Popular, Inc. Q1 FY2024 Earnings Call

Hello all. And welcome to Popular Inc.’s First Quarter Earnings Call. My name is Lydia, and I’ll be the operator today. I’ll now hand over to your host, Paul Cardillo, Investor Relations Officer to begin. Please go ahead.

Good morning and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our COO, Javier Ferrer; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano. They will review our results for the first 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 regarding Popular, such as projections of revenue, earnings, expenses, taxes, and capital structure as well as statements regarding Popular’s plans and objectives. These statements 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 release and 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 a solid first quarter, net income totaled $103 million, which includes the impact of an additional accrual for the FDIC Special Assessment and a tax expense related to prior intercompany distribution. Excluding these items, net income would have been $135 million compared to adjusted net income of $140 million in the previous quarter. The results in the first quarter were driven by higher net interest income and a lower provision for credit losses offset in part by lower noninterest income and a slightly higher operating expense. Our ending loan balance increased by $54 million during the quarter with large commercial payoffs impacting both banks. Our average loan balances, however, increased by $612 million driven by a substantial amount of loan activity toward the end of the fourth quarter. BPPR generated loan growth of $124 million, driven by growth in mortgage and auto, offset in part by decreases in personal and commercial loans. Popular Bank saw a $70 million decrease in loan balances driven by commercial loan payoffs that offset growth in construction loans. Deposit balances increased by approximately $191 million, driven primarily by a higher level of retail demand deposits in BPPR, which increased by $232 million, offset somewhat by lower Puerto Rico public deposits. Our net interest margin increased by 8 basis points to 3.16%, mainly driven by higher average loan balances and the repricing of loans and securities and a higher interest rate environment. This was partially offset by higher deposit costs. Noninterest income remained solid at $164 million. Excluding the additional FDIC assessment and the expenses associated with the prior period tax expense operating expenses increased by $3 million. Credit quality trends remained generally favorable with slightly lower NPLs and delinquencies. We have continued to see credit normalization in the Puerto Rico unsecured consumer segments which began in the second half of last year, and we continue to be attentive to the evolving credit landscape. Tangible value per share increased by $0.32 as our quarterly net income was offset in part by dividends and an increase in unrealized losses in our investment portfolio. Last year, we crossed a significant milestone in Puerto Rico and now serve more than 2 million unique customers. We believe that there continues to be an opportunity to deliver more value and services to our clients and deepen those relationships. For the past two years, we have been engaged in a companywide transformation and we are confident that these efforts will help us capitalize upon that opportunity. Consumer spending remained healthy. Combined credit and debit card sales increased by 2% compared to the first quarter of 2023. Our auto loan and lease balances increased by $80 million compared to the fourth quarter as demand for new cars continues to be strong in Puerto Rico. Mortgage balances at BPPR increased by $92 million in the first quarter driven primarily by home purchase activity and our strategy to retain FHA loans in portfolio. The Puerto Rico economy performed well during the quarter. Business activity is solid, as reflected in the positive trends in total employment and other economic data. The tourism hospitality sector continues to be a source of strength for the local economy. Passenger traffic at the San Juan International Airport increased by 12% in the first quarter compared to the first quarter of 2023. Additionally, in March, the hotel occupancy rate increased to 84% from 79% in March of 2023. The average daily rate and RevPAR increased by 10% and 17%, respectively, compared to the same month a year ago. There is a significant amount of committed federal funds that have yet to be dispersed. The pace of disbursement of these funds has accelerated, and we anticipate that they will support economic activity for several years. We are encouraged by the performance of the Puerto Rico economy. We remain optimistic about the future of our primary market and are well positioned to support our clients during the coming years. In short, we are pleased with the results for the quarter, particularly in Puerto Rico, where continued loan growth and the strength of our deposit base helped contribute to our increase in net interest income and support our optimistic outlook for the balance of the year. On that note, I'll now turn the call over to Jorge for more details on our financial results.

Thank you, Ignacio, and thank you all for joining the call today. As Ignacio stated in his remarks, we reported net income of $103 million in the first quarter. Excluding the effect of the FDIC assessment and the tax expenses related to prior period intercompany distributions, adjusted net income was $135 million, $5 million lower than the prior quarter's adjusted results. Although the quarter had some noise because of these two items, we are pleased with the core results, particularly the NII growth and the expansion of the NIM. Net interest income increased by $17 million in the quarter. Our net interest margin increased by 8 basis points on a GAAP basis and 12 basis points on a tax equivalent basis, driven by higher average loan balances and the repricing of loans and securities. We should continue to see NIM expansion throughout the rest of 2024. Consistent with our previous guidance, we expect our 2024 NII to increase by approximately 9% to 13% from 2023 levels. Loan growth this quarter was lower than recent trends driven by the early repayment of two large loans totaling around $200 million and decreased loan demand in the U.S. mainland. The underlying economic activity in Puerto Rico remains strong and as such, we continue to expect loan growth of 3% to 6% in 2024. Noninterest income was $164 million, a decrease of $5 million from Q4, driven by lower contingent commissions in our insurance business, which are usually recognized in the second and fourth quarter of each year. We continue to expect noninterest income to be approximately $160 million to $165 million per quarter in 2024. We were also pleased to see stable credit metrics and the early benefits of changes we implemented to address the credit losses that arose late last year in our consumer loan portfolio. The provision for credit losses was $73 million, compared to $79 million in the fourth quarter. Total operating expenses were $483 million, including the additional expense of $14 million related to the FDIC special assessment, and $6 million in expenses related to the late payment of taxes from prior period intercompany distributions. Excluding these two items, operating expenses were $462 million, an increase of $3 million from Q4's adjusted operating expenses. Other significant expense variances in the quarter were higher personnel costs by $21 million, mainly due to annual incentive awards and payroll taxes, which are traditionally higher during the first quarter of the year and higher credit card processing expenses by $6 million, mainly due to lower volume-driven rebates in the first quarter. These expenses were offset in part by a decrease in professional fees by $10 million, mainly related to regulatory consulting fees and other advisory expenses. Business promotion expenses were also lower as these are typically higher in the fourth quarter. Notwithstanding the impact of the incremental FDIC expense and expenses related to the tax liabilities from the prior period distributions, we continue to expect annual expenses in the range of $1.89 billion to $1.95 billion for 2024. Our effective tax rate for the quarter was 35%, due mainly to having recorded $17 million in income tax expense related to prior period intercompany dividends from our U.S. subsidiary to the Puerto Rico Bank Holding Company. These dividends are subject to a 10% federal tax withholding and ordinary income tax in Puerto Rico that we failed to pay for several years. Therefore, these results reflect the cumulative effect of correcting this oversight. Excluding the impact of the FDIC special assessment and the prior period tax matter, the effective tax rate would have been 25%. This adjusted effective tax rate in Q1 also reflects approximately $7 million in income tax expenses arising from a $50 million distribution from the U.S. sub completing during this quarter. We don't anticipate the tax treatment of U.S. source dividends to the bank holding company to impact liquidity or future capital action. On a GAAP basis, we now expect the effective tax rate for the year to be in a range of 21% to 23%. This includes the impact of the $17 million in income tax expense related to the prior period distribution. Please turn to slide 6. Net interest margin increased by eight basis points. On a taxable equivalent basis, NIM was 3.38%, an increase of 12 basis points. The increase was driven by higher loan yields and average balances across most lending categories as well as higher yields in our investment portfolio. This was partially offset by higher interest expense on deposits due to increased average balance of public deposits at BPPR and high-cost online deposits at Popular Bank. Excluding Puerto Rico deposits, consolidated customer deposit balances increased by roughly $240 million, primarily in retail accounts. At the end of the first quarter, Puerto Rico public deposits were $18 billion, down slightly compared to Q4 and at the upper end of our guidance range. For the rest of 2024, we expect public deposits to be in the range of $15 billion to $18 billion. As usual, normal seasonality should result in public deposit balances trending higher and peaking in Q2, mostly related to tax receipts. Our interest rate sensitivity remains relatively neutral; a higher for longer rate environment should not have a significant impact on our NII forecast for 2024. Except to the extent that such an environment increases pressure on deposit pricing, particularly in our U.S. operations due to changes in client or competitor behavior. Please turn to slide 7. Deposit betas in the current time cycle are above the prior cycle. We have seen a total cumulative deposit beta of 35% to date, driven by public deposits in Puerto Rico and online deposits in the U.S. The rate of increase in deposit cost of the corporation continued to slow down in the quarter. In BPPR total deposit costs increased by two basis points compared to an increase of 11 basis points in Q4, led by higher average balances of public deposits. The cost of public deposits decreased by one basis point. At Popular Bank, deposit costs increased by 23 basis points compared to an increase of 33 basis points in Q4, driven by deposits gathered primarily through our online channel. Please turn to slide 8. We continue to target a sustainable 14% return on tangible common equity by the end of 2025. Regulatory capital levels remained strong. Our CET1 ratio of 16.4% increased by six basis points from Q4. Tangible book value per share at quarter end was $60.06, an increase of $0.32 per share from Q4. Our long-term outlook on capital return has not changed. Over time, we expect our regulatory capital ratios to gravitate towards the levels of our mainland peers plus a buffer driven by our geographic concentration in Puerto Rico. We continue working towards announcing new capital actions in the second half of 2024. The size and nature of any future capital actions will depend on the outlook of the interest rate environment, including the impact on our TCE ratio.

Thank you, Jorge, and good morning. Credit quality metrics were stable from the fourth quarter as trends remain consistent with recent performance. The corporation's mortgage and commercial portfolios continue to reflect credit metrics significantly below pre-pandemic levels, but credit quality metrics continue to normalize for Puerto Rico's unsecured personal loans, credit card, and auto and lease finance loans. We continue to closely monitor changes in the macroeconomic environment and on borrower performance. Given higher interest rates and inflationary pressure, we have made changes to underwriting criteria to decrease exposure to higher-risk segments. We believe that the improvements over recent years in risk management practices and the risk profile of the corporation's loan portfolios position Popular to continue to operate successfully in the current environment. Turning to slide 9. Nonperforming assets and nonperforming loans decreased slightly driven by the Puerto Rico region. NPLs in Puerto Rico decreased by $30 million, reflecting improvements in most loan categories. NPLs in the U.S. increased by $27 million related to higher mortgage NPLs by $17 million impacted by a single loan and higher commercial NPLs by $10 million. Inflows of NPLs increased by $8 million, driven by the previously mentioned increase in NPLs in the U.S. mortgage and commercial portfolios. In Puerto Rico, total inflows decreased by $19 million, driven by an $18 million relationship that entered NPL in the fourth quarter of 2023. The ratio of NPLs to total loans held in portfolio remained flat at 1%. Turning to slide 10. Net charge-offs amounted to $62 million, or annualized 71 basis points of loans held in portfolio compared to $57 million or 66 basis points in the prior quarter. The increase in net charge-off was driven by a $5 million charge-off related to a previously reserved loan. Excluding this, the charge-offs were flat. In Puerto Rico, net charge-off increased by $5 million, mainly driven by higher commercial and consumer net charge-offs. The charge-off in the U.S. were flat quarter-over-quarter. We continue to expect net charge-offs for the full year to be between 65 to 85 basis points due to the ongoing credit normalization and general economic environment. Please turn to slide 11. The allowance for credit losses increased by $10 million to $740 million. In Puerto Rico, the ACL increased by $4 million, driven by the consumer portfolio due to changes in credit quality. In the U.S., the ACL increased by $6 million driven by higher commercial reserves due to rate and migration. The corporation's ratio of ACL to loans held in portfolio remained flat at 2.1%, while the ratio of ACL to NPL stood at 209% compared to 204% in the previous quarter. The provision for credit losses was $72 million compared to $75 million in the prior quarter. In Puerto Rico, the provision was $61 million compared to $67 million, while in the U.S., the provision was $11 million versus $8 million. To summarize, credit quality remains stable during the first quarter, consistent with recent performance. We are attentive to the evolving environment, and we 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, Lidio and Jorge for your updates. Popular started off 2024 with a solid first quarter, building on the positive momentum seen in 2023. Our results were driven by strong net interest income and expanding net interest margin, stable credit quality, and continued customer growth. The strength of our franchise is once again reflected in the increase experienced during the quarter in retail demand deposits in Puerto Rico. Last week, we launched our new institutional marketing campaign in Puerto Rico, titled 'Seguimos Tu Ritmo' or 'We Follow Your Rhythm.' This campaign includes a custom-composed audio brand and focuses on our unmatched omnichannel offering, highlighting our wide range of financial services through digital and traditional channels as well as our convenience and accessibility. We have also made great progress in our transformation efforts, and some of those initiatives are already producing encouraging results. We will continue these efforts to ensure our organization's success for many years to come. This entails meeting the rapidly changing needs of our customers, providing our colleagues a workplace where they can thrive, promoting progress in the communities we serve, and generating sustainable value for our shareholders. I am optimistic about our prospects for the remainder of 2024. Economic trends in Puerto Rico continue to be positive, and we are well positioned to participate in the economic activity that is expected to be generated in the coming years. I want to thank our colleagues for their continued dedication and commitment to serve our customers and contribute to Popular’s success. We are now ready to answer your questions.

Our first question today comes from Gerard Cassidy of RBC Capital Markets.

Thank you. Hi, Ignacio and Jorge. Can you give us an update on the timeline on deciding about a share repurchase program? Obviously, you're very well capitalized, the outlook this year is rather strong, better than many of your peers in terms of your economic growth and net income growth. And so if you could just update us what you're thinking in terms of possibly announcing a share buyback program in the next 6 to 12 months.

I think we've got to reiterate what we said. We're working hard. We anticipate that we will be making an announcement about our plans, likely in the second half of the year. I wouldn't want to pinpoint it too much in terms of specific months or whatnot, but rest assured, we know people want to hear from us, and we're working hard to make some kind of announcement.

I guess as a follow-up to that question, because your capital levels, I know you haven't given us a specific CET1 ratio that you want to manage to. Assuming you're comfortable to say that your current levels are more than sufficient. Would you be willing or would you consider a program that would actually give back more capital to shareholders in dividends and buybacks that would exceed a current period of earnings so that the combined ratio, if you will, would exceed 100%.

Gerard, this is Jorge. I think at this stage, as we said in the prepared remarks, the level of any new capital actions that we announce will depend on a lot of factors. I think, like I said, we know this is important to our shareholders. We have that in mind. Let's get started with an announcement sometime in the second half, and then we'll see where we go from there. But it's important that we at this stage expect capital actions to be gradual over time. This is not going to be a step function where we see a huge decrease or something like that; it will be over time.

Got it. And then just as a final question, when you guys look at the next two to three years, what's the optimal mix of money market and investment securities as a percentage of assets relative to loans? Are you comfortable keeping it in the 45% to 50% range over time, maybe gradually come down further?

Yes. I'll let Jorge add to that, but I think it's going to depend on the level of public funds. To the extent that the public funds go down, we would expect the investment securities to go down. If you ask me, I always prefer more loans to investment securities. But I think it's going to depend mostly on the level of public funds. If they go down, you can expect a percentage of investment securities to go down also.

Our next question today comes from Timur Braziler of Wells Fargo.

Hi, good morning. Looking at just the NII performance in the first quarter and then your unchanged guidance for the year, the annualizing first quarter performance gets you to the upper end of the guidance. You get a seasonally strong quarter for deposits in 2Q. Loan growth is going to pick up relative to where first quarter came in. Is it safe to say that you're targeting closer to the upper end of the guidance? What would need to take place for you to come in closer to the lower end of your guidance at this point?

I'll reiterate, we reaffirmed the guidance, 9% to 13%. We gave a range recently, Timur. In terms of the risk to the guidance, I think we talked about it a little bit in the prepared remarks; I think the deposit, competitive deposit activity, particularly in our U.S. operations, presents a higher for longer environment or if another bank failure occurs, it creates a lot of pressure for liquidity and competition. Those are the kinds of things that can impact that guidance.

Okay. And then I guess just speaking to deposits more specifically with public funds being at $18 billion in 1Q, 2Q being seasonally high. Are those expected to go higher? In the same line of questioning, maybe the competition for those deposits is a little more intense on the island. Are you anticipating having to pay more to get your fair share of that seasonal deposit growth in the second quarter?

No. The public deposits generally have a formula that we abide by. It's really going to depend on what we noted before; it's a formula based on short-term rates. So that's not going to depend on the competitive pressures. The banks in Puerto Rico, in terms of the nonpublic deposits, we continue to have a very healthy loan-to-deposit ratio, perhaps too healthy. So I don't see that competitive environment changing in the short run.

Okay. And then just last for me, looking at the unsecured consumer credit and maybe some of these other consumer categories. We're hearing from some of the consumer companies just a lot of activity during the pandemic. Now as seasoning occurs, you're seeing kind of a commensurate increase in delinquency rates with the expectation for that to actually peak and then move lower throughout the course of the year. Should we expect a similar dynamic in Puerto Rico or as you get through some of the excess capacity that was taken on during COVID, could we actually see some of these consumer delinquency rates decline as some of the underwriting period kind of kicks in?

I think a couple of things. As we mentioned in the prepared remarks, during the first quarter, we saw a stability in our, actually a decrease in some of the delinquencies on the consumer portfolios, which tends to indicate that maybe we're close to reaching normalization. Additionally, as you mentioned, we made significant changes in the fourth quarter to some of our underwriting criteria, and those changes can ensure big or short-duration portfolios. We expect that we'll see a peak soon.

Our next question comes from Brett Rabatin from Hovde Group.

Hey, good morning, everybody. I had a question around the multifamily U.S. portfolio of $1.4 billion, which is, I guess, 4% of the total portfolio. It's not huge, but I didn't understand the comment on slide 22 that says no exposure to rent control buildings. But then the next bullet says rent stabilized units represent less than 40% of the total units in the portfolio. Can you explain the rent control piece of the multifamily portfolio? Obviously, multifamily is something folks are thinking about, the classifieds are still low for you guys, but they did increase linked quarter. I just wanted to get a better understanding of the book.

I think with the multifamily in New York, there are different levels. Obviously, there are market rate apartments. They are rent stabilized apartments that allow for certain increases in rent provided on a yearly basis by the state government, and then there are rent-controlled apartments in which the rents basically remain fixed for a period. So we're saying that we have no exposure to rent-controlled apartments; we have exposure to a rent-stabilized environment.

Okay. And then do you just generally what do you expect from that portfolio from here as you look at it in terms of where migration might occur, classified criticized in that book?

I don’t think we provide that level of detail or guidance on any of our portfolios. However, as mentioned, the biggest risk in multifamily is the level of rent control and the possibility of portfolio repricing moving forward. We only have about $38 million of multifamily loans repricing in 2024, and over 50% of our units are stabilized. Therefore, we feel comfortable, and I believe this is reflected in the ratings of our portfolios.

Okay. Thanks, Lidio. And then I wanted to ask back on capital. When I look at slide, I think it's the investment portfolio, it's slide 19. When I go back to the 10-K and look at the fair value marks on the securities portfolio, if you look at the duration on slide 19, it's two years. But then if you look at the 10-K, there's a pretty good slug that's I'd call it a barbell strategy. Can you guys talk about any willingness to maybe restructure the longer piece of the securities portfolio that at year-end was about $1 billion of the $1.3 billion in total AOCI?

Brett, one thing I think in the 10-K, the MBS portfolio is structured based on our regional maturity. It doesn't have a prepayment factor, which you would see in the maturity profile that you have on slide 19. So in terms of the maturity curve, I would look at slide 19. When you see, particularly on the treasury, you see a latter strategy where we're seeing quarterly maturities of somewhere around $900 million when you add prepayment maturities on MBS of around $150 million a quarter, it really is repricing about $1 billion a quarter. We expect about 33% of our unrealized loss at the end of this quarter to have been accreted back to tangible book value by the end of 2025, assuming no changes in the rate scenario, of course. So we believe that given our profile and the amount of the unrealized loss that's just going to naturally accrete back to tangible book value, a trade where we realize a loss does not make sense. Essentially, any trade with a similar duration has no economic value to our shareholders, and we're just trading capital, a big chunk of capital for EPS. At this stage, we don't believe that that's a good trade.

Okay. That's really helpful. And if I could sneak in one last one on the unchanged NII guidance. And relative to the loan growth guidance, is it fair to assume the balance sheet is very flat for the year?

What would drive growth in the balance sheet would be growth in deposits as we would probably, given the amount of liquidity and security. So I would say that when you look at the NII guidance, it is really driven by the repricing of those investment portfolios that are maturing every quarter. You have the repricing of loans in a higher rate environment. I mean just to run in place, we have to generate a lot of new loans every quarter. So there is a lift from that. If public deposits come down, given our range where we are at the top end, that will reduce the balance sheet. We don't give guidance in terms of when we think the balance sheet is going to be, but there are a lot of levers there that could impact that projection.

Our next question comes from Ben Gerlinger of Citi.

Good morning. Just curious in terms of the charge-off guidance, the 65 to 85 basis points is a pretty wide range. I guess at the beginning of the year, there was quite a bit of the range of outcomes is pretty wide. And it seems like not only things are slowing down, but they are showing a clear plateauing effect. Is it fair to think that the 85 is a bit draconian at this level?

We're providing the guidance that we updated to 65 to 85 basis points. I think you're right in a sense that as we move along the year, there can be more confidence in terms of the guidance, but as of today, we're sticking with 65 to 85 basis points.

Got it. From an expense standpoint, I understand you provided a range for this year. Looking ahead to next year or even 2026, do you see any potential efficiency opportunities? I realize you may not want to provide guidance for 2025 or 2026 at this time, but from an operational perspective, are there ways to optimize the expense base? I think you’re doing a great job currently, and I’m just curious about how you can improve further.

I think as you said, we don't want to give guidance for '25 or '26. But we're doing a lot of efforts in the transformation that help us to go towards that 2025 ROTCE guidance. Most of that effort, we believe, is top-line driven. So we'll be creating operational efficiency and while we always are focused on managing costs and trying to slow down the acceleration of expenses, I would not expect a driver that would decrease our expense base significantly. I would see more of an opportunity to create more efficiency, operational efficiency from higher revenues and slowing down the growth of expenses.

The next question comes from Jared Shaw of Barclays.

Hi, good morning. Maybe looking at the loan growth in light of the weaker end-of-period balances this quarter from some of those payoffs, what gives you confidence in the pipeline here? Do you feel just that we should see some C&I and CRE growth accelerate to keep that range stable here?

In terms of Puerto Rico, I mean, we're still optimistic about the economic conditions, which after all, will end up influencing loan growth. The economy seems strong. We're seeing a lot of interest in clients and different deals; we're seeing investors asking around. Given a number on the pipeline, in general, the environment is strong. So I would expect that commercial loan growth will pick up. I would expect construction to pick up. There is a number of construction projects that we've signed up but haven't really disbursed any funds. Auto remains strong, and I would consider that will remain strong. So I think in Puerto Rico, you're going to see commercial growth increase, and I think auto will remain strong. We're building up our mortgage loan strategy of holding mortgage loans in portfolio that should be relatively steady. In the U.S., I think we're expecting the construction loans to go up in the New York area. We also expect growth there. As you know, in Florida after there was a tragic accident at a condominium, they passed a number of laws and regulations that require that kind of condominium to undergo certain appraisals of assessment of their structural integrity of the units. I think there's a deadline coming up in February ‘25. We expect to see a lot of activity there, and hopefully, we'll be able to pick up some more regular commercial growth. Generally, in Puerto Rico, it's the economic environment that gives us the confidence to maintain the guidance on loan growth.

Okay. Great. That's good color. And then looking at deposits, it really feels like you found a stable level here on DDAs as a percentage of total deposits. Should we expect that DDAs keep track of growth in overall deposits from here? Or could there still be some incremental diminishment?

That depends a lot on the interest rate environment. We did get benefits as it is tax season. So there's tax refunds, and that usually goes into people's DDA accounts. We'll have to see how consumers; the higher-end consumer and the commercial clients are still looking for alternatives to regular demand deposits. So we can expect that trend to continue as interest rates rise. However, we feel that our regular retail demand deposits are reflecting the strength of our branch network. They had a significant pickup this quarter. Although many refunds occur in April, we anticipate seeing some benefits from that in April. That might have been a short-term thing. But in general, we feel pretty strong about our retail deposit franchise.

The next question in the queue is from Alex Twerdahl of Piper Sandler.

Good morning, all. I wanted to go back to a comment you made, Jorge, about just the amount of churn in the loan portfolio and kind of just the amount of new generation needed just to stay where you are. And then the yield lift that is kind of inherent with that. We saw some nice yield lift this quarter; like at 7.5% overall loan yields. Can you give us a sense for what kind of loan yield lift still remains in the portfolio, assuming we see churn at similar rates to what we've seen in the past couple of quarters?

Alex, I think I'd be lying if I tell you I had that level of granularity. Let's look at the different components. The investment portfolio, we feel very comfortable that you're going to get a 300 basis point plus lift in that. I expect, particularly around our commercial clients, that any renewals in this environment should reflect a higher yield, but we do see perhaps some compression in some of those margins. At this stage, I will stick to the NII guidance.

Okay, not sure earlier, you talked about some of the loan portfolio categories you expect to grow commercial, construction, and auto. Are there any categories that you'd expect to be a headwind in terms of overall balances that maybe would decline in the next year?

We've tightened our credit policies around some of the unsecured consumer portfolios. So I don't expect you to see a lot of growth in personal loans and credit cards. Those are really the only areas that I would pinpoint that I think we're not expecting growth, and it's for a reason. It's because we've tightened up, so we can expect those to decrease. Personal loans, especially, are subject to amortization. If we don't originate at the rate we were, it will decline. So those are the only two categories I would highlight. Mortgage depends on the interest rate. It’s not a great environment for originating mortgage loans because of the high interest rates. We’re basically limited to home purchases. Other mortgages are refinancing now. However, we are holding more in portfolio, so that offsets this. I think mortgage will be more steady. I don't anticipate the balances to decline significantly, but they will be steady. I do think that personal and credit cards are not expecting growth.

Okay. Thanks for that color. And then you alluded to a $17.2 million mortgage in the press release in BPNA that migrated into NPL. Was that a residential mortgage or is that multifamily?

It's a residential mortgage. I think Lidio will give you more color on that. Yes. This was a loan made on a very expensive home in New York, and it's not something we normally do. It's a special situation for our clients that had other relationships with us. In my opinion, it's a one-off. It is a residential mortgage, but you have a solid loan-to-value ratio. So we're not anticipating losing any money on that.

Would it be like a high-profile divorce or something that would result in something like that?

No. I don't think, again, it's not, I'm pretty certain it's not a divorce. I don't know all the facts, but it's just someone who went into NPL. Again, it is a single loan to a single borrower in a residential property in New York, a very luxury property, something we normally wouldn't do. We did it as an accommodation for business reasons. I believe it's a one-off.

With that, when I look at the yields on the mortgage portfolio, it looked like they dropped this quarter. Would that be, for example, interest reversal accrued related to that loan?

There will certainly be some impact with that as we would reverse three months' worth of interest related to that loan. However, the mortgage portfolio does get impacted in Puerto Rico by tax equivalent adjustments. In the fourth quarter, we may have had a positive benefit in the fourth quarter related to those adjustments.

Remember that the FHA loans in Puerto Rico are tax-exempt for us here, the interest on the FHA loans.

Got it. Okay. And then I just wanted to ask another one on the multifamily just because you did provide some pretty good color, and it has become a bigger issue for the investment community. Do you happen to have loan-to-values of some of the loans, either portfolio overall and particularly the loans that are coming due this year or maturing this year as well as debt service coverage ratios?

Could you repeat the question? I'm sorry.

I can complete it. Whether we have more color in terms of loan-to-value ratio and debt service ratios on the multifamily loans due this year?

Generally, I would say that we underwrite any loan to value, debt service coverage in excess of 1.30. We will continue providing more detail in our future filings. But today, we don't have that information.

Our next question comes from Kelly Motta of KBW.

Hey, everyone. Good morning. Most of my questions have been asked and answered at this point. But I guess the 14% ROTCE target by 4Q '25, you've talked about it a lot in the past. I think you put it for the first time in writing in the proxy this year. Just wondering, I know we've spoken about how you anticipate getting there, talking about mostly top line and maybe a capital component. But asking a different way, what do you think are the biggest risks or headwinds that could cause you to fall short of that number? Just wondering how we should be thinking about that.

Jorge, do you want to take it?

Sure. As I mentioned earlier, there are a lot of efforts related to the transformation that will drive operational efficiency for us to achieve those results. I think at the end of this quarter, we had something like 35, 40 ongoing transformation projects throughout the organization that will contribute to that success in reaching those numbers. I think delays in the projects, extending beyond what we think we're going to be able to see benefits, could impact that guidance. Certainly, interest rate environment and factors that generally affect bank earnings will have a spillover effect.

Got it. That's helpful. And in your prepared remarks, you mentioned with capital planning, one thing you're looking at regarding whether to come in again with some capital return is your TCE ratio. That got as low as a four handle in 2022. I know we're not guiding specifically to CET1 yet or ready to. But just wondering if there's any sort of line in the sand that we should be thinking about in terms of where you might be comfortable with the TCE ratio in terms of a bottoming level, just to be mindful of when we're modeling capital.

When we look at TCE, obviously, there are levels that we're comfortable at, but it's not just black-and-white. We like to consider the rate scenario, the projected rate environment, and our sensitivity in our investment portfolio. So all those factors contribute to our confidence in the level that we're comfortable with. We believe that we will be able to come to you in the second half of this year with more information on these aspects.

And we've had a follow-up registered from Gerard Cassidy from RBC Capital Markets.

Thank you. Gentlemen, can you share with us the latest update on the bankruptcy proceedings? Obviously, you're a lot closer to it than the folks here in the mainland, but any insights on how it's winding down and possibly a final settlement sometime this year?

Yes. They had a series of hearings, and they had hoped originally to have it done in the first quarter. I think we're probably looking now maybe at the second or early part of the third quarter. There’s a lot of complexities; it will be done this year, one way or another. It’s been delayed. There have been objections from many sides, some arguing that the proposed rate hikes that will pay for the continued charge are too high, some of the bondholders claiming that the payout is too low. Different perspectives from all sides. I'm confident it will get done this year; maybe not in the second quarter, but likely in the third quarter. It’s hard to predict exactly when, but that’s my assessment.

Very good. And then just as a quick follow-up, can you remind us what drives the government's deposits? You mentioned that they're elevated right now. I'm talking about the securities earlier in the call, but what should we keep an eye on for the government to draw down those deposits? I know there's some seasonality due to tax payments. If there was a downward shift, what should we look out for?

The main driver is tax seasonality. We're paying debt on public obligations; we have a payment due on July 1. Other than that, it’s really how the government runs its finances. There are some special federal funds that Puerto Rico has used for various departments, but that money runs out eventually. Some of that will need to be replaced from the treasury of the Puerto Rico government. We expect Puerto Rico to spend more as some of these post-pandemic stimulus funds run down. Additionally, some COVID relief that had term limits may have to be returned if not utilized. Those are the factors we see impacting government liquidity over time.

Thank you. We have no further questions in the queue. So I'll turn the call back over to Ignacio Alvarez for any closing remarks.

Yes, once again, thank you everyone for joining our call and for your questions. We look forward to updating you on our second-quarter results in July. Have a great day and a great week. Thank you, everyone. Goodbye.

This concludes today's call. Thank you for joining. You may now disconnect your lines.