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Popular, Inc. (NASDAQ:BPOP)

Q4 2012 Earnings Call

January 24, 2013 10:30 am ET

Executives

Richard Carrión – President & Chief Financial Officer

Jorge Junquera – Chief Financial Officer

Lidio Soriano – Executive Vice President, Corporate Risk Management

Jorge Garcia – Senior Vice President, Corporate Comptroller

Enrique Martel – Manager of Corporate Communications

Analysts

Ken Zerbe – Morgan Stanley

Gerard Cassidy – RBC Capital Markets

Todd Hagerman – Sterne Agee & Leach

Alex Twerdahl – Sandler O’Neill & Partners

Derek Hewett – Keefe Bruyette & Woods

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2012 Popular, Inc. Earnings Conference Call. My name is Tahitia and I’ll be your Operator for today. (Operator instructions.) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Enrique Martel, Manager of Corporate Communications. Please proceed.

Enrique Martel

Good morning. Thank you for joining us on today’s call. Our Chairman and CEO Richard Carrión, our CFO Jorge Junquera, and our CRO, Lidio Soriano, will review our Q4 results and then answer your questions. We’ll be joined in the Q&A session by other members of our management team.

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, our quarterly release, and supplements. You may find today’s press release and our SEC filings on our webpage which you may visit by going to www.popular.com.

We also want to remind shareholders and analysts that we will hold our Investor Day on Friday, March 1 in San Juan. You can find a link to the webcast in the Investor Relations section of our website. For further information please contact us via email at investor-relations@bppr.com. I will now turn the call over to Richard Carrión.

Richard Carrión

Good morning and thank you all for joining the call. I’d like to first address the highlights and key events of the quarter and then discuss our progress and priority areas. Jorge will go into greater detail on Q4 and full-year financial results and Lidio will provide an overview of credit trends and metrics. With that, please turn to the second slide.

While we reported $84 million in net income in Q4, this included a $27 million after-tax gain or equity pickup from our 49% interest in EVERTEC. Excluding this gain, net income amounted to $57 million for Q4 which was marked by another strong performance by our core businesses and continued improvement in credit. The sequential increase of $10 million in net income was driven by greater interest income, lower loss estimates for our covered portfolio, and further declines in our funding costs.

Q4 marked a strong finish to a good year that positions the company for continued progress in 2013. The $27 million after-tax gain was our proportional share of a tax grant received by EVERTEC from the Puerto Rico Treasury. Excluding the EVERTEC gain, we earned $218 million for the year in line with our expectations. [Including that], net income for the year amounted to $245 million.

We continued to make significant progress on the credit front. The $125 million decline in held in portfolio nonperforming loans was our largest quarterly decrease during the current credit cycle excluding bulk sales, while NPLs at quarter-end reached their lowest level since December, 2009. More than two-thirds of the decrease in NPLs this quarter occurred in our Puerto Rico commercial portfolio, which underwent its annual credit review in Q3 and Q4. The reduction in Puerto Rico commercial NPLs was mostly driven by lower NPL inflows and loans returning to accrual status.

We entered 2013 with strong capital levels. At year-end, our common equity Tier 1 ratio reached 13.18% and our total capital exceeded the current well-capitalized threshold by $2 billion. Our tangible booked value per share at quarter-end stood at $32.55. I also want to highlight that in December we received a $24 million cash dividend from EVERTEC. Some of the analysts who cover Popular have published estimates of the value of EVERTEC and of our 49% stake. I won’t comment on those estimates but I will say that based on EVERTEC’s total adjusted EBITDA of $118 million for the first nine months of 2012, we believe that our stake in the company is worth substantially more than its current booked value of $74 million.

Improved credit performance increased the contribution of our $3.8 billion covered loan portfolio in Q4 while our Puerto Rico mortgage operation had another superb performance. Excluding the EVERTEC gain, gross revenues amounted to $452 million and our net interest margin increased to 4.41% which continues to span well above our peers. Our continued improvement in credit, our unique franchise in Puerto Rico, and our strong capital levels were the primary reasons cited by Fitch Ratings for their one notch upgrade of Popular last week.

Please turn to the third slide. In 2012, we made clear and consistent progress in our number one objective – reducing NPLs. For the year, non-covered NPLs declined by $313 million to the lowest level since 2009, and NPAs fell $384 million to the lowest point since 2010. These reductions were the result of aggressive loss mitigation efforts, resolutions and restructuring, NPL sales, and stabilizing economic conditions. These results have helped lower the provision expense in Q4 by 30% when compared with the year-ago quarter.

We’ve added resources to our credit management function and are operating with both greater speed and higher efficiency in addressing NPLs. We will continue to pursue all opportunities to reduce NPLs including bulk sales provided that they make economic sense and create value for our shareholders.

Our significant progress on the credit front in 2012 did not have the benefit of a tailwind from an economic recovery. While we are seeing some stabilization, additional measures are needed to put Puerto Rico’s public finances on a sustainable footing as recent credit rating agency reports attest to. We are however, very encouraged by the new economic and fiscal teams the new Governor has appointed. As the largest financial institution on the island we continue to promote economic development and capital formation to help spur growth.

Another important area of focus is continuing to take actions to put Popular in the best possible position to exit TARP at the appropriate time with the least possible dilution. We have nothing new to report on this front but of course we’ll continue to keep you posted. Please turn to Slide 4.

Based on the latest market share data, we increased our share in four out of nine banking categories, maintaining leading share in seven of them. Nobody in the Puerto Rico banking sector can offer the range of financial services we provide, and we’re making sure that we do so in the best possible way for our clients. Our 32% share of the mortgage origination market and our $22 billion mortgage servicing portfolio has helped us capture much of the opportunity presented by low interest rates, federal refinance programs, and local housing incentives. Our Puerto Rico mortgage business increased total originations by 15% to $446 million in Q4. For the year, mortgage originations were up 21% to $1.5 billion.

Increased activity in the Puerto Rico commercial sector during Q4 led to a $113 million increase in loan volume from the previous quarter. In the US, our loan balances have been decreasing as a result of our exiting from discontinued businesses. However, in Q4 we succeeded in growing the loan book again through higher originations as well as renewal and additional borrowings by clients. US non-legacy commercial volumes grew by $117 million. We’d like to see more consistency in loan demand but we are encouraged by recent loan activity from our commercial clients.

To supplement originations we acquired close to $800 million in high-quality assets during the year: $475 million in US mortgages and $221 million in Puerto Rico consumer and mortgage loans. We will continue to seek opportunities to add low-risk assets to our existing infrastructure as well as to capitalize on our unique market position to reap the benefits of greater economic stability.

Our revenue generating capacity remains strong. Popular produced $1.8 billion in gross revenues in 2012, and despite the low rate scenario, the net interest margin of our Puerto Rico operation increased to 5.18%. Going forward, continued improvement in credit performance will support a strong net interest margin and revenue growth by reducing the drag from nonearning assets.

As I stated last quarter, we are viewing all of our strategic decisions through the lens of driving shareholder value by increasing ROE. If we can grow quality assets and generate returns in excess of our cost of capital then and only then will we do so. If that can’t be done prudently then we will not pursue growth simply for the sake of growth. With that, I would like to turn the call over to Jorge now.

Jorge Junquera

Thank you, Richard. Please turn to Slide 5. Our Q4 performance capped a good year. On the revenue side, we saw a four basis point sequential increase in the net interest margin. While the 4.41% NIM was partially driven by the spike in the [creditable] yield of the cover portfolio, the margin was still above 4.00% excluding the impact of the covered portfolio.

Cost of funds was down five basis points on a quarterly basis and 26 basis points when compared with the year-ago quarter. In 2012 we made additional progress in further aligning the cost of deposits with mainland banks. Despite the additional rate cuts we implemented in a low rate environment, we were successful in maintaining our core deposit base. Our average balance of deposits excluding broker, public funds, and demand deposit accounts remained relatively stable in Q4 versus the previous year, declining by only $13 million. DDA accounts during the same period increased $315 million which helped support our NIM. Declines in deposit costs have slowed down recently but we think there is still some room left for additional savings.

[Net] income remained stable but other operating income was pushed higher by the EVERTEC equity pickup which, as mentioned earlier, included a $32 million pre-tax benefit related to our proportionate share of the tax grant received by EVERTEC. We also recorded a $12 million increase on net gain of loan sales driven by higher gains on mortgage loan securitizations in Puerto Rico and sales of commercial loans held for sale in the US.

The performance of the covered portfolio continued to exceed our expectations. Lower loss estimates and resolutions that exceed the booked value of certain commercial loans helped push net interest income higher and lower the provision for covered loans by $26 million. However, the benefits were offset by a $30 million increase in FDIC loss share expense. Keep in mind that in the long term lower losses will result in loans generating higher cash flows for a higher period of time.

[Total] operating expenses remained at elevated levels. Higher operating costs associated with the covered portfolio, which are reimbursable by the FDIC, increased the costs related to performance-based compensation. Seasonal ad campaigns and reserves for operational losses led to an increase of $6 million in total operating expenses for the quarter. We expect operating expenses to decline with further reductions in nonperforming loans, and lower NPL levels should reduce costs associated with collections, pickup fees, appraisals, and OREO expenses.

As we said last quarter, we have identified about $18 million in quarterly, non-personnel costs that are related to collections and OREO expenses. In a normalized environment we should aim to cut about half of that. We have also generated savings as a result of the retirement window we implemented at the beginning of the year. Via the greater need for personnel in credit and risk management functions, salary expenses are down $9 million annualized when compared with Q4 2011.

Please turn to Slide 6. We started 2013 with strong capital levels relative to US and Puerto Rico peers and regulatory requirements. Our common equity Tier 1 ratio increased to 13.18% and we have approximately $2 billion in excess common equity Tier 1 capital over the well-capitalized requirement of 5%. We anticipate maintaining strong capital levels during the next several years as the Basel III rules are implemented. On the Basel III we expect continued growth in excess capital but at a slower pace.

Building on our progress in 2012, we remain focused on continuing to increase our strategic and financial flexibility in 2013. Additional declines in NPLs and further strengthening of our capital resources will provide enhanced flexibility for the eventual structuring of our TARP exit. With that I’ll turn the call over to Lidio, thank you.

Lidio Soriano

Thank you, Jorge. We are pleased to report that we continue to make steady progress on the credit front. Before going into the details let me highlight the key credit trends. Nonperforming loans and nonperforming assets continued and decline and are at the lowest levels since 2009 and 2010 respectively. NPL inflows reached the lowest levels in three years in Q4. On a year-over-year basis, NPL inflows were down approximately 27%. The net charge-off ratio remained below 2% for the third consecutive quarter.

Please turn to Slide 7. On the top half of this slide we summarize the trending NPLs over the last year. In speaking in Q3 2010, NPLs were down approximately $920 million or 39%. For the quarter a $90 million reduction in Puerto Rico commercial portfolio, a $17 million reduction in the US commercial portfolio, an $8 million drop in the US legacy portfolio and a $6 million decline in the US construction portfolio led to a sequential reduction of $120 million in NPLs.

In Puerto Rico most of the decrease in commercial NPLs was driven by lower inflows of nonperforming loans and loans written in (inaudible) a sustained performance by borrowers. In the US, two milestones are worth highlighting. First, commercial and construction NPLs including legacy loans are below $200 million. Second, from a peak of $250 million in nonperforming construction loans in 2009, we are down to one nonperforming construction relationship for approximately $6 million for which we expect resolution during Q1 2013.

On the bottom half of the slide we illustrate the steady decline of nonperforming assets during the year. The $384 million decrease for the year was primarily driven by the previously mentioned decrease in NPLs held in portfolio, and a decrease in NPLs held for sale driven by loan resolutions and sales. As Richard alluded to earlier, we are seeing signs of economic stability while at the same time we are also seeing the benefits of our NPL reduction strategies and the increase of resources added to the [worked out] areas. As a result, total NPAs are down $729 million or 29% in speaking of Q3 2010.

The Q4 increase in OREO reflects our continuous efforts to aggressively resolve nonperforming loans. The increase was primarily caused by properties foreclosed in the Puerto Rico mortgage and commercial portfolio. During the second half of the year we restructured our mortgage OREO sales process by assigning our properties to real management companies that have the responsibility of maintaining and selling the collateral. During Q4 the number of Puerto Rico mortgage OREO sales and the realization of these sales reached their highest levels for the year.

Please turn to Slide 8 to review NPL inflows. On the top right corner of the slide we illustrate NPL inflows excluding consumer loans. As stated in the introduction, NPL inflows in Q4 declined to the lowest levels in the last three years and decreased approximately $436 million in 2012 when compared with 2011. The year-over-year decrease was primarily driven by decreases in the commercial and construction NPL inflows coupled with a slight improvement in the mortgage portfolio.

Commercial and construction NPL inflows including legacy amounted to $69 million during Q4, a decrease of $73 million or 51% when compared with the previous quarter. For the year, total commercial and construction NPL inflows declined $402 million or 47%. The decrease is driven by improvements in both Puerto Rico and the US. Mortgage NPL inflows increased by $8 million or 5% during Q4 compared with the previous quarter.

The increase in mortgage NPLs was driven by a greater level of loss mitigation activities from our mortgage portfolio with recourse. We are aggressively working problem loans through our loss mitigation program which continued to produce good results. Approximately 70% of our restructured mortgage loans are performing a year later. As we discussed in previous calls, we stopped selling mortgage with recourse in early 2009. These loans have an average seasoning of seven years, an average size of approximately $100,000. Recursive activity taken in 2011 was approximately $16 million per quarter. For the year, mortgage NPL inflows decreased by approximately $34 million.

Please turn to Slide 9. As I mentioned earlier, our net charge-off remained below 2.00% for the third consecutive quarter at 1.94%. Net charge-offs amounted to $101 million compared with $96 million a quarter ago and $126 million in the year-ago quarter. Net charge-offs for 2012 totaled $403 million, an improvement of $131 million or 25% compared with 2011. The decrease in net charge-offs for 2012 was mainly driven by improvements in the commercial and construction portfolios in both Puerto Rico and the US.

The provision for loan losses increased slightly by $3 million from Q3 to $86 million due to higher net charge-offs in the Puerto Rico commercial loan portfolio, offset in part by lower losses in the US loan portfolios. The increase in net charge-offs in the Puerto Rico commercial portfolio was mainly related to one relationship. For the quarter, provision to net charge-off remains relatively flat at 86% with a decrease in the ratio for the US offset by increasing the ratio for Puerto Rico. Notwithstanding the decrease in NPLs and net charge-offs in 2012, our provision to net charge-off for the year increased slightly to 83% from 81% in 2011.

The last item that I would like to cover is the allowance and related ratios. For Q4, the allowance for loan losses decreased slightly by $15 million, driven by the improvement in credit quality and stability of our net charge-off ratio. The coverage ratio increased to 44% from 41% in Q3 driven mainly by the $125 million decrease in NPLs. As discussed in previous calls, please bear in mind our coverage ratio is influenced by the percentage of loans subject to specific analysis in our mortgage portfolio. Approximately 50% of our NPLs are subject to individual analysis and those have been written down to an estimated net realizable loan value.

We continue to experience low levels of losses in our mortgage portfolio. The mortgage net charge-off ratio stood at 1.37% for Q4. With that I would like to turn the call over to Richard for his concluding remarks, thank you.

Richard Carrión

Thank you, Lidio. Please turn to Slide 10. Let me conclude today’s call by summarizing the key takeaways. We closed the year with a solid performance and strong capital ratios. Our covered portfolio continues to produce better-than-expected results. We’ve added resources to our credit management function and are operating with both greater speed and higher efficiency in addressing NPLs as demonstrated by the continuing improvement in the credit quality of our portfolios in both the US and Puerto Rico.

Notably, the substantial decline in Puerto Rico commercial NPLs was the main driver behind our largest organic quarterly decrease in NPLs. We continue to explore all avenues to reduce NPLs including resolutions and sales that make economic sense. The leading market positions of our unique Puerto Rican franchise are allowing us to benefit from a rebound in loan demand in certain sectors of the economy and sustaining above average margins.

In the US, we will continue to build on the improvement we made in 2012 and seek to originate quality assets to offset runoff and pursue profitable growth. The corporation’s revenue generating capacity remains strong despite current economic conditions, while our total capital exceeds the current well-capitalized threshold by $2 billion.

When we reported Q4 2011 earnings we made an exception from our historical practice and provided guidance for 2012. At that time, there was a wide disparity between our expectations and analysts’ estimates for 2012 and we felt the need to address that by offering some clarity regarding our outlook. We want to be as helpful as possible but we don’t believe that providing annual net income guidance is the most meaningful way to do that. So we’re returning to our historical practice of not providing annual earnings guidance. We intend to provide an update on our estimated normalized earnings at our Investor Day in just over a month. We believe this is a more appropriate metric for the underlying performance and value of this company.

To be clear, we feel good about the progress we’ve made over the past year and are optimistic that we can continue to build on this progress to increase our strategic and financial flexibility in 2013.

Lastly, as you saw this morning, we announced that Carlos Vázquez has been appointed CFO of Popular, succeeding Jorge who is transitioning to a new role as Vice Chairman. As I stated in the press release issued this morning, Carlos has an extensive financial background and brings a wealth of experience to the CFO position having shown a great ability to perform in critical and diverse positions at Popular and previously at JP Morgan. Most recently he restored our US operations to profitability. This change is part of Popular’s normal management succession process and reflects the depth of talent available in the company. We expect a seamless transition.

I want to reiterate we are pleased with the progress we made in 2012 and are optimistic that we can continued to build on this progress in 2013 with Carlos and Jorge in their new positions. Jorge has demonstrated uncompromising commitment and has made invaluable contributions during his more than 40 years of service to Popular, the last 16 as CFO including playing a key role in the development of our business in Puerto Rico. During the Financial Crisis Jorge ensured that the corporation and its banking subsidiaries always maintained adequate levels of capital and liquidity. I am confident he’ll continue to make important contributions in his new role as Vice Chairman. To Carlos and Jorge, my sincere congratulations.

And with that I’d like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Your first question comes from the line of Ken Zerbe from Morgan Stanley. Please proceed.

Ken Zerbe – Morgan Stanley

Great, thanks. My first question just in terms of loan growth, you obviously seemed a little more or probably much more positive on the outlook for loan growth or the activity, the commercial activity that you’re seeing in Puerto Rico right now. When we think about 2013 is it fair to assume that we could continue to see positive commercial growth from here or was this more of a one quarter unusual positive? Thanks.

Richard Carrión

Well, it’s one quarter in a row so far but we’re hoping yeah, we are hoping that we can generate more commercial loan activity in both Puerto Rico and the US, and that’s our plan.

Ken Zerbe – Morgan Stanley

So if the economy’s strong enough that’s a viable possibility.

Richard Carrión

You know, strong is not what I would say but I there are some encouraging signs and we are encouraged, absolutely.

Ken Zerbe – Morgan Stanley

Okay, that helps. And then I guess the other question just on the NPAs coming down, so good job in terms of getting those down a little bit. Was any of that, were there any bulk sales of any size in the quarter? And if not, what’s the outlook for bulk sales going forward because I know it’s something you’ve been working on for a while and we just haven’t seen.

Richard Carrión

No, no bulk sales in the quarter. As we’ve said probably too many times, we’ll look at bulk sales and if they make sense we’ll go ahead and pull the trigger and execute them. But key is that they make sense and we’re happy to do them. We are also happy with the progress we’ve made in bringing down NPAs and we think we can continue to do that even absent bulk sales.

Ken Zerbe – Morgan Stanley

At the same pace?

Richard Carrión

You know, a bulk sale would be faster obviously.

Ken Zerbe – Morgan Stanley

No, I mean without the bulk sales do you think that you can-

Richard Carrión

We can continue the pace, yes.

Ken Zerbe – Morgan Stanley

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Gerard Cassidy from RBC. Please proceed.

Gerard Cassidy – RBC Capital Markets

Thank you very much. Can you guys talk about the cost of deposits? You’ve got such a great market share in Puerto Rico – can you bring that down to current levels where you are today?

Richard Carrión

I think as Jorge mentioned we have succeeded in bringing it down. We do have a high component of passbook and other types that it gets tougher to bring it down. I think we operate better, our margin operates better in a higher interest rate environment. That said, we have had a lot of success in bringing it down. The margin increased this quarter which is not what you’ve seen on the mainland so we’ve had success bringing it down. We think there’s still a ways to go there.

Gerard Cassidy – RBC Capital Markets

And to follow up on your comments about the EVERTEC investment, what kind of analysis do you do to determine… You pointed out that the market value is materially greater than what you carry it for and everybody has their own estimate of course, but what kind of analysis are you doing to determine whether you should just keep it on the books or should you sell it, realize the sale and then use it to possibly write down distressed assets more quickly?

Richard Carrión

Well, you know, we are a passenger in that car, not in the driver’s seat. We like where the car is going but we don’t have control of that asset. We have 49% and there are some governance provisions which determine what we can and cannot do with our stake. That said, we think that the capital is earning a very good return and if there is an opportunity down the road we will certainly execute.

Gerard Cassidy – RBC Capital Markets

And then the final question on TARP, you pointed to that you could potentially start paying it off in segments or chunks. Should we anticipate that there could be a possible partial TARP repayment in 2013 or is that too optimistic?

Richard Carrión

Well, what we said is we have no new news on exiting TARP. Obviously we want to do it but we want to do it in terms that are favorable and in terms that we think are just. So we’ll continue to work on that, we’ll continue our dialog with regulators because anything we want to do will need to be approved by them. What we do think is that the better we improve our condition the more flexibility and the more optionality that we’ll have regarding our TARP exit, and as I think we’ve mentioned the interest rate reset doesn’t really affect us in the sense that we have that discount and the effective rate will not really change. There’ll be some slight impact on cash but nothing that we can’t handle. So in that sense we don’t feel this immense pressure. Although I must mention some of my guys occasionally talk about the cash bonuses but not too frequently. [laughing]

Gerard Cassidy – RBC Capital Markets

Understood, thank you for your answers.

Richard Carrión

Thanks, Gerard.

Operator

(Operator instructions.) Your next question comes from the line of Todd Hagerman from Sterne Agee. Please proceed.

Todd Hagerman – Sterne Agee & Leach

Good morning everybody. A couple of questions I guess for Lidio on the credit side. One on the commercial, obviously very good progress again on the commercial side, but as I look at the numbers and I think about the cleanup in Q2 with the held for sale and the marks there, charge-offs fairly heavy again this quarter; but I guess the question simply is as we think about the charge-offs and the marks taken on the commercial portfolio over the last six months, how should we think about the outlook going forward, again assuming that NPAs will continue to trend lower?

Lidio Soriano

As it relates to charge-offs specifically?

Todd Hagerman – Sterne Agee & Leach

Well yeah, just in terms of the marks in the commercial book, the progress you’re making and again, like if I think about Q2 and the held for sale, and the charge-offs in Q4 in the commercial portfolio you’re obviously making progress. But I’m just trying to think in terms of more order of magnitude, are we getting closer in terms of the appraised values? You mentioned the deep dive that you’ve done the last two quarters in terms of reviews – what’s the comfort level now in terms of the underlying book value on these credits?

Lidio Soriano

I will say much more comfort than the first time I sat to take a call. Over the last year we have seen tremendous progress on the commercial front, and net charge-offs as we mentioned for the corporation has been under 2% for three consecutive quarters. So to answer your question I will say our outlook is more positive than what it has been last year and in our recent experience.

Todd Hagerman – Sterne Agee & Leach

In other words, $57 million this quarter, obviously a fair amount of cleanup but again, in terms of order of magnitude could we possibly see that number drop in half? Is it going to come down modestly? How should I think about that… [technical difficulties]

Lidio Soriano

Generally I mean this is a difficult question to answer what is precisely going to be the number, [we should have 70%, 80%]. Clearly I think the trend in credit quality is an improvement in both Puerto Rico and the US so we will expect those numbers to show equal improvement as we continue to move forward.

Operator

Pardon the interruption, we just lost [Todd]. His line went idle so we’ll move on to the next question, and that comes from the line of Alex Twerdahl from Sandler O’Neill. Please proceed.

Alex Twerdahl – Sandler O’Neill & Partners

Good morning guys. First off I was wondering if you could elaborate on the drop in the FDIC deposit insurance that happened sequentially? Just talk a little bit about what changed and can we take that to assume that maybe your CAMELS rating has improved?

Lidio Soriano

No, I would not assume that. I mean it’s a tough formula to really look at. We did do a deep dive and we found some savings opportunity, so I think that that Q4 expense decline reflects the benefits of certain risk-based adjustments to the calculation that we made as a result of that review. Another example is we merged our mortgage subsidiary into the Puerto Rico bank and that reduces the annual expense by about $10 million based on the related asset classifications under that assessment methodology which is to say the least, pretty convoluted.

Alex Twerdahl – Sandler O’Neill & Partners

Okay, so the $13.7 million number, is that kind of around the run rate that we should expect going into 2013 per quarter?

Lidio Soriano

Well again, remember that that assessment will depend on asset size and the balance sheet risk composition. So it’s a variable that would change over time. The Q4 number did include some one-time benefits. We would expect a near term normalized expense under $20 million per quarter. But of course, that’ll depend on what happens on the balance sheet.

Alex Twerdahl – Sandler O’Neill & Partners

Okay. And then I didn’t see the level of accruing PDRs in the press release. Lidio, do you have that number in front of you?

Lidio Soriano

Sure. Accruing PDRs for the quarter stood at approximately $650 million from a total of $1.15 billion.

Alex Twerdahl – Sandler O’Neill & Partners

Of total PDRs, okay. And then Lidio, you also talked a little bit about how 51% of the loans are subject to individual analysis and have been written down to estimated realizable loan value, and I was wondering if you could maybe put some numbers around that and talk about what that estimated realizable value would be for some of those loans as a percentage of unpaid principal balance?

Lidio Soriano

In previous releases we have provided much more details into the coverage [spread] and the information but generally it’s about a 30% mark in terms of a lifetime charge-off and evaluation vis-à-vis the unpaid principal balance, so it’s about a 30% mark.

Alex Twerdahl – Sandler O’Neill & Partners

Okay, and then just the final question: on the joint venture you sold, the $360 million of commercial and construction loans about a year and a half, can you maybe give us a little update on how the resolutions are going there and whether or not you think they might have some appetite for further loan purchases off your balance sheets in the future?

Lidio Soriano

Well let me say I think they’re going a lot better and a lot faster than was originally forecast, and the evidence is that the loans we made to the entity are being paid off at a much faster rate. And our loans need to be paid off before any cash distributions get made. As to whether they want to do some more you’ll have to ask them, I don’t know.

Alex Twerdahl – Sandler O’Neill & Partners

Okay, thank you very much.

Lidio Soriano

Sure.

Operator

Your next question comes from the line of Derek Hewett of KBW. Please proceed.

Derek Hewett – Keefe Bruyette & Woods

Good morning everyone. Hi, I’m not sure if you guys mentioned this earlier but what portion of the island commercial loan growth was organic versus purchased?

Richard Carrión

In this quarter it was all organic.

Derek Hewett – Keefe Bruyette & Woods

It was all organic?

Richard Carrión

Yep.

Derek Hewett – Keefe Bruyette & Woods

Okay, and then how much cash is currently at the parent given the EVERTEC dividend?

Richard Carrión

I’m getting the sign that it’s around $300 million, Derek.

Derek Hewett – Keefe Bruyette & Woods

Okay, great. And then maybe asking that credit question a different way – if you take a look at your total level of NPAs, at what percentage of a mark on the entire portfolio do you guys currently carry those loans?

Lidio Soriano

I’m sorry, Derek, related to commercial or the whole book?

Derek Hewett – Keefe Bruyette & Woods

On the entire book.

Lidio Soriano

It is quite different because obviously a significant portion of our NPA book is mortgage loans. As we have mentioned before, in that particular book the losses for Puerto Rico, which is the biggest component of the portfolio has been low, and therefore the mark on that portfolio is much different than in the commercial piece. In that portfolio the mark is, I mean the (inaudible) one, the commercial book that I mentioned is closer to 30%.

Richard Carrión

OREO would be at market value less disposition costs.

Derek Hewett – Keefe Bruyette & Woods

Okay, so you have a 30% mark on the entire commercial portfolio for Puerto Rico?

Lidio Soriano

Correct. (Inaudible) yes, about 30%.

Derek Hewett – Keefe Bruyette & Woods

Okay, and of that 30% mark what percentage is current reserves on that?

Lidio Soriano

Most of it is charge-offs. Most of our portfolio as we have mentioned is specifically analyzed and back in 2010 we changed our charge-off policy in which we don’t reserve. We take any impairment, we charge off promptly. So most of it is lifetime charge-offs.

Derek Hewett – Keefe Bruyette & Woods

Okay, great, and then maybe one final question on credit is do you think that the pace of NPL inflows will kind of improve from kind of these low Q4 levels going forward?

Lidio Soriano

We’re very encouraged by the trend and we think that we’ll continue to see positive trends as we move into 2013.

Derek Hewett – Keefe Bruyette & Woods

Okay, great. Thank you.

Operator

And gentlemen, we have Mr. Hagerman that is back on the line. You may proceed.

Todd Hagerman – Sterne Agee & Leach

Okay, hopefully this works out this time – I apologize. Let me move on, but Lidio, now I wanted to transition to the mortgage portfolio if I could. And what I’m trying to get at is really the split and a better understanding between the core portfolio and the repurchase portfolio. I notice in the quarter that effectively charge-offs were relatively flat, NPLs came down but NPA inflows actually ticked up a little bit. Can you give me a little more insight between the core portfolio and the [recourse] portfolio and how those optics really come together?

Lidio Soriano

The recourse portfolio was, as we have said, is part of our legacy activities that we did. We stopped those activities in early 2009. That portfolio is down to about $3 billion. It has come down over the last two years about $1 billion and in terms of asset quality is has gone down from double digits and 90% plus delinquency to a number that is closer to 5% today. We used to, speaking about 2011 we purchased about $240 million of mortgages from our recourse portfolio. We are down to $35 million a quarter and this quarter it was about $41 million.

As I mentioned and alluded to during the script or the conference part of that increase related to loss mitigation activities. As clients come in and they’re looking for loss mitigation activities we’re providing them such benefit to them, and when we do that we purchase the mortgages from the recourse portfolio. So that was the increase that you saw in Q4. But overall, we feel very comfortable with the risk that we have both on the books as well as our off books portfolios.

Todd Hagerman – Sterne Agee & Leach

And then just in terms of the past due number, the 90 days past due – just in terms of some insight there?

Lidio Soriano

For the on books or off books?

Todd Hagerman – Sterne Agee & Leach

For your book, yeah, again the core portfolio.

Lidio Soriano

In terms of our core portfolio the 90 plus is around 12% in Puerto Rico. I’m talking about mostly Puerto Rico because that drives the numbers, so it’s about a 12% number which includes the loans that we have repurchased.

Todd Hagerman – Sterne Agee & Leach

Okay, terrific. And then Jorge, a question for you just in terms of the spread income. Again, it looks like essentially a kind of reclassification this quarter with the covered portfolio and the cash flows. How should we think about that on a go forward basis and kind of the benefit if you will in spread income with this reevaluation this quarter? I’m trying to get the numbers squared away.

Jorge Junquera

As you know we do have to do the recasting every quarter and the nature of this portfolio is that it’s reducing and it’s a high-yielding portfolio. So it will continue to put pressure, downward pressure on the yield on loans. We’re continuing to try to offset that by lowering the cost of deposits both here in Puerto Rico and in the US, but as we mentioned earlier the drop that we have undertaken, it’s beginning to slow down – the continuous drop is beginning to slow down but we still see some more room for improvement. By nature you’re going to get the margin to gravitate lower but slowly. We still see that we will maintain a very comfortable margin in our operations for the next few quarters.

Todd Hagerman – Sterne Agee & Leach

Okay. And just in terms of the quarter itself, about what was the influence on the cash flow adjustment in terms of basis points? Do you have that number?

Jorge Junquera

Vis-à-vis… We don’t have that number, no. But as we mentioned, if you exclude the entire effect of the covered portfolio the margin will still be above 4%.

Todd Hagerman – Sterne Agee & Leach

Okay, that’s very helpful. And if I can have just one quick last one: it looks like the disallowed DTA ticked up a little bit in the quarter. Could you just talk a little bit about that?

Richard Carrión

Okay, we’ll have Jorge Garcia answer that.

Jorge Garcia

Yes, good morning. The changes in the disallowed related to the tax basis – it’s more of a tax strategy. It’s not related to any type of book income or anything like that, it’s more on the tax side.

Todd Hagerman – Sterne Agee & Leach

Was any part of that tied to the EVERTEC?

Jorge Garcia

No.

Todd Hagerman – Sterne Agee & Leach

Okay. And on a go forward basis, again just you think about the improving profitability of the company. I know a lot of this, or potentially all of it is tied to North America but how should we think about the pace of that coming down?

Jorge Junquera

The DTA is really all in Puerto Rico.

Todd Hagerman – Sterne Agee & Leach

Excuse me, I’m sorry – Puerto Rico, correct.

Jorge Garcia

And the changes on the disallowed depends a lot on that actual statutory tax impact of Puerto Rico. So it’s not just simply on a GAAP accounting basis.

Todd Hagerman – Sterne Agee & Leach

Okay, alright, thanks very much. I appreciate it.

Operator

Alright, you have a follow-up question from the line of Ken Zerbe from Morgan Stanley. Please proceed.

Ken Zerbe – Morgan Stanley

Yeah, just a quick one here: just in terms of the total operating expenses ex anything related to the FDIC, it just seems they were a little bit higher. I mean personnel, occupancy, professional fees – how should we be thinking about this going forward? I mean as you continue to grow loans do we see more related expenses or is there something unusual, or do they just stay high?

Richard Carrión

No, there wasn’t really anything extraordinary in the quarter. As we have mentioned, we’re running relatively high on operating expenses due to the cost of managing credit. To the extent that we continue to lower the nonperforming loans we will be looking for reductions in expenses and that’s going to be the main driver in reduction of expenses going forward. And there is some room. There is some room for reduction but it will be principally dependent on the activity of reduced NPLs.

Ken Zerbe – Morgan Stanley

Okay, thanks.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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