Earnings Call Transcript - BPOP Q2 2021

Operator, Operator

Good morning, and welcome to the Popular, Inc. Second Quarter 2021 Earnings Conference Call. I would now like to turn the conference over to Paul Cardillo, Investor Relations Officer. Please proceed.

Paul Cardillo, Investor Relations Officer

Good morning, and thank you for joining us. With us on the call 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 web page at popular.com. I will now turn the call over to our CEO, Ignacio Alvarez.

Ignacio Alvarez, CEO

Good morning, and thank you for joining the call. The second quarter was another strong quarter in which we achieved net income of $218 million. Our results reflect the continued rebound in economic activity and the unprecedented level of federal stimulus. They also reflect our diversified sources of revenue and prudent risk management. Please turn to Slide 3. Our quarterly net income of $218 million was $45 million lower than the first quarter and $90 million higher than the same quarter of 2020. The quarter-over-quarter variance was driven by a lower benefit in the provision for credit losses compared to last quarter, higher revenues and lower expenses. The increase in net interest income was driven by higher income from our investment portfolio and lower deposit costs. Our noninterest income increased due to a higher volume of credit and debit card transactions. Credit quality trends were positive in the quarter with lower nonperforming loans and net recoveries. During the quarter, we continued to return capital to our shareholders. In late April, we entered into a $350 million accelerated share repurchase program. And on July 1, we paid a dividend of $0.45 per common share, an increase of $0.05. Please turn to Slide 4 for an update on various business metrics. Our customer base in Puerto Rico continues to grow, increasing by 17,000 in the second quarter and by nearly 30,000 year-to-date to reach more than 1.9 million unique customers. Adoption of digital channels among our retail customers continues to be strong. Active users on our Mi Banco platform exceed 1.1 million and have grown by 18% since March 2020. We captured 66% of our deposits in the second quarter through digital channels. As expected, these trends have adjusted slightly lower compared to the levels seen over the past year but remain significantly higher than pre-pandemic levels. With respect to the PPP program, we funded nearly 50,000 loans totaling $2.1 billion across both rounds. We originated more than 29,000 loans or $1.4 billion in round one and nearly 21,000 loans or $678 million in round two. In Puerto Rico, we funded 62% of all PPP loans that were originated on the island. Of the loans originated in round one, close to $965 million or 68% have been forgiven as of the end of June. Within Popular's clientele, the dollar volume of credit and debit card sales have continued to trend higher, increasing by 17% compared to last quarter and by 45% compared to the second quarter of 2019. Auto loan and lease originations at BPPR increased by 8% in the second quarter compared to the first quarter and by 32% compared to the second quarter of 2019. Similarly, we have continued to see strength in the housing market. The dollar volume of mortgage originations at Banco Popular increased by 6% compared to last quarter and by 63% compared to the second quarter of 2019. Please turn to Slide 5 for an update on the current macro environment in Puerto Rico. In the second quarter, business trends and customer activity continued to improve, building upon the momentum seen in recent quarters as most of the COVID-related restrictions that were in place have been either relaxed or eliminated. Puerto Rico has continued to make solid progress on the vaccination front. According to the CDC website, 1.9 million or 66% of the population over 12 years old have been vaccinated and 2.2 million or 76% of the population over 12 years old have received at least one dose. New auto sales continue to reflect strong consumer demand with sales of more than 35 units in the second quarter. Year-to-date, auto sales have more than doubled compared to the first six months of 2020 and are up 31% from the same period in 2019. Cement sales have remained strong. Year-to-date sales through May were higher than the level of sales that we're seeing during the same time period in 2018 and 2019 when the island was rebuilding following the 2017 hurricanes. The improvement in the tourism hospitality sector has been extraordinary. With much of the world travel still somewhat limited, Puerto Rico continues to be a popular destination for mainland residents that have become more comfortable with traveling. Additionally, earlier this month, the CDC improved its assessment of the risk of contracting COVID in Puerto Rico to Level 2 or moderate. This action should help further stimulate travel to the island. Wholesale demand has picked up dramatically. In June, occupancy rates in Puerto Rico were nearly 79%. Additionally, the revenue per available room reached $216, the highest level on record and compares to $129 in June of 2019. Airport traffic has continued to improve at a rapid pace. Year-to-date, passenger traffic is 75% higher than last year and is down only 6% compared to 2019. In the month of June, traffic was up 372% compared to the same month a year ago and was 14% higher than in June 2019. In fact, June was the highest level of passenger traffic seen at the airport since it was privatized in 2013. Cruise ships are now scheduled to recommence arrivals during the first week of August. Employment levels have improved but are still below pre-pandemic levels. Total nonfarm employment has increased by 2% since December 2020 and by 7% since June 2020. We are extremely pleased with the results for the second quarter. We continue to be very optimistic about the economic recovery, but we remain attentive to how the evolving health situation may impact the economic outlook. I'll now turn the call over to Carlos for more details on our financial results.

Carlos Vázquez, CFO

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 $488 million, an increase of $9 million from Q1, driven by increased balances in the investment portfolio and lower deposit costs. Noninterest income increased by $1 million to $155 million in Q2. Contributing to these results were higher credit card interchange fees of $4 million plus $2.4 million higher net earnings from investments held under the equity method, along with various other smaller positive variances. This was almost entirely offset by a $9.9 million lower mortgage banking income, primarily due to a negative quarter-over-quarter variance in MSR valuation of $6.8 million versus a positive variance of $9.2 million in Q1. The provision for the second quarter was a benefit of $17 million. This was $65 million lower than the $82 million benefit recorded in the first quarter. Lidio will expand on credit-related matters. Total operating expenses were $368 million in the quarter, down $7 million from Q1. The decrease was primarily due to lower employee compensation costs by $5 million, mostly driven by seasonality of compensation plans and lower other operating expenses by $4 million, primarily due to a reserve release on our mortgage servicing business. These were partially offset by higher customer reward program expenses of $3 million resulting from increased credit card transactions as well as slightly higher advertising costs. For the full year 2021, we now expect our average quarterly expenses to be $380 million to $385 million, $5 million per quarter higher than our prior estimate. A number of factors contributed to this increase. We expect compensation expenses to be higher due to continued business outperformance as well as increased competition for talent. Some projects and activities that were delayed in the first half of the year should materialize in the second half. And finally, we also expect higher processing and technology costs. Our effective tax rate for the quarter was 25% compared to 23% in the first quarter. This increase was primarily due to a higher proportion of taxable income in Puerto Rico. For 2021, we now expect our effective tax rate to be between 22% and 25%, which is an increase from our prior range of 20% to 24%. Please turn to Slide 7. NII on a taxable equivalent basis was $541 million, $11 million higher than in the first quarter. The primary drivers of the increase were higher interest income from the investment portfolio by $13 million due to a $4.4 billion increase in average balances, lower deposit costs by $2 million and an additional $4 million of income due to one more day in the quarter. Deposits grew by $5.9 billion in the quarter. This increase was spread across all business lines. The majority of the growth was in Puerto Rico government deposits. But similar to Q1, our retail and commercial deposits increased by $1.9 billion. NIM decreased by 16 basis points to 2.91% in Q2. On a taxable equivalent basis, NIM was 3.22%, a decrease of 17 basis points. The lower margin is due to asset mix, meaning higher balances of low-yielding money market and investment securities. The total loan yield decreased by 2 basis points in Q2 as a result of lower PPP-related income of $13.9 million compared to $23.1 million in the first quarter. PPP loans yielded approximately 4.45% this quarter compared to 7.21% last quarter. The reduction in yield was due to slower accelerated recognition of fee income upon forgiveness. The remaining unamortized portion of fees for the PPP portfolio is approximately $60 million. We believe most of the remaining $354 million first round PPP loans will be forgiven during the third and fourth quarters of this year and a majority of the $670 million second round PPP loans by the middle of next year. We expect margin will continue to drop in Q3 due to continued high levels of deposits but should recover towards year-end. The ultimate result will depend on our asset mix and the rate of forgiveness of PPP loans. As of the end of the second quarter, Puerto Rico public deposits were roughly $19 billion, an increase of just over $4 billion from last quarter. These balances reflect the most recent CARES Act federal stimulus, including assistance to state and local governments. We continue to expect public deposit balances to come down over time, driven by outlays of funds advanced from the CARES and Jobs Act, the restructuring of public sector debt and the return to current debt service. Our ending loan balances decreased by $69 million in the quarter. This decline was due to a $224 million decline in PPP loans, partially offset by an increase of $139 million in the auto and lease portfolio. First round PPP loans dropped by $418 million, while second round disbursements were approximately $192 million. Excluding the impact of PPP, loan balances grew by $170 million. We continue to see strong demand and net portfolio growth in auto loans and leases, while our other loan portfolios are either flat or have decreased since the first quarter. We expect loan balances to be impacted by PPP forgiveness as well as limited demand resulting from unprecedented levels of client liquidity. As such, we do not expect overall loan growth to materialize until next year when the demand resulting from expected economic growth should outpace forgiveness of PPP loans. Please turn to Slide 8. Our capital levels remain strong relative to mainland peers and well-capitalized regulatory requirements. Our common equity Tier 1 ratio in Q2 was 16.6%, down 60 basis points from Q1, primarily due to capital actions. In April, the corporation entered into a $350 million accelerated share repurchase transaction. As a result, we recognized in shareholders' equity approximately $280 million in treasury stock and $70 million as a reduction of capital surplus. The final accounting treatment for the program will depend on the average price of the stock during the term of the ASR, scheduled to close in Q3. Our EPS in Q2 increased by $0.08 because of this transaction. We will continue to explore opportunities to manage our capital during the remainder of 2021 and in future periods. However, we do not expect further dividend increases or common stock repurchases this year. We have returned to our normal capital planning schedule this year, hopefully resulting in an announcement of Popular's 2022 capital actions no later than our January 2022 webcast. Our stockholders' equity decreased in the quarter, primarily due to the impact of the $350 million ASR. However, our tangible book value per share increased by $1.82 to $63.24. This increase was driven by our quarterly net income, higher cumulative unrealized gains on investments and the lower share count. Our return on tangible equity was 17.6% in the second quarter. With that, I turn the call over to Lidio.

Lidio Soriano, CRO

Thank you, Carlos, and good morning. During the second quarter, the corporation continued to exhibit strong credit quality metrics and low credit costs, driven by the improving economic environment. Please turn to Slide 9 to discuss credit metrics. Nonperforming assets decreased by $7 million to $777 million this quarter, mainly driven by an NPL decrease of $13 million, offset in part by an increase of $5 million in NPLs held for sale. In Puerto Rico, NPLs decreased by $9 million, mainly due to lower mortgage NPLs of $20 million, resulting from lower inflows and continued improvement in early delinquency trends, coupled with lower consumer NPLs, mainly in the overall portfolio. These decreases were offset in part by higher commercial NPLs of $17 million, mainly due to the inflow from a single $32 million non-COVID-related client. This increase was offset in part by the resolution of a $9 million NPL relationship that resulted in a significant recovery. In the U.S., NPLs decreased by $4 million mostly related to a construction loan transferred to held for sale. The ratio of NPLs to total loans held in portfolio was 2.4%, flat versus the prior quarter. Please turn to Slide 10 to discuss NPL inflows. Compared to the first quarter, NPL inflows, excluding consumer loans, increased by $11 million, driven by an increase of $17 million in Puerto Rico, mainly due to the previously mentioned commercial relationship. This increase was offset in part by lower mortgage NPL inflows of $15 million. In the U.S., NPL inflows decreased by $6 million as the prior quarter included a $12 million construction loan that reached 90 days during its renewal process was current at the end of the quarter. Turning to Slide 11. Net charge-offs amounted to a net recovery of $1.3 million or an annualized negative 2 basis point of average loans held in portfolio compared to net charge-offs of $21 million or 29 basis point in the previous quarter. The results for the quarter were aided by the recovery of $7.9 million related to the resolution of the above-mentioned nonperforming relationship. Excluding this, the net charge-off ratio would have been 9 basis points, which is lower than trend and pre-pandemic levels. In Puerto Rico, net charge-off decreased by $21 million, primarily driven by $8.4 million of lower commercial net charge-offs due to the resolution of the NPL relationship, lower mortgage net charge-off by $7.4 million and lower construction net charge-off by $6.4 million as the prior quarter included a $7 million charge-off related to a previously reserved loan. In the U.S., net charge-off decreased by $1.3 million quarter-over-quarter. Our allowance for credit losses decreased by $15 million to $786 million, driven mainly by improving credit quality and releases from our hospitality portfolio's qualitative reserve, as discussed in the following slide. The ratio of allowance for credit losses to loans held in portfolio decreased to 2.7% from 2.75% in the prior quarter. Excluding Payment Protection Program loans and guaranteed mortgage loans, this ratio is 3.02%. The ratio of allowance for credit losses to NPLs held in portfolio was 115%, flat to the prior quarter. Please turn to Slide 12 to discuss details on the drivers of the variance in our allowance for credit losses. The allowance for credit losses decreased by $15 million when compared to the previous quarter. Variances were driven by changes to qualitative reserves and economic outlook as well as portfolio credit quality and mix. While a strong recovery is evident, we also consider more adverse outcomes given uncertainties around the impact of the new virus strains and the Puerto Rico government's ability to utilize available federal assistance. As a result, we continue to assign the highest probability to the baseline scenario followed by a more pessimistic test-free scenario. Our macroeconomic forecast uses a number of economic variables with the unemployment rate and GDP being the largest drivers. The current baseline scenarios show a slight improvement in both 2021 GDP growth and unemployment rates when compared to the previous estimates. However, revisions to historical macroeconomic indicators conducted by the Puerto Rico Planning Board contributed to increases in the allowance for credit losses in Puerto Rico. These revisions caused ACL to increase by $21 million. During the quarter, we released $10 million from our qualitative reserve prompted by the economic environment and improvements in our performance. Total portfolio changes caused the ACL to decrease by $27 million. Portfolio changes include fluctuations in credit quality, volume and mix. To summarize, our loan portfolio exhibited improved credit quality metrics during the second quarter, aided by the government stimulus and an improving economic environment. We will continue to monitor the exposure of the portfolios to pandemic-related risks and changes in the economic outlook. With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.

Ignacio Alvarez, CEO

Thank you, Lidio and Carlos, for your updates. Our results for the first half of 2021 were strong, driven by solid earnings, improved credit quality, record deposit levels, continued consumer growth and our capital actions. We are optimistic about the economic outlook. In addition to the unprecedented level of federal stimulus related to COVID, Puerto Rico still has a significant amount of hurricane recovery funds that have yet to be dispersed, which we expect will now start flowing at a faster pace. The combined impact of these factors and improved consumer confidence should generate considerable economic activity in many sectors for the coming years, and we are well positioned to benefit from such activity. We are looking forward to having the entire team together in our office again. Given progress in the vaccination process, a general improvement in health conditions and sound and safety protocols in our facilities, we will begin to bring back to the office our colleagues that are still working remotely. Managers and supervisors will be returning in mid-August and the remainder of our workforce will return after Labor Day. We will, however, be offering eligible employees a hybrid work arrangement. In June, we released our second annual Corporate Sustainability Report. It highlights our commitment, progress, and achievements in our initiatives to operate as a responsible, ethical, and sustainable company. We are mindful of the responsibility we have as Puerto Rico's leading banking institution and, in fact, to all the communities we serve. We have a firm commitment to continue to expand our levels of transparency around our ESG practices, and we will continue working to ensure we have a positive impact on all our stakeholders. You can find our report on our website. We are now ready to answer your questions.

Operator, Operator

Our first question comes from Brock Vandervliet of UBS.

Brock Vandervliet, Analyst

If you could talk more about loan growth and what you see. I think, Carlos, you're very clear you're not expecting growth until next year. I guess I'm trying to put together what appears to be multiple economic data points pointing toward a resurgence of economic growth and the lack of it in the loan book. Maybe if you could talk about utilization or origination pipelines. Anything that could kind of help us triangulate.

Carlos Vázquez, CFO

Sure. First, I'd like to say that our bankers are performing well in originating loans. If we exclude the impact of the PPP this quarter, we saw a loan growth of $170 million, which is a positive development. We continue to highlight net loan growth in '22 because, while our bankers are doing a commendable job, we still have clients with very high liquidity levels. The average balance for our commercial and retail clients at Popular has increased by over 40% since February last year, indicating substantial liquidity. Additionally, the normal operations of our business play a role. If we assume that the remaining PPP funds, around $350 million, are eliminated by year-end, that seems like a reasonable estimate. Our old Westernbank portfolio amortizes approximately $25 million each quarter, leading to a total of about $50 million. Furthermore, despite our organization’s strong performance, our mortgage book's normal amortization, which is significantly high, results in a negative number, likely exceeding $800 million per quarter. Considering these factors, we anticipate a natural decline in our portfolio of about $500 million. Although our bank is excelling, they would need to compensate for this decline and achieve additional growth. This is why our focus on '22 remains due to the considerable liquidity held by clients and the need to address the natural depreciation of our portfolio. We would like to be proven wrong on this, and we hope growth will materialize sooner, but our current estimation is that balances may start reversing early in '22.

Brock Vandervliet, Analyst

Okay. I appreciate that color. And anything under the hood in terms of loan efforts to open new lines of credit on the C&I side that haven't been drawn yet as a result of some of the economic pickup we're seeing?

Ignacio Alvarez, CEO

I think the activity we're seeing is pretty normal. Many of our existing clients have established lines. The area where I'd say you'd probably observe increased activity is the renewed investor interest in Puerto Rico. We are noting more new activity, such as acquisition loans for purchasing businesses or properties, rather than lines of credit, since most of our commercial clients have sufficient liquidity and available lines. Therefore, they don’t really need new lines. However, we are experiencing greater activity in terms of acquisitions.

Operator, Operator

The next question is from Gerard Cassidy of RBC.

Gerard Cassidy, Analyst

Carlos, coming back to the liquidity comment you were making about your customers. Can we tie that to the deposit growth as well, ex the government deposit growth? What do you think is driving that liquidity? Is it primarily the stimulus programs, meaning PPP? And then on the consumer side, the stimulus checks? Or is there something else going on in addition to that, that is driving that liquidity, and therefore, you're still seeing these nice deposit levels or higher deposit levels?

Ignacio Alvarez, CEO

This is Ignacio. I think there's no doubt that the stimulus payment had a big effect. I mean a lot of money came directly into people's accounts and they didn't spend it all. I also think that for a while, people didn't have the ability to really spend their money. They couldn't travel. They couldn't do other things. They weren't commuting, so they saved on gas. So there were a number of things that people, I think, were building up liquidity. So I would expect that going forward, that liquidity buildup is not going to continue because this was a special period. But there's still a lot of money in the bank to actually to my surprise. You hear a lot of stories about people buying cars and refrigerators and, by the way, we know they're doing that, but they still have money in the banks.

Carlos Vázquez, CFO

Yes.

Gerard Cassidy, Analyst

Do you want to go ahead, Carlos? Sorry.

Carlos Vázquez, CFO

Gerard, you can see that client activity is increasing when we look at the usage of our debit and credit cards. Clients are continuing to spend their money, but it may take a few months for that to fully show. It's also worth noting that when a retail client spends their money in their account with us, there’s a good chance that it will end up as a deposit in one of our commercial clients' accounts. This creates a situation where, even though money is moving, you might not see a decrease in our deposit balances, as it is just circulating. Conversely, if the client spends money at a store like Walmart, that money goes to the state. So, there’s some movement between different types of accounts as well.

Gerard Cassidy, Analyst

Very good. And when your line officers or when you guys go out and talk to your clients, is there any determination yet that because of what we've come through and now they have these higher levels of liquidity, could this be permanent? Where, let's say, like your auto dealers, you're obviously very big in the auto business. Are they going to just run with lower inventory levels permanently and just use higher margins? Any sense on that yet that this could be a permanent shift and not something temporary?

Ignacio Alvarez, CEO

I have been visiting clients more frequently, and I haven't heard that. I believe inventory levels are relatively low mainly because it's difficult to obtain more inventory. However, I don't think this situation will continue. Once the market stabilizes, I anticipate there will be significant competitive pressures pushing people to lower their margins. I expect it will balance out. Many of our clients went through a challenging phase where having liquidity was essential. Given that experience, I think they will tend to retain more liquidity. Additionally, I believe they are waiting to see a firm recovery before making decisions about investing and expanding. That’s why Carlos mentioned we expect to see more loan growth later, as businesses will not want to miss out on opportunities. Right now, they're working to meet the current demand, but eventually, they will need to increase their capacity rather than just stretching it. That's what we are waiting for.

Gerard Cassidy, Analyst

Very good. And then as a follow-up question, maybe this is for Lidio. The large credit that went on nonaccrual this quarter, if you could maybe give us some color on what caused it to go on and what type of credit it is? And then second, I think you also mentioned that a large construction loan that was 90 days past due in the first quarter went back to performing status. Maybe some color on how you did that. And then the third part of the question, in your outlook for the allowance, I noticed that in the first quarter baseline, the unemployment rate assumption in Puerto Rico for '21 was 8%. And now in the second quarter, the baseline unemployment rate is 8.4%, which I found on considering all the positive economic trends we're hearing about in Puerto Rico. So if you don't mind, if you could address those questions.

Lidio Soriano, CRO

Let me see if I can remember all three or beginning with the first...

Gerard Cassidy, Analyst

I'll help you.

Lidio Soriano, CRO

Okay. Thank you so much, Gerard. As I mentioned in the prepared remarks, the nonperforming relationship was non-COVID related. It is a pharmaceutical company whose main product went off patent, and they have also issues related to trying to get new products FDA approved. So that's really the issue behind that one company. The second question was related to...

Ignacio Alvarez, CEO

The construction loan.

Lidio Soriano, CRO

As we mentioned in the last webcast, the renewal process for this relationship extended beyond the 90-day maturity. As a result, in accordance with our policy, we classified it as nonaccrual, but it was refinanced or restructured at the end of the quarter. This is why it has returned to a current status. To some extent, we can consider it an administrative or technical delinquency. Regarding the unemployment rate, we utilize Moody's services for our estimates. While it did increase in 2021, it actually declined in 2022. Overall, when examining the unemployment rate for Puerto Rico during the recent supportable period, it has decreased. This is why we noted a slight improvement in the economic forecast from one quarter to the next.

Operator, Operator

The next question is from Alex Twerdahl with Piper Sandler.

Alex Twerdahl, Analyst

Just wanted to go back to some of the different components of loan growth expectations. Is my understanding that there's some rather large construction projects potentially being sponsored somewhat by the CDBG money that potentially could come online in the next couple of quarters and you see disbursements that could, I don't know, potentially meaningfully impact construction loan balances across the banks? And obviously, you would expect you guys to get more than your fair share of that. Can you talk about some of those projects and the expectations for the timings for some of those disbursements and whether that's something that we can expect this year?

Ignacio Alvarez, CEO

Yes, this is Ignacio. The FEMA process is quite complicated. There are numerous public projects that will be carried out, some by the state, such as the highway authority, some through PREPA, now managed by LUMA, and others by the Aqueduct and Sewer Authority or the municipalities. I emphasize that in 2021, we won't see significant disbursements because even though FEMA has approved many of these projects' budgets, they still must go through the design and permitting processes, along with signing a construction contract. All of this involves bidding through FEMA. Thus, 2021 appears to be more of a preparatory stage in terms of federal funds. While some smaller-scale municipal projects will see some outlay, the larger projects won't have substantial funding until 2022, primarily due to the lengthy process that requires bidding at every stage. You need to bid for architectural and construction work, and the permitting process in Puerto Rico is not the most efficient, which further complicates matters. On the private side, there is an active residential construction market, but that also takes time due to the need to find land and obtain permits. While there's currently a tight supply of housing, developers will be active, but similar delays exist in acquiring land and permits. Beyond FEMA, private construction will definitely come, but I don't foresee much happening until 2022 regarding large disbursements.

Alex Twerdahl, Analyst

When you talk about the big disbursements, can you give us some sort of sense for what sort of the magnitude of some of those projects might be? And like how big a component BPOP would be willing to finance?

Ignacio Alvarez, CEO

I don't have it on a project-by-project basis, but $10 billion has been assigned to the power authority for improvements in the power, right? $3 billion has been assigned to the Aqueduct and Sewer Authority for improving that. So those are big projects. Highway, I don't have the number on the highway, but highway had another couple of hundred million dollars in funds. So most of what we have been doing is a lot of that is being financed by federal funds. Our biggest participation to date has not been like project financing but has been financing the contractors who do the work. So in many of these projects, they have to put out the work and advance funds before they get reimbursed. So much of what we anticipate will happen is that our construction clients will have to increase their lines and draw more down to these projects. Obviously, on the private side, it's a little bit different. We will finance the construction there. But on the public side, I don't think that really is the case. I think we'll be financing more the people involved, the contractors, the architects, the suppliers of materials, that type of thing. I think that's where it's going to be our sweet spot instead of traditional project financing.

Alex Twerdahl, Analyst

Okay. Understood. What about the residential market, which seems to be thriving right now? Many of the mortgage loans you're providing are conforming and you're selling them. Is the jumbo market making a significant comeback? Could that help counterbalance the residential runoff as we consider the next few years?

Ignacio Alvarez, CEO

Yes, I think there are a few points to consider. Carlos and Lidio might have more insights, but there is a limit to how much nonconforming we want to pursue. Currently, we don’t have an issue with satisfying our demand for nonconforming loans. One thing we are managing is the tremendous demand in Puerto Rico, which has led to a significant jumbo market that wasn’t previously established. We are heavily involved in that. As you may have heard, in places like Dorado and Mayagüez, we are making mortgages of $3 million, $4 million, and $5 million, amounts we have never issued before. Our main concern is not so much acquiring those loans but adjusting our risk tolerance regarding how much we can hold. This demand is certainly beneficial. However, in the current low-interest-rate environment, we prefer not to take on too much risk by holding these mortgages on our balance sheet, especially considering how hot the residential market is at the moment. We've witnessed unprecedented scenarios in Puerto Rico, such as houses selling for $30 million or $20 million, which we've never encountered before.

Alex Twerdahl, Analyst

Wow. I have a couple more questions. When I examine the deposit flows, there's $19 billion in public deposits. I understand you anticipate that will eventually decrease over time. Do you have a clearer idea of the timing for these deposits? I know there’s about $7 billion that could be withdrawn once the GOs are resolved. Is there a way to estimate when other portions might be withdrawn later this year?

Ignacio Alvarez, CEO

I believe the main factor influencing our situation is the plan of adjustment. This plan not only allocates around $7 billion to pay general obligations, but also includes other funds, possibly up to $10 billion. This will likely be a significant catalyst, altering perspectives in various ways. Firstly, a substantial amount will be disbursed. Although progress has been slow, we've made headway in what is arguably one of the most intricate bankruptcy processes in U.S. history. Recently, an agreement was reached with the Unsecured Creditors Committee, which is notable given their previously assertive stance. They’ve nearly finalized arrangements with most parties, excluding the insurance sector, which has been a major hurdle. The primary outstanding issue now revolves around pensions, particularly concerning the provision that reduces payments above $1,500 a month by 8%. This element has generated considerable controversy, with the government indicating they might reject this provision. Most anticipate a resolution by the end of the year or early next year, as the judge is progressing the timeline. While I’m uncertain about the resolution concerning PREPA, we remain optimistic about the situation overall, anticipating a substantial outflow of funds. Furthermore, once the Puerto Rican government has clarity on what to expect financially, we may see them adjust their investment strategies accordingly. Presently, they are uncertain about their funds' reliability and are opting to reserve their money with us, but as conditions stabilize, we expect them to modify their financial management approach.

Alex Twerdahl, Analyst

Got it. And then sticking on the topic of deposits in terms of the rates that you guys are paying, I imagine there's not a whole lot of room to reduce the rates, but maybe there is some opportunity to increase fees related to deposits. I mean can you talk about whether or not that is the case and sort of how you're thinking about that?

Ignacio Alvarez, CEO

Yes, you need to be cautious because deposit tranches are a long-term asset. It's important not to gain a reputation for nickel-and-diming your deposit clients simply due to a low deposit market. They are already affected by the low interest we are offering. So, in terms of deposit fees, I don't believe that will be the case. However, as the economy improves, as we observed this quarter, we anticipate our other sources of fee income will rise. We experienced a significant increase in fees from debit and credit cards. Over time, we expect insurance revenues to grow as people see the value and necessity of insurance, and we continue to expand our business in that area. We are indeed looking for fee opportunities, but we must ensure that the value of our deposit franchise is not jeopardized, especially with competition from fintechs and others. Therefore, I don't see increasing deposit fees as viable; it will be more about other services where we can charge fees by offering value to our clients. That’s our focus.

Carlos Vázquez, CFO

Yes. Regarding the cost of deposits, you're correct that it's challenging to further reduce it in Puerto Rico. Our total cost of deposits is currently 14 basis points, which is nearly best-in-class. However, there is still some potential for lowering deposit costs at Popular Bank. We've managed to decrease our total cost of deposits to 47 basis points compared to a few quarters ago. While there’s still some opportunity in the U.S., keep in mind that it represents a smaller portion of our overall deposit book, so any savings will have a limited overall impact.

Alex Twerdahl, Analyst

Great. And then just a final question for me, which I think I asked last year as well, but just so that everyone on the call understands the accounting behind the ASR. My understanding is that we've seen the full impact of the $350 million come out of equity already, but we've only seen about 80% of the shares come out of the share count. And so we should see an adjustment at the end of the third quarter where we could see the share count reduced a bit further, but there shouldn't be much of an impact on equity. Is that correct?

Carlos Vázquez, CFO

Your understanding is correct. You described it well.

Operator, Operator

The next question is a follow-up from Brock Vandervliet of UBS.

Brock Vandervliet, Analyst

Carlos, could you review the guide on expenses and explain how we transitioned from approximately $370 million this quarter to the guidance of $385 million, and then back to $380 million? What are the changes driving this?

Carlos Vázquez, CFO

Yes, I outlined the components that will drive our expenses. The main factors will be threefold. First, we anticipate an increase in our compensation costs. This is partly due to the regular business cycle, as we implement major salary increases in July. Consequently, we will likely see elevated personnel expenses in the second half of the year. Compensation is also influenced by the company's overall performance, so if we continue to exceed expectations as we did in the first two quarters, this will also elevate compensation expenses. Lastly, competition for talent is significant, and this affects our compensation offerings for both new and current employees to ensure their satisfaction and retention at the bank. These factors will all contribute to higher compensation expenses. In the second quarter, we experienced a slight relief in this area because we were somewhat behind on hiring the staff we need. Our employee count has decreased slightly, which means expenses that would have been incurred did not materialize as we have not yet hired all the necessary personnel. We hope to address this, which would again lead to increased compensation costs. Second, there is timing to consider. Some projects and associated expenses were intended to be spread evenly across each quarter, but many have been delayed or have not yet commenced. These ongoing activities related to those projects will still occur, but they are happening later in the year, resulting in higher expected expenses. Lastly, it's typical for our costs to rise as our clients become more active and engage in more transactions, increasing our processing costs. Like all banks, we cannot prevent our technology expenses from rising, driven by compliance, cybersecurity, and regulatory requirements. Unfortunately, we are not immune to this trend. Altogether, these factors will raise our overall expense base. As a result, while we typically report expenses on an average quarterly basis, it's accurate that our expenses in the first two quarters were slightly below the previously mentioned range, which means we expect to surpass that range in the latter half of the year. This is our current best estimate for expenses. We aim to exceed these expectations, but this remains our most informed projection at this time.

Brock Vandervliet, Analyst

Okay. And just separately on credit. Given where net charge-offs are, the economic backdrop, what would you need to see to get conviction that perhaps looking ahead we're looking at a much lower net charge-off pattern than you've seen historically and you'd have the flexibility to further reduce reserves? Just trying to better understand how you're thinking about the reserving.

Lidio Soriano, CRO

The reserve process is now more analytical than before, relying heavily on models. While we have some flexibility, it may not be as extensive as one might assume regarding our comfort with low-end reserves. The allowance for credit losses is influenced by various factors, including past performance, credit quality, and economic conditions, alongside environmental considerations. If the current trends persist, with low losses, improving credit quality, and a positive economic outlook, we can reasonably anticipate that the allowance will decrease as we move through the remainder of 2021 into 2022.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Ignacio Alvarez for closing remarks.

Ignacio Alvarez, CEO

Thank you for joining us today and for all your questions. We look forward to updating you on our progress in our October call. Thank you very much. Have a great weekend.

Carlos Vázquez, CFO

Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.