Popular, Inc. Q3 FY2023 Earnings Call

Hello, and welcome to today's Popular Inc. 3Q Earnings Call. My name is Jordan, and I'll be coordinating your call today. I'm now going to hand over to Paul Cardillo, Investor Relations Officer of Popular to begin. Paul, please go ahead.

Good morning, and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano. They will review our results for the third quarter and then answer your questions. Other members of our management team will also be available during the Q&A session. Before we begin, 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. We are pleased to report another strong quarter. Net income totaled $137 million, which includes the effect of an after-tax goodwill impairment of $16 million in our U.S.-based equipment leasing subsidiary. Excluding this impact, net income would have been $153 million, $2 million more than the previous quarter. The increase in net income was driven by lower operating expenses and higher net interest income, offset in part by a higher provision for credit losses and higher income taxes. We grew loan balances by $1 billion during the quarter. BPPR generated loan growth across almost all business segments reflecting the continued strength of the local economy. Popular Bank achieved growth in commercial and construction loans. Year-to-date, loan balances have grown by $2 billion. Our net interest margin decreased seven basis points to 3.07% in the quarter, primarily due to a 27-basis point increase in deposit costs. This was partially offset by higher loan balances and the repricing of loans in a higher interest rate environment. Noninterest income remains solid and continues to benefit from steady customer transactional activity. Excluding the goodwill charge, operating expenses decreased $17 million driven by lower professional fees and customer activity-related fees. Credit quality trends generally remain positive. Nonperforming loans decreased once again and net charge-offs remain well below pre-pandemic levels. While we are beginning to see some credit normalization in the Puerto Rico unsecured consumer segments, we are attentive to the evolving credit landscape and have taken action to address these developments. Deposit balances at quarter end decreased by approximately $700 million, primarily due to a lower level of Puerto Rico public deposits. However, average deposits for the period increased by $1.4 billion, also driven by public deposit activities. Borrowings decreased by approximately $300 million due to the redemption of senior notes during the quarter. Tangible book value per share ended the quarter at $50.20, a decrease of $1.17 per share as net income for the period was offset by an increase in the unrealized losses in our investment portfolio. Regulatory capital levels remained strong. Our common equity Tier 1 ratio in the third quarter was 16.8%. Please turn to Slide 4. I'm very pleased to highlight that during the third quarter, we crossed a significant milestone in Puerto Rico and now serve more than two million unique customers. Utilization of digital channels among our retail customers also remains strong. Active users on our Mi Banco platform exceeded $1.1 million or 54% of our customer base. In addition, we continue to capture more than 60% of our deposits through digital channel. In the third quarter, consumer spending remained healthy with combined credit and debit card sales up 6% compared to the third quarter of 2022. Our auto and lease loan balances increased by $104 million compared to the second quarter as demand for cars has continued to be strong in Puerto Rico and available inventories have improved. Mortgage loan balances at BPPR increased by $121 million sequentially in the third quarter, driven primarily by home purchase activity. The Puerto Rico economy performed well during the third quarter. Business activity is solid and remains in good shape as reflected in the continued positive trends in total employment and other economic data. The tourism and hospitality sector continues to be a source of strength for the local economy. There are roughly $51 billion of hurricane disaster recovery, infrastructure, and pandemic relief funds that have yet to be dispersed. The pace of disbursement of these funds has accelerated, and we anticipate that these funds will support future economic activity for several years. As this infrastructure investment and the economy expand, we are well positioned to serve the needs of our customers and to benefit from such activity. In short, we are pleased with our results for the quarter, particularly our strong loan growth in both Puerto Rico and in the U.S. as well as the continued strength of our deposit base. We are also encouraged by the strong performance of the Puerto Rico economy. We remain optimistic about the future of our primary market and our ability to manage and serve the needs of our growing customer base. I'll now turn the call over to Carlos for more details on our financial results.

Thank you, Ignacio. Please turn to Slide 5. We reported net income of $137 million compared to $151 million in Q2. Quarterly net income includes the impact of a goodwill charge. Excluding this charge, net income was $153 million, which is $2 million higher than the previous quarter. Net interest income was $534 million, up by $2 million from Q2. On a taxable equivalent basis, net interest income amounted to $564 million, reflecting a $5 million increase from Q2 due to a higher volume of tax-exempt investment securities, partially offset by higher disallowed interest expenses related to Puerto Rico taxes. Noninterest income stood at $160 million, remaining essentially flat with Q2. The provision for current losses was $45 million compared to $37 million in the second quarter. Total operating expenses were $466 million in Q3, an increase of $6 million from the prior quarter. This total includes a $23 million pretax and noncash goodwill impairment related to our U.S.-based equipment leasing subsidiary. The impairment is due to two main factors: a higher discount rate for projected cash flows because of increased rates and equity premiums, and a lowered projection of future income. Currently, this subsidiary has lease balances of about $113 million and remaining goodwill of $17 million. Excluding this noncash expense, Q3 expenses decreased by $17 million from the prior quarter. The change in operating expenses was largely due to a $12 million reduction in professional fees related to advisory services for corporate initiatives, mainly concerning regulatory compliance and transformation efforts, as well as an $8 million reversal of an accrual for regulatory termination fees in BPPR. In Q3, we incurred $4 million in transformation-related expenses compared to $7 million last quarter. Our transformation efforts are progressing as planned, but due to the timing of various major projects, some expenses will be slightly delayed. Additionally, our choice to utilize in-house resources to replace previously budgeted consulting fees with longer-term investments has resulted in lower forecasted expenses. Consequently, we now anticipate transformation expenses for 2023 to be around $30 million, down from our previous guidance of $50 million. We anticipate Q4 expenses to be approximately $475 million. Adjusting for the $23 million noncash goodwill impairment, total expenses for 2023 would reach about $1.82 billion, which is $50 million better than our original forecast, supported by lower transformation expenses and cost control measures implemented during the year. If the proposed FDIC special assessment proceeds as currently drafted, we estimate that Popular would face an additional cost of around $66 million. We will provide 2024 expense guidance, including transformation efforts, in our January webcast once next year’s budget is finalized. Our effective tax rate for the quarter was 25.1%. The higher tax rate in Q3 is attributed to certain tax benefits recorded in the second quarter, countered by lower income before tax. For the full year 2023, we still expect the effective tax rate to be between 22% and 25%. Please turn to Slide 6. Net interest margin decreased by 7 basis points to 3.07% in Q3. On a taxable equivalent basis, NIM was 3.24%, down 5 basis points from Q2. This decline is driven by higher interest expenses on deposits due to rising costs of public deposits and increased growth in high-cost deposit accounts at Popular Bank. This was partially offset by higher loan yields and balances across all major lending categories, as well as improved yields on our cash balances and investments. At the end of the third quarter, public deposits in Puerto Rico were approximately $17.8 billion, a decrease of about $700 million compared to Q2. The decrease is consistent with historical trends, but public deposit balances have remained higher than expected. Therefore, we now project that by the end of 2023, public deposits will fall within a range of $16 billion to $18 billion, up from our earlier estimate of $14 billion to $16 billion. Excluding Puerto Rico public deposits, customer deposit balances rose by $46 million, primarily due to increases in time and savings deposits at Popular Bank, offset in part by retail outflows at BPPR. About $300 million of client deposit balances at BPPR were moved to our broker-dealer during the quarter in search of better yields. Ending loan balances grew by $1 billion compared to Q2, driven primarily by increases in almost all loan segments at BPPR and in commercial and construction loans at PB. Year-to-date, loan balances have gone up by $2 billion, compared to an increase of $2.3 billion for the same period last year. We are encouraged by the demand for credit at BPPR and PB. We will continue to seek prudent opportunities to extend credit and enhance the use and yield of our existing liquidity. Our interest rate sensitivity remains relatively neutral, and we expect the margin to begin increasing again in Q4. This expectation results from our forecasted growth and mix of loans and deposits, our investment portfolio strategy, and the speed of repricing public and incremental retail and commercial deposits. Please turn to Slide 7. Deposit betas in the current tightening cycle have surpassed those in the previous cycle. To date, we have seen a cumulative deposit beta of 34%, but the rate at which deposit costs are increasing is slowing. In BPPR, total deposit costs rose by 24 basis points versus a 26 basis point increase in Q2, with public deposits leading this increase. Excluding public deposit balances, total deposit costs were 55 basis points compared to 50 basis points in the previous quarter, resulting in a cumulative beta of 7%. In the third quarter, the cost of public deposits went up by 47 basis points, compared to our July estimate of 50 basis points. We anticipate the cost of public deposits to increase by about 10 basis points in Q4. The deposit pricing agreement with the Puerto Rico public sector is linked to the market with a lag, yielding an attractive spread below market rates. At Popular Bank, deposit costs increased by 29 basis points, compared to a 54 basis point increase in Q2, primarily driven by retail deposits attracted to our online channel. Please turn to Slide 8. Our investment portfolio is almost entirely made up of treasury and agency mortgage-backed securities, which carry minimal credit risk. Including our cash position, this portfolio has an average duration of approximately 2.2 years. In Q3, the unrealized loss in the AFS portfolio grew by $231 million, primarily due to a $274 million increase in the Agency MBS portfolio, partially offset by a $44 million decrease in the U.S. Treasury portfolio. At the end of the third quarter, the balance of the unrealized loss in AOCI for our HTM portfolio was $702 million, a reduction of $44 million from Q2. We expect this loss to be amortized back into capital throughout the remaining life of that portfolio at around 5% per quarter through 2026. Please turn to Slide 9. Our return on tangible equity was 9.4% for the quarter. We continue to aim for a sustainable 14% ROTCE by the end of 2025, primarily driven by higher net income. Regulatory capital levels remain strong, with a common equity Tier 1 ratio in Q3 of 16.8%, a decrease of 6 basis points from Q2. Tangible book value per share at the end of the quarter was $50.20, reflecting a decrease of $1.17 per share, mainly due to an increase in AOCI. Given the ongoing uncertainty regarding rates, the economy, and proposed regulatory responses in the banking sector, we will not engage in share repurchases during 2023. However, we do plan to consider a dividend increase this year. We will evaluate future capital actions as market conditions change. Our long-term outlook on capital return remains consistent, supported by our strong regulatory capital ratios. Over time, we expect our regulatory capital ratios to align more closely with those of our mainland peers, plus an additional buffer. With that, I turn the call over to Lidio.

Thank you, Carlos, and good morning. Overall, Popular continues to exhibit stable credit quality trends with low levels of net charge-offs and decreasing nonperforming loans. The consumer portfolio, however, reflected increased delinquencies and net charge-offs, primarily due to the expected credit normalization. We continue to closely monitor changes in the macroeconomic environment and borrowing performance even with higher interest rates and inflationary pressures. We believe that the improvements over recent years in risk management practices and the risk profile of the corporation's loan portfolio positions Popular to continue to operate successfully under the current environment. Before discussing the credit metrics for the quarter, I would like to address the risk profile of our office commercial real estate exposure and consumer portfolios. We have included additional information for these segments in the appendix to today's presentation. Popular consolidated office CRE exposures are limited, representing only 1.9% or $634 million of our total loan portfolio. It is mainly comprised of low to mid-rise properties located in suburban areas and is well diversified across tenant types with an average loan size of $2.1 million. The portfolio has a favorable credit risk profile with low levels of NPLs and classified loans. In terms of our consumer portfolios, these have begun to normalize as expected, reflecting increased delinquencies and net charge-offs. The credit card, auto loan, and lease portfolios continue to exhibit delinquencies and net charge-offs that are below pre-pandemic levels, although gradually increasing. In the case of unsecured personal loans, however, the year-to-date net charge-off ratio is 3.4%, which is above the 2.5% average for the 2011-2019 period. We're closely monitoring the performance of our consumer portfolio and have made changes to our underwriting criteria to decrease exposure to higher-risk segments. Turning to Slide 10. Nonperforming assets and nonperforming loans continued to decrease, driven by the commercial and mortgage portfolios. The decrease in the Puerto Rico commercial portfolio was aided by the payoff of an $11 million relationship. NPL inflows also decreased, driven by lower commercial inflows in Puerto Rico and lower commercial inflows in the U.S., offset in part by higher mortgage inflows in Puerto Rico. At the end of the quarter, the ratio of NPLs to total loans held in portfolio decreased to 1.1% from 1.2% in the previous quarter. Turning to Slide 11. Net charge-offs increased from the prior quarter to $33 million or an annualized 39 basis points of average loans held in the portfolio. The increase was driven by higher consumer net charge-offs in Puerto Rico, mainly in the auto and personal loans portfolio. This increase was in part offset by an $11 million recovery from a commercial loan payoff. Please turn to Slide 12. The allowance for credit losses increased by $11 million to $711 million driven by reserve buildup in the Puerto Rico auto and personal loans portfolio, changes in macroeconomic scenarios, and loan growth. In the U.S., the allowance for credit losses decreased by $18 million due to the implementation of a more granular model for the U.S. commercial real estate portfolio. The provision for credit losses was $44 million compared to $36 million in the prior quarter. The corporation's ratios of allowance for credit losses to total loans remained flat at 2.1%, while the ratio of ACL to NPL stood at 197%, up 15 percentage points from the previous quarter. To summarize, our loan portfolio continues to exhibit strong credit quality trends in the third quarter with low net charge-offs and decreasing nonperforming loans. Consumer portfolios, however, reflected increased delinquencies and net charge-offs due to credit normalization. We remain attentive to the evolving environment but remain encouraged by the performance of our loan book. With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.

Thank you, Lidio, and Carlos, for your updates. Our results for the quarter and year-to-date have been strong, driven by solid earnings, robust loan growth, stable credit quality, and continued customer growth. It is an honor to serve over 2 million customers in Puerto Rico, providing a wide variety of products, services, and channels, and we value immensely the trust that is placed in us. Earlier this month, we celebrated Popular's 130th anniversary. Since 1893, we have successfully adapted and led throughout changing conditions, and we are proud of our history and the legacy that has made Popular what it is today, a strong, vibrant organization with deep-rooted values. I have the privilege of visiting many of our colleagues during the anniversary and was inspired by their passion and dedication. We are encouraged with the progress of our transformation that positions us well for the future. We are optimistic about the opportunities that lie ahead. Economic trends in Puerto Rico continue to be positive, and a considerable amount of recovery funds yet to be disbursed are expected to support increased economic activity for the coming years. Our diversified business model, robust levels of capital, and, most importantly, the talent and dedication of our people position us well to support and meet the evolving needs of our growing customer base. We're now ready to answer your questions.

Thank you. Our first question comes from Timur Braziler of Wells Fargo Securities. Timur, the line is yours.

Hi, good morning.

Good morning, Timur.

Good morning.

Hi, I'm wondering how much of the delayed transformation expenses occur in '24. And I guess the total amount of transformation costs, is that now lower? Or is that expense just pushed out?

Yes. Some of the expenses have been recharacterized. For instance, some costs that we anticipated for external consultants were brought in-house, and some of these may be capitalized as part of the project. Additionally, some expenses have been delayed because the projects have taken longer to initiate. Therefore, we will see a mix of expenses pushed into 2024 and some that will no longer occur. The specifics of this mix will become clear when we finalize our project plan and budget for 2024, at which point we will provide guidance on expenses in January, as we typically do, covering both overall expenses and transformation expenses.

Okay. And then I guess, looking at funding costs. To what extent are interest rates now done pressuring deposits and the pressure now comes from mix shift?

Well, I mean, to the extent that you think the Fed is done, we will continue to have an effect because of the one-quarter lag of the effect of public sector deposit costs in Puerto Rico. But most of the rest will probably be a result of a shift as opposed to base rates changing. With the sole exception of the Puerto Rico public sector, again will have the lag of the third quarter increases into the fourth quarter.

Okay. But just looking at the period end compared to the average and considering the expected seasonal outflows in the fourth quarter, those public fund deposit balances should be significantly lower on average in the fourth quarter. Is that correct?

Well, it depends. We've updated our range for year-end as you heard from 14 to 16 to 16 to 18, if the balances end up at the high end of that range, then the average for the fourth quarter will be not very different. They will be a bit lower than the average for the third quarter but not too much difference. So it will depend on where we end up in Q4.

Great. And then just last for me on the credit normalization, the unsecured PR consumer book. The comment about limiting exposure to higher-risk segments. Can you just maybe talk through what's been the greatest source of stress in that portfolio? And which segment you're referring to in that comment?

I would say, lower FICOs and the auto portfolio of used car lower FICO segments.

Great, thanks for the questions.

Our next question comes from Brett Rabatin of Hovde Group. Brett, please go ahead.

Good morning, everyone.

Good morning, Brett.

I wanted to start by discussing the expenses in the third quarter and get some clarification on the lower regulatory costs, as most are experiencing higher costs. Can you elaborate on the factors that contributed to the reduced expenses in the third quarter and how you anticipate that might change in the fourth quarter, considering the $475 million guidance?

Yes. It's primarily professional fees. We engaged consultants to help us with various tasks. The decrease this quarter was mainly due to assistance we received with regulatory matters and our transformation initiatives. Generally, this figure fluctuates, but professional fees are typically more stable than they are lower. You may have noticed the change, but the costs associated with professional fees can vary from quarter to quarter, depending on whether we’re seeking advice on regulations, transformation, or other areas. This quarter's variation is just more pronounced. Additionally, we reversed an over-accrued regulatory expense of $8 million this quarter, which also contributed to the expense reduction.

I think it's also fair to say that we are challenging our teams to make sure as much as possible in-house versus consulting or using our consultants more intelligently. So it's not that regulatory costs are necessarily going down but the professional fees and consulting fees are going down.

Okay. That's helpful. And then on the margin, as we think about '24, assuming the Fed has stopped, would seem like the margin would start moving higher with the government deposits not repricing every lag three months. Any thoughts on your willingness or ability to invest maybe some of the cash flow in the securities portfolio into higher rates and just how you see the NII dollars playing out over the coming year?

We anticipate having a decision on the investor portfolio extension because there is sufficient loan demand for us to reallocate maturities into loans. This would be our preferred outcome, as it's the most effective use of our liquidity in terms of margin. If the Fed's actions have concluded, the pressure on funding should also decrease. We are currently originating loans at higher interest rates, which should positively impact our margin. Similarly, with our investment portfolio, any investments coming due are generally older treasuries or earlier investments with lower rates. This should also be beneficial. These factors will contribute to our overall financial calculations.

Okay. And then just lastly for me, the 14% ROTCE target by 2025. It seems like it's possible but that might be shaped a little bit earlier if things line up relative to rates and loan growth. Any thoughts on timing of that target?

Well, the timing, we were very specific in our timing. It was not the end of 2025 and this target is not an easy target. So we're working very hard to make sure we get there. God bless you and hope you're right that we can get there earlier. But at this point in time, for us, it looks like the end of 2025.

Okay, fair enough. Thanks for all the color.

Thanks.

Our next question comes from Alex Twerdahl of Piper Sandler. Alex, please go ahead.

Hey, good morning.

Hey, Alex.

Good morning.

I would like to clarify your previous question regarding the ROTCE target. When this was initially set in January, it seemed possible that buybacks would be part of the plan for this year, but that is not the case. I’m wondering if your statement about it being unchanged essentially means you are repeating what was communicated in January, or if there has been any update to the assumptions regarding capital levels that should be considered in the reiterated guidance.

It's unchanged.

Okay. So you're not making any changes to your thought around capital levels. You're just from when you initially set the target out in January?

There obviously are assumptions in that number, and the assumptions were not made public and we're not making them public now.

Okay.

But they're unchanged.

They're unchanged, yes.

I want to ask the government deposit question in a different way. Clearly, we are very focused on how this affects your balance sheet. However, if we look at it from another perspective, it appears that there is nearly $18 billion in government deposits that the Puerto Rican government has, which will eventually be utilized to stimulate the economy through various programs and initiatives that should continue to improve the situation in Puerto Rico. Is that line of thought correct?

It is indeed diverse among depositors. We estimate over 140 different deposit clients, spanning from the Puerto Rico Treasury Department to small municipalities. Most agencies currently have more funds available than before. While some of this money is designated for specific programs, and cannot be freely utilized, there is definitely movement occurring. The municipalities, along with the Puerto Rico central government, are reducing their debt, which provides them with spending power. This improvement will allow for future economic growth as they have more room to borrow and engage in viable capital projects. Overall, it's a positive development. It's beneficial for the economy that governments are working to reduce their debt levels, which I believe is significant.

Yes. When you talk about the earmarks, are there any like big ones out there that you kind of have line of sight on hitting in the next couple of months or years, I guess, years is too far. But next couple of quarters that would make that number change dramatically one way or another?

No. But as we mentioned in the prepared remarks, we have observed an increase in the pace of disbursement of federal funds throughout the year. Up until August, approximately $2.8 billion had been dispersed, compared to $1.7 billion last year, indicating that the pace is accelerating. Many infrastructure projects are gaining momentum, particularly in the energy, water, and highway sectors. A significant amount of activity is still in the planning and permitting stages. We anticipate that the CDBG-DR funds for housing will also pick up next year. Multiple projects have been awarded where private developers will construct houses that the government will purchase, later providing them to individuals with vouchers of up to $230,000. We are involved in 11 of these awarded projects, so we expect to see increased activity next year. While permitting processes may take time, the basic infrastructure for energy, highways, and water will continue to advance, and we expect housing to gain traction next year.

Keep in mind, Alex, that probably more than half of this balance is the actual operating accounts of those 100 plus or almost 200 clients. So there's always going to be a given balance there that a normal course of business will never go away. So there is that, which is what we'll always see there, there's the amounts that are earmarked for different projects. There are a whole bunch of different things in different accounts for different purposes. So it is positive that the government has more cash on hand, but it will probably be an understatement to think it's anywhere close to $18 billion. It's a fraction of that.

Okay. That's great. And then just expanding on the 11 projects and some of the other things that Ignacio, you're just mentioning, does that result in a larger level of construction disbursements for Popular next year that could help to drive loan balances higher?

Yes, I definitely believe there will be an increase in residential construction, which has been somewhat limited. This will depend on when the projects actually start and the disbursements begin. Unfortunately, those products will not remain on our balance sheet for long because, typically, the developer builds the homes, and the government purchases them instead of individual buyers. However, in the short term, we should see an uptick, particularly in residential construction. Additionally, beyond government programs in Puerto Rico, we are observing low-income tax credits that are also encouraging certain developments for the elderly, particularly in Puerto Rico and for local income housing. It’s not limited to Puerto Rico; there are several projects gaining traction, and I expect we will see some progress next year.

Great. And then is it fair to assume that mortgage that's been growing for a couple of quarters, is that expected to continue? Just given that obviously, where rates are?

Yes. Well, that's a question I ask, obviously. We've seen some pickup in the purchase activity, but you're right. I mean I think we've got to expect that the higher interest rates will have some impact on that. I mean that's just basic logic. So a lot of the activity, as we said in the prepared remarks, is purchase activity. So that's going to have to be impacted.

And then final question on loan growth. Are you guys willing to disclose how much of the highway loan you guys will take down?

Yes, I believe we are in a good position. The highway deal is significant from multiple angles. Firstly, it reflects substantial confidence in Puerto Rico, as it involves a 40-year concession. This is the largest project Abertis, the Spanish company, has undertaken in the past 15 years, and it ranks as their second-largest project ever. The syndicated banks involved include a group of international banks, notably major Japanese banks, which have recently invested in Puerto Rican projects. We acted as a lead bank alongside one of those large Japanese banks. At closing, we will be finalizing approximately $240 million, with an additional commitment of $60 million for future capital improvements and working capital. In total, our commitment is around $300 million, but we will be discussing $240 million at the closing.

Great. Thanks for taking my questions.

Hey, good morning everyone.

Good morning, Brody.

Good morning.

I wanted to follow up on the government deposits. Did I hear you correctly, Carlos, saying you expect the cost of those to increase by 10 basis points in the fourth quarter?

You heard me right. That's our estimate, yes.

What is the impact of the additional $2 billion in balances on net interest income enhancements compared to if that $2 billion was not available? How much extra net interest income do we expect from that?

We will share that formula, Brody. You will need to rely on your estimate of the margin in that business. I want to acquire around $2 billion because, as you know, we don't provide specific details about our margin in that sector. However, if the balances reach the high end of our updated range, it should positively impact net interest income.

All right. You're too quick. I was trying to catch on your feet. I did notice that the commercial beta ticked down on the chart that you disclosed, and it looks like it was driven by the U.S. business with that beta taking down from 45% cycle to date to 36% cycle to date as of 3Q. And I wanted to ask if there was something specific that drove that like a higher balance kind of account leaving that was maybe costly, just looking for some color there?

There was some balanced distortion of accounts, specifically larger high-cost accounts that left, but that didn't occur in this quarter. In this quarter, costs remained relatively flat, and the recent increase in rates wasn't passed through, leading to a slight decrease and accumulation in beta as a result.

Got it. Do you think that the commercial beta can continue to level off? Or do you believe that regardless of what happens with rates going forward, you may have reached a peak in the rate offering and that beta can continue to decrease?

Yes. I mean I think what we call is more of a stabilization. I think that intense pressure that was in deposit costs, especially following kind of the many banking crisis that we saw at the beginning of the year, some of those pressures have leveled off and the fact that the rate of increase in Fed funds rates again has slowed down. So I think all of these things help reduce the pressure on that and specifically on the commercial. The area where it continues to be a bit more sensitive is kind of like the higher-cost retail deposits. There's still a fair amount of competition both in our branches and our national online gathering platform.

Got it. Okay. I also wanted to ask on the nonowner-occupied CRE growth that you had this quarter. Was that a result of prior commitments kind of funding up? Or was that kind of new originations? And if so, can you kind of speak to the geographic location of it? Was it on the island? Was it on the mainland? I just wanted some more color there.

I would say it's a combination of both. I mean, we had some growth in terms of our construction portfolio in New York. And we also have growth, non-occupied growth both in Puerto Rico and the U.S. Puerto Rico, more in the retail space, and the U.S., more in the shelter, health care sectors.

Got it. Okay. And then just my last one. I understand that you are being cautious with capital use. However, when I take a step back and consider the math on securities restructures, it appears quite appealing. You can quickly increase CET1 on the back end, and within a few years, you could return to a very strong CET1 ratio. But you'll significantly reduce earnings, which could potentially benefit the stock price. How do you view securities restructuring and capital use at this time?

We are aware of the situation and have analyzed the numbers. It is something we review periodically. One of the important factors we consider is that if nothing changes and we do nothing, we expect to acquire roughly a third of AOCI by the end of next year. When you start comparing that, without taking execution risk or market rates into account, it becomes challenging to explore alternative options. However, we have examined it and continue to do so. At this time, we have not concluded that it makes sense for us.

Thank you very much for taking my questions. I appreciate it.

Thank you.

Our next question comes from Kelly Motta of KBW. Kelly the line is yours.

Carlos, to your last point, I want to make sure I got that right. So one-third of AOCI comes back by the end of next year, if no change in rates?

Yes, that's our best estimate. That number aligns with what we've been discussing for the past quarter when we did the calculation. It's probably what I expect it to be.

Pretty fast tangible book value accretion. Can you remind us what the cash flows are of the securities portfolio? And where you're prioritizing that money, whether it's just sticky and in cash yielding higher rates versus loan growth versus paying down some of the higher cost borrowings that you have?

Yes. It's about $1 billion a quarter still that matures in the bond portfolio. And I think, this quarter is a nice example where we did everything you mentioned essentially because we mostly funded loan growth, which is our preference. And then some of the cash also went to repayment of the senior notes. Now we don't have an immense amount of high-cost debt in our balance sheet. So that option is not huge. But the preference would be to fund client activity to the extent we can, and hopefully, the demand will be there for that to occur.

No, in addition to that, this is a key point. And you could see it on the presentation on Page 8. We have around $1 billion worth of treasury notes and MBS that prepay any given quarter, that's being then reinvested at market rates in T-bills. So you kind of see about $1 billion going off of term portfolio and going into short-term T-bills, which currently have very attractive yields and especially that are exempt for Puerto Rico tax purposes as well. So you get that incremental push every quarter.

I appreciate the information. I'm curious about any loan portfolio purchases you may have made in the past that you're considering. Is there any update on that, or are there changes in the opportunities you're seeing for those strategic purchases?

There's nothing to update. I mean our appetite remains the same. If we get shown portfolios of assets that are within our wheelhouse, in other geographies and segments that we like, and we think the opportunity we will take a very close look at them. But we do have anything to report. We are looking and people bring us opportunities all the time. Sometimes they're outside our credit box or outside our geographies. But yes, we're open and we will continue to be opportunistic if the right opportunity comes our way.

Got it. Last question for me and then I'll step back. I think on prior calls, you said on the fee income side, about $155 million to $160 million a quarter was a good run rate. And this quarter was really strong if you back out the MSR gain, you're right in the middle of that. Just wondering if you could provide an update on what you're seeing on the fee side, any give or take there?

Yes, we still believe that the right range is $155 million to $160 million. One reason we discuss this range is that any specific line in our fees can fluctuate each quarter. However, when we look at the total, it tends to be less volatile than the individual lines. The fees from credit cards might decrease while fees from another area could increase, and this could reverse in the next quarter. Although there are a lot of movements, the overall business remains quite steady. So, $155 million to $160 million still appears to be the appropriate range for us.

Thank you so much. I’ll step back.

Our next question comes from Gerard Cassidy of RBC.

Hello? Gerard, are you there?

Our next question is a follow-up from Alex Twerdahl of Piper Sandler. Alex, please go ahead.

Just a couple of follow-ups. Just back on the fee comment there, are you able to disclose the level or your level of interchange fees in any given quarter?

Yes, we do. If the reason for your question is the newly announced proposed changes on interchange debit fees. The proposal, if implemented as it stands, would probably mean something in the neighborhood of $3 million a quarter to us in reduced income.

You got it right. That's precisely what I was asking about. Additionally, I wanted to follow up on the question regarding loan purchases. Many of us are closely observing the FDIC loans being sold, and several of these have unique joint venture structures. Would you consider looking into that, or do you prefer to focus solely on cash purchases?

No. We'll look at everything. I mean, the JV structures might produce fee income if it makes sense. So we'll look at everything. We're a little bit shy about the sharing losses with the FDIC given our prior experience. But we'll look at everything. I mean if the deal is right, and if the price is right, we'll take a look at.

Got it. All right. Thanks for taking my follow-ups.

Thank you.

We have no further questions on the phone line. So I'll hand back to Ignacio Alvarez.

Thanks again for joining us today and for your questions. We look forward to updating you on our full-year results in January, and a happy weekend to all of you. Thank you very much.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.