, increased by $5 million, or 5%, when compared to the inflows for the same quarter in 2016. Inflows of non-performing loansheld-in-portfolio at the BPPR segment increased by $4 million, or 4%, compared to the inflows for the third quarter of 2016, mostly related to higher mortgage inflows of $10 million, impacted by Hurricane María. Inflows of non-performing loans held-in-portfolio at BPNA remained flat when compared to the same quarter in 2016.
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Table 22—Activity in Non-Performing Loans Held-in-Portfolio (Excluding Consumer and Covered Loans)
Plus:
New non-performing loans
Advances on existing non-performing loans
Less:
Non-performing loans transferred to OREO
Non-performing loanscharged-off
Loans returned to accrual status / loan collections
Ending balance NPLs
Table 23—Activity in Non-Performing Loans Held-in-Portfolio (Excluding Consumer and Covered Loans)
Reclassification from construction loans to commercial loans
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Table 24—Activity in Non-Performing Commercial Loans Held-in-Portfolio (Excluding Covered Loans)
Table 25—Activity in Non-Performing Commercial Loans Held-in-Portfolio (Excluding Covered Loans)
Table 26—Activity in Non-Performing Construction Loans Held-in-Portfolio (Excluding Covered Loans)
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Table 27—Activity in Non-Performing Construction Loans Held-in-Portfolio (Excluding Covered Loans)
Reclassification form construction loans to commercial loans
Table 28—Activity in Non-Performing Mortgage Loans Held-in-Portfolio (Excluding Covered Loans)
Table 29—Activity in Non-Performing Mortgage loans Held-in-Portfolio (Excluding Covered Loans)
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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 Note 9 and the Critical Accounting Policies / Estimates section of this MD&A for a description of the Corporation’s allowance for loans losses methodology.
Refer to the following table for a summary of the activity in the allowance for loan losses and selected loan losses statistics for the quarters and nine months ended September 30, 2017 and 2016.
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Table 30—Allowance for Loan Losses and Selected Loan Losses Statistics - Quarterly Activity
Charged-offs:
BPPR
Total BPPR charged-offs
BPNA
Total BPNA charged-offs
Total charge-offs
Recoveries:
Total BPPR recoveries
Total BPNA recoveries
Total recoveries
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Net loans charged-offs (recovered):
Total BPPR net loans charged-offs (recovered)
Total BPNA net loans charged-offs (recovered)
Total net loans charged-offs (recovered)
Ratios:
Annualized net charge-offs to average loans held-in-portfolio
Provision for loan losses to net charge-offs[3]
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Table 31—Allowance for Loan Losses and Selected Loan Losses Statistics -Year-to-date Activity
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Net recoveries[2]
The following table presents annualized net charge-offs to average loansheld-in-portfolio (“HIP”) for the non-covered portfolio by loan category for the quarters and nine months ended September 30, 2017 and 2016.
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Table 32—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
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Table 33—Composition of ALLL
Impaired loans [1]
Specific ALLL to impaired loans [1]
Loansheld-in-portfolio, excluding impaired loans [1]
General ALLL to loansheld-in-portfolio, excluding impaired loans [1]
Total ALLL
Total non-covered loans held-in-portfolio [1]
ALLL to loansheld-in-portfolio [1]
Table 34—Composition of ALLL
Non-covered loans portfolio
At September 30, 2017, the allowance for loan losses, increased by $104 million when compared with December 31, 2016.
The allowance for loan losses at the BPPR segment increased by $56 million to $524 million, or 3.06% ofnon-covered loans held-in-portfolio when compared to December 31, 2016. The environmental factors reserve, which considers unemployment and deterioration in economic activity, increased by $64 million to $122 million based on management’s best estimate, including the
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hurricanes’ impact on the loan portfolios using currently available information. While the total reserve was increased to $122 million as the nearmid-range loss estimate, management’s loan loss estimate ranged from approximately $70 million to $160 million. Since there is significant uncertainty with respect to the full extent of the impact due to the unprecedented nature of Hurricane Maria, the estimate is judgmental and subject to change as conditions evolve. Management will continue to carefully assess and review the exposure of the portfolios to hurricane-related factors, economic trends and their effect on credit quality. The ratio of the allowance to non-performing loans held-in-portfolio was 95.55% at September 30, 2017, compared with 87.88% at December 31, 2016.
The allowance for loan losses at the BPNA segment increased to $90 million, or 1.48% of loans held-in-portfolio, compared with $42 million, or 0.75% of loansheld-in-portfolio, at December 31, 2016, driven by higher reserves for the U.S. Taxi Medallion portfolio. The ratio of the allowance to non-performing loans held-in-portfolio at the BPNA segment was 240.48% at September 30, 2017, compared with 166.56% at December 31, 2016.
Covered loans portfolio
The Corporation’s allowance for loan losses for the covered loan portfolio acquired in the Westernbank FDIC-assisted transaction amounted to $33 million at September 30, 2017, compared to $30 million at December 31, 2016. This increase was mainly due to adjustments in the estimated cash flows of purchased credit impaired loans accounted for under ASC 310-10 to reflect the three-month payment moratorium offered to certain eligible borrowers.
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 ASCSection 310-10-35 for loans individually evaluated for impairment.
Troubled debt restructurings
The Corporation’s TDR loans, excluding covered loans, amounted to $1.3 billion at September 30, 2017, increasing by $17 million, or 1.4%, from December 31, 2016. TDRs in accruing status increased by $30 million from December 31, 2016 to $1.1 billion at September 30, 2017, due to sustained borrower performance, while non-accruing TDRs decreased by $13 million.
Refer to Note 9 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.
The tables that follow present 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, 2017 and December 31, 2016.
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Table 35—Non-Covered Impaired Loans with Appraisals Dated 1 year or Older
ADOPTION OF NEW ACCOUNTING STANDARDS AND ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS
Refer to Note 4, “New Accounting Pronouncements” to the Consolidated Financial Statements.
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Adjusted net income – Non-GAAP Financial Measure
The Corporation prepares its Consolidated Financial Statements using accounting principles generally accepted in the United States (“U.S. GAAP” or the “reported basis”). In addition to analyzing the Corporation’s results on a reported basis, management monitors the “adjusted net income” of the Corporation and excludes the impact of certain transactions on the results of its operations. Adjusted net income is a non-GAAP financial measure. Management believes that the adjusted net income provides meaningful information about the underlying performance of the Corporation’s ongoing operations.
No adjustments are reflected for the quarter and nine months ended September 30, 2017. Tables 36 and 37 present a reconciliation of reported results to Adjusted net income for the quarter and nine months ended September 30, 2016.
Table 36—Adjusted Net Income for the Quarter Ended September 30, 2016 (Non-GAAP)
U.S. GAAP Net income
Non-GAAP adjustments:
FDIC arbitration award[1]
Goodwill impairment charge[2]
Adjusted net income (Non-GAAP)
Table 37—Adjusted Net Income for the Nine Months Ended September 30, 2016 (Non-GAAP)
Non-GAAP Adjustments:
Impact of EVERTEC restatement [1]
Bulk sale of WB loans and OREO [2]
FDIC arbitration award[3]
Goodwill impairment charge[4]
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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 2016 Form 10-K.
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
During the quarter ended September 30, 2017, due to the disruption in power and telecommunications caused by hurricanes Irma and Maria and the resulting inability of certain of the Corporation’s bank branches to communicate electronic data through our network, some automated processes for the recording or capture of certain bank branch transactions were performed manually. Management implemented certain temporary modifications to its internal controls, the effectiveness of which has not been tested, in order to be able to capture and record these transactions. Based on the information currently available, management believes that these 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, 2017 have not materially affected, nor 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 22, “Commitments and Contingencies, to the Consolidated Financial Statements.
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed below and under “Part I - Item 1A - Risk Factors” in our 2016 Form 10-K. 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 below and in our 2016 Form 10-K.
There have been no material changes to the risk factors previously disclosed under Item 1A of the Corporation’s 2016 Form10-K, except for the items listed below.
The risks described in our 2016 Form10-K 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, liquidity, results of operations and capital position.
Recent hurricanes caused extensive damage in Puerto Rico, our primary market, and in other markets in which we operate, which could have a material adverse effect on such jurisdictions’ economies and could materially adversely affect us.
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During the month of September 2017, Hurricanes Irma and Maria, two major hurricanes, caused extensive destruction in Puerto Rico, the U.S. Virgin Islands (“USVI”) and the British Virgin Islands (“BVI”), disrupting the primary markets in which Banco Popular de Puerto Rico (“BPPR”) does business. Most relevant, Hurricane Maria made landfall on September 20, 2017, causing severe wind and flood damage to infrastructure, homes and businesses throughout Puerto Rico. Following the passage of Hurricane Maria, all Puerto Rico was left without electrical power, other basic utility and infrastructure services (such as water, communications, ports and other transportation networks) were severely curtailed and the government imposed a mandatory curfew. The hurricanes caused a significant disruption to the island’s economic activity. Most business establishments, including retailers and wholesalers, financial institutions, manufacturing facilities and hotels, were closed for several days.
Our credit exposure is concentrated in Puerto Rico, which accounted as of September 30, 2017 for approximately 80% of ouryear-to-date revenues, 75% of our total assets and 78% of our deposits. As such, our financial condition and results of operations are dependent upon the general trends of the Puerto Rico economy and, in particular, the residential and commercial real estate markets and asset values in Puerto Rico. The deterioration in economic activity and potential impact on asset values resulting from the hurricanes, when added to Puerto Rico’s ongoing fiscal crisis and recession, could materially adversely affect our business, financial condition, liquidity, results of operations and capital position in a manner greater than estimated by management and reflected in our financial statements for the quarter ended September 30, 2017. To a lesser extent, we are also exposed to other areas that were similarly affected by the hurricanes, such as the US and British Virgin Islands, where as of September 30, 2017 we had 2% of our total assets, 3% of our deposits and accounted for approximately 3% of our year-to-date revenues.
Recent hurricanes caused significant disruptions to our BPPR operations and negatively impacted our results of operations as well as certain of the Corporation’s asset quality ratios. Furthermore, while the Corporation has made an allowance for loan losses based on management’s current best estimate of the impact of the hurricanes, there is significant uncertainty with respect to the full extent of the impact of the hurricanes and, as a result, the financial impact on the Corporation’s financial condition and results of operations could be significantly greater.
The recent hurricanes, especially Hurricane Maria, significantly disrupted our operations and negatively impacted certain of the Corporation’s asset quality ratios. Hurricane Maria impacted our branch and ATM network, with certain branches and ATMs still closed to this day. As of November 7, 2017, we have been able to resume operations in approximately 85% of BPPR’s branches and 69% of our ATMs are operational. The lack of power and telecommunications services has also affected the infrastructure necessary to process electronic transactions by our customers. Our ability to reopen our remaining branches and ATMs, as well as the recovery of merchant transaction activity, principally depends on the government’s ability to restore electricity and other basic infrastructure, the timing of which remains uncertain.
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These hurricanes adversely affected our operations and financial performance during the third quarter of 2017, resulting in additional operating expenses (net of insurance receivables) of approximately $9.5 million and an incremental provision for loan losses related to the impact of the hurricanes of approximately $69.9 million. In addition, our non-interest income was lower by $16.4 million when compared to the second quarter of 2017, reflecting, in part, the effect of the disruption caused by the hurricanes in a number of categories, including credit and debit card fees and other service fees and charges.
The effects of the hurricanes continue to adversely affect our operations during the fourth quarter of 2017 as most of the island continues to be without power and our operations, and those of many of our customers, continue to be significantly affected. Although management has made estimates as to the probable losses related to the hurricanes as part of its evaluation of the allowance for loan and lease losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact that the hurricanes will have on the credit quality of our loan portfolios. In affected areas, the value of our loan collateral and the extent to which damages to properties collateralizing loans, among other factors, may further impact those estimates of losses. The extent of the economic impact of the hurricanes is also impossible to determine with certainty at this time as it is partly dependent on the time it takes the government to restore power and other basic infrastructure services and the effects of the potential influx of Federal emergency funds and private insurance proceeds. As management continues to assess the impact of these hurricanes on economic activity, asset values in Puerto Rico, and our customers in particular, our results of operations may continue to be adversely affected, and such adverse impact could be material to us and exceed management’s current estimates.
Measures implemented by Popular to address customer needs as a result of the recent hurricanes, including fee waivers and temporary payment moratorium across most loan portfolios, have had, and are expected to continue to have, a negative impact on results of operations and liquidity.
Given the widespread level of disruption to basic infrastructure and commercial activity in the regions impacted by the passage of hurricanes Irma and Maria, BPPR decided to adopt certain measures to assist its customers in affected areas. These measures include the waiver of certain fees and charges, such as late payment charges and ATM transaction fees and a temporary payment moratorium of three months to eligible borrowers across most loan portfolios during which BPPR will continue to accrue interest on the loans.
These measures, while important to assist in the recovery of our customers post-hurricane, will negatively impact our results of operations and liquidity. For example, the waiver of fees and other charges impacted the Corporation’s revenues for the third quarter and the Corporation estimates that revenues in the fourth quarter will also be negatively impacted by such waivers. The moratorium measures, whose ultimate effect will depend in part on the number of customers who take advantage of such plans, will also impact our liquidity not only due to principal and interest payments that BPPR will not receive during the period, but also as a result of loans serviced by the Corporation where we are required to advance to the owners the payment of principal and interest on a scheduled basis even when such payment is not collected from the borrower.
Management believes that the liquidity impact of these measures will not be significant in light of BPPR’s existing liquidity resources and that BPPR has sufficient liquidity to meet anticipated cash flow obligations. However, no assurance can be given that BPPR will have access to sufficient liquidity sources, or that BPPR may not have to rely on more expensive funding sources, if there were unanticipated demands on its liquidity due to deteriorating market conditions or any future stress event. Furthermore, because of the moratoriums, we will have limited visibility as to the impact of the hurricanes on the financial condition of our retail customers and the credit quality of our loan portfolio until the end of the moratorium period when borrowers have to resume loan repayments.
Recent hurricanes have significantly affected government operations in Puerto Rico and the USVI, which could materially affect the value of our portfolio of government securities and loans to government entities in Puerto Rico and the USVI.
The recent hurricanes have caused significant disruption in economic activity and government operations in Puerto Rico and the USVI. While it is too early to quantify the effects of these hurricanes on the financial condition of the affected government entities, the negative economic and other effects from the hurricanes could result in reduced revenues from taxes and services as well as extraordinary expenses that may not be fully offset by Federal and other extraordinary assistance. We have direct exposure to
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various Puerto Rico and USVI government entities, the majority of which consists of loans to various Puerto Rico municipalities that are principally backed by property tax revenues. Further deterioration of the fiscal situation of the Puerto Rico and USVI government entities to which we have exposure could adversely affect the value of our loans and securities that are directly or indirectly payable from or guaranteed by Puerto Rico and USVI government entities, resulting in losses to us. For a discussion of our exposure to the Puerto Rico and USVI government entities, refer to the Geographic and Government Risk section in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report.
Recent hurricanes have caused significant disruptions in power and telecommunications in Puerto Rico, which have required us to adopt temporary modifications to our internal controls, the effectiveness of which has not been tested by management in connection with our annual Sarbanes-Oxley Act assessment and which, if determined to be ineffective, could materially affect our internal control over financial reporting. If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.
The loss of power and telecommunications and the resulting inability of certain of the Corporation’s bank branches to communicate electronic data through our network caused some automated processes for the recording or capture of certain bank branch transactions to be performed manually. While management has evaluated and believes that the temporary modifications implemented and mitigating controls in place are adequate to maintain an effective control over financial reporting, management has not yet tested the effectiveness of these modified controls in connection with its annual assessment of the effectiveness of internal control over financial reporting pursuant to the requirements of Section 404 of the Sarbanes-Oxley Act and cannot be certain that the new temporary processes will ensure that we maintain adequate controls over the processing of certain bank transactions. Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. If these controls were deemed ineffective, management or our outside auditors could conclude that there is a deficiency in our internal control over financial reporting, which, until remediated, could result in misstatements to our interim or annual consolidated financial statements and disclosures that may not be prevented or detected on a timely basis. If such deficiency rises to the level of a material weakness in internal control over financial reporting, it would mean that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Any failure to maintain effective internal controls could also cause us to fail to meet our reporting obligations on a timely basis and cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.
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, 2017 the maximum number of shares of common stock that may have been granted under this plan was 3,500,000.
There were no purchases of Common Stock during the quarter ended September 30, 2017 under the 2004 Omnibus Incentive Plan.
Item 3. Defaults upon Senior Securities
None.
Not applicable.
Item 5. Other Information
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Exhibit Index
Exhibit No.
Exhibit Description
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Carlos J. Vázquez
/s/ Jorge J. García
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