UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended March 31, 2018
Commission File Number: 001-34084
POPULAR, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
Incorporation or organization)
(IRS Employer
Identification Number)
(787) 765-9800
(Registrant’s telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ 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, 102,285,819 shares outstanding as of May 7, 2018.
INDEX
Part I – Financial Information
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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, 2017 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:
Time deposits with other banks
Total money market investments
Trading account debt securities, at fair value:
Pledged securities with creditors’ right to repledge
Other trading securities
Debt securitiesavailable-for-sale, at fair value:
Other investment securitiesavailable-for-sale
Debt securitiesheld-to-maturity, at amortized cost (fair value 2018 - $98,740; 2017 - $97,501)
Equity securities (realizable value 2018 -$169,340); (2017 - $168,417)
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 21) Stockholders’ equity:
Preferred stock, 30,000,000 shares authorized; 2,006,391 shares issued and outstanding
Common stock, $0.01 par value; 170,000,000 shares authorized; 104,263,919 shares issued (2017 - 104,238,159) and 102,189,914 shares outstanding (2017 - 102,068,981)
Surplus
Retained earnings
Treasury stock - at cost, 2,074,005 shares (2017 - 2,169,178)
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
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
Mortgage banking activities (Refer to Note 10)
Net (loss) gain, including impairment, on equity securities
Net loss on trading account debt securities
Adjustments (expense) to indemnity reserves on loans sold
FDIC loss share expense (Refer to Note 28)
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
Total operating expenses
Income before income tax
Income tax 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
The accompanying notes are an integral part of these Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
Net income
Reclassification to retained earnings due to cumulative effect of accounting change (Note 3)
Other comprehensive (loss) income 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 losses on debt securities arising during the period
Unrealized holding gains on equity securities arising during the period
Reclassification adjustment for gains included in net income
Unrealized net gains (losses) on cash flow hedges
Reclassification adjustment for net (gains) losses included in net income
Other comprehensive (loss) income before tax
Income tax benefit (expense)
Total other comprehensive (loss) income, net of tax
Comprehensive (loss) income, net of tax
Tax effect allocated to each component of other comprehensive (loss) income:
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Balance at December 31, 2016
Issuance of stock
Dividends declared:
Common stock
Preferred stock
Common stock purchases
Other comprehensive income, net of tax
Balance at March 31, 2017
Balance at December 31, 2017
Cumulative effect of accounting change
Common stock reissuance
Stock based compensation
Balance at March 31, 2018
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
Depreciation and amortization of premises and equipment
Net accretion of discounts and amortization of premiums and deferred fees
Share-based compensation
Impairment losses on long-lived assets
Fair value adjustments on mortgage servicing rights
FDIC loss share expense
Earnings from investments under the equity method, net of dividends or distributions
Deferred income tax expense
(Gain) loss on:
Disposition of premises and equipment and other productive assets
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 debt securities
Equity 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
Equity
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
Held-to-maturity
Proceeds from sale of investment securities:
Net disbursements on 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 insurance claims
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 decrease in cash and due from banks, and restricted cash
Cash and due from banks, and restricted cash at beginning of period
Cash and due from banks, and restricted cash at the end of the period
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Notes to Consolidated Financial
Statements (Unaudited)
Nature of operations
Basis of presentation and summary of significant accounting policies
New accounting pronouncements
Restrictions on cash and due from banks and certain securities
Debt securitiesavailable-for-sale
Debt securitiesheld-to-maturity
FDIC loss share asset and true-up payment obligation
Mortgage banking activities
Transfers of financial assets and mortgage servicing assets
Other real estate owned
Goodwill and other intangible assets
Borrowings
Offsetting of financial assets and liabilities
Stockholders’ equity
Other comprehensive loss
Guarantees
Commitments and contingencies
Non-consolidated variable interest entities
Related party transactions
Fair value measurement
Fair value of financial instruments
Net income per common share
Revenue from contracts with customers
Pension and postretirement benefits
Stock-based compensation
Income taxes
Supplemental disclosure on the consolidated statements of cash flows
Segment reporting
Subsequent events
Condensed consolidating financial information of guarantor and issuers of registered guaranteed securities
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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 mainland United States and 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. In the U.S. mainland, the Corporation provides retail, mortgage and commercial banking services through its New York-chartered banking subsidiary, Popular Bank (“PB”), which has branches located in New York, New Jersey and Florida.
Prior to April 9, 2018, PB operated under the legal name of Banco Popular North America and conducted business under the assumed name of Popular Community Bank.
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Note 2 – Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The consolidated interim financial statements have been prepared without audit. The consolidated statement of financial condition data at December 31, 2017 was derived from audited financial statements. The unaudited interim financial statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, all of a normal recurring nature, for a fair statement of such results.
Certain reclassifications have been made to the 2017 consolidated financial statements and notes to the financial statements to conform with the 2018 presentation.
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, 2017, included in the Corporation’s 2017 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 3 – New accounting pronouncements
Recently Adopted Accounting Standards Updates
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 of pension and postretirement benefit plans. 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.
As a result of the adoption of this accounting pronouncement during the first quarter of 2018, the Corporation recognized $2.2 million (March 31, 2017—$1.9 million) as components of net periodic benefit cost other than service cost in the other operating expenses caption, which would have otherwise previously been recognized as personnel cost. The presentation for prior periods has been adjusted to reflect the new classification. Effective January 1, 2018, these expenses are no longer capitalized as part of loan origination costs.
FASB Accounting Standards Update (“ASU”) 2017-05, Other Income– Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets
The FASB issued ASU 2017-05 in February 2017, which, among other things, clarifies the scope of the derecognition of nonfinancial assets, the definition of in substance financial assets, and impacts the accounting for partial sales of nonfinancial assets by requiring full gain recognition upon the sale.
The adoption of this standard during the first quarter of 2018 did not have a material impact on the Corporation’s financial statements.
FASB Accounting Standards Update (“ASU”) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business
The FASB issued ASU 2017-01 in January 2017, which revises the definition of a business by providing an initial screen to determine when an integrated set of assets and activities (“set”) is not a business. Also, the amendments, among other things, specify the minimum inputs and processes required for a set to meet the definition of a business when the initial screen is not met and narrow the definition of the term output so that the term is consistent with Topic 606.
The Corporation adopted ASU 2017-01 during the first quarter of 2018. As such, the Corporation will consider this guidance in any business combinations completed after the effective date.
FASB Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash
The FASB issued ASU2016-18 in November 2016, which require entities to present the changes in total cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new guidance also requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheet if restricted cash and restricted cash equivalents are presented in a different line item in the balance sheet.
As a result of the adoption of this accounting pronouncement during the first quarter of 2018, the Corporation included restricted cash and restricted cash equivalents within money market investments of $9.8 million at March 31, 2018 (March 31, 2017—$8.7 million) in the Consolidated Statements of Cash Flows. In addition, the Corporation presented a reconciliation of the totals in the Consolidated Statements of Cash Flows to the related captions in the Consolidated Statements of Condition in Note 32, Supplemental disclosure on the consolidated statements of cash flows.
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FASB Accounting Standards Update (“ASU”) 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory
The FASB issued ASU 2016-16 in October 2016, which eliminates the exception for all intra-entity sales of assets other than inventory that requires deferral of the tax effects until the transferred asset is sold to a third party or otherwise recovered through use. The new guidance requires a reporting entity to recognize the tax impact from the sale of the asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer.
As a result of the adoption of this accounting pronouncement during the first quarter of 2018, the Corporation recorded a positive cumulative effect adjustment of $1.3 million to retained earnings to reflect the net tax benefit resulting from intra-entity sales of assets.
FASB Accounting Standards Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
The FASB issued ASU 2016-15 in August 2016, which addresses specific cash flow issues with the objective of reducing existing diversity in practice, which may lead to a difference in the classification of transactions between operating, financing or investing activities. Among other things, the guidance provides an accounting policy election for classifying distributions received from equity method investees and clarifies the application of the predominance principle.
As a result of the adoption of this accounting pronouncement during the first quarter of 2018, the Corporation reclassified from investing to operating activities $0.5 million in the Consolidated Statements of Cash Flows for the quarter ended March 31, 2017 as a result of electing the cumulative earnings approach for classifying distributions received from equity investees.
FASB Accounting Standards Updates (“ASUs”), Revenue from Contracts with Customers (Topic 606)
The FASB has issued a series of ASUs which, among other things, clarify the principles for recognizing revenue and develop a common revenue standard. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services, that is, the satisfaction of performance obligations, to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. A five-step process is defined to achieve this core principle. The new guidance also requires disclosures to enable users of financial statements to understand the nature, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
The Corporation adopted this accounting pronouncement during the first quarter of 2018 using the modified retrospective approach. The Corporation elected the practical expedient that permits an entity to expense incremental costs of obtaining contracts, given the amortization periods were one year or less. There were no material changes in the presentation and timing of when revenues are recognized. ASC Topic 606 was applied to contracts that were not completed as of January 1, 2018. There was no impact in the evaluation of these contracts. Refer to additional disclosures on Note 27, Revenue from contracts with customers.
FASB Accounting Standards Update (“ASU”) 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
The FASB issued ASU 2016-01 in January 2016, which primarily affects the accounting for equity investments and financial liabilities under the fair value option as follows: require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; simplify the impairment assessment of equity investments without readily determinable fair values; require changes in fair value due to instrument-specific credit risk to be presented separately in other comprehensive income for financial liabilities under the fair value option; and clarify that the need for a valuation allowance on a deferred tax asset related to available-for-sale securities should be evaluated in combination with the entity’s other deferred tax assets. In addition, the ASU also impacts the presentation and disclosure requirements of financial instruments.
As a result of the adoption of this accounting pronouncement during the first quarter of 2018, the Corporation aggregated $11 million previously classified as available-for-sale and as trading to those under the other investment securities caption and reclassified under the caption of equity securities which amounted to $165.2 million at March 31, 2018 (December 31, 2017—$165.1 million). In addition, a positive cumulative effect adjustment of $0.6 million was recognized due to the reclassification of unrealized gains of equity securities available-for-sale, net of tax, from accumulated other comprehensive loss to retained earnings.
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The adoption of FASB Accounting Standards Update (“ASU”)2017-09, Compensation– Stock Compensation (Topic 718): Scope of Modification Accounting, effective during the first quarter of 2018, did not have a significant impact on the Consolidated Financial Statements.
Recently Issued Accounting Standards Updates
FASB Accounting Standards Update (“ASU”) 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities
The FASB issued ASU 2018-03 in February 2018, which clarifies certain aspects of the guidance in ASU 2016-01, principally related to equity securities without a readily determinable fair value.
The amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Early adoption is permitted.
The Corporation does not expect to be significantly impacted by these technical corrections and improvements.
For recently issued Accounting Standards Updates not yet effective, refer to Note 4 to the Consolidated Financial Statements included in the 2017 Form 10-K.
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Note 4 – Restrictions on cash and due from banks and certain securities
The Corporation’s banking subsidiaries, BPPR and PB, 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 $ 1.5 billion at March 31, 2018 (December 31, 2017 - $ 1.4 billion). Cash and due from banks, as well as other highly liquid securities, are used to cover the required average reserve balances.
At March 31, 2018, the Corporation held $39 million in restricted assets in the form of funds deposited in money market accounts, debt securities available for sale and equity securities (December 31, 2017—$41 million). The amounts held in debt securities available for sale and equity securities 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 5 – Debt securitiesavailable-for-sale
The following tables present the amortized cost, gross unrealized gains and losses, approximate fair value, weighted average yield and contractual maturities of debt securities available-for-sale at March 31, 2018 and December 31, 2017.
U.S. Treasury securities
Within 1 year
After 1 to 5 years
After 5 to 10 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 10 years
Total collateralized mortgage obligations—federal agencies
Mortgage-backed securities
Total mortgage-backed securities
Other
Total other
Total debt securitiesavailable-for-sale[1]
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The weighted average yield on debt securities available-for-sale is based on amortized cost; therefore, it does not give effect to changes in fair value.
Debt securities not due on a single contractual maturity date, such as mortgage-backed securities and collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations, mortgage-backed securities and certain other securities may differ from their contractual maturities because they may be subject to prepayments or may be called by the issuer.
There were no securities sold during the quarters ended March 31, 2018 and March 31, 2017.
The following tables present the Corporation’s fair value and gross unrealized losses of debt securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2018 and December 31, 2017.
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Total debt securitiesavailable-for-sale in an unrealized loss position
As of March 31, 2018, the portfolio ofavailable-for-sale debt securities reflects gross unrealized losses of approximately $248 million, driven mainly by mortgage-backed securities, U.S. Treasury securities, and collateralized mortgage obligations.
Management evaluates debt 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. The OTTI analysis requires management to consider various factors, which include, but are not limited to: (1) the length of time and the extent to which fair value has been less than the amortized cost basis, (2) the financial condition of the issuer or issuers, (3) actual collateral attributes, (4) the payment structure of the debt security and the likelihood of the issuer being able to make payments, (5) any rating changes by a rating agency, (6) adverse conditions specifically related to the security, industry, or a geographic area, and (7) management’s intent to sell the debt security or whether it is more likely than not that the Corporation would be required to sell the debt security before a forecasted recovery occurs.
At March 31, 2018, 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 of such date. At March 31, 2018, 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 debt securities prior to recovery of their amortized cost basis.
The following table states the name of issuers, and the aggregate amortized cost and fair value of the debt securities of such issuer (includes available-for-sale and held-to-maturity debt securities), in which the aggregate amortized cost of such securities exceeds 10% of stockholders’ equity. This information excludes debt 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.
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FNMA
Freddie Mac
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Note 6 – Debt securitiesheld-to-maturity
The following tables present the amortized cost, gross unrealized gains and losses, approximate fair value, weighted average yield and contractual maturities of debt securities held-to-maturity at March 31, 2018 and December 31, 2017.
Collateralized mortgage obligations - federal agencies
Total collateralized mortgage obligations - federal agencies
Trust preferred securities
Total trust preferred securities
Total debt securitiesheld-to-maturity[1]
Debt 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 debt securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2018 and December 31, 2017.
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Total debt securitiesheld-to-maturity in an unrealized loss position
As indicated in Note 5 to these Consolidated Financial Statements, management evaluates debt 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 March 31, 2018 are primarily associated with securities issued by municipalities of Puerto Rico and are generally not rated by a credit rating agency. This includes $47 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 $44 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 March 31, 2018. 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 debt 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 21 for additional information on the Corporation’s exposure to the Puerto Rico Government.
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Note 7 – 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 9.
During the quarter ended March 31, 2018, the Corporation recorded purchases (including repurchases) of mortgage loans amounting to $156 million and consumer loans of $51 million, compared to purchases (including repurchases) of mortgage loans of $136 million, consumer loans of $42 million and leases of $2 million, during the quarter ended March 31, 2017.
The Corporation performed whole-loan sales involving approximately $10 million of residential mortgage loans during the quarter ended March 31, 2018 (March 31, 2017 - $28 million). Also, during the quarter ended March 31, 2018, the Corporation securitized approximately $112 million of mortgage loans into Government National Mortgage Association (“GNMA”) mortgage-backed securities and $26 million of mortgage loans into Federal National Mortgage Association (“FNMA”) mortgage-backed securities, compared to $147 million and $28 million, respectively, during the quarter ended March 31, 2017.
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 March 31, 2018 and December 31, 2017, including loans previously covered by the commercial FDIC loss sharing agreements.
23
March 31, 2018
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
Popular U.S.
Legacy
24
Popular, Inc.
Legacy[3]
December 31, 2017
25
The level of delinquencies for mortgage loans was impacted by the loan moratorium implemented by the Corporation as part of its hurricane relief measures. Also, loans with a delinquency status of 90 days past due as of March 31, 2018 include approximately $535 million in loans previously pooled into GNMA securities (December 31, 2017—$840 million). Under the GNMA program, issuers such as BPPR have the option but not the obligation to repurchase loans that are 90 days or more past due. For accounting purposes, these loans subject to the repurchase option are required to be reflected on the financial statements of the Bank with an offsetting liability. While the borrowers for our serviced GNMA portfolio benefited from the loan payment moratorium, the delinquency status of these loans continued to be reported to GNMA without considering the moratorium. Management will continue to monitor the effect of the moratorium as the period comes to an end and the loan repayment schedule is resumed.
26
The following tables present non-covered loans held-in-portfolio by loan class that are in non-performing status or are accruing interest but are past due 90 days or more at March 31, 2018 and December 31, 2017. 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.
At March 31, 2018
Mortgage[3]
Total[2]
27
At December 31, 2017
Covered loans
The following tables present the composition of loans by past due status at March 31, 2018 and December 31, 2017 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
28
The following table presents covered loans in non-performing status and accruing loans past-due 90 days or more by loan class at March 31, 2018 and December 31, 2017.
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 March 31, 2018 (December 31, 2017—$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
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 March 31, 2018 (December 31, 2017 - $1.9 billion). At March 31, 2018, 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.
29
Changes in the carrying amount and the accretable yield for the Westernbank loans accounted pursuant to the ASC Subtopic 310-30, for the quarters ended March 31, 2018 and 2017, were as follows:
Beginning balance
Accretion
Change in expected cash flows
Ending balance
Collections / loan sales / charge-offs
Ending balance[1]
Allowance for loan losses ASC 310-30 Westernbank loans
Ending balance, net of ALLL
Other loans acquired with deteriorated credit quality
The outstanding principal balance of other acquired loans accounted pursuant to ASC Subtopic 310-30,amounted to $552 million at March 31, 2018 (December 31, 2017—$556 million). At March 31, 2018, none of the other acquired loans accounted under ASC Subtopic 310-30 were considered non-performing loans. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, was recognized on all acquired loans.
Changes in the carrying amount and the accretable yield for the other acquired loans accounted pursuant to the ASC Subtopic310-30, for the quarters ended March 31, 2018 and 2017 were as follows:
Activity in the accretable yield - Other acquired loans ASC 310-30
Additions
30
Carrying amount of other acquired loans accounted for pursuant to ASC 310-30
Collections and charge-offs
Allowance for loan losses ASC 310-30 non-covered loans
Ending balance, net of allowance for loan losses
31
Note 8 – 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 March 31, 2018, 45% (March 31, 2017—55%) 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 mortgage, leasing, credit cards and auto loans portfolios for 2018 and in the mortgage, other consumer and commercial real estate owner occupied portfolios for 2017.
For the period ended March 31, 2018, 5.41% (March 31, 2017—0.35%) of our Popular U.S. 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 2018 and in the commercial multifamily loan and legacy portfolios for 2017.
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 ended March 31, 2018 and 2017.
32
For the quarter ended March 31, 2018
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
Provision
Impaired covered loans
Covered loansheld-in-portfolio excluding impaired loans
Total covered loansheld-in-portfolio
Impaired loans
Loansheld-in-portfolio excluding impaired loans
Total loansheld-in-portfolio
33
For the quarter ended March 31, 2017
Puerto Rico - Covered Loans
34
The following table provides the activity in the allowance for loan losses related to Westernbank loans accounted for pursuant to ASC Subtopic 310-30.
Provision for loan losses (reversal of provision)
Net charge-offs
The following tables present loans individually evaluated for impairment at March 31, 2018 and December 31, 2017.
35
Total Puerto Rico
HELOCs
Total Popular U.S.
Credit Cards
Total Popular, Inc.
36
The following tables present the average recorded investment and interest income recognized on impaired loans for the quarters ended March 31, 2018 and 2017.
37
Helocs
Modifications
Troubled debt restructurings (“TDRs”) related to non-covered loan portfolios amounted to $ 1.3 billion at March 31, 2018 (December 31, 2017 - $ 1.3 billion). The amount of outstanding commitments to lend additional funds to debtors owing receivables whose terms have been modified in TDRs amounted to $16 million related to the commercial loan portfolio at March 31, 2018 (December 31, 2017 - $8 million).
At March 31, 2018, the mortgage loan TDRs include $463 million guaranteed by U.S. sponsored entities at BPPR, compared to $449 million at December 31, 2017.
A modification of a loan constitutes a TDR 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 3 to the 2017 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 March 31, 2018 and December 31, 2017.
38
Commercial
Leases
The following tables present the loan count by type of modification for those loans modified in a TDR during the quarters ended March 31, 2018 and 2017. Loans modified as TDRs for the U.S. operations are considered insignificant to the Corporation.
39
The following tables present, by class, quantitative information related to loans modified as TDRs during the quarters ended March 31, 2018 and 2017.
(Dollars in thousands)
40
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 March 31, 2018 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.
Defaulted during the quarter ended March 31, 2018
Defaulted during the quarter ended March 31, 2017
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 March 31, 2018 and December 31, 2017.
41
Puerto Rico[1]
Total Commercial
Total Consumer
42
The following table presents the weighted average obligor risk rating at March 31, 2018 for those classifications that consider a range of rating scales.
43
44
The following table presents the weighted average obligor risk rating at December 31, 2017 for those classifications that consider a range of rating scales.
45
Note 9 – FDIC loss-share asset and true-up payment obligation
In connection with the Westernbank FDIC-assisted transaction, BPPR entered into loss-share arrangements with the FDIC with respect to the covered loans and other real estate owned. Pursuant to the terms of the loss-share arrangements, the FDIC’s obligation to reimburse BPPR for losses with respect to covered assets begins with the first dollar of loss incurred. The FDIC reimburses BPPR for 80% of losses with respect to covered assets, and BPPR reimburses the FDIC for 80% of recoveries with respect to losses for which the FDIC paid 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.
Amortization of loss-share indemnification asset
Credit impairment losses to be covered under loss-sharing agreements
Reimbursable expenses
Net payments from FDIC under loss-sharing agreements
Other adjustments attributable to FDIC loss-sharing agreements
Balance due to the FDIC for recoveries on covered assets
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 the quarter ended June 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 March 31, 2018 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-up measurement date”) of the final shared-loss month, or upon the final disposition of all covered assets under the loss-share agreements, in the event losses on the loss-share agreements fail to reach expected levels. The estimated fair value of such true-up payment obligation is recorded as contingent consideration, which is included in the caption of other liabilities in the consolidated statements of financial condition. Under the loss sharing agreements, BPPR will pay to the FDIC 50% of the excess, if any, of: (i) 20% of the intrinsic loss estimate of $4.6 billion (or $925 million) (as determined by the FDIC) less (ii) the sum of: (A) 25% of the asset discount (per bid) (or ($1.1 billion)); plus (B) 25% of the cumulative shared-loss payments (defined as the aggregate of all of the payments made or payable to BPPR minus the aggregate of all of the payments made or payable to the FDIC); plus (C) the sum of the period servicing amounts for every consecutive twelve-month period prior to and ending on the true-up measurement date in respect of each of the loss-sharing agreements during which the loss-sharing provisions of the applicable loss-sharing agreement is in effect (defined as the product of the simple average of the principal amount of shared- loss loans and shared-loss assets at the beginning and end of such period times 1%).
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 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 ASC310-30.
46
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 March 31, 2018 and December 31, 2017.
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 5.47% in 2017 to 4.57% in 2018 due to a lower risk premium. The discount rate reflects Popular’s credit risk for the term remaining before the payment. Therefore, a significant component of the discount rate is the credit spreads on Popular’s publicly traded debt securities. This spread has been impacted by the effect of the hurricanes, resulting in volatility in the fair value of the true-uppayment obligation, even though the undiscounted value of the liability has not varied signififcantly. 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:
47
Note 10 – 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 profit (loss):
Unrealized losses on outstanding derivative positions
Realized gains (losses) on closed derivative positions
Total trading account profit (loss)
Total mortgage banking activities
48
Note 11 – 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 20 to the Consolidated Financial Statements for a description of such arrangements.
No liabilities were incurred as a result of these securitizations during the quarters ended March 31, 2018 and 2017 because they did not contain any credit recourse arrangements. During the quarter ended March 31, 2018, the Corporation recorded a net gain of $1.0 million (March 31, 2017 - $5.0 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 ended March 31, 2018 and 2017:
Assets
Debt securities available for sale:
Mortgage-backed securities—FNMA
Total debt securitiesavailable-for-sale
Trading account debt securities:
Mortgage-backed securities—GNMA
Total trading account debt securities
Mortgage servicing rights
During the quarter ended March 31, 2018, the Corporation retained servicing rights on whole loan sales involving approximately $10.0 million in principal balance outstanding (March 31, 2017 - $18.2 million), with realized gains of approximately $0.1 million (March 31, 2017 - gains of $0.4 million). All loan sales performed during the quarters ended March 31, 2018 and 2017 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 (“MSR”) 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.
49
The following table presents the changes in MSRs measured using the fair value method for the quarters ended March 31, 2018 and 2017.
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
Fair value at end of period
Residential mortgage loans serviced for others were $16.1 billion at March 31, 2018 and December 31, 2017, which in part was impacted by a reduction of $535 million (December 31, 2017 - $840 million), in mortgage loans at BPPR due to the rebooking of loans previously pooled into GNMA securities.
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 credited to income when they are collected. At March 31, 2018 and 2017, those weighted average mortgage servicing fees were 0.30%. 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 ended March 31, 2018 and 2017 were as follows:
Prepayment speed
Weighted average life (in years)
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:
50
Fair value of servicing rights
Weighted average prepayment speed (annual rate)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Weighted average discount rate (annual rate)
The 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 March 31, 2018, the Corporation serviced $1.4 billion (December 31, 2017 - $1.5 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 March 31, 2018, the Corporation had recorded $535 million in mortgage loans on its Consolidated Statements of Financial Condition related to this buy-back option program (December 31, 2017 - $840 million). While the borrowers for our serviced GNMA portfolio benefited from the loan payment moratorium, the delinquency status of these loans continued to be reported to GNMA without considering the moratorium. 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 quarter ended March 31, 2018, the Corporation repurchased approximately $85 million (March 31, 2017 - $45 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.
51
Note 12 – Other real estate owned
The following tables present the activity related to Other Real Estate Owned (“OREO”), for the quarters ended March 31, 2018 and 2017.
Write-downs in value
Sales
Other adjustments
52
Note 13 – 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
53
Note 14 – Goodwill and other intangible assets
There were no changes in the carrying amount of goodwill for the quarters ended March 31, 2018 and 2017.
The following tables present the gross amount of goodwill and accumulated impairment losses by reportable segments.
Banco Popular de Puerto Rico
Other Intangible Assets
At March 31, 2018 and December 31, 2017, 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 March 31, 2018, the Corporation recognized $ 2.3 million in amortization expense related to other intangible assets with definite useful lives (March 31, 2017 - $ 2.3 million).
54
The following table presents the estimated amortization of the intangible assets with definite useful lives for each of the following periods:
Remaining 2018
Year 2019
Year 2020
Year 2021
Year 2022
Year 2023
Later years
55
Note 15 – 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 March 31, 2018 follows:
2018
2019
2020
2021
2022
2023 and thereafter
At March 31, 2018, the Corporation had brokered deposits amounting to $ 0.6 billion (December 31, 2017 - $ 0.5 billion).
The aggregate amount of overdrafts in demand deposit accounts that were reclassified to loans was $4 million at March 31, 2018 (December 31, 2017 - $4 million).
56
Note 16 – Borrowings
The following table presents the balances of assets sold under agreements to repurchase at March 31, 2018 and December 31, 2017.
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 debt 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 this 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 March 31, 2018 and December 31, 2017.
Advances with the FHLB paying interest at maturity with fixed rates ranging from 1.63% to 2.02%
Total other short-term borrowings
Note: Refer to the Corporation’s 2017 Form 10-K for rates information at December 31, 2017.
57
The following table presents the composition of notes payable at March 31, 2018 and December 31, 2017.
Advances with the FHLB with maturities ranging from 2018 through 2029 paying interest at monthly fixed rates ranging from 0.84% 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 $2,606
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 $443
Total notes payable
A breakdown of borrowings by contractual maturities at March 31, 2018 is included in the table below.
Total borrowings
At March 31, 2018 and December 31, 2017, the Corporation had FHLB borrowing facilities whereby the Corporation could borrow up to $3.8 billion and $3.9 billion, respectively, of which $844 million and $726 million, respectively, were used. In addition, at March 31, 2018 and December 31, 2017, the Corporation had placed $435 million and $260 million, respectively, of the available FHLB credit facility as collateral for a municipal letter of credit to secure deposits. The FHLB borrowing facilities are collateralized with loans held-in-portfolio, and do not have restrictive covenants or callable features.
Also, at March 31, 2018, the Corporation has a borrowing facility at the discount window of the Federal Reserve Bank of New York amounting to $1.1 billion (2017 - $1.1 billion), which remained unused at March 31, 2018 and December 31, 2017. The facility is a collateralized source of credit that is highly reliable even under difficult market conditions.
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Note 17 – 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 March 31, 2018 and December 31, 2017.
As of March 31, 2018
Derivatives
Repurchase agreements
As of December 31, 2017
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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 18 – 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. 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. During the quarter ended March 31, 2018, the Corporation declared dividends on its common stock of $ 25.5 million; which were paid on April 2, 2018.
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 $540 million at March 31, 2018 (December 31, 2017 - $540 million) There were no transfers between the statutory reserve account and the retained earnings account during the quarters ended March 31, 2018 and March 31, 2017.
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Note 19 – Other comprehensive loss
The following table presents changes in accumulated other comprehensive loss by component for the quarters ended March 31, 2018 and 2017.
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 net holding losses on debt securities
Unrealized holding gains on equity securities
Reclassification to retained earnings due to cumulative effect adjustment of accounting change
Other comprehensive income before reclassifications
Amounts reclassified from accumulated other comprehensive income
Unrealized net losses on cash flow hedges
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive loss
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The following table presents the amounts reclassified out of each component of accumulated other comprehensive loss during the quarters ended March 31, 2018 and 2017.
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
Realized gain on sale of equity securities
Forward contracts
Income tax (expense) benefit
Total reclassification adjustments, net of tax
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Note 20 – Guarantees
At March 31, 2018 the Corporation recorded a liability of $0.5 million (December 31, 2017 - $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 March 31, 2018 the Corporation serviced $1.4 billion (December 31, 2017 - $1.5 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 ended March 31, 2018, the Corporation repurchased approximately $ 8 million of unpaid principal balance in mortgage loans subject to the credit recourse provisions (March 31, 2017 - $ 9 million). 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 March 31, 2018 the Corporation’s liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $ 57 million (December 31, 2017 - $ 59 million).
The following table shows the changes in the Corporation’s liability of estimated losses related to loans serviced with credit recourse provisions during the quarters ended March 31, 2018 and 2017.
Balance as of beginning of period
Provision for recourse liability
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 three months ended March 31, 2018, BPPR repurchased $9 million in loans under representation and warranty arrangements (there were no loan repurchases during the same period of the prior year). 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 ended March 31, 2018 and 2017.
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Reversal of provision 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 March 31, 2018, the Corporation serviced $16.1 billion in mortgage loans for third-parties, including the loans serviced with credit recourse (December 31, 2017 - $16.1 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 March 31, 2018, the outstanding balance of funds advanced by the Corporation under such mortgage loan servicing agreements was approximately $110 million (December 31, 2017 - $107 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 March 31, 2018 and December 31, 2017. In addition, at March 31, 2018 and December 31, 2017, 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 22 to the Consolidated Financial Statements in the 2017 Form 10-K for further information on the trust preferred securities.
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Note 21 – 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 March 31, 2018 and December 31, 2017, the Corporation maintained a reserve of approximately $11 million and $10 million, respectively, 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 33 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 and other basic utility and infrastructure services were severely curtailed. As of the date of this report, electricity and water services have been restored to the vast majority of the clients of the Commonwealth’s electric and water utilities, but the electric system remains fragile. The damages caused by the hurricanes are substantial and have had a material adverse impact on economic activity in Puerto Rico. It is still, however, too early to fully assess and quantify the extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity.
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) requires 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 (iii) 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.
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The Oversight Board has designated a number of entities as “covered entities” under PROMESA, including the Commonwealth and all of its instrumentalities. 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. Pursuant to PROMESA, the Oversight Board certified fiscal plans for certain of these “covered entities,” including the Commonwealth, Government Development Bank for Puerto Rico (“GDB”) and several other public corporations in 2017. However, following the hurricanes, the Oversight Board requested the submission of new fiscal plans for such entities. The Oversight Board certified revised fiscal plans for the Commonwealth, GDB, the Puerto Rico Highways and Transportation Authority (“HTA”), the Puerto Rico Electric Power Authority (“PREPA”), the Puerto Rico Aqueduct and Sewer Authority and the University of Puerto Rico on April 2018. Both last year’s fiscal plans and the new certified fiscal plans indicate that the applicable government entities are unable to pay their outstanding obligations as currently scheduled, thus recognizing a need for a significant debt restructuring and/or write downs.
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 the Puerto Rico Sales Tax Financing Corporation, the Employees Retirement System, HTA and PREPA. The Oversight Board has also authorized GDB to pursue a restructuring of its financial indebtedness under Title VI of PROMESA. 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. However, 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 March 31, 2018, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 481 million, which was fully outstanding at quarter-end (compared to a direct exposure of approximately $484 million, which was fully outstanding at December 31, 2017). Of this amount, $ 434 million consists of loans and $ 47 million are securities ($ 435 million and $ 49 million at December 31, 2017). All of the amount outstanding at March 31, 2018 were obligations from various Puerto Rico municipalities. In most cases, these are “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. At March 31, 2018, 74% of the Corporation’s exposure to municipal loans and securities was concentrated in the municipalities of San Juan, Guaynabo, Carolina and Bayamón.
The following table details the loans and investments representing the Corporation’s direct exposure to the Puerto Rico government according to their maturities:
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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 March 31, 2018, the Corporation had $382 million in indirect exposure to loans or securities issued or guaranteed by Puerto Rico governmental entities whose principal source of repayment is non-governmental. In such obligations, the Puerto Rico government entity guarantees any shortfall in collateral in the event of borrower default ($386 million at December 31, 2017). These included $306 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, 2017 - $310 million). These mortgage loans are secured by the underlying properties and the HFA guarantee serve 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, at March 31, 2018 and December 31, 2017, the Corporation had $44 million in Puerto Rico housing bonds issued by HFA, which are secured by second mortgage loans on Puerto Rico residential properties, $7 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 $25 million of commercial real estate notes issued by government entities, but payable from rent paid by third parties).
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 $80 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 9 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 $ 171 million at March 31, 2018 (December 31, 2017 - $ 165 million). For additional information refer to Note 9.
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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 reasonably 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 $28.2 million as of March 31, 2018. 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 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 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. 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
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the complaint. A follow-up hearing was set for March 6, 2018. On December 21, 2017, the Popular Defendants filed a certiorari petition before the Puerto Rico Court of Appeals, which plaintiffs opposed on January 9, 2018. On March 4, 2018, the Court of Appeals declined to entertain the certiorari petition. Plaintiffs sought to amend the complaint and defendants filed an answer thereto. The case is now in its discovery stage.
BPPR has separately been named a defendant in a putative class action complaint captioned Ramirez 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 as 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 and on March 21, 2018, the Court of Appeals reversed the Court of First Instance’s dismissal. On April 5, 2018, co-defendant Oriental Bank filed a motion for reconsideration, which the Court denied on April 27th. Banco Popular intends to appeal the Court of Appeals’ determination.
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 maintain that when they sought to reduce their loan payments, defendants failed to provide them with such 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 the Home Affordable Modification Program (“HAMP”), the Home Affordable Refinance Program (“HARP”) and other federally sponsored loan modification programs, as well as the Puerto Rico Mortgage Debtor Assistance Act and the Truth in Lending Act (“TILA”). For the alleged violations stated above, Plaintiffs request that all Defendants (over 20, including all local banks), be held jointly and severally liable in an amount no less than $400 million. BPPR waived service of process in June and filed a motion to dismiss in August 2017, as did most co-defendants. On March 28, 2018, the Court dismissed the complaint in its entirety. On April 9, 2018, plaintiffs filed a motion for reconsideration of such dismissal, which is still pending before the Court.
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. As in González Camacho, plaintiffs contend that when they sought to reduce their loan payments, defendants failed to provide them with such 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 (in Costa Dorada) and unspecified damages (in Saad Maura). Banco Popular has not yet been served with summons in relation to the Costa Dorada Matter. On January 3, 2018, plaintiffs in the Saad Maura case requested that Banco Popular waive service of process, which it agreed to do on February 1, 2018. BPPR subsequently filed a motion to dismiss the complaint on the same grounds as those asserted in the Gonzalez Camacho action (as did most co-defendants, separately). BPPR further filed a motion to oppose class certification.
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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 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, because 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 extended plaintiffs three consecutive six-month payment forbearances, the last of which is still in effect, and has recently engaged in preliminary settlement discussions with plaintiffs. In November 2017, the FDIC notified BPPR that it had agreed to indemnify the Bank in connection with its Doral-related exposure, pursuant to the terms of the relevant Purchase and Assumption Agreement. On April 11, 2018, the Court stayed these proceedings in light of the FDIC’s filing of a motion to remove this matter to Federal Court.
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 notified applicable regulators and conducted a review of its mortgage files to assess the scope of potential customer impact. The review is substantially complete. The review found that while the mailing error extended to approximately 23,000 residential mortgage loans (approximately 50% of which are serviced by the Corporation for third parties), the number of borrowers actually harmed by the mailing error was substantially lower. This was due to, among other things, the fact that the Corporation regularly uses means other than the mail to communicate with borrowers, including email and hand delivery of written notices at our mortgage servicing centers or bank branches. Importantly, more than half of all borrowers potentially subject to such error actually closed on a loss mitigation alternative.
During the fourth quarter of 2017, the Corporation began outreach to potentially affected borrowers with outstanding loans. These efforts are substantially complete; however, outreach to certain borrowers whose loans require special handling is still in progress. Such borrowers include for example, those in bankruptcy. The Corporation is engaged in ongoing dialogue with applicable regulators with respect to this matter, including remediation plans. 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
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the counterclaim filed by the Involuntary Debtors in local court. The court allowed limited discovery to take place prior to an evidentiary hearing to determine the merits of debtors’ motion to dismiss. At a hearing held in November 2017, the Court determined that it was inclined to rule against the dismissal of the complaint but requested that the parties submit supplemental briefs on the subject, which the parties did; however, no decision has been rendered to date. Discovery is ongoing.
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 117 arbitration proceedings with aggregate claimed amounts of approximately $243 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, as well as the Commonwealth’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 arbitration proceedings described above, or a significant increase in customer complaints, could have a material adverse effect on Popular.
Subpoenas for Production of Documents in relation to PROMESA Title III Proceedings
Popular Securities has, together with Popular, Inc. and BPPR (collectively, the “Popular Companies”) 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 sought 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 PROMESA Oversight Board, who opposed the UCC’s request, submit further briefing on this subject. The parties argued their respective positions at the omnibus hearing held on November 15, 2017. Upon listening to arguments on this matter, Magistrate Dein denied the UCC’s request without prejudice, to allow the law firm of Kobre & Kim to carry out its own independent investigation on behalf of the PROMESA Oversight Board.
Since the August 2017 hearing, the Popular Companies have been served with additional requests for the preservation and voluntary production of certain documents and witnesses from the UCC and the COFINA Agents in connection with the COFINA-Commonwealth adversary complaint, as well as from the Oversight Board’s Independent Investigator, Kobre & Kim. The Popular Companies are cooperating with all such requests but have 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 BANK
Josefina Valle v. Popular Community Bank (now Popular Bank)
PB 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, PB customers, allege among other things that PB 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 PB improperly disclosed its consumer overdraft policies and that the overdraft rates and fees assessed by PB violate New York’s usury laws. Plaintiffs seek unspecified damages, including punitive damages, interest, disbursements, and attorneys’ fees and costs.
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A motion to dismiss was filed on September 9, 2013. After several procedural steps that included a ruling partially granting PB’s motion to dismiss and the filing of an amended complaint that was also partially dismissed, on August 12, 2015, Plaintiffs filed a second amended complaint. On September 17, 2015, PB filed a motion to dismiss the second amended complaint and on February 18, 2016, the Court granted it in part and denied it in part, dismissing 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, PB filed an answer to the second amended complaint. On April 7, 2016, PB filed a notice of appeal on the partial denial of PB’s motion to dismiss and after briefing and the holding of oral argument, on April 25, 2017, the Appellate Division issued an order denying PB’s appeal. On November 13, 2017, the parties reached an agreement in principle. Under this agreement, subject to certain customary conditions including court approval of a final settlement agreement in consideration for the full settlement and release of defendant, an amount up to $5.2 million will be paid to qualified plaintiffs. In March 2018, the Court entered an order for the preliminary approval of the settlement. A fairness hearing has been scheduled for August 2018.
Eugene Duncan v. Popular North America
Popular North America was named a defendant in a putative class action complaint captioned Duncan v. Popular North America, filed on January 29, 2018 in the United States District Court for the Eastern District of New York. The complaint generally asserted that Popular North America (“PNA”) failed to design, construct, maintain and operate its website to be fully accessible to and independently usable by plaintiff and other blind or visually-impaired people, and that PNA’s denial of full and equal access to its website, and therefore to its products and services, violates the Americans with Disabilities Act. Plaintiff sought a permanent injunction to cause a change in defendant’s allegedly unlawful corporate policies, practices and procedures so that its website becomes and remains accessible to blind and visually impaired customers. On April 3, 2018, the parties reached an agreement in principle to settle this matter.
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Note 22 – 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 24 to the Consolidated Financial Statements for additional information on the debt securities outstanding at March 31, 2018 and December 31, 2017, which are classified asavailable-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 March 31, 2018 and December 31, 2017.
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 $11.4 billion at March 31, 2018 (December 31, 2017 - $11.7 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 March 31, 2018 and December 31, 2017, 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 March 31, 2018 and December 31, 2017.
Equity investment
Liabilities
Total net assets
The Corporation determined that the maximum exposure to loss under a worst case scenario at March 31, 2018 would be not recovering the net assets held by the Corporation as of the reporting date.
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ASU 2009-17 requires that an ongoing primary beneficiary assessment should be made to determine whether the Corporation is the primary beneficiary of any of the VIEs it is involved with. The conclusion on the assessment of these non-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 March 31, 2018.
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Note 23 – 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 March 31, 2018, the Corporation’s stake in EVERTEC was 16.09%. 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.
During the quarter ended March 31, 2018, there were no dividend distributions received by the Corporation from its investments in EVERTEC’s holding company (March 31, 2017—$ 1.2 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 March 31, 2018 and December 31, 2017. 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 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 and changes in stockholders’ equity for the quarters ended March 31, 2018 and 2017.
Share of income from investment in EVERTEC
Share of other changes in EVERTEC’s stockholders’ equity
Share of EVERTEC’s changes in equity recognized in income
The following table present the impact of transactions and service payments between the Corporation and EVERTEC (as an affiliate) and their impact on the results of operations for the quarters ended March 31, 2018 and 2017. Items that represent expenses to the Corporation are presented with parenthesis.
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
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PRLP 2011 Holdings, LLC
As indicated in Note 22 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 March 31, 2018 and December 31, 2017.
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 ended March 31, 2018 and 2017.
Share of loss from the equity investment in PRLP 2011 Holdings, LLC
No capital distributions were received by the Corporation from its investment in PRLP 2011 Holdings, LLC during the quarters ended March 31, 2018 and 2017. There were no transactions between the Corporation and PRLP 2011 Holdings, LLC during the quarters ended March 31, 2018 and 2017.
PR Asset Portfolio 2013-1 International, LLC
As indicated in Note 22 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 March 31, 2018 and December 31, 2017.
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 loss from PR Asset Portfolio 2013-1 International, LLC for quarters ended March 31, 2018 and 2017.
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Share of loss from the equity investment in PR Asset Portfolio2013-1 International, LLC
During the quarter ended March 31, 2018, there were no capital distributions received by the Corporation from its investment in PR Asset Portfolio 2013-1 International, LLC (March 31, 2017—$ 3.4 million). The Corporation received $0.7 million in dividend distributions during the quarter ended March 31, 2017, which were declared by PR Asset Portfolio 2013-1 International, LLC during the quarter ended December 31, 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 ended March 31, 2018 and 2017.
Interest income on loan to PR Asset Portfolio 2013-1International, LLC
Centro Financiero BHD León
At March 31, 2018, 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 March 31, 2018, the Corporation recorded $ 8.5 million in earnings from its investment in BHD Leon (March 31, 2017 - $ 6.1 million), which had a carrying amount of $ 143.0 million at March 31, 2018 (December 31, 2017 - $ 135.0 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 was repaid and expired during March 2017. On December 2017, BPPR extended a credit facility of $ 40 million to BHD León, with an outstanding balance of $ 40 million at March 31, 2018 (December 31, 2017 - $ 40 million). There were no dividend distributions received by the Corporation from its investment in BHD Leon during the quarters ended March 31, 2018 and 2017.
On June 30, 2017, BPPR extended an $8 million credit facility to Grupo Financiero Leon, S.A. Panamá (“GFL”), a shareholder of BHD Leon with an outstanding balance of $8 million at March 31, 2018. 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 quarter ended March 31, 2018 administrative fees charged to these investment companies amounted to $ 1.7 million (2017 - $ 2.0 million) and waived fees amounted to $ 0.5 million (2017 - $ 0.6 million), for a net fee of $ 1.2 million (2017 - $ 1.4 million).
The Corporation, through its subsidiary Banco Popular de Puerto Rico, has also entered into lines of credit facilities with these companies. As of March 31, 2018, the available lines of credit facilities amounted to $356 million (December 31, 2017 - $356 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. At March 31, 2018 there was no outstanding balance for these credit facilities.
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Note 24 – 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 2017 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.
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 March 31, 2018 and December 31, 2017:
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RECURRING FAIR VALUE MEASUREMENTS
Debt securitiesavailable-for-sale:
Trading account debt securities, excluding derivatives:
Mortgage-backed securities—federal agencies
Total trading account debt 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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Mortgage-backed securities - federal agencies
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 ended March 31, 2018 and 2017 and excludes nonrecurring fair value measurements of assets no longer outstanding as of the reporting date.
Quarter ended March 31, 2018
NONRECURRING FAIR VALUE MEASUREMENTS
Loans[1]
Other real estate owned[2]
Other foreclosed assets[2]
Total assets measured at fair value on a nonrecurring basis
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Quarter ended March 31, 2017
The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters ended March 31, 2018 and 2017.
Gains (losses) included in earnings
Gains (losses) included in OCI
Settlements
Changes in unrealized gains
(losses) included in earnings relating to assets still held at March 31, 2018
Transfers out of Level 3
(losses) included in earnings relating to assets still held at March 31, 2017
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 ended March 31, 2018. During the quarter ended March 31, 2017, a certain MBS amounting to $88 thousand was transferred from Level 3 to Level 2 due to a change in valuation technique from an internally-prepared pricing matrix to a bond’s theoretical value.
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Gains and losses (realized and unrealized) included in earnings for the quarters ended March 31, 2018 and 2017 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statements of operations as follows:
Trading account loss
The following table includes quantitative information about significant unobservable inputs used to derive the fair value of Level 3 instruments, excluding those instruments for which the unobservable inputs were not developed by the Corporation such as prices of prior transactions and/or unadjusted third-party pricing sources.
Valuation technique
Unobservable inputs
CMO’s - trading
Other - trading
Loansheld-in-portfolio
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.
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The significant unobservable inputs used in the fair value measurement of the Corporation’s mortgage servicing rights are constant prepayment rates and discount rates. Increases in interest rates may result in lower prepayments. Discount rates vary according to products and / or portfolios depending on the perceived risk. Increases in discount rates result in a lower fair value measurement. The Corporation’s Corporate Comptroller’s unit is responsible for determining the fair value of MSRs, which is based on discounted cash flow methods based on assumptions developed by an external service provider, except for prepayment speeds, which are adjusted internally for the local market based on historical experience. The Corporation’s Corporate Treasury unit validates the economic assumptions developed by the external service provider on a quarterly basis. In addition, an analytical review of prepayment speeds is performed quarterly by the Corporate Comptroller’s unit. The Corporation’s MSR Committee analyzes changes in fair value measurements of MSRs and approves the valuation assumptions at each reporting period. Changes in valuation assumptions must also be approved by the MSR Committee. The fair value of MSRs are compared with those of the external service provider on a quarterly basis in order to validate if the fair values are within the materiality thresholds established by management to monitor and investigate material deviations. Back-testing is performed to compare projected cash flows with actual historical data to ascertain the reasonability of the projected net cash flow results.
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Note 25 – 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 March 31, 2018 and December 31, 2017, 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 2017 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 debt securities, excluding derivatives[1]
Debt securitiesavailable-for-sale[1]
Debt securitiesheld-to-maturity:
Collateralized mortgage obligation-federal agency
Total debt securitiesheld-to-maturity
Equity securities:
FHLB stock
FRB stock
Other investments
Total equity 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
FHLB advances
Unsecured senior debt securities
Junior subordinated deferrable interest debentures (related to trust preferred securities)
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Financial Liabilities:
Other short-term borrowings[2]
Notes payable:
Unsecured senior debt
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The notional amount of commitments to extend credit at March 31, 2018 and December 31, 2017 is $ 7.5 billion and $ 7.6 billion, respectively, and represents the unused portion of credit facilities granted to customers. The notional amount of letters of credit at March 31, 2018 and December 31, 2017 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 26 – 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 ended March 31, 2018 and 2017:
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 18, 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 during the term of the ASR, net of a discount. Based on the discounted VWAP of $40.60, the Corporation received 1,847,372 shares of its outstanding common stock.
For the quarters ended March 31, 2018 and 2017, the Corporation calculated the impact of potential dilutive common shares under the treasury stock method, consistent with the method used for the preparation of the financial statements for the year ended December 31, 2017. For a discussion of the calculation under the treasury stock method, refer to Note 34 of the Consolidated Financial Statements included in the 2017 Form 10-K.
For the quarters ended March 31, 2018 and 2017, there were no stock options outstanding.
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Note 27 – Revenue from contracts with customers
The following table presents the Corporation’s revenue streams from contracts with customers by reportable segment for the quarters ended March 31, 2018 and 2017:
Other service fees:
Debit card fees
Insurance fees, excluding reinsurance
Credit card fees, excluding late fees and membership fees
Sale and administration of investment products
Trust fees
Total revenue from contracts with customers
Revenue from contracts with customers is recognized when, or as, the performance obligations are satisfied by the Corporation by transferring the promised services to the customers. A service is transferred to the customer when, or as, the customer obtains control of that service. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized based on the services that have been rendered to date. Revenue from a performance obligation satisfied at a point in time is recognized when the customer obtains control over the service. The transaction price, or the amount of revenue recognized, reflects the consideration the Corporation expects to be entitled to in exchange for those promised services. In determining the transaction price, the Corporation considers the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Corporation is the principal in a transaction if it obtains control of the specified goods or services before they are transferred to the customer. If the Corporation acts as principal, revenues are presented in the gross amount of consideration to which it expects to be entitled and are not netted with any related expenses. On the other hand, the Corporation is an agent if it does not control the specified goods or services before they are transferred to the customer. If the Corporation acts as an agent, revenues are presented in the amount of consideration to which it expects to be entitled, net of related expenses.
Following is a description of the nature and timing of revenue streams from contracts with customers:
Service charges on deposit accounts are earned on retail and commercial deposit activities and include, but are not limited to, nonsufficient fund fees, overdraft fees and checks stop payment fees. These transaction-based fees are recognized at a point in time, upon occurrence of an activity or event or upon the occurrence of a condition which triggers the fee assessment. The Corporation is acting as principal in these transactions.
Debit card fees include, but are not limited to, interchange fees, surcharging income and foreign transaction fees. These transaction-based fees are recognized at a point in time, upon occurrence of an activity or event or upon the occurrence of a condition which triggers the fee assessment. Interchange fees are recognized upon settlement of the debit card payment transactions. The Corporation is acting as principal in these transactions.
Insurance fees
Insurance fees include, but are not limited to, commissions and contingent commissions. Commissions and fees are recognized when related policies are effective since the Corporation does not have an enforceable right to payment for services completed to date. An allowance is created for expected adjustments to commissions earned related to policy cancellations. Contingent commissions are recorded on an accrual basis when the amount to be received is notified by the insurance company. The Corporation is acting as an agent since it arranges for the sale of the policies and receives commissions if, and when, it achieves the sale.
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Credit card fees
Credit card fees include, but are not limited to, interchange fees, additional card fees, cash advance fees, balance transfer fees, foreign transaction fees, and returned payments fees. Credit card fees are recognized at a point in time, upon the occurrence of an activity or an event. Interchange fees are recognized upon settlement of the credit card payment transactions. The Corporation is acting as principal in these transactions.
Fees from the sale and administration of investment products include, but are not limited to, commission income from the sale of investment products, asset management fees, underwriting fees, and mutual fund fees.
Commission income from investment products is recognized on the trade date since clearing, trade execution, and custody services are satisfied when the customer acquires or disposes of the rights to obtain the economic benefits of the investment products and brokerage contracts have no fixed duration and are terminable at will by either party. The Corporation is acting as principal in these transactions since it performs the service of providing the customer with the ability to acquire or dispose of the rights to obtain the economic benefits of investment products.
Asset management fees are satisfied over time and are recognized in arrears. At contract inception, the estimate of the asset management fee is constrained from the inclusion in the transaction price since the promised consideration is dependent on the market and thus is highly susceptible to factors outside the manager’s influence. As advisor, the broker-dealer subsidiary is acting as principal.
Underwriting fees are recognized at a point in time, when the investment products are sold in the open market at a markup. When the broker-dealer subsidiary is lead underwriter, it is acting as an agent. In turn, when it is a participating underwriter, it is acting as principal.
Mutual fund fees, such as distribution fees, are considered variable consideration and are recognized over time, as the uncertainty of the fees to be received is resolved as NAV is determined and investor activity occurs. The promise to provide distribution-related services is considered a single performance obligation as it requires the provision of a series of distinct services that are substantially the same and have the same pattern of transfer. When the broker-dealer subsidiary is acting as a distributor, it is acting as principal. In turn, when it acts as third-party dealer, it is acting as an agent.
Trust fees are recognized from retirement plan, mutual fund administration, investment management, trustee, escrow, and custody and safekeeping services. These asset management services are considered a single performance obligation as it requires the provision of a series of distinct services that are substantially the same and have the same pattern of transfer. The performance obligation is satisfied over time, except for optional services and certain other services that are satisfied at a point in time. Revenues are recognized in arrears, when, or as, the services are rendered. The Corporation is acting as principal since, as asset manager, it has the obligation to provide the specified service to the customer and has the ultimate discretion in establishing the fee paid by the customer for the specified services.
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Note 28 – FDIC loss share expense
The caption of FDIC loss-share expense in the consolidated statements of operations consists of the following major categories:
Amortization of loss share indemnification asset
80% mirror accounting on credit impairment losses[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 29 – 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:
Other operating expenses:
Interest cost
Expected return on plan assets
Amortization of net loss
Total net periodic pension cost (benefit)
During the quarter ended March 31, 2018 the Corporation made a contribution to the pension and benefit restoration plans of $59 thousand. The total contributions expected to be paid during the year 2018 for the pension and benefit restoration plans amount to approximately $235 thousand.
During the quarters ended March 31, 2018 and 2017, there is no service cost recognized as part of the net periodic pension cost since the accrual of benefits for all participants has been frozen. As part of the implementation of ASU 2017-07, the other components of net periodic pension cost in the amount of $ 1.2 million were reclassified from “Personnel costs” to “Other operating expenses” in the consolidated statement of operations for the quarter ended March 31, 2017.
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.
Personnel costs:
Service cost
Amortization of prior service cost
Total postretirement cost
Contributions made to the postretirement benefit plan for the quarter ended March 31, 2018 amounted to approximately $1.2 million. The total contributions expected to be paid during the year 2018 for the postretirement benefit plan amount to approximately $6.3 million.
As part of the implementation of ASU 2017-07, the other components of net periodic postretirement benefit cost other than the service cost components in the amount of $ 0.6 million were reclassified from “Personnel costs” to “Other operating expenses” in the consolidated statement of operations for the quarter ended March 31, 2017.
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Note 30 – Stock-based compensation
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 and performance 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 and the second part is vested at termination of employment after attainment of 55 years of age and 10 years of service. The five-year vesting part is accelerated at termination of employment after attaining 55 years of age and 10 years of service. The vesting schedule for restricted shares granted on or after 2014 was modified as follows, the first part is vested ratably over four years commencing at the date of the grant 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 four year vesting part is accelerated at termination of employment after attaining the earlier of 55 years of age and 10 years of service or 60 years of age and 5 years of service.
The 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 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.
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, 2016
Granted
Performance Shares Quantity Adjustment
Vested
Non-vested at December 31, 2017
Forfeited
Non-vested at March 31, 2018
During the quarter ended March 31, 2018, 84,616 shares of restricted stock (March 31, 2017 - 64,479) and 72,414 performance shares (March 31, 2017 - 73,684) were awarded to management under the Incentive Plan.
During the quarter ended March 31, 2018, the Corporation recognized $ 2.7 million of restricted stock expense related to management incentive awards, with a tax benefit of $ 0.3 million (March 31, 2017 - $ 2.0 million, with a tax benefit of $ 0.2 million).
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For the quarter ended March 31, 2018, the fair market value of the restricted stock and performance shares vested was $3.5 million at grant date and $4.4 million at vesting date. This triggers a windfall, of $0.4 million that was recorded as a reduction on income tax expense. For the quarter ended March 31, 2018, the Corporation recognized $2.6 million of performance shares expense, with a tax benefit of $0.3 million (March 31, 2017 - $1.7 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 March 31, 2018 was $ 8.9 million and is expected to be recognized over a weighted-average period of 2.3 years.
The following table summarizes the restricted stock activity under the Incentive Plan for members of the Board of Directors:
During the quarters ended March 31, 2018 and 2017, no shares of restricted stock were granted 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 restricted stock previously granted, with a tax benefit of $39 thousand (March 31, 2017 - $0.3 million, with a tax benefit of $31 thousand). There was no fair value at vesting date of the restricted stock vested during the quarter ended March 31, 2018 for directors.
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Note 31 – 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
Adjustments in net deferred tax due to change in tax law
State and local taxes
Income tax (benefit) expense
Income tax expense amounted to $22.2 million for the quarter ended March 31, 2018, compared with an income tax expense of $33.0 million for the same quarter of 2017. The reduction in income tax expense was primarily due to lower taxable income before tax and higher tax benefit on net exempt interest income.
The following table presents a breakdown of the significant components of the Corporation’s deferred tax assets and liabilities.
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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 in outside basis from pass-through entities
Other temporary differences
Total gross deferred tax assets
Deferred tax liabilities:
FDIC-assisted transaction
Indefinite-lived intangibles
Unrealized net gain (loss) on trading and available-for-sale securities
Total gross deferred tax liabilities
Valuation allowance
Net deferred tax asset
The net deferred tax asset shown in the table above at March 31, 2018 is reflected in the consolidated statements of financial condition as $1.0 billion in net deferred tax assets in the “Other assets” caption (December 31, 2017 - $1.0 billion) and $1.5 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2017 - $1.3 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 March 31, 2018 the net deferred tax asset of the U.S. operations amounted to $731 million with a valuation allowance of approximately $381 million, for a net deferred tax asset of approximately $350 million. As of March 31, 2018, 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 $350 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 March 31, 2018, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $680 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 March 31, 2018. 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 March 31, 2018. 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 valuation allowance is recorded on the deferred tax asset at the PIHC, which amounted to $74 million as of March 31, 2018.
The reconciliation of unrecognized tax benefits, excluding interest, was as follows:
(In millions)
Balance at January 1
Additions for tax positions -January through March
Balance at March 31
At March 31, 2018, the total amount of interest recognized in the statement of financial condition approximated $2.8 million (December 31, 2017 - $2.7 million). The total interest expense recognized at March 31, 2018 was $151 thousand (March 31, 2017 - $145 thousand). Management determined that at March 31, 2018 and December 31, 2017 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, while the penalties, if any, are reported in other operating expenses in the consolidated statements of operations.
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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 $9.2 million at March 31, 2018 (December 31, 2017 - $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 March 31, 2018, 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 $4.6 million.
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Note 32 – Supplemental disclosure on the consolidated statements of cash flows
Additional disclosures on cash flow information and non-cash activities for the quarters ended March 31, 2018 and March 31, 2017 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 loansheld-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
Interest capitalized on loans subject to the temporary payment moratorium
Loans booked under the GNMA buy-back option
The following table provides a reconciliation of cash and due from banks, and restricted cash reported within the Consolidated Statement of Financial Condition that sum to the total of the same such amounts shown in the Consolidated Statement of Cash Flows.
Restricted cash and due from banks
Restricted cash in money market investments
Total cash and due from banks, and restricted cash[2]
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Note 33 – Segment reporting
The Corporation’s corporate structure consists of two reportable segments – Banco Popular de Puerto Rico and Popular U.S. 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 March 31, 2018, additional disclosures are provided for the business areas included in this reportable segment, as described below:
Popular U.S.:
Popular U.S. reportable segment consists of the banking operations of PB, E-LOAN, Inc., Popular Equipment Finance, Inc. and Popular Insurance Agency, U.S.A. PB operates through a retail branch network in the U.S. mainland under the name of Popular, while E-LOAN, Inc. supported PB’s deposit gathering through its online platform until March 31, 2017, when said operations were transferred to Popular Direct, a division of PB. During 2017, the E-LOAN brand was transferred to BPPR and is being used to offer personal loans through an online platform. 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 PB 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 including: 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
Segment assets
Net interest income (expense)
Provision (reversal) for loan losses
Income tax expense (benefit)
Net income (loss)
2017
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Additional disclosures with respect to the Banco Popular de Puerto Rico reportable segment are as follows:
Geographic Information
Revenues:[1]
United States
Total consolidated revenues
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Selected Balance Sheet Information:
Deposits [1]
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Note 34 – Subsequent events
On February 14, 2018, we announced that BPPR, our Puerto Rico banking subsidiary, agreed to acquire certain assets and liabilities related to Wells Fargo’s auto finance business in Puerto Rico for a cash purchase price of approximately $1.7 billion. Notwithstanding our expectation that further regulatory approvals would not be necessary, we now anticipate that regulatory approval will be required to consummate the transaction. Transaction economics will not be impacted. Although there can be no guarantee that regulatory approval will be received, we continue to anticipate that the transaction will close during the second quarter of 2018.
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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 March 31, 2018 and December 31, 2017, and the results of their operations and cash flows for periods ended March 31, 2018 and 2017.
PNA is an operating, wholly-owned subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries: Equity One, Inc. and Popular Bank (“PB”), including PB’s wholly-owned subsidiaries Popular Equipment Finance, Inc., Popular Insurance Agency, U.S.A., and E-LOAN, Inc.
PIHC fully and unconditionally guarantees all registered debt securities issued by PNA.
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Condensed Consolidating Statement of Financial Condition (Unaudited)
Trading account debt securities, at fair value
Debt securities available-for-sale, at fair value
Debt securities held-to-maturity, at amortized cost
Investment in subsidiaries
Loans held-for-sale, at lower of cost or fair value
Loans held-in-portfolio:
Less - Unearned income
Total loans held-in-portfolio, net
Stockholders’ equity:
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
Net (loss) profit on trading account debt securities
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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Provision (reversal) for loan losses- non-covered loans
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
Comprehensive income, net of tax
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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
Shared-based compensation
Adjustments to indemnity reserves on loans sold
Deferred income tax (benefit) expense
Sale of loans, including valuation adjustments on loans held for sale and mortgage banking activities
Trading securities
Pension and other postretirement benefits obligations
Net cash (used in) provided by operating activities
Net decrease (increase) in money market investments
Net (disbursements) repayments on loans
Capital contribution to subsidiary
Net cash provided by (used in) investing activities
Dividends paid to parent company
Return of capital to parent company
Net cash (used in) provided by financing activities
Cash and due from banks, and restricted cash at end of period
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Condensed Consolidating Statement of Cash Flows
(Earnings) losses from investments under the equity method
Deferred income tax expense (benefit)
Net (increase) decrease in:
Net cash provided by (used in) operating activities
Net repayments (disbursements) on loans
Net increase (decrease) in cash and due from banks
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report includes management’s discussion and analysis (“MD&A”) of the consolidated financial position and financial performance of Popular, Inc. (the “Corporation” or “Popular”). All accompanying tables, financial statements and notes included elsewhere in this report should be considered an integral part of this analysis.
The Corporation is a diversified, publicly-owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation has operations in Puerto Rico, the United States (“U.S.”) mainland, and the U.S. and British Virgin Islands. In Puerto Rico, the Corporation provides retail, 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 provides retail, mortgage and commercial banking services through its New York-chartered banking subsidiary, Popular Bank (“PB”), which has branches located in New York, New Jersey and Florida. Note 33 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 March 31, 2018, the Corporation had a 16.09% interest in the holding company of EVERTEC, which provides transaction processing services throughout the Caribbean and Latin America, and services many of the Corporation’s systems infrastructure and transaction processing businesses. During the quarter ended March 31, 2018, the Corporation recorded $ 3.8 million in earnings from its investment in EVERTEC, which had a carrying amount of $52 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 March 31, 2018, the Corporation recorded $8.5 million in earnings from its investment in BHD Leon, which had a carrying amount of $143 million, as of the end of the quarter.
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SIGNIFICANT EVENTS
Agreement to acquire Wells Fargo’s Auto Finance Business in Puerto Rico
Name Change and rebranding of Popular’s U.S. Operations
On April 9, 2018, the Corporation’s New York-chartered banking subsidiary changed its legal name from Banco Popular North America to Popular Bank. Formerly operating as “Popular Community Bank”, Popular Bank will use the brand “Popular” to market its businesses. These changes align the new name and brand with the New York-based bank’s strategic initiatives, expanded capabilities and recent launch of several business platforms designed to attract diverse consumer and business segments in the U.S. markets it serves. As a result of the rebranding initiative, the Corporation now operates under a single brand, “Popular”, throughout all its regions – the United States mainland, Puerto Rico and the U.S. and British Virgin Islands – for the first time in the Corporation’s history.
OVERVIEW
Table 1 provides selected financial data and performance indicators for the quarters ended March 31, 2018 and 2017.
Table 1 - Financial highlights
Financial Condition Highlights
Earning assets
Operating Highlights
Provision for loan losses - non-covered loans
Provision (reversal) for loan losses - covered loans
Operating expenses
Net income per common share - Basic
Net income per common share - Diluted
Dividends declared per common share - Basic
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Selected Statistical Information
Common Stock Data
Market price
High
Low
End
Book value per common share at period end
Profitability Ratios
Return on assets
Return on common equity
Net interest spread
Net interest spread (taxable equivalent) (non-GAAP)
Net interest margin
Net interest margin (taxable equivalent) (non-GAAP)
Capitalization Ratios
Average equity to average assets
Common equity Tier 1 capital
Tier I capital
Total capital
Tier 1 leverage
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.
For the quarters ended March 31, 2018 and March 31, 2017, there were no adjustments identified by management to arrive at an Adjusted net income presentation.
Net interest income on a taxable equivalent basis
Net interest income, on a taxable equivalent basis, is presented with its different components in Table 2 for the quarter ended March 31, 2018 as compared with the same period in 2017, 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.
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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 March 31, 2018
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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.
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 2017 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 Form 10-Q for additional information.
The Corporation’s common stock is traded on the NASDAQ Global Select Market under the symbol BPOP.
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 2017 Form 10-K. Refer to Note 3 to the Consolidated Financial Statements included in the 2017 Form 10-K for a summary of the Corporation’s significant accounting policies and to Note 3 to the Consolidated Financial Statements included in this Form 10Q for information on recently adopted accounting standard updates.
OPERATING RESULTS ANALYSIS
NET INTEREST INCOME
Net interest income was $393.0 million for the first quarter of 2018, an increase of $30.9 million when compared to $362.1 million for the same quarter of 2017. Taxable equivalent net interest income was $425.1 million for the first quarter of 2018, an increase of $37.5 million when compared to $387.6 million for the same quarter of 2017. The increase in $6.5 million in the taxable equivalent adjustment is directly related to a higher volume of tax exempt investments in P.R. Net interest margin for the first quarter of 2018 was 3.89%, a decrease of 19 basis points when compared to 4.08% for the same quarter of the previous year. Net Interest margin, on a taxable equivalent basis, for the first quarter of 2018 was 4.21%, a decrease of 16 basis points when compared to 4.37% for the same quarter of 2017. The decrease in net interest margin is mostly related to the mix in asset composition, due to higher proportion of money market, investment and trading securities to total earning assets (41% this quarter versus 35% in the first quarter of 2017) which have a lower yield when 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:
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Positive variances:
Negative variances:
Interest income for the quarter ended March 31, 2018 included the amortization of deferred loans fees, prepayment penalties, late fees and the amortization of premium/discounts, amounting to $3.4 million, compared with $6.4 million for the same period in 2017.
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Table 2 - Analysis of Levels & Yields on a Taxable Equivalent Basis for Continuing Operations (Non-GAAP)
Quarters ended March 31,
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)
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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Provision for Loan Losses
The Corporation’s total provision for loan losses was $71.1 million for the quarter ended March 31, 2018, compared to $40.7 million for the quarter ended March 31, 2017, an increase of $30.4 million.
The provision for loan losses for thenon-covered loan portfolio totaled $69.3 million, compared to $42.1 million for the same quarter in 2017, an increase of $27.2 million, mostly driven by the BPPR segment. Total non-covered net charge-offs increased by $16.9 million when compared with the same quarter in 2017, mainly due to higher commercial and consumer net charge-offs in each of the Popular U.S. and BPPR segments.
The provision for loan losses for the non-covered loan portfolio at the BPPR segment totaled $56.7 million, compared to $31.5 million for the same quarter in 2017. The increase of $25.2 million was mainly related to an increase in the allowance of $21.6 million for a single commercial borrower, coupled with higher charge-offs by $8.3 million, mostly related to the consumer portfolio, in part offset by a downward adjustment of $7.5 million to the estimated losses associated with Hurricane Maria. Management continues to evaluate the impact of the hurricanes on its loan portfolios and the effect on its credit metrics after the end of the payment moratorium granted to certain customers and commercial borrowers as a result of the hurricanes.
The provision for loan losses for the Popular U.S. segment amounted to $12.6 million, compared to $10.6 million for the same quarter in 2017, an increase of $2.0 million. Net charge-offs increased $8.6 million when compared to the quarter ended March 31, 2017, mostly related to its taxi medallion portfolio. The Popular U.S. segment continued to reflect strong growth and favorable credit quality metrics, except in the case of the taxi medallion portfolio acquired from the FDIC in the assisted sale of Doral Bank, which continues to reflect the pressure on medallion collateral values, particularly in the New York City metro area. During the quarter ended March 31, 2018, the Corporation recorded a provision of $11.8 million and charge offs amounting to $7.6 million related to the taxi medallion portfolio.
For the first quarter of 2018, the covered loan portfolio reflected a provision expense of $1.7 million, compared to a provision reversal of $1.4 million for the same quarter in 2017.
Refer to the Credit Risk section 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 was $113.5 million for the first quarter of 2018, a decrease of $2.4 million, when compared with the same quarter of the previous year, driven primarily by the following:
These decreases were partially offset by:
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Table 3 - Financial Information - Westernbank FDIC-Assisted Transaction
Interest income on WB loans
FDIC loss share expense:
Total income
Provision (reversal) for loan losses- WB loans
Total income less provision (reversal) for loan losses
Average balances
Operating Expenses
Operating expenses for the quarter ended March 31, 2018 increased by $ 10.7 million when compared with the same quarter of 2017, driven primarily by:
These increases were partially offset by:
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Table 4 - Operating Expenses
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
Credit and debit card processing, volume and interchange expenses
Operational losses
All other
Total other operating expenses
INCOME TAXES
For the quarter ended March 31, 2018, the Corporation recorded income tax expense of $22.2 million, compared to $33.0 million for the same quarter of the previous year. The decrease in income tax expense is primarily due to lower taxable income and the impact to our U.S. operations of the reduction in the federal income tax rate, from 35% to 21%, pursuant to the Federal Tax Cuts and Jobs Act.
In December 2017, the Federal Tax Cuts and Jobs Act (“TCJA”) was enacted, which reduced the U.S. federal corporate income tax rate from a maximum rate of 35% to a single tax rate of 21%. The Act contains other provisions, which became effective on January 1, 2018 and which may impact the Corporation’s tax calculations and related income tax expense in future years. Management continues to evaluate the impact of the TCJA in future periods and may make further adjustments as a result of additional analysis and guidance issued on the legislation.
Puerto Rico’s recently Certified Fiscal Plan (as hereinafter defined) proposes to enact a comprehensive tax reform with the intention of spurring economic development, lowering the cost of doing business and making Puerto Rico more competitive. The proposed tax reform seeks to, among other things, reduce individual and corporate income tax rates and gradually eliminate, over a two year period, the business-to-business sales and use tax. Maximum corporate tax rates in particular would be reduced from a current rate of 39% to 31%. According to the Certified Fiscal Plan, any tax reform should be revenue-neutral, with stabilizing mechanisms to offset revenue shortfalls. The tax reform, including the reduction in the maximum corporate tax rates referenced above, require legislative action and are thus subject to approval by the Legislative Assembly and the Governor. The PROMESA Oversight Board could also assert the power to veto any tax reform legislation that in their view is inconsistent with the Certified Fiscal Plan.
A reduction in corporate tax rates to 31%, if approved, would result in a write down of the Corporation’s deferred tax asset (“DTA”) related to its P.R. operations of approximately $150 million, with a corresponding charge to the Corporation’s income tax expense.
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If such a reduction in the Corporation’s DTA from its P.R. operations would have occurred as of March 31, 2018, Common Equity Tier 1 Capital and Total Regulatory Capital would have been reduced by approximately 30 bps. On a forward-looking basis, a reduction of the maximum corporate income tax rate to 31% could result in a reduction in the Corporation’s effective tax rate of between 2% and 3% on an annual basis.
At March 31, 2018, the Corporation had a DTA amounting to $1.0 billion, net of a valuation allowance of $0.5 billion. The DTA related to the U.S. operations was $0.3 billion, net of a valuation allowance of $0.4 billion.
Refer to Note 31 to the Consolidated Financial Statements for a reconciliation of the statutory income tax rate to the effective tax rate and additional information on DTA balances.
REPORTABLE SEGMENT RESULTS
The Corporation’s reportable segments for managerial reporting purposes consist of Banco Popular de Puerto Rico and Popular U.S. (previously 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 33 to the Consolidated Financial Statements.
The Corporate group reported a net loss of $18.5 million for the quarter ended March 31, 2018, compared with a net loss of $15.3 million for the same quarter of the previous year. The change was mostly driven by higher personnel costs, higher professional fees and an unfavorable variance of income taxes. These unfavorable variances were partially offset by higher earnings from investments under the equity method, and higher interest income on commercial loans and money market 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 $91.4 million for the quarter ended March 31, 2018, compared with net income of $97.6 million for the same quarter of the previous year. The principal factors that contributed to the variance in the financial results included the following:
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For the quarter ended March 31, 2018, the reportable segment of Popular U.S. reported a net income of $18.1 million, compared to net income of $10.4 million for the same quarter of the previous year. The factors that contributed to the variance in the financial results included the following:
FINANCIAL CONDITION ANALYSIS
The Corporation’s total assets were $45.8 billion at March 31, 2018, compared to $44.3 billion at December 31, 2017. Refer to the Consolidated Statements of Financial Condition included in this report for additional information.
Money market investments, trading and investment securities
Money market investments totaled $7.0 billion at March 31, 2018, compared to $5.3 billion at December 31, 2017. The increase was mainly at BPPR due to higher liquidity driven by an increase in deposits.
Trading account debt securities amounted to $42 million at March 31, 2018, compared to $34 million at December 31, 2017. Refer to the Market Risk section of this MD&A for a table that provides a breakdown of the trading portfolio by security type.
Debt securities available-for-sale and held-to-maturity amounted to $10.5 billion at March 31, 2018, compared with $10.3 billion at December 31, 2017. The increase of $0.2 billion was mainly at BPPR due to purchases of U.S. Treasury securities, partially offset by pay-downs and unfavorable unrealized fair value changes in mortgage-backed agency pools.
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Table 5 provides a breakdown of the Corporation’s portfolio of debt securities available-for-sale (“AFS”) and held-to-maturity (“HTM”) on a combined basis. Also, Notes 5 and 6 to the Consolidated Financial Statements provide additional information with respect to the Corporation’s debt securities AFS and HTM.
Table 5 - Breakdown of Debt Securities Available-for-Sale and Held-to-Maturity
Total debt securities AFS and HTM
Refer to Table 6 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 6. The risks on covered loans are significantly different as a result of the loss protection provided by the FDIC as described in Note 7, Loans. As of March 31, 2018, the Corporation’s covered loans portfolio amounted to $515 million, comprised mainly of residential mortgage loans.
The Corporation’s total loan portfolio amounted to $ 24.7 billion at March 31, 2018, compared to $24.9 billion at December 31, 2017. Refer to Note 7 for detailed information about the Corporation’s loan portfolio composition and loan purchases and sales.
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Table 6 - 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-portfoliodecreased by $205 million to $ 24.1 billion at March 31, 2018, principally due to a decrease of $0.3 billion in mortgage loans rebooked at BPPR which are subject to the GNMA repurchase option, partially offset by growth in commercial loans at PB by $0.1 billion.
The loans held-for-saleportfolio decreased by $55 million from December 31, 2017, mainly at BPPR, due to a higher volume of securitization activity than that of the fourth quarter of 2017 due to operational delays caused by Hurricane Maria.
Westernbank loans accounted for under ASC 310-30
The covered loans portfolio amounted to $515 million at March 31, 2018, compared to $517 million at December 31, 2017. The decrease is due to loan resolutions and the normal portfolio run-off. Refer to Table 6 for a breakdown of covered loans by major loan type categories.
Tables 7 and 8 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 7 - Activity in the Carrying Amount of Westernbank Loans Accounted for Under ASC 310-30
Allowance for loan losses (ALLL)
Table 8 - Activity in the Accretable Yield on Westernbank Loans Accounted for Under ASC 310-30
Accretion[1]
Table 9 sets forth the activity in the FDIC loss share asset for the quarters ended March 31, 2018 and 2017.
Table 9 - 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 to non-interest income is recognized as a result of increases in expected reimbursements due to higher loss estimates (accretion). Table 10 presents the activity associated with the outstanding balance of the FDIC loss share asset amortization (or negative discount).
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Table 10 - Activity in the Remaining FDIC Loss Share Asset Amortization
Balance at beginning of period[1]
Amortization of negative discount[2]
Impact of changes in lower (higher) projected losses
Other real estate owned represents real estate property received in satisfaction of debt. At March 31, 2018, OREO decreased to $168 million from $189 million at December 31, 2017 mainly due to a decrease in residential properties at BPPR. Refer to Note 12 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 agreement.
Refer to Note 13 for a breakdown of the principal categories that comprise the caption of “Other Assets” in the Consolidated Statements of Financial Condition at March 31, 2018 and December 31, 2017.
The Corporation’s total liabilities were $40.7 billion at March 31, 2018, compared to $39.2 billion at December 31, 2017. Refer to the Corporation’s Consolidated Statements of Financial Condition included in this Form 10-Q.
Deposits and Borrowings
The composition of the Corporation’s financing sources to total assets at March 31, 2018 and December 31, 2017 is included in Table 11.
Table 11 - Financing to Total Assets
Non-interest bearing deposits
Interest-bearing core deposits
Other interest-bearing deposits
The Corporation’s deposits totaled $37.1 billion at March 31, 2018 compared to $35.5 billion at December 31, 2017. The deposits increase of $1.6 billion was mainly due to an increase in retail and commercial savings and NOW deposits at BPPR, including an increase of $567 million from Puerto Rico government deposits. Refer to Table 12 for a breakdown of the Corporation’s deposits at March 31, 2018 and December 31, 2017.
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Table 12 - 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 relatively flat at $2.1 billion at March 31, 2018, compared to $2.0 billion at December 31, 2017. Refer to Note 16 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.
The Corporation’s other liabilities amounted to $1.4 billion at March 31, 2018, a decrease of $0.3 billion when compared to December 31, 2017, due to a decrease in the liability for GNMA loan sold with an option to repurchase.
Stockholders’ Equity
Stockholders’ equity totaled $5.1 billion at March 31, 2018, down $39 million from $5.1 billion at December 31, 2017, principally due to higher unrealized losses on debt securities available-for-sale by $115.0 million, declared dividends of $25.5 million on common stock ($0.25 per share) and $0.9 million in dividends on preferred stock, partially offset by net income for the quarter of $91.3 million and a cumulative effect of an accounting change of $1.9 million. Refer to the Consolidated Statements of Financial Condition, Comprehensive Income and of Changes in Stockholders’ Equity for information on the composition of stockholders’ equity.
REGULATORY CAPITAL
The Corporation, BPPR and PB are subject to regulatory capital requirements established by the Federal Reserve Board. The current risk-based capital standards applicable to the Corporation, BPPR and PB (“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 March 31, 2018, the Corporation’s, BPPR’s and PB’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 13, which include common equity tier 1, Tier 1 capital, total capital and leverage capital as of March 31, 2018 and December 31, 2017, 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 13 - Capital Adequacy Data
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 March 31, 2018, the Corporation, BPPR and PB 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 March 31, 2018 as compared to December 31, 2017 was mainly attributed to the three months period earnings, and lower risk-weighted assets driven by a decrease in loans held-in-portfolio. 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 14 provides a reconciliation of total stockholders’ equity to tangible common equity and total assets to tangible assets as of March 31, 2018, and December 31, 2017.
Table 14 - Reconciliation of Tangible Common Equity and Tangible Assets
(In thousands, except share or per share information)
Less: Preferred stock
Less: Goodwill
Less: Other intangibles
Total tangible common equity
Total tangible assets
Tangible common equity to tangible assets
Common shares outstanding at end of period
Tangible book value per common share
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 20 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 March 31, 2018, 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 $324 million at March 31, 2018 of which approximately 50% mature in 2018, 25% in 2019, 14% in 2020 and 11% thereafter.
The Corporation also enters into derivative contracts under which it is required either to receive or pay cash, depending on changes in interest rates. These contracts are carried at fair value on the Consolidated Statement of Financial Condition with the fair value representing the net present value of the expected future cash receipts and payments based on market rates of interest as of the statement of condition date. The fair value of the contract changes daily as interest rates change. The Corporation may also be required to post additional collateral on margin calls on the derivatives and repurchase transactions.
Refer to Note 16 for a breakdown of long-term borrowings by maturity.
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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 15 presents the contractual amounts related to the Corporation’s off-balance sheet lending and other activities at March 31, 2018.
Table 15 - Off-Balance Sheet Lending and Other Activities
Commitments to extend credit
At March 31, 2018 and December 31, 2017, the Corporation maintained a reserve of approximately $11 million and $10 million, respectively, for probable losses associated with unfunded loan commitments related to commercial and consumer lines of credit. The estimated reserve is principally based on the expected draws on these facilities using historical trends and the application of the corresponding reserve factors determined under the Corporation’s allowance for loan losses methodology. This reserve for unfunded loan commitments remains separate and distinct from the allowance for loan losses and is reported as part of other liabilities in the consolidated statement of financial condition.
Refer to Note 21 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) 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
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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 PB, 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.
The RMG is responsible for the overall coordination of risk management efforts throughout the Corporation and has four divisions that are charged with risk management responsibilities: (i) Credit Risk Management, (ii) Regulatory and Financial Compliance, (iii) Financial Crimes Compliance; and (iv) 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 Corporate Risk Reviews 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.
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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 New Products and Fiduciary Risk 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.
Most of the assets subject to market valuation risk are securities in the debt securities portfolio classified as available-for-sale. Refer to Notes 5 and 6 for further information on the debt securities available for sale and held to maturity portfolio. Debt securities classified as available-for-sale amounted to $10.4 billion as of March 31, 2018. Other assets subject to market risk include loans held-for-sale, which amounted to $78 million, mortgage servicing rights (“MSRs”) which amounted to $166 million and securities classified as “trading”, which amounted to $42 million, as of March 31, 2018.
Liabilities subject to market risk include the FDIC clawback obligation, which amounted to $ 171 million at March 31, 2018.
Management believes that market risk is currently not a material source of risk at the Corporation.
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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 Net Interest Income (“NII“) 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. NII 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 NII simulations under different interest rate scenarios that differ in direction of interest rate changes, the degree of change and the projected shape of the yield curve. For example, the types of rate scenarios processed during the quarter include flat rates, implied forwards, parallel and non-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 simulation analyses 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.
The Corporation processes NII simulations under interest rate scenarios in which the yield curve is assumed to rise and decline by the same amount (parallel shifts). 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 March 31, 2018 and December 31, 2017, assuming a static balance sheet and parallel changes over flat spot rates over a one-yeartime horizon:
Table 16 - Net Interest Income Sensitivity (One Year Projection)
Change in interest rate
+400 basis points
+200 basis points
-200 basis points
The results of the NII simulations at December 31, 2017 in the table above have been adjusted to align the assumptions used with respect to interest rates on non-maturity public funds deposits to contractual terms of their related depository agreements. Previously, assumptions with respect to such deposits had been based on the historical behavior of commercial and public deposits in the aggregate and did not consider the fact that contracts governing such non-maturity public deposits contained provisions that require BPPR, in certain circumstances, to make adjustments to the interest rate payable
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on such deposits based upon changes in market interest rates. Although as a result of such adjustment the magnitude of the Corporation’s sensitivity to increases in interest rates becomes lower, the Corporation continues to be in an asset sensitive position due mainly to, among other reasons: (i) a high level of money market investments that are highly sensitive to changes in interest rates, (ii) approximately 34% 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 following table compares the results of the sensitivity analysis at December 31, 2017, as initially reported in the Corporation’s Form 10-K, with the amounts resulting from the changes described above:
Table 17 - Net Interest Income Sensitivity (One Year Projection) Correction
+ 400 basis points
+ 200 basis points
- 200 basis points
At March 31, 2018, the simulations showed that the Corporation maintains an asset-sensitive position. The increase in sensitivity from December 31, 2017 in the +200 and +400 scenarios is mainly driven by an increase in money market investments of $1.7 billion, from $5.3 billion at December 31, 2017 to $7.0 billion at March 31, 2018, primarily due to growth in interest-bearing non-maturity deposits. The increase in sensitivity in the -200 scenario is also driven by the increase in money market investments, which are subject to immediate repricing as rates change across all scenarios, combined with the increase in the Federal Funds Target Rate in March 2018 by the Federal Reserve, which led to an increase in the magnitude of the -200 basis points scenario.
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, BPPR 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 March 31, 2018, the Corporation held trading securities with a fair value of $42 million, representing approximately 0.1% of the Corporation’s total assets, compared with $34 million and 0.1%, respectively, at December 31, 2017. As shown in Table 18, the trading portfolio consists principally of mortgage-backed securities relating to BPPR’s mortgage activities described above, which at March 31, 2018 were investment grade securities. As of March 31, 2018, the trading portfolio also included $9 million in U.S. Treasury securities and $0.2 million in Puerto Rico government obligations ($0.3 million and $0.2 million as of December 31, 2017,
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respectively). Trading instruments are recognized at fair value, with changes resulting from fluctuations in market prices, interest rates or exchange rates reported in current period earnings. The Corporation recognized a net trading account loss of $0.2 million and $0.3 million for the quarters ended March 31, 2018 and March 31, 2017, respectively. Table 18 provides the composition of the trading portfolio at March 31, 2018 and December 31, 2017.
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 $0.2 million for the last week in March 2018. 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 debt securities, debt securities available-for-sale, certain equity securities, derivatives, mortgage servicing rights and contingent consideration. Occasionally, the Corporation may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, impaired loans held-in-portfolio that are collateral dependent and certain other assets. These nonrecurring fair value adjustments typically result from the application of lower of cost or fair value accounting or write-downs of individual assets.
The fair value of assets and liabilities may include market or credit related adjustments, where appropriate. During the quarter ended March 31, 2018, inclusion of credit risk in the fair value of the derivatives resulted in a net loss of $344 thousand recorded in the other operating income and interest expense captions of the Consolidated Statement of Operations, which consisted of a loss of $315 thousand resulting from the Corporation’s own credit standing adjustment and a loss of $29 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.
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Refer to Note 24 to the Consolidated Financial Statements for information on the Corporation’s fair value measurement required by the applicable accounting standard. At March 31, 2018, approximately $ 10.5 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 notes, 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.
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 $ 1 million at March 31, 2018. These Level 3 assets consisted 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.
Refer to Note 31 to the Consolidated Financial Statements in the 2017 Form10-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 2017 Form10-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 ended March 31, 2018, 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 ended March 31, 2018, the Corporation did not adjust any prices obtained from pricing service providers or broker dealers for its investment securities.
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 quarter ended March 31, 2018, the Corporation declared dividends on its common stock of $ 25.5 million. During the first quarter of 2017, the Corporation completed a $75 million privately negotiated accelerated share repurchase transaction. Refer to additional information on Note 18 – 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 81% of the Corporation’s total assets at March 31, 2018 and 80% at December 31, 2017. The ratio of total ending loans to deposits was 66% at March 31, 2018, compared to 70% at December 31, 2017. In addition to traditional deposits, the Corporation maintains borrowing arrangements. At March 31, 2018, these borrowings consisted primarily of $ 380 million in assets sold under agreement to repurchase, $844 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 $447 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 16 to the Consolidated Financial Statements. Also, the Consolidated Statements of Cash Flows in the accompanying Consolidated Financial Statements provide information on the Corporation’s cash inflows and outflows.
The following sections provide further information on the Corporation’s major funding activities and needs, as well as the risks involved in these activities. A detailed description of the Corporation’s borrowings and available lines of credit, including its terms, is included in Note 16 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 PB), 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.
During the quarter ended March 31, 2018, BPPR declared cash dividends of $23 million, a portion of which was used by Popular, Inc. for the payments of the cash dividends on its outstanding common stock.
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.
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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 12 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 $ 32.3 billion, or 87% of total deposits, at March 31, 2018, compared with $30.9 billion, or 87% of total deposits, at December 31, 2017. Core deposits financed 76% of the Corporation’s earning assets at March 31, 2018, compared with 76% at December 31, 2017.
Certificates of deposit with denominations of $100,000 and over at March 31, 2018 totaled $ 4.3 billion, or 12% of total deposits (December 31, 2017 - $4.1 billion, or 11% of total deposits). Their distribution by maturity at March 31, 2018 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 March 31, 2018 and December 31, 2017, approximately 1% of the Corporation’s assets were financed by brokered deposits. The Corporation had $ 0.6 billion in brokered deposits at March 31, 2018 (December 31, 2017 - $0.5 billion). In the event that any of the Corporation’s banking subsidiaries’ regulatory capital ratios fall below those required by a well-capitalized institution or are subject to capital restrictions by the regulators, that banking subsidiary faces the risk of not being able to raise or maintain brokered deposits and faces limitations on the rate paid on deposits, which may hinder the Corporation’s ability to effectively compete in its retail markets and could affect its deposit raising efforts.
To the extent that the banking subsidiaries are unable to obtain sufficient liquidity through core deposits, the Corporation may meet its liquidity needs through short-term borrowings by pledging securities for borrowings under repurchase agreements, by pledging additional loans and securities through the available secured lending facilities, or by selling liquid assets. These measures are subject to availability of collateral.
The Corporation’s banking subsidiaries have the ability to borrow funds from the FHLB. At March 31, 2018 the banking subsidiaries had credit facilities authorized with the FHLB aggregating to $3.8 billion, based on assets pledged with the FHLB at those dates (December 31, 2017 - $3.9 billion). Outstanding borrowings under these credit facilities totaled $844 million at March 31, 2018 and $726 million at December 31, 2017. Such advances are collateralized by loans held-in-portfolio, do not have restrictive covenants and do not have any callable features. At March 31, 2018 the credit facilities authorized with the FHLB were collateralized by $4.8 billion in loansheld-in-portfolio (December 31, 2017 - $4.9 billion). Refer to Note 16 to the Consolidated Financial Statements for additional information on the terms of FHLB advances outstanding.
At March 31, 2018 and December 31, 2017, the Corporation’s borrowing capacity at the Fed’s Discount Window amounted to approximately $1.1 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 March 31, 2018, this credit facility with the Fed was collateralized by $2.1 billion of loans held-in-portfolio (December 31, 2017 - $2.0 billion).
At March 31, 2018, management believes that the banking subsidiaries had sufficient current and projected liquidity sources to meet their anticipated cash flow obligations, as well as special needs and off-balance sheet commitments, in the ordinary course of business and have sufficient liquidity resources to address a stress event. Although the banking subsidiaries have historically been able to replace maturing deposits and advances, no assurance can be given that they would be able to replace those funds in the
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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 quarter ended March 31, 2018, PIHC received $23 million in dividends from BPPR and $2.0 million in dividends from its non-banking subsidiaries.
Another use of liquidity at the parent holding company is the payment of dividends on its outstanding stock. During the quarter ended March 31, 2018, the Corporation declared quarterly dividends on its outstanding common stock of $0.25 per share, for a total of $ 25.5 million. Refer to additional information on Note 18– Stockholder’s equity. The dividends for the Corporation’s Series A and Series B preferred stock amounted to $ 0.9 million for the quarter ended March 31, 2018.
The BHC’s have in the past borrowed in the money markets and in the corporate debt market primarily to finance theirnon-banking subsidiaries, however, the cash needs of the Corporation’s non-banking subsidiaries other than to repay indebtedness and interest are now minimal. These sources of funding have become more costly due to the reductions in the Corporation’s credit ratings. The Corporation’s principal credit ratings are below “investment grade”, which affects the Corporation’s ability to raise funds in the capital markets. The Corporation has an automatic shelf registration statement filed and effective with the Securities and Exchange Commission, which permits the Corporation to issue an unspecified amount of debt or equity securities.
Note 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 $887 million at March 31, 2018, compared with $886 million at December 31, 2017. 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 March 31, 2018 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 quarter ended March 31, 2018.
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.
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Non-banking subsidiaries
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 the non-banking subsidiaries include repayment of maturing debt, operational expenses and payment of dividends to the BHCs. The liquidity needs of the non-banking subsidiaries are minimal since most of them are funded internally from operating cash flows or from intercompany borrowings from their holding companies, BPPR or PB.
Other Funding Sources and Capital
The debt securities portfolio provides an additional source of liquidity, which may be realized through either securities sales or repurchase agreements. The Corporation’s debt 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 debt securities, amounted to $3.1 billion at March 31, 2018 and $3.2 billion at December 31, 2017. A substantial portion of these debt 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.
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 March 31, 2018 that are subject to rating triggers.
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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 20 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 $45 million at March 31, 2018. 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 33 to the Consolidated Financial Statements.
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 significantly impacted by two major hurricanes in September 2017.
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 electric power and other basic utility and infrastructure services (such as water, communications, ports and other transportation networks) were severely curtailed. The hurricanes caused 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. Federal, state and local governments have carried out a significant recovery operation since the impact of the hurricanes, including efforts related to debris removal, repair or replacement of damaged facilities, homes and infrastructure, and restoration of water and electricity services. As of the date of this report, electricity and water services have been restored to the vast majority of the clients of the Commonwealth’s electric and water utilities, but the electric system remains frail. Electronic transactions, a significant source of revenue for BPPR, declined significantly in the months following the hurricanes as a result of the lack of power and telecommunication services, but have already returned to pre-hurricane levels. 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.
The damages caused by the hurricanes are substantial and are expected to have, at least in the short-term, a material adverse impact on economic activity in Puerto Rico. As further discussed below, the Certified Fiscal Plan (as defined below) estimates a 13.2% decrease in real gross national product (“GNP”) in fiscal year 2018 (July 2017-June 2018), as well as a decrease in the government’s tax revenues. It is still, however, too early to fully assess and quantify the extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity.
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Fiscal and Economic Crisis
Even before the hurricanes, the Commonwealth was experiencing a severe fiscal and economic 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. The Commonwealth’s deficits were historically covered with bond financings, loans from 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.
Notwithstanding the implementation of a number of extraordinary measures aimed at increasing revenues, reducing expenditures, and managing the government’s liquidity, the Commonwealth’s structural imbalance between revenue and expenditure and its unfunded legacy obligations, coupled with the Commonwealth’s inability to access the capital markets, eventually resulted in the Commonwealth and certain of its instrumentalities being unable to pay scheduled debt payments while continuing to provide government services. A moratorium on most debt service payments has been in place since 2016 and, as further discussed below, the Commonwealth and several of its instrumentalities are currently pursuing debt restructuring proceedings under Titles III or VI of the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”).
Following the hurricanes, the Commonwealth and its instrumentalities have had to incur significant extraordinary expenditures, while experiencing a decrease in tax and other revenues. The Commonwealth’s municipalities are also facing similar challenges. Such circumstances have aggravated the enduring fiscal and economic crisis and have further strained the liquidity of certain government entities, notwithstanding the receipt of significant Federal assistance. The government announced earlier this year that it would need to obtain loans from the Federal government in order to continue financing the recovery efforts and to provide necessary, interim support to the Puerto Rico Electric Power Authority (“PREPA”) and the Puerto Rico Aqueduct and Sewer Authority (“PRASA”). Furthermore, in January 2018, the Legislative Assembly enacted legislation to authorize the government to make loans of up to $550 million and $80 million to PREPA and PRASA, respectively, in order to cover the expected liquidity shortfalls of such entities, which provide essential electric power and water services to the residents of Puerto Rico. On February 19, 2018, the federal judge presiding over the pending debt restructuring proceedings under Title III of PROMESA (further discussed below) authorized PREPA to obtain a $300 million emergency loan from the Commonwealth, a significant portion of which has already been repaid. The purpose of such loan was to provide temporary liquidity relief to PREPA to allow for recovery efforts to continue and prevent further service interruptions. The Oversight Board and the Government anticipate that the Government will need to implement a number of additional extraordinary measures to address its many challenges, some of which are described below under “Fiscal Plans.”
Economic Performance
Puerto Rico entered into recession in the fourth quarter of fiscal year 2006. Puerto Rico’s 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). The last Puerto Rico Planning Board estimates, released in April 2017 (before the impact of the hurricanes), projected GNP 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 2.1% reduction in the average for fiscal year 2017, compared to the prior fiscal year. During the first six months of fiscal year 2018 (July 2017-December 2017), the Economic Activity Index reflected a 9.4% average reduction compared to the corresponding figure for fiscal year 2017.
As discussed above, Hurricanes Irma and Maria have had a material adverse impact on economic activity that is likely to be reflected in further reductions to GNP and the Economic Activity Index during fiscal year 2018. The Puerto Rico economy could also be adversely impacted as a result of the enactment by the U.S. Congress of the Tax Cuts and Jobs Act of 2017, which imposes a 12.5% tax on income generated from patents and licenses held by companies outside of the United States, including those operating in Puerto Rico. Such new tax could affect Puerto Rico’s ability to attract or retain foreign corporations engaged in manufacturing, a dominant sector in the Puerto Rico economy. Considering these factors, the Certified Fiscal Plan estimates a 13.2% contraction in real GNP for fiscal year 2018.
Enactment of PROMESA
PROMESA, which was enacted by the Federal government in June 2016, created a seven-member federally-appointed oversight board (the “Oversight Board”) with ample powers over the fiscal and economic affairs of the Commonwealth, its instrumentalities, and municipalities. On August 2016, President Obama appointed the seven voting members of the Oversight Board. Pursuant to PROMESA, the Oversight Board will 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.
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The Oversight Board has designated the Commonwealth and all of its instrumentalities as “covered entities” under PROMESA. None of the Commonwealth’s municipalities, however, have been designated as covered entities as of the date of this report. Such designation has several implications under PROMESA. First, it means that the Governor has 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 entities 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, they could also potentially be eligible to use the restructuring processes provided by PROMESA. One of such restructuring processes, Title VI, is a largely out-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 other one, 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.
Fiscal Plans
Commonwealth Fiscal Plan. As required by PROMESA, the government submitted a fiscal plan to the Oversight Board, which the Oversight Board certified, with certain amendments, on March 2017 (the “Original Fiscal Plan”). The Original Fiscal Plan, covering the Commonwealth and several of its instrumentalities, estimated that, absent the revenue enhancing and expense reduction measures set forth therein and assuming the payment of debt service as contracted, the Commonwealth’s10-year budget gap would reach approximately $66.9 billion. Assuming the successful implementation of all measures set forth therein, the Original Fiscal Plan projected that the Commonwealth and the other entities covered by the fiscal plan would 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), thus recognizing the need for significant debt restructuring and/or write downs.
As a result of the aftermath of Hurricanes Irma and Maria, on October 31, 2017, the Oversight Board requested that the government prepare a new fiscal plan (i) revising macroeconomic driver effects on revenue and expenses, (ii) adapting fiscal/structural reform measures and schedule based on feasibility and recovery timeline, and (iii) integrating recovery funds and reimbursement timing with the capital plan. The government submitted several drafts of proposed fiscal plans to the Oversight Board from January through April 2018. The Oversight Board issued various notices of violation to the Government providing that the proposed fiscal plans did not comply with the requirements of PROMESA and including required revisions, some of which the Government included in subsequent submissions. As permitted under PROMESA, however, the Oversight Board ultimately developed and certified its own fiscal plan for Puerto Rico (the “Certified Fiscal Plan”). As further discussed below, the Governor and legislative leaders have publicly announced that they are in disagreement with, and do not intend to implement, certain of the measures included in the Certified Fiscal Plan.
The Certified Fiscal Plan, which covers a 6-year period, estimates a 13.2% contraction in real GNP during fiscal year 2018, followed by 5 years of economic growth. It also projects that the Commonwealth will have a cash flow surplus of approximately $6.7 billion over such period, assuming the implementation of all measures included therein and excluding the payment of any debt service (compared to a $4.8 billion cash flow surplus projected by the Original Fiscal Plan for the same period, excluding the payment of debt service) due to revenues buoyed by a positive macroeconomic trajectory resulting from significant disaster relief funding stimulus, as well as federal Medicaid funding.
The Certified Fiscal Plan includes illustrative estimates of the implied debt capacity of the Commonwealth and the instrumentalities covered by the plan, based on a range of interest rates and assuming a 30-year term. Such estimates reaffirm the need for significant debt restructuring and/or write-downs. The Certified Fiscal Plan does not take any position as to the allocation of debt repayments to any particular class of creditors. Finally, the Certified Fiscal Plan requires the Government to implement a number of structural and fiscal reforms. Such reforms include a labor reform that contemplates significant reductions in statutorily required employee benefits and a 10% reduction in pension benefits to retired Government employees. The Government has stated that it does not intend to implement these two reforms, and it is currently unknown whether the Oversight Board will seek judicial intervention to require such implementation. Other reforms contemplated by the Certified Fiscal Plan include energy sector, infrastructure, tax and healthcare reforms, among others.
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The Certified Fiscal Plan does not contemplate a restructuring of the debt of Puerto Rico’s municipalities. It does, however, contemplate the gradual reduction of budgetary subsidies provided to municipalities, which constitute a material portion of the operating revenues of certain municipalities. In fiscal year 2018, the total appropriations to municipalities were reduced to $220, a $150 million (or 40%) reduction from the prior fiscal year. The Certified Fiscal Plan contemplates that such subsidies will be further reduced by 20% each fiscal year, up to an 80% aggregate reduction by fiscal year 2023. Pursuant to the Certified Fiscal Plan, the reduction in municipal subsidies could be partially offset by the consolidation of services across municipalities, a property tax reform, and enhanced property tax collections. The Certified Fiscal Plan is publicly available at the Oversight Board’s website.
Other Fiscal Plans. Pursuant to PROMESA, in 2017, the Oversight Board also requested and certified fiscal plans for (i) GDB, (ii) Puerto Rico Highways and Transportation Authority (“HTA”), (iii) PREPA, (iv) PRASA and (v) the Public Corporation for the Supervision and Insurance of Cooperatives. All such fiscal plans reflected that the applicable government entity is unable to pay its financial obligations in full, thus recognizing the need for debt relief. Moreover, following the hurricanes, the Oversight Board requested that the government submit new fiscal plans for such entities. The Oversight Board certified revised fiscal plans for GDB, HTA, PREPA, PRASA and the University of Puerto Rico on April 20, 2018, all of which reaffirm the need for significant debt restructuring. The fiscal plans certified by the Oversight Board for such entities (other than GDB) include amendments introduced by the Oversight Board to the draft fiscal plans that were submitted by the Government. PREPA’s certified 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 new certified 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, as amended, 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 new bonds to be issued by a new government entity and which would have an upfront exchange ratio of 55%. 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.
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. However, the GDB RSA has since been amended and the revised agreement is pending approval by the Oversight Board.
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 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.
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At March 31, 2018 and December 31, 2017, the Corporation’s direct exposure to the Puerto Rico government and its instrumentalities and municipalities amounted to $ 481 million and $484 million, respectively, which is fully outstanding at March 31, 2018 and December 31, 2017. 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, $ 434 million consists of loans and $ 47 million are securities ($435 million and $49 million, respectively, at December 31, 2017). All of the amount outstanding at March 31, 2018 and December 31, 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. At March 31, 2018, 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 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 21 – Commitments and contingencies.
In addition, at March 31, 2018, the Corporation had $382 million in indirect exposure to loans or securities issued or guaranteed by Puerto Rico governmental entities, but whose principal source of repayment arenon-governmental entities. In such obligations, the Puerto Rico governmental entity guarantees any shortfall in collateral in the event of borrower default ($386 million at December 31, 2017). These included $306 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, 2017—$310 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, at March 31, 2018, the Corporation had $44 million in Puerto Rico housing bonds issued by HFA, which are secured by second mortgage loans on Puerto Rico residential properties, $7 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 $25 million of commercial real estate notes issued by government entities, but payable from rent paid by private parties ($44 million, $7 million and $25 million December 31, 2017, 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 current and former government employees which could also be negatively affected by fiscal measures such as employee layoffs or furloughs or reductions in pension benefits.
BPPR also has a significant amount of deposits from the Commonwealth, its instrumentalities, and municipalities. The amount of such deposits may fluctuate depending on the financial condition and liquidity of such entities, as well as on the ability of BPPR to maintain these customer relationships.
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.
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.
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At March 31, 2018, the Corporation’s direct exposure to USVI instrumentalities and public corporations amounted to approximately $80 million, of which approximately $72 million is outstanding (compared to $82 million and $73 million, respectively, at December 31, 2017). 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) $15 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 (compared to $43 million, $14 million and $16 million, respectively, at December 31, 2017).
U.S. Government
As further detailed in Notes 5 and 6 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, $1.4 billion of residential mortgages and $87 million commercial loans were insured or guaranteed by the U.S. Government or its agencies at March 31, 2018 (compared to $1.7 billion and $88 million, respectively, at December 31, 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 continue to be presented as covered assets in the accompanying tables and credit metrics as of March 31, 2018.
Because of the application of ASC Subtopic 310-30 to the Westernbank acquired loans and the loss protection provided by the FDIC which limits the risks on the covered loans, the Corporation has determined to provide certain quality metrics in this MD&A that exclude such covered loans to facilitate the comparison between loan portfolios and across periods. The Corporation believes the inclusion of these loans in certain asset quality ratios in the numerator or denominator (or both) would result in a distortion to these ratios. In addition, because charge-offs related to the acquired loans are recorded against the non-accretable balance, the net charge-off ratio including the acquired loans is lower for the single-family loan portfolios 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.
The first quarter of 2018 metrics reflect higher inflows into NPLs and total non-performingloans, largely attributed to the end of the payment moratorium granted to certain consumer and commercial borrowers as a result of the 2017 hurricanes. The Corporation continues to monitor credit quality trends given the uncertainties that remain regarding the full effect of the hurricanes on its loan portfolios and the pace of recovery in Puerto Rico from the impact of the storms.
Non-performing assets, excluding covered loans and OREO, increased by $40 million when compared with December 31, 2017, mainly attributed to higher Puerto Rico mortgage NPLs of $51 million, primarily due to certain customers still being evaluated for post-moratorium loss mitigation options, partially offset by lower Puerto Rico mortgage OREOs of $19 million, mainly related to sales activity and reduced foreclosure activity due to the moratorium.
At March 31, 2018, non-performing loans secured by real estate held-in-portfolio, excluding covered loans, amounted to $500 million in the Puerto Rico operations and $30 million in the U.S. operations. These figures compare to $449 million in the Puerto Rico operations and $36 million in the U.S. operations at December 31, 2017. In addition to the non-performing loans included in Table 21. at March 31, 2018, there were $184 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 $155 million at December 31, 2017.
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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
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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. Under the GNMA program, issuers such as BPPR have the option but not the obligation to repurchase loans that are 90 days or more past due. For accounting purposes, these loans subject to the repurchase option are required to be reflected on the financial statements of the issuer with an offsetting liability. As of March 31, 2018, and December 31, 2017, loans past due 90 days or more include approximately $535 million and $840 million, respectively, in loans previously pooled into GNMA securities with a buy-back option. While the borrowers for our serviced GNMA portfolio benefited from the loan payment moratorium as part of the hurricane relief efforts, the delinquency status of these loans continued to be reported to GNMA without considering the moratorium. 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.
In consumer lending, delinquencies are near pre-hurricanelevels except for the credit cards portfolio, which has experienced an increase in delinquency partly related to some customer balances becoming over-limit due to interest accumulated during the payment moratorium period. As a result of the interest accumulation, the minimum payment for these customers has increased as the Corporation requires payments to bring the balance to the approved limit. Open-end consumer loans are charged off when these become 180 days in arrears.
The Corporation’s commercial loan portfolio secured by real estate (“CRE”), excluding covered loans, amounted to $7.6 billion at March 31, 2018, of which $2.0 billion was secured with owner occupied properties, compared with $7.6 billion and $2.1 billion, respectively, at December 31, 2017. CREnon-performing loans, excluding covered loans, amounted to $121 million at March 31, 2018, compared with $124 million at December 31, 2017. The CREnon-performing loans ratios for the BPPR and U.S. segments were 2.80% and 0.02%, respectively, at March 31, 2018, compared with 2.77% and 0.10%, respectively, at December 31, 2017.
For the quarter ended March 31, 2018, total non-performing loan inflows, excluding consumer loans, increased by $9 million, or 8%, when compared to the inflows for the same quarter in 2017. Inflows of non-performing loansheld-in-portfolio at the BPPR segment increased by $12 million, or 10%, compared to the inflows for the first quarter of 2017, mostly related to higher mortgage inflows of $26 million, prompted by the end of the payment moratorium after the hurricanes. Inflows of non-performing loansheld-in-portfolio at the U.S. segment decreased by $2 million, or 39%, from the same quarter in 2017, mostly driven by lower mortgage inflows of $2 million.
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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)
Table 24 - Activity in Non-Performing Commercial Loans Held-In-Portfolio (Excluding Covered Loans)
Beginning Balance—NPLs
Ending balance—NPLs
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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)
Table 27 - Activity in Non-Performing Mortgage Loans Held-in-Portfolio (Excluding Covered Loans)
Beginning balance—NPLs
Table 28 - Activity in Non-Performing Mortgage LoansHeld-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 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 ended March 31, 2018 and 2017.
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Table 29 - Allowance for Loan Losses and Selected Loan Losses Statistics—Quarterly Activity
Charge-offs:
Total BPPR charge-offs
Total Popular U.S. charge-offs
Total charge-offs
Recoveries:
BPPR
Total BPPR recoveries
Total Popular U.S. recoveries
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Total recoveries
Net charge-offs (recoveries):
Total BPPR net charge-offs
Total Popular U.S. net charge-offs
Total net charge-offs
Annualized net charge-offs to average loans held-in-portfolio
Provision for loan losses to net charge-offs
The following table presents annualized net charge-offs to average loans held-in-portfolio (“HIP”) for the non-covered portfolio by loan category for the quarters ended March 31, 2018 and 2017.
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Total annualized net charge-offs to average loans held-in-portfolio
Net charge-offs, excluding covered loans, for the quarter ended March 31, 2018, increased by $16.9 million, when compared to the same quarter in 2017. Increase from 2017 was mainly driven higher U.S. commercial and P.R. consumer net charge-offs of $7.3 million and $6.2 million, respectively. The U.S. operations commercial net charge-offs increase was mostly related to its taxi medallion portfolio.
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Table 31 - Composition of ALLL
Specific ALLL to impaired loans [1]
Loansheld-in-portfolio, excluding impaired loans [1]
General ALLL to loansheld-in-portfolio, excluding impaired loans [1]
Total non-covered loansheld-in-portfolio [1]
ALLL to loansheld-in-portfolio [1]
Table 32 - Composition of ALLL
Non-covered loans portfolio
At March 31, 2018, the allowance for loan losses, increased by $17 million when compared with December 31, 2017, mostly driven by an increase in the BPPR segment of $15 million.
At March 31, 2018, the allowance for loan losses at the BPPR segment increased by $15 million to $534 million, or 3.01% of non-covered loans held-in-portfolio, compared with $518 million, or 2.87% of non-covered loans held-in-portfolio, at December 31, 2017.
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The increase was mostly driven by an increase in the allowance with respect to a single commercial borrower, in part offset by a downward adjustment to the estimated losses associated with Hurricane María of $7.5 million. The allowance for the BPPR segment continued to carry qualitative reserves to address the uncertainties that remain with respect to the full impact of the 2017 hurricanes over our loan portfolios due to their unprecedented nature and the effects of the payment moratorium. 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 as conditions continue to evolve. The ratio of the allowance to non-performing loans held-in-portfolio was 93.0% at March 31, 2018, compared with 101.3% at December 31, 2017.
The U.S. operation continued to reflect strong growth and favorable credit quality metrics, except in the case of its taxi medallion portfolio acquired from the FDIC in the assisted sale of Doral Bank, which continues to reflect the pressure on medallion collateral values, particularly in the New York City metro area. At March 31, 2018, the allowance for loan losses at the U.S. segment increased slightly by $1 million to $73 million, or 1.16% of loans held-in-portfolio, compared with $72 million, or 1.16% of loans held-in-portfolio, at December 31, 2017. The allowance for loans losses for the U.S. taxi medallion portfolio increased by $12 million, in part offset by total net charge-offs of $7.6 million during the first quarter of 2018, mostly related to the taxi portfolio. The ratio of the allowance to non-performing loans held-in-portfolio at the U.S. segment was 220.47% at March 31, 2018, compared with 182.40% at December 31, 2017.
Covered loans portfolio
The Corporation’s allowance for loan losses for the covered loan portfolio acquired in the Westernbank FDIC-assisted transaction amounted to $34 million at March 31, 2018, compared to $33 million at December 31, 2017.
Decreases in expected cash flows after the acquisition date for loans (pools) accounted for under ASC Subtopic 310-30are recognized by recording an allowance for loan losses in the current period. For purposes of loans accounted for under ASC Subtopic 310-20 and new loans originated as a result of loan commitments assumed, the Corporation’s assessment of the allowance for loan losses is determined in accordance with the accounting guidance of loss contingencies in ASC Subtopic 450-20 (general reserve for inherent losses) and loan impairment guidance in ASC Section 310-10-35 for loans individually evaluated for impairment.
Troubled debt restructurings
The Corporation’s TDR loans, excluding covered loans, amounted to $1.3 billion at March 31, 2018, increasing by $84 million, or approximately 7%, from December 31, 2017. TDRs in accruing status increased by $73 million from December 31, 2017, while non-accruing TDRs increased by $11 million. The increase in accrual TDRs was mostly prompted by two commercial relationships in the BPPR commercial portfolio.
Refer to Note 8 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 March 31, 2018 and December 31, 2017.
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Table 33 - 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 3, “New Accounting Pronouncements” to the Consolidated Financial Statements.
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 2017 Form 10-K.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act and such information is accumulated and communicated to management, as appropriate, to allow timely decisions regarding required disclosures.
Internal Control Over Financial Reporting
There have been no changes in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
For a discussion of Legal Proceedings, see Note 21, Commitments and Contingencies, to the Consolidated Financial Statements.
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Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed under “Part I - Item 1A - Risk Factors” in our 2017 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 2017 Form 10-K.
There have been no material changes to the risk factors previously disclosed under Item 1A of the Corporation’s 2017 Form10-K.
The risks described in our 2017 Form 10-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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan. During the quarter ended March 31, 2018, the Corporation used shares reissued from treasury stock to make grants under the Plan. As of March 31, 2018 the maximum number of shares of common stock that may have been granted under this plan was 3,500,000.
Item 3. Defaults upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Item 6. Exhibits
Exhibit Index
Exhibit No.
Exhibit Description
161
162
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
163