Popular, Inc. Q2 FY2020 Earnings Call

Good day, and welcome to the Popular Inc. Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today's event is being recorded. I would now like to turn the conference over to Paul Cardillo, Investor Relations Officer of Popular Inc. Please go ahead, sir.

Good morning, and thank you for joining us on today's call. With us today is our CEO, Ignacio Alvarez; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano. They will review our results for the second quarter and then answer your questions. Other members of our management team will also be available during the Q&A session. Before we start, I would like to remind you that on today's call, we may make forward-looking statements that are based on management's current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release and are detailed in our SEC filings. You may find today's press release and our SEC filings on our webpage at popular.com. I will now turn the call over to our CEO, Ignacio Alvarez.

Good morning, and thank you for joining the call. I hope that you and your loved ones are healthy and staying safe. Before addressing our quarterly results, I'd first like to discuss the current business environment in Puerto Rico as outlined in the first two slides of the presentation. The pandemic and related economic disruption continue to have a significant impact on the markets we serve, particularly in Puerto Rico. The strict lockdown mandated by the governor of Puerto Rico on March 15th helped curtail the initial spread of the pandemic. As a result, starting on May 26, many of the restrictions that were in place were gradually loosened, and the local economy largely reopened over the past couple of months. As the economy reopened, we had started to see a revival in business activity, especially in the month of June. However, the recent surge in positive cases and hospitalizations led the governor on July 16th to announce the rollback of some business and recreational activities and to impose further restrictions on inbound travel. While affecting a much smaller portion of the economy than the original lockdown, these restrictions will undoubtedly have a significant impact on the hotel and restaurant segment, the severity of which will depend on the length of these restrictions. Employment trends deteriorated rapidly in April and are still down significantly compared to last year, but they have begun to stabilize. The peak in unemployment claims to date in 2020 was during the first week of April. Nonfarm employment improved by nearly 5% from April to June. New auto sales had been severely impacted by the lockdown and were 49% lower in the second quarter compared to the second quarter of 2019. However, June was the best month of auto sales in the past decade, and auto sales were 5% higher than the year-ago period. Additionally, cement sales in the second quarter were 6% lower than last year's second quarter but up 42% in the month of June year-over-year. Our customer spending increased as the economy reopened. While debit and credit card sales in the second quarter were down 5% compared to the year-ago period, they increased 7% sequentially from the first quarter. In June alone, sales were 43% higher than in June 2019. Similarly, while BPPR's second quarter mortgage originations were 50% lower in the second quarter of 2019, originations for the month of June were on par with 2019 results. Tourism, however, continued to lag. Hotel occupancy bottomed in April at 4%. However, as restrictions were lifted, occupancy levels had increased to 23% by mid-June, driven primarily by internal summer tourism. Additionally, according to the Puerto Rico Tourism Company, hotel occupancy reached 78% over the three-year 4th of July weekend, 92% of which were local tourists. However, we are already seeing this positive trend reverse as a result of the recently announced restrictions. According to the operator of the San Juan International Airport, during June 2020, arrivals decreased by 67% compared to June 2019. And year-to-date through June, Puerto Rico received 46% fewer passengers than during the same period in 2019. Local and federal governments continue to provide relief and assistance in response to the pandemic. The Puerto Rico government has approved $787 million in fiscal stimulus. Also, it is estimated that Puerto Rico will receive approximately $14 billion in funds under various federal stimulus programs. Puerto Rico residents are eligible to receive the supplemental federal unemployment benefit of $600 per week. So that benefit is currently scheduled to sunset on July 31. As a management team, we've taken measures to ensure the soundness of our operations and the safety of our employees and customers. Most of our branches are open, though some are still operating under reduced schedules. We are communicating regularly with our employees to keep them informed of the evolving health and business environment. We continue to offer alternative work arrangements for a significant portion of our employee base. We have established a return-to-work protocol to ensure a safe transition back to on-premise activity when deemed advisable. I am also happy to announce that during the quarter, we extended health care coverage to part-time employees. We remain focused on supporting our customers and enhancing their experience at Popular. We have provided broad payment relief for our consumer and commercial lending clients. We've encouraged customers to use alternative digital banking options. We've seen a 13% increase in active online users since March 2020 and surpassed one million monthly active users on our Mi Banco digital platform in Puerto Rico, a very significant milestone. Additionally, in the second quarter, we captured 72% of our deposits through digital channels compared to 56% in the first quarter. Finally, and most impressively, given Puerto Rico's recent demographic trends, our customer base continues to grow, increasing by 52,000 since March 2020 to nearly 1.86 million customers. Following the passage of the CARES Act, Popular secured funding approval under the SBA's PPP program for more than 28,000 loans for small and medium-sized businesses, totaling over $1.4 billion, including $1.2 billion in Puerto Rico, $215 million in the mainland United States, and $29 million in the U.S. Virgin Islands. In fact, we originated 69% of all PPP loans originated to date in Puerto Rico. The businesses supported by these loans employed 278,000 persons and 73% of the loans originated were for less than $25,000. Additionally, Popular has secured more than 300,000 in Federal Home Loan Bank of New York grants to support local non-profits and small businesses in Puerto Rico and the U.S. Metro area. As we continue to respond to this rapidly changing situation, our plans and actions will continue to evolve. Please turn to slide 5. As in the first quarter, our second quarter results reflect the impact of the economic disruption caused by the pandemic. Our quarterly net income of $128 million was higher than the $34 million reported in the first quarter. However, it was down 25% from the $171 million reported in the year-ago period. Second quarter results were driven by lower provisions. Revenues were down in the quarter and were partially offset by lower operating expenses. The decrease in net interest income was driven by the cumulative impact of interest rate cuts by the Fed, partially offset by the issuance of the PPP loans, lower deposit costs, and the increase in our investment portfolio driven by higher deposit balances. Credit quality trends remained stable; however, the full extent of future economic disruption as a result of the pandemic is still uncertain. I will now hand the call over to Carlos, who will discuss the financial results in more detail.

Thank you, Ignacio. Good morning. Please turn to slide 6. As usual, additional information is provided in the appendix to the slide deck. Today's earnings press release details variances from the first quarter. Net interest income for the second quarter was $451 million, a decrease of $22 million from the first quarter. Non-interest income decreased by $14.6 million to $112 million in Q2, primarily driven by lower deposit service charges by $11.5 million, mainly in Puerto Rico, due to lower transaction volumes and higher deposit balances; and lower other service fees by $12.7 million as lower transaction volumes dropped debit and credit card fees by $8.6 million. Also contributing to the reduction was the elimination of certain service charges and late fees related to our response to the pandemic. These items were partially offset by, first, an increase in the net unrealized gain on equity securities of $5.2 million, related to employee deferred compensation plans. This entry has an offsetting expense in the personnel cost line. And second, a $12.6 million increase in other operating income, mostly due to a $5.6 million gain from the sale of a corporate office building. For the last couple of years, non-interest income had a quarterly run rate between $135 million and $140 million. A lot of moving parts contributed to the difference of $23 million to $28 million between this run rate and our Q2 results. But this reduction is consistent with our prior guidance of potential reduction of around $8 million per month. The speed at which we could return to more trend-like non-interest income levels will depend on the rate of reopening of our markets and the increase in client activity levels. Provision expense for the quarter was $62 million, which is $137 million lower than in Q1. Lidio will expand later. Total operating expenses were $348 million, $24 million lower than the prior quarter. Personnel costs decreased by $7.7 million driven by lower incentive compensation, commissions, and bonuses. Professional fees decreased by $8.5 million, due to lower processing and technology costs resulting from lower transactions. We also benefited from lower advisory, legal, and tax & accounting expenses. OREO expenses decreased by $2.8 million, due to discontinued foreclosure activity related to the pandemic. Last quarter, we announced that in response to lower interest rates and the effect of the pandemic, we implemented various cost savings initiatives affecting personnel-related expenses, professional fees, business promotion and other operating expenses. We are on track to achieve this $55 million in savings and thereby reiterate our expectation of average quarterly expenses for 2020 to be around $369 million. Our effective tax rate for the quarter was 16%. For the full year 2020, we currently expect our effective tax rate to be between 14% and 17%. Please turn to slide 7. In the second quarter, we saw a reduction of $22 million in net interest income. The primary driver of this decrease was the impact of lower market rates on the yields of our investment and loan portfolios. This was only partially offset by larger balances in both portfolios and lower deposit costs. The increase in balances in the investment portfolio was related to $9 billion in deposit growth. This increase in deposits was seen across all segments in Puerto Rico: public, retail, and commercial, as many of our customers benefited from Federal COVID assistance initiatives. The increase in the loan portfolio was driven by $1.4 billion in PPP loans. Our deposit costs were 34 basis points in the quarter, a reduction of 23 basis points, primarily due to the impact of lower market rates on Puerto Rico public deposits. NIM decreased by 69 basis points to 3.25% in Q2. On a taxable equivalent basis, net interest margin was 3.56%, a decrease of 78 basis points. This lower NIM is mainly related to three factors. First, the impact of our loan and investment yields on the federal funds rates decreasing 150 basis points in mid-March. Second, the significant increase in average deposits, which are mostly invested in our night fed funds and in short-term U.S. treasury securities. And finally, the origination of $1.4 billion in PPP loans, this asset although accretive to net interest income and with an attractive risk-adjusted return are low-yielding and resulted in a compression in net interest margin. We expect margin for the rest of 2020 to be steady but slightly improving from the second quarter level. This outlook is very dependent on asset mix, loan demand, and deposit levels. As of the end of the second quarter, Puerto Rico public deposits were roughly $14 billion, about $4 billion higher than in Q1. We expect public deposit balances to come down over the long term, but additional COVID-related federal assistance, as well as the impact of seasonal tax collections will probably lead to increased balances in the near term. The rate of expenditure of these funds and the timing of agreements on the government's debt restructuring will dictate the amount and timetable of any balance reduction. Our average loan balances grew by $835 million in the quarter. This growth was primarily driven by lower-yielding PPP loans partially offset by lower levels of higher-yielding consumer balances at BPPR. In the month of June, we have seen strong rebound in demand in mortgage, auto loans, and other leases, while demand and balances in our higher-yielding personal loan and credit card portfolios continue to show net repayment and lower demand. The level of loan balances for the rest of 2020 will depend on the duration of the PPP loans and the performance of the economy. As such, we are not providing loan balance guidance at this time. Please turn to Slide 8. Our capital levels remain strong relative to mainland peers as well with respect to well-capitalized regulatory requirements. As you may recall, on January 30th of this year, we entered into an accelerated share repurchase agreement for $500 million of common stock which was completed on May 27. Popular received 11.8 million shares at $42.30 per share. Our common equity Tier 1 ratio in Q2 was 15.7%, down from 15.8%. The capital simplification rules effective April 1, 2020 reduced CET1 by 48 basis points. Tangible book value increased in the quarter by almost $4 per share to $60.13. This increase was driven by our quarterly net income, higher realized gains on investment and a lower share count offset somewhat by dividend payments. In this slide, we repeat an update of the calculation of our pro forma capital ratios applying the loss ratio of our last published DFAST severely adverse stress test from 2017. In this relation, we still end up with a very strong CET1 ratio of 14.5%. These results reflect Popular's robust capital position. For the second quarter of 2020, our allowance for credit losses represent 52% of our severely adverse DFAST loss estimate. Our return average tangible equity was 11.2% in the second quarter. We will continue to pursue our target of double-digit return on tangible. While Popular is not required to run or publish regulatory stress tests for the last few years, we have completed our stress test in the summer, developed our capital plan during the third quarter, and upon approval of our Board of Directors engaged with regulators on capital discussions in the last quarter of the year. This process has allowed us to disclose our capital plans for the upcoming year early in the first quarter of that year. We now expect that this timetable will be delayed by one quarter. As a result, we expect to engage in capital discussions with our regulators early next year. We then will make capital-related announcements in the second quarter of 2021. With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. Before discussing the CECL impacts and credit trends for the quarter, I would like to take the opportunity to highlight changes in Popular's credit risk profile since the global financial crisis which you can see on Slide number 9. Also one might be tempted to view Popular based on the last crisis in 2008. We are a different company with a stronger balance sheet and more conservative risk profile. In the U.S. we shifted from being a lender with significant subprime and construction exposures to a community and niche lender with a lower risk profile. In Puerto Rico, we also shifted our commercial mix to segments with lower losses and collateralized consumer loans, mortgage, and auto. We believe Popular is well positioned to operate successfully during diverse economic environments given our improved risk profile and changes in our portfolio mix. Turning to slide number 10. We are monitoring the impact of the COVID-19 crisis on our entire loan portfolio, yet certain portfolio segments are more sensitive and are highlighted on this slide. Within the CRE non-retail segment, the exposure in Puerto Rico is mainly comprised of office space, while the exposure in the U.S. is mainly comprised of multi-family. Office space and multi-family occupancy and collections have remained stable throughout the pandemic. Today, there have been limited numbers of downgrades in this segment. The level of deferrals mainly relates to customers' liquidity strategies. In the health care facilities segment, our Puerto Rico exposure is mainly to hospitals, while our U.S. exposure is to skilled nursing facilities. For both regions, federal and local assistance has supported the industry operation. Today there have been a limited number of deferral requests and downgrades in this portfolio. Within non-essential retail, the shelter-in-place orders have curtailed the activity of this segment. As a result, we have experienced a significant number of deferrals and have downgraded most within the past-rated category 23% of the portfolio. Based on our surveys, occupancy has remained stable compared to pre-COVID levels. Strip malls reported an 86% occupancy and 82% collection rate, while shopping centers reported an 86% occupancy and 64% collection rate. An important part of our shopping centers portfolio in both regions are owned by long-term customers with financially strong principles that can withstand short-term disruption in cash flow. Regarding auto retail in Puerto Rico, this activity was subject to the lockdown order and sales decreased significantly. Upon the authorization to resume sales, the segment reported record sales in June with over 10,000 new units sold. Popular historically has had low losses in the dealer segment, even during prolonged periods of decreased auto sales, given the collateralized nature of these loans. Regarding the construction segment, most of our exposure is in the U.S. and principally in the New York Metro region. The majority of our projects are in the late-stage of completion, have low loan-to-cost, and nominal exposure to higher-end residential. To date, there have been a limited number of deferral requests and downgrades in this portfolio. Our hotel exposure is mostly in Puerto Rico. At the end of the quarter, our total exposure stood at $368 million. This segment has experienced elevated levels of stress due to travel restrictions. This segment has started to reopen gradually as part of the government's reopening plan prior to the imposition of the renewed restriction on the use of beaches and hotel common areas. Puerto Rico will not resume promotion of the destination until August 15. To date, we have had a significant number of deferrals and downgrades mostly within the past category in this portfolio. Restaurant balances were $359 million at quarter end. This segment has experienced stress driven by the shelter-in-place orders. Through the lockdown orders, the majority of our restaurant borrowers, particularly quick service or fast food, have continued to operate through delivery and carry out. As part of the government's four-phase reopening plans, restaurants were allowed to operate first with 25% capacity, then 50%, then 75%, and recently went back to 50%. Once the economy fully reopens, we expect this segment to rebound at a faster pace, especially the quick service restaurants. To date, we have had a significant number of deferrals and downgrades within the past category. To finalize, let me also discuss the segments to which we are not exposed to. We do not have material current exposure to energy, airlines, or shared national credits. Turning to slide number 11. We have continued to provide relief to our customers through loan modifications either deferrals, forbearance or extensions. New requests for modifications have declined 97% from their peak in April. We have granted assistance to approximately 116,000 customer accounts, representing $3.9 billion of loans and 27% of total balance. Of the accounts modified, a significant percentage, 35% continue to make at least one payment, while in the forbearance period. Please turn to slide number 12 to discuss credit metrics. Non-performing assets decreased by $22 million to $881 million this quarter, mainly driven by an OREO decrease of $10 million, coupled with a non-performing loan decrease of $8 million. The decrease in NPLs was in Puerto Rico, driven by the mortgage and auto portfolio. The OREO decrease was driven by the resumption of sales activity. At the end of the quarter, the ratio of NPLs to total loans held in portfolio was 2.6%, compared to 2.8% in the previous quarter. Please turn to slide number 13 to discuss NPL inflows. Compared to the first quarter, NPL inflows excluding consumer loans increased by $21 million, driven by increases of $9 million in the Puerto Rico commercial portfolio and $7 million in the Puerto Rico mortgage portfolio. The increase in the Puerto Rico commercial portfolio was mainly driven by a single relationship, which will get more clarity on the behavior of NPL inflows in the third quarter, now that we have restarted collection activities that have been suspended since March. In the U.S., inflows to NPLs increased by $5 million mainly driven by higher mortgage inflows. Turning to slide number 14, net charge-offs amounted to $65 million or annualized 92 basis points of average loans held in portfolio, compared to $63 million or 91 basis points in the previous quarter. The corporation allowance for credit losses remained relatively flat from the prior quarter at $918 million. The ratio of allowance for credit losses to loans held in portfolio was 3.2% in the second quarter, compared to 3.3% in the prior quarter. The ratio of the allowance for credit losses to NPLs held in portfolio was 121%, compared to 120% in the first quarter. The provision for credit losses decreased by $126 million to $63 million mainly driven by the pandemic impact on the macroeconomic scenarios. Please turn to slide number 15 to discuss details on the drivers of the variance in the allowance for credit losses. We adopted CECL on January 1st, 2020. Since implementation, our allowance for credit losses related to loans has increased by $441 million or 92%, driven by the day one adoption impact, changes to macroeconomic scenarios and on portfolio changes. At the end of the second quarter, the allowance for credit losses remained essentially flat when compared to the first quarter of 2020. Variances were driven by the economic outlook, changes to portfolio balances, and portfolio credit quality. In the first quarter, Popular opted to use the March 27th, Moody's Analytics S3 scenario, which was more severe than the baseline scenario that Moody had at a time. We felt that the first quarter S3 scenario was more representative of the economic forecast. For the second quarter, we used Moody's baseline scenario, as we believe it has now caught up with what most economists are expecting in terms of the impact of the pandemic. Although the path of economic variables is different than the first quarter S3 scenario, the magnitude of competitive changes in variable is comparable to the Moody's second quarter baseline scenario, which we use for our ACL calculation. The change in macroeconomic scenario caused the ACL to decrease by $23 million. As discussed by Carlos and Ignacio, portfolio balances increased by $1.4 billion, mainly driven by portfolios insured by the U.S. government. And thus had no ACL impact, mainly PPP loans and Ginnie Mae loans, subject to repurchase options. Excluding this, loan balances decreased by $287 million driven by consumer loans, causing a reduction in ACL of $17 million. During the quarter, we downgraded approximately $190 million to substandard or worse. The downwards net charge-off and other changes to ACL caused the ACL to increase by $130 million. To summarize, our loan portfolio exhibited stable credit quality metrics during the second quarter. However, the effects of the pandemic continue to change and the full extent of economic disruption is uncertain. The improvements over the last few years in the risk profile of our loan portfolio position Popular to successfully operate in challenging environments. Management will continue to carefully monitor the exposure of the portfolio to pandemic-related risk, changes in economic outlook, and how delinquencies and net charge-off evolve after the period of payment deferral lapses. With that, I would like to turn the call over to Ignacio for his concluding remarks.

Thank you, Lidio and Carlos for your update. After 126 years in the banking business, we know success requires that we act quickly and decisively, putting people first. I want to express my gratitude to our employees for their commitment to serve our customers and their creativity and ability to adapt to a rapidly changing situation. We continue to support the communities we serve through these difficult times by providing payment deferrals to more than 116,000 customers and also provided assistance to the health care professionals and non-profit organizations as they battle the pandemic. I would also like to thank our customers for their continued trust and for adapting to this new reality. They have accelerated their adoption of digital channels. Our market-leading digital offering in Puerto Rico helped us surpass an important milestone of more than one million active users on our digital banking platform. We are aware that there remains much uncertainty as to the future of the economy. Economic performance will continue to be tied to developments on the health front which are very difficult to predict. If the health situation deteriorates leading to a new round of restrictions on businesses, this will obviously hamper the economic recovery. However, the strength of our balance sheet, levels of capital and liquidity place us in a strong position to continue to serve our clients and weather the challenges that may lie ahead. We are now ready to answer your questions. Thank you.

Thank you. And today's first question comes from Arren Cyganovich with Citi. Please go ahead.

Thanks. I was wondering if you could just talk a little bit more about the decision to change your Moody's scenario that you used. I know you addressed it somewhat in your prepared remarks that it looks like the total economic in the new baseline is a little worse, but the recovery happens a lot earlier. I'm just curious as to why not stick with the more of a double-dip recession that you previously had?

Yes, based on our first quarter scenarios, we felt that Moody's was lagging behind. They hadn't adjusted their scenarios quickly enough to the rapidly changing situation. When we shut down for the second quarter, our perspective shifted. I believe they have mostly caught up, and I would describe the second quarter scenario as an elongated U-type recovery, where growth occurs much later than 2021. As mentioned in the prepared remarks, both scenarios show similar cumulative impacts on the main economic variables, although they differed in the past.

Okay. And on the deposit growth that you had obviously some boost from the public deposits. But in general the large level that has occurred, how much of that do you view as somewhat temporary and wouldn't be able to really deploy that into higher earning assets?

Well, I think it's clear that we've had challenges in predicting public deposits in the past, and I'm hesitant to make predictions about their future deployment. Generally, there's been significant liquidity in the system due to federal stimulus payments, as opposed to hurricane relief, since many of these payments went directly to individuals. With the $1,200 payments and unemployment benefits, there has been an influx of liquidity. The PPP loans also contributed to this liquidity. It's difficult for us to predict how this will play out. Some of this money will be spent, and some will return to us, especially when goods are consumed off-island. At this time, it's challenging for us to accurately assess these cash flow patterns. Additionally, the compensation for taking risks with longer-term investments is not very appealing right now. Therefore, we're trying to gain a clearer understanding before making significant changes to our investment strategy.

Okay. And then lastly, the growth in card volume was pretty astounding in June. I think you said it was up about 42% or 43%. Was that really just pent-up demand because of the lockdown? What was driving the really strong growth there?

I mean it's hard to pin one thing. But obviously there was pent-up demand. People were locked up in their houses. I think we saw some of that in China when in the first coronavirus when people got out for the first time they started spending. Also they've got money in their pockets. I mean again, I don't want to underestimate that a lot of people in Puerto Rico that were making minimum wage or close to minimum wage were getting checks of $5,000 and $6,000 on unemployment. Yes, they were getting $600 a week, but the checks were delayed in many states. And by the time they got the checks it was retroactive. They were really getting checks of $5,000 something they would never have in their lives. So a lot of money in the system and pent-up demand. I think consumer demand picked up faster than we actually anticipated. People started going back to restaurants and stores. So we'll have to see how this recent surge affects that. But I think the consumer came back a lot faster than I would have thought.

Okay. Thank you.

Thanks.

Our next question today comes from Alex Twerdahl with Piper Sandler. Please go ahead.

Good morning.

Good morning.

Just wondering maybe if you can give us a little bit more color on the downgrades that you guys did during this quarter and the reserve that was associated with them. And I guess what I'm trying to figure out is when you do the downgrades, what assumptions were you making about the economy; were you at the point where things are trying to reopen and the expectation was that they're going to remain open, or is there a slightly more pessimistic view taken, especially in some of the hotels and the restaurants and some of the higher downgraded buckets?

I mentioned in the prepared remarks that most of the downgrades we observed during the quarter fell within a certain category. However, it's important to note that there were specific segments where, based on the information available and the industry's prospects, we downgraded to substandard or worse. We reported downgrading about $200 million, specifically $190 million, to substandard or worse. As always, we consider the company's performance and its future outlook. We assess the organization's ability to endure further disruptions from the pandemic but are not making changes to our economic outlook. We believe the situation remains quite uncertain, and our focus is more on the organization's current ability to handle additional crises and its liquidity position.

Okay. Thanks for that. And then one topic that I think a lot of us on the call have been following and maybe haven't gotten that much information on is kind of this idea that pharmaceutical manufacturing, which is already a huge part of the economy in Puerto Rico, could grow even further based on some repatriation of medical device and pharmaceutical manufacturing away from other parts of the world. On the ground, is there more that you can kind of give us in terms of sort of what's going on in capacity in the space, things like that or any other bills? I know we've seen one kind of circulating, any other bills that are being talked about that could be helpful for people trying to figure out how much weight this thesis can hold.

There are several bills being discussed in Congress, and some individuals in the administration have suggested making Puerto Rico a key player in the pharmaceutical sector for the U.S. This presents a great opportunity for the island. I believe conditions are working in our favor, although the effects will take time to manifest. We have a better chance of retaining and attracting new production lines to Puerto Rico. With ongoing logistical concerns and the conflict with China, the landscape is shifting. The question remains how significant this shift will be. Production will likely move closer to the U.S., with some potentially located domestically. I am optimistic that Puerto Rico will benefit. However, much of the information I have is anecdotal. Notably, earlier this week, there was a major expansion announced by CooperVision, a large company in the southern region of the island. This is a positive indication. Overall, I don't have much more detailed information to share at this time.

That's helpful. Thanks for taking my questions.

Thanks, Alex.

Our next question today comes from Joe Gladue with Alden Securities. Please go ahead.

Hey good afternoon.

Hey, Joe.

Just a couple of quick ones. Just regarding the PPP loans, just wondering what your guess or assumptions are as to when forgiveness starts to come through and when most of that has completed this?

I believe most of our clients will seek to have their loans forgiven. Based on our discussions with them, many are aiming for 100% forgiveness. Once the SBA provides clear guidelines on the process, I expect it to occur within the next few months, especially since they have extended the period for using the funds to 24 weeks. Therefore, I anticipate this will be completed by the end of the year.

It's a good chance a significant part of all the portfolio will be gone by the end of the year.

I understand you've mentioned this in your prepared remarks and previous questions, but I'd like to ask about liquidity and deposits on the balance sheet, which include some of the PPP funds. Have you gained any insights over the last month or two? Are these funds being drawn down gradually, in larger chunks, or do you have any updates on how they are being utilized?

No, I'm not sure there is a lot of clarity Joe. Some of the expenditures by the government will be in big chunks. But what ends up happening with a lot of those big chunks is they move from a government account at the bank to individual or corporate accounts at the bank. So, we do recapture some of that. So, while there may be a big chunk of funds transferred in assistance, for example, by the government, you may not see the same effect in drop in our overall deposits because it just moves to other deposit accounts. So, it's hard to get a handle of it. The government has taken a long time to actually start disbursing the assistance money. So, a lot of that money is very new getting to people in the last month or so. So, it's very early days. Hopefully we'll have more clarity by the end of the third quarter.

Yes, I think a lot on the private deposits is going to depend on what the new federal stimulus package looks like. A lot of people have a lot of liquidity; if they have to start using that liquidity and the unemployment benefits run out or go down substantially, or there's not a new PPP program or it's not extended, the businesses that got that liquidity will have to use it and has done a replacement for it. So, I think a lot of it's also going to depend on this next stimulus program.

Okay. Last question. I appreciate the information on the PPP loans that were distributed to some of your sensitive lending segments. I just need one additional detail on that. Do you have an idea of how many or what percentage of the deferral customers received benefits from the government programs, particularly PPP?

I don't think we have that information. He wants to know what percentage of our clients in the deferral programs obtained PPP loans, do we have that?

I don't have that information.

Sorry we didn't...

I don't think we have that information either.

Let's take that question another time.

Yes. Maybe we will include it in the sensitive segment slide next time. Thank you for the feedback.

All right. Well, thank you.

Thank you.

Today's next question comes from Glen Manna with Keefe Bruyette & Woods. Please go ahead.

Hi, good morning.

Good morning. How are you, Glen?

Good. Thanks Lidio. Carlos, thank you for the detailed information on the NIM. Just if I could follow up, could you break out the part of the NIM move that was attributed to rates, the excess liquidity and then the PPP loans this quarter, basically the 79 basis point drop in the FTA? And also with respect to the PPP loans, given your prior comments that your anticipation is that 100% could be forgiven by the end of the year, what rate did you use on those loans for the current quarter?

As far as breaking up the drop, it's very hard to do, Glenn, because you have to make assumptions as far as where the additional funding on the new funding was invested. So there's a gazillion assumptions you have to make to answer your question, your very good question intelligently from our part. We have taken a shot at that, and our estimate at this point in time is that roughly big picture, two-thirds of the drop in NIM was a result of the change in mix and the increase in the balance sheet. And the other one-third roughly was linked to rates or asset mix or other things. So, it's roughly two-thirds, one-third. Again, depending on your assumptions, you can call out a different number, but that's the best we could do. As far as the PPP, the yield that we have on is 2.85.

Okay. And then, just qualitatively and maybe this is a big picture across the industry, but given the rapidity of the moves from the Fed, do you think this cycle that NIMs reached trough levels a little bit sooner than they did in the last cycle? And I know, you gave your guidance was for stable to maybe slightly up in the back half of the year and some of that could be from PPP loans rolling off. But just like longer-term and maybe just qualitatively, I'd like to hear your thoughts on that.

Yes, that will vary significantly depending on the bank. As reflected in our results, we have successfully reduced our deposit costs. However, in a climate of considerable uncertainty, we tend to be cautious in our approach. Other banks might take a more aggressive stance on lowering deposit costs. Additionally, the timing of how a decline in rates impacts our deposit portfolio can differ. Not all of our deposit rates decreased on March 1, so the full impact of the rate drop will affect part of the second quarter rather than the entire quarter. We hope to gain some benefits from this in the third quarter. Ultimately, it is quite bank-specific, and by the end of the third quarter, most banks will have experienced much of the effect. In our situation, the net interest margin varies more due to factors such as asset mix and deposit levels rather than just rates. Therefore, the influences on our results might be somewhat unique.

Okay. And then if I may just one for Lidio. Thank you for the information on the deferrals. I noticed in the press release that you said deferrals were going to start to roll off in July through September. I guess we're a month through July now, what are you seeing on re-deferral rates from customers and also maybe if you could just highlight some of the differences in deferral policies on the island versus those on the mainland?

I would say a couple of things. The first thing you asked, I mean, I don't have up-to-date information to provide you in terms of re-deferral rates for some of our customers. So we will provide details to the market on our next webcast. In terms of some of the differences, I think to a certain extent, there are two things that I would say. I mean we have gone through crises in the past and we have offered deferral programs to customers across the whole island before. So they're used to having deferral programs and taking advantage of it. The other item that I will say particularly related to our commercial portfolio, in the U.S. banking industry, you have seen a lot of line utilization as part of our customer liquidity strategies. In Puerto Rico, we haven't really seen that. What they have done is use deferral programs as part of their liquidity strategy. So rather than hitting the line, they have used deferrals to just keep cash within their operation.

Yes. I would add then – this is Ignacio. I would add then on the consumer front as opposed to most U.S. jurisdictions, in Puerto Rico there were mandated deferrals for consumer products beyond mortgage. I know some jurisdictions had mortgage relief and the CARES Act, obviously had mortgage relief. But basically, in Puerto Rico, we had mandated moratoriums and deferrals for all consumer products. All the client had to do was basically state that they had been impacted by the pandemic with no further evidence. So that's a major substantive difference.

Okay. Thank you very much for taking my question.

Thank you.

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

Thank you for joining us today and for your questions. Please continue to focus on your health and be diligent about your safety. That's the most important thing. We look forward to sharing our results for the third quarter in October. Take care.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.