Popular's CEO Hosts Investor Day (Transcript)

| About: Popular, Inc. (BPOP)

Popular, Inc. (NASDAQ:BPOP)

Investor Day

March 01, 2013 9:00 am ET


Enrique Martel

Richard L. Carrion - Chairman, Chief Executive Officer, President, Member of Funding Committee, Member of Pricing Committee, Chairman of Banco Popular De Puerto Rico and Chief Executive Officer of Banco Popular De Puerto Rico

Elí Sepúlveda - Executive Vice President of Commercial Credit

Gilberto Monzon - Executive Vice President of Individual Credit

Carlos J. Vazquez - Senior Executive Vice President and President of Banco Popular North America

Lidio V. Soriano - Chief Risk Officer and Executive Vice President of Corporate Risk Management Group

Jorge A. Junquera - Chief Financial Officer, Senior Executive Vice President, Member of Funding Committee, Chief Financial Officer of Banco Popular de Puerto Rico and Director of Banco Popular de Puerto Rico


Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Enrique Martel

Good morning. Go ahead and get started. I'd like to thank you for joining us for our Investor Day presentation. Before we start, I'd like to remind you that we will make forward-looking statements that are subject to risks and uncertainties. Factors that could cause actual results to differ materially from the forward-looking statements are set forth within today's Investor presentation and are detailed in our SEC filings, our financial quarterly release and supplements. You may find today's presentation and our SEC filings in our webpage which you may visit by going to www.popular.com. I want to add that for the question-and-answer period after our presentation, we will first take questions live from the audience here in Puerto Rico. Listeners online can submit questions via the webcast player which we will read and answer live. I will now turn it over to Popular's Chairman and CEO, Richard Carrion.

Richard L. Carrion

Good morning, and thank you all for joining us at the Popular's Investor Day. I just hope the ones that are here that just listened to the previous presentation, you're all ready to move down. If you are and you need a mortgage loan or a credit card or auto loan, I know people. So at any rate, we want to share with you a lot of progress we've made on various fronts since the last year's Investor Day. We look forward to have the opportunity to give you an additional perspective on the progress we've made, where we're headed and what our priorities are for 2013.

Following my opening remarks, you will hear from 5 members of our senior management team who will address topics we think are most important to you and, following our presentations, we will have ample time for Q&A with all of our management team here. So with that, please turn to Slide #5.

Underlying all of our presentations today are the following key points: First, Popular has a truly unique franchise in Puerto Rico that gives us strong and stable revenue-generating capacity even in periods of economic weakness or uncertainty. Our margins are well above those of peers and we're confident that we'll continue to produce above average margins going forward. When the Puerto Rico economy does recover, we're better positioned than anyone to benefit from that rebound. But even without a significant rebound in the Puerto Rico economy, we're pursuing several opportunity to build shareholder value.

We have substantially improved our credit metrics and expect these trends to continue, as you will hear later on from Lidio Soriano, our Chief Risk Officer. The bulk sale of NPLs we announced this morning represent a critical step for Popular, one we are confident is creating a lot of value for our shareholders and I'll have more to say about that in just a minute. Our capital levels are very strong. At year end, our common equity Tier 1 ratio reached 13.12%, which exceeded the well-capitalized threshold by almost $2 billion. While the NPL sale will reduce that excess somewhat, we expect to replenish that amount from future earning. And the possible realization of value from our EVERTEC investment would further strengthen this capital level. We continue to execute our plan to increase our returns and flexibility for our U.S. operations via improved performance and you'll hear from Carlos Vasquez who we recently announced will succeed Jorge Junquera as CFO. He'll expand on our U.S. operations.

We're seeing some areas of opportunity for profitable growth and quality loans both in Puerto Rico and in the U.S. as our total assets stabilize. All of these actions are bringing us closer to the potential normalized earnings level that Jorge will speak to later on in the presentation. And I hope by the end of today, it will be clear that all of the actions we are taking are positioning the company well for improved profitability and an exit from TARP at the appropriate time in the most shareholder-friendly fashion.

For those who are not familiar with us, let me just take a minute to give you a quick snapshot of Popular, so please turn to Slide 6.

We just had a strong finish to a good year with $245.3 million in net income. Again, we have a unique franchise in Puerto Rico with $27.6 billion in assets and top market share in 7 of 9 banking categories. In the U.S. we are pursuing a community bank strategy and we have 92 branches, 5 different markets. In total, we have $8.7 billion in assets in the U.S.

We have some other valuable assets. These include a 48.5% stake in EVERTEC, which is, as you know, a leading transaction processing business in Puerto Rico, the Caribbean and Latin America, and a 20% investment in Centro Financiero BHD, a premier financial institution based in the Dominican Republic with $3.5 billion in assets.

With that, please turn to Slide #8. They say a picture is worth a thousand words and I believe this chart shows very clearly the power of our franchise in Puerto Rico. It presents pre-provision net revenue as a percent of average assets by quarter over the past 3 years. And the dark blue bars represent Banco Popular Puerto Rico and the light blue bars represent the medium or a peer group of banks -- 40 banks, with assets between $10 billion and $50 billion.

As you can see, we've been in the top 10 since 2010, despite some noise in the second quarter of last year where we incurred a write-down for a held-for-sale loan that we sold in the next quarter and we also recorded a penalty for prepaying high cost debt. Two actions that, obviously, will benefit our earnings capacity in subsequent quarters.

Elí Sepúlveda, who heads our Commercial Lending business, and Gilberto Monzon, who heads our Consumer business, will provide you a closer look at the main business fundamentals in Puerto Rico where our powerful revenue-generating capacity gives Popular significant upside as credit conditions and our credit losses normalize, which brings me to Slide #10.

This morning, we announced the large bulk sale of NPAs just in time because otherwise, I'll be doing a tap dance here, by selling almost 30% of our NPAs and our mortgage OREOs including a significant portion of a riskier asset class which is our Puerto Rico Commercial and Construction nonperforming loans. We will substantially de-risk our balance sheet and boost future profitability.

The structure of the deal is very similar to the one we did in late 2011. It involves an initial cash payment and a joint venture in which we will have a minority stake. And that structure and that minority stake will allow us to benefit from any upside potential. As we did in the previous deal, Popular will provide seller financing for the JV. And as you can see from the slide, the sale price represents a meaningful discount from book value.

As you know, any loan sale will involve some discount, which will reflect the buyer's required return, time value of money and a large bulk sale would also add to that discount. So again, this deal includes some of our highest severity loans and that is reflected in that price. Nonetheless, we believe the very tangible benefit of this transaction clearly outweigh any value we might recover from those NPLs in the long term. So please turn to the next slide.

First, we expect a reduction in credit-related expenses including provision expense. A reduction in overall portfolio risk and continued progress towards greater profitability and an eventual TARP exit. The deal will lead to a $568 million reduction in our NPAs and a decline in our NPA to total assets ratio of around 150 basis points, from $548 million to $395 million. We have said repeatedly that we would only pursue transactions of this nature if they made sense for our shareholders. And we're very confident that this transaction is consistent with that commitment.

With that, let me turn the floor over to my colleagues who will expand on these key point I just highlighted for you. And we'll start with Elí who will discuss our Puerto Rico Commercial business. So you're on.

Elí Sepúlveda

Good morning. I'm Elí Sepúlveda from Puerto Rico's Commercial Group. Thanks for joining us today. I will be focusing my remarks on Popular's leading commercial franchise here in Puerto Rico. Despite a difficult economic environment, our dominant Puerto Rico Commercial Banking operation is consistently generating solid revenues. The strength of our franchise is supported by our size, which allowed us to engage with clients and manage close relationships at a level that peers cannot, and our ability to address clients' specific needs with the appropriate financial solutions to drive strong client relationships.

Among our 72,000 commercial clients are major players in key industries, medium-sized companies and small businesses with attractive growth prospects. Everything from manufacturing to restaurant chains. Important to notice that this figure includes approximately 3,600 clients from the Westernbank acquisition. We have been able to leverage from many of this relationships and they have represented an additional source of new loans and additional cross-selling opportunities of our commercial services. Our strong fee-generating Commercial business benefits from our retail banking network and delivery channel. As you see on this graph, apart from our credit business, we are strategically focused to continue enhancing our products and service offerings to grow fee income. We have definitely a dominant commercial business that shows strong core earnings power.

Please turn to the next slide. Next, I want to focus on the opportunities we are currently seeing in the market. On our corporate segment, it is showing increased activity with important transactions in the pipeline. Big players are strong and looking for opportunities to grow. Mergers and acquisitions are taking place within different industries. An important example is the merger of the 2 major players in the cable industry in Puerto Rico, Liberty and OneLink. We also expect additional business from exporting companies looking to take advantage of the new tax incentives. In the middle market, we shall expect a moderate increase in credit demand as the economy starts to slowly recover. Working capital and capital expenditure needs still drive the credit demand. Two industries that have shown increasing signs of growth despite the economic recession are the food and health industry where we continue to identify compelling opportunities. On our small business group, we are increasing our participation in government guaranteed loans, where Popular continues to be the leading SBA, and other guaranteed loan programs.

We are aware of the importance of providing financing to the small business segment to restart this economy while we are still very cautious due to the challenge this represents to our institution. So to summarize the key point on this slide, even in this challenging environment, there are opportunities out there. Our margins should continue to be strong even though there could be the risk of pricing pressure by competitors. Please turn to the next slide.

Next, I would like to give an overview of our non-covered commercial portfolio, meaning Banco Popular's legacy portfolio, and where we believe it is in solid shape. As you will see, it is a well-diversified portfolio with no significant concentration in any specific industry. That portfolio shows a healthy loan yield and with 68% of the portfolio being variable rate, we are convinced that we are well positioned to increase our margin when rates go up.

Now moving to our next slide. And lastly, I would like to provide some detail regarding the corporation's exposure to the Puerto Rico government sector. Most importantly on this front, no individual or single group of related accounts is considered material in relation to our total assets or deposit or in relation to our overall business.

At year end, the corporation had approximately $859 million of credit facilities granted to the Puerto Rico government, its municipalities and public corporations, of which $75 million were uncommitted lines of credit.

From the $784 million total credit facilities, $340 million of those account for the financing of 10 municipalities out of the 78 municipalities in Puerto Rico. Important to highlight that all of the 10 municipalities have a pass grade risk rating and the credit facilities are secure by full state credit and a limited taxing power of these municipalities. The remaining of the portfolio is mainly short-term oriented with loan structures that include a pledge of a clear identifiable source of revenue segregated from other revenue sources or that is senior to other existing debt.

To summarize, Popular believes and is convinced that its current level of credit risk to the Puerto Rico government is manageable, given the fact that the exposure is highly diversified as it contains different types of governmental instrumentalities with different sources of revenue such as taxes, rent and other fees.

In conclusion, regarding our outlook, our commercial business continue to be strong and to generate solid revenues despite the current economic situation. We will continue concentrating on our efforts on organic growth, improving profitability and customer satisfaction of our current client base.

With that, I will leave you with Gilberto Monzon, head of the Consumer Group. Thank you.

Gilberto Monzon

Thank you, Elí. Good morning. My name is Gilberto Monzon and I run the Consumer Credit Group for Banco Popular Puerto Rico. First, let me take the opportunity to welcome you and thank you for joining us today. This morning, I would like to walk you through an overview of the Puerto Rico Consumer business. As part of this overview, I will provide you with more specific data on mortgage portfolios, as well as loss mitigation efforts. We can turn to Slide 18.

On this first slide, you can clearly see that without a doubt, we are the market leader in all segments of Consumer business with the one and only exception being Popular Auto. And believe me, if I have anything to do about that, we will not be there for long. We will lead this business. And the next group we will talk to you about and give you a breakdown on all the mortgages. We continue to maintain leadership in the mortgage origination front. We currently have a 30% market share. This year, we will focus on the redesigning of the servicing processes, as well as the migration to a new servicing system.

At Popular Auto, which you can see there, our portfolio and our market share, we are restructuring and refocusing our business model, which will help us gain market share, as well as getting us closer to the goal of becoming market leaders.

Let me emphasize this. This -- there is absolutely, absolutely no reason for Popular not to be the leader -- leading provider of auto financing in Puerto Rico, an island where a car is almost a required asset and the primary means of transportation to the 1.5 million client of Banco Popular. Our strategy is clear and focused: to serve this market and to reclaim the leadership in this segment.

As part of the things that we've done so far, we assigned and changed certain key management positions within the Popular Auto business, as well as hired a consultant from the Puerto Rico Auto Finance industry to help us with a new model and business strategy in this segment.

In Personal Loans, we lead this market by a large margin. It is a key and profitable segment for us. And this is a product where we really leverage our sales force. It's the largest sales force on the financial business on the island, our branches and employees. There is no main competitor in this segment. The remaining market is highly fragmented between credit unions and other banks. Our strategy here is very simple: to increase customer satisfaction and profitability by constantly improving our credit processes and offering of new innovative product.

Credit Card. Now here is a business that I truly love. Once again, we have a privileged position with a 50% market share that gives us a clear advantage in this segment. Our strategy will be focused on identifying and promoting opportunities based on our customers' purchasing behavior. We will also develop new delivery channels for account acquisitions and continue to improve customer engagement and loyalty.

We can turn to Slide 19. We are, again, on this slide you can see that we are the leading originator and servicer in Puerto Rico. Our origination business market share is north of 30%. 2012 was a great year for Popular Mortgage. We increased our originations by 21% over 2011. So let me give you a brief look at what we've been closing. 77% of our closings are GSE and government loans and 23% are nonconforming, 60% of which are refinancing and 40% purchase money mortgage -- mortgages. Our 2012 credit metrics have also been strong. Our average FICO is 730 and the average LTV was 76%.

Overall, we are confident and very pleased with the quality of our 2012 vintage. In the bottom graph, you can see our servicing portfolio growth. We are, by far, the largest servicer on the island with more than a 50% market share. As of December 31, 2012, we serviced 223,000 loans with an outstanding balance of $22.3 billion. Our servicing portfolio mix is 68% GNMA and GSEs, 20% bank owned and 12% private label.

As I mentioned before, we continue to improve and redesign our servicing processes and we will, this year, be moving to our new servicing system. Our goal -- let me talk to you a little about what we did in servicing thus far. In our goal of applying best industry's practices, we changed last year in early 2012, our -- the way we run the mortgage business. We created 2 different areas: one area that handles regular servicing, customer service and investor accounting functions and the other area that was created was mortgage default. This group now handles the remaining functions like collection, loss mitigation, foreclosure, claims and OREOs.

Let's move to Slide 20. In this slide, I wanted to provide you with an overview of our mortgage originations -- or our mortgage portfolios I must say. This slide breaks down our portfolio into 4 categories. This I did to give you a better understanding of the characteristics and exposure for each of these segments.

First, let's look at our regular portfolio. Has a balance of $4.6 billion and an average loan size of $111,000. The delinquency here for 90-day plus uninsured mortgages is 6.6%. Second, we identify the recourse repurchased portfolio, which has a balance of $354 million and an average loan size of $126,000. The delinquency here is 32.6% for 90-days-plus uninsured mortgages.

It is important to point out that most of these mortgages, if not all of them, when purchased -- when repurchased from the investors or from Fannie and Freddie, they were delinquency -- at a very late stage in delinquency. What you can see now in this category, it reveals that over 2/3 of it, of the loans that we repurchased are now performing.

Third, we give you a view of our Westernbank portfolio with a balance of $1 billion and an average loan size of $99,000. Our delinquency here is 16.9% for uninsured 90-day-plus mortgages. This portfolio, as you know, has a loss share agreement, an agreement that will remain in place through April of 2020.

On the fourth category, I wanted to give you a view of the recourse portfolios at Fannie Mae and Freddie Mac. The portfolio balance is $2.9 billion with an average loan size of $99,000. This portfolio has a delinquency of 5.4% per 90-day-plus uninsured.

Let me tell you that we constantly review these portfolios. Even though we wanted to show you that this was a portfolio that we viewed differently in terms of risk, we constantly review and work with all of them and apply different collection strategies and our full array of loss mitigation alternatives.

If we can move to Slide 21. In this slide, I wanted to illustrate that the overall 90-day-plus delinquency for both regular and recourse portfolio has decreased since early 2011. We feel very confident that our collection and loss mitigation strategies have worked and most importantly continue to work. Move to the Slide 22.

In this -- this slide looks at 90-day-plus uninsured -- no, not uninsured. This is all of the 90-day-plus mortgages and our loss mitigation group. The main takeaway here is that we still have an opportunity impact, nonperforming mortgages, with all of the array of loss mitigation strategies that we have. We currently provide loss mitigation alternatives to 300 clients per month. One measure of success in our loss mitigation program is that at 1 year after the loan is modified, 82% are still performing. We can move to the next slide.

Here, we give you a view of our growing consumer business portfolio. First, our personal loan portfolio grew by 12% last year. This marks the second consecutive year in which we have experienced growth for this segment. And one important takeaway is that the ending balance for the personal loan portfolio, excluding acquisitions, also grew by 1.4%. And if you include the acquisitions that we did throughout the year, it grew by 25%.

Last year, we purchased about $265 million and that segment -- and you have the highlights there on which -- one was done in the middle of the year and the one -- there was one done in December.

The credit card portfolio spending has increased. I mean you can see in the chart that it is moving in the right direction. However, when you look at the ending balance of the portfolio, it has remained stable. And this is due to the fact that clients are now taking better care of what they're spending and at the end of the day are paying the balances down a lot more. Will you move to Slide 24.

In this last slide, I wanted to share with you the improving credit quality of our consumer book. Delinquencies have shown a downward trend since 2010, our credit card and personal loan net charge-offs have also continued to decrease in 2011, as well as 2012.

Our auto business net charge-offs have remained well below 2% for the past 2 years. This is the lowest charge-off since 1999. In late 2011, we'd sold previously charge-off loans. This sale is reflected in the graph as recoveries in the net charge-off for both personal loans and credit card portfolios.

This concludes my presentation on the Consumer business. I would now like to leave you with Carlos Vasquez who will cover our U.S. operation.

Carlos J. Vazquez

Thank you, Gilberto, and good morning. I would like to join my colleagues in welcoming you to San Juan. Today's presentation appropriately focuses on Popular's Puerto Rico operation. This is -- it's this operation that drives the majority of the revenue and the financial resource for the corporation. However, you should not interpret this focus as an indication of lack of management attention to Popular's U.S. mainland operations. Please turn to Slide 26.

Over the last 4 years, we have pursued a very deliberate strategy to improve the profitability of our U.S. operation with the goals of increasing our optionality and positioning Popular to execute for a stronger financial and business position. Our strategy has been focused on reducing NPLs and the related charge-offs, protecting our margin and maintaining expense discipline. As you can see from the table on this slide, we have made significant progress in all of these areas.

Our U.S. operations have earned a modest profit in the last 2 years compared to a loss in excess of $700 million in 2009. The main driver of this profitability improvement has been reduced credit cost. NPLs have dropped almost 70% from their peak level. Our NPL to loan ratio has dropped from over 9% to roughly 4%. Net charge-offs have dropped almost 80% from their peak and our annualized net charge-off ratio in the fourth quarter of 2012 was 1.6%.

Our margin is up 74 basis points from its low point in 2009 to a level of 3.6% in 2012, which is comparable to the mean of most U.S. banks.

In terms of operating expenses, you can see from the table the magnitude of the reductions we have made. Businesswise, improving our existing operation has meant a reduction of roughly 33% of our branches, assets and employee. But it has also meant strengthening our community bank or retail strategy, mostly anchored around the rebranding as Popular Community Bank, which included improved and new product offering like Internet banking, mobile applications and enhanced credit products.

We are also building our Commercial Banking business in areas where we believe we can compete effectively. Please turn to Slide 27.

Our senior management team is fully aligned around the understanding that after continuing to reduce NPLs and addressing TARP, the next highest priority for the corporation is to increase the return on the capital we have deployed in the U.S. mainland. We are considering all options to achieve this. We plan to grow existing businesses. For example, we have a very successful commercial lending niche in providing financing to condo association, which we are planning to expand. We are also seeing significant demand for new CRE loans and refinancing of existing loans in California and New York, as well as growth in our Illinois-based nursing home and assisted care financing network.

On the new business front, we have entered the multifamily warehouse lending business. We hired an experienced team of professionals in that field and hope to develop, over time, a quality portfolio in this segment. The entry into other specialized businesses like leasing is also being considered. We continuously revisit our regional and branch process and evaluate if changes to that process would improve our risk profile and our performance.

Finally, we also revisit constantly what opportunities we may be able to exploit by building closer ties between our U.S. and Puerto Rico operations.

The financial and operational improvement in our U.S. Bank are evident and continuing. On the broader strategic front, the fact that we have not made more significant changes does not reflect a lack of analysis or an unwillingness to act. Thus far, our analysis indicates that the alternatives available to us would create less value for shareholders than the continued and deliberate improvement in the quality of the operations that we are achieving. This is, nevertheless, not a fixed conclusion but rather a dynamic condition.

We constantly evaluate new opportunities and consider adjustments to our strategy. As evidenced by today's announcement of the sale of NPLs in our Puerto Rico operation, we are prepared to act decisively in the U.S. mainland if and when we determine that a path different from our current one is in the best interest of shareholders.

Now I would like to leave the floor for Lidio Soriano to discuss our risk management.

Lidio V. Soriano

Thank you, Carlos. And let me also extend a warm welcome to all of you to this, the second annual Investor Day. Last year, I provided an overview on the risk organization, as well as provided insight into some of the trends and credit metrics of our loan portfolio. Today, I would like to take the opportunity to again provide you with some insights into our risks of organization, discuss the vision of our group and accomplishments in 2012 and then we'll finish the discussion by discussing trends and the NPA ratios after the sales announced today. Please turn to Slide #29.

As with most financial institution, Popular's Board of Directors delegate the responsibility of overseeing the corporation's risk program to our independent risk management committee. The risk management group is responsible, among other things, for assessing and reporting the risk positions of the corporation, developing and implementing policies and procedures to identify, measure and monitor risk and coordinating risk activities within the corporation. The implementation of the risk management process and policies is the responsibility of management.

The implementation is conducted jointly by the lines of business and the risk management group. The oversight of the risk-taking and risk management activity is conducted through the committees that I show in the slide here. Let me just briefly go through them.

The Credit Strategy Committee, or CRESCO, of which everyone that is presenting here today is a member of, manages the corporation's overall credit exposure, approves credit policies and monitor credit risk. This committee also review asset quality ratios, trends and forecasts and is responsible for the provision on the allowance.

The Asset Liability Committee, or ALCO, manages and monitors the corporation's exposure to interest rate, market and liquidity risk.

The Operational Risk Committee, or ORCO manages and monitors the operational risk of the corporation. We also have a number of compliance committees that monitor compliance-related matters. Overseeing and providing our independent assessment of the corporation's risk-taking and management activity is also the corporation's Internal Audit Division. With that, we complete the framework for our risk division. So let's turn to the next slide, please.

Before discussing the main accomplishment for the group, I want to discuss the vision that I have laid out for my group. In the top half of the slide, we provide you a look at the relationship between the size of a bank and some key elements of the regulatory framework that applies to it.

The main takeaway is that total asset of a financial -- as the total asset of a financial institution increases, regulatory expectations and influence also increases. As a result, the risk management organization's processes, policies and practices also needs to be enhanced and strengthened to keep up.

Based on total assets, Popular is in the mid-regional category. And it is reasonable to expect that we will have practices commensurate with a financial institution between $10 billion to $50 billion. However, given Popular's prominent status among financial institutions in Puerto Rico, the vision and challenge that I've laid out to my group is that we need to hold ourselves to a much higher standard and should base our practice and process with those of value peers in the U.S.

During 2011 and 2012, we laid the foundation for this by updating and enhancing resources, policies and practices to strengthen our risk management function. This action included executing our 2011 credit administration remediation plan by adding personnel in the areas of loan review, operational review and compliance-related functions and also updating our risk tolerance policy, allowance methodology, stress-testing model and implementing process and provisions to comply with Dodd-Frank.

We also staffed a quantitative team to improve the capabilities within credit risk. Some of the early work of the team include the release of the allowances on loan losses methodology that I mentioned before. The group is also developing the infrastructure and model input for the credit component of the stress test. Please turn to the next slide to review our credit trends and metrics.

As discussed during the fourth quarter earnings call, in 2012, we continued to make progress in the credit front. Nonperforming loans and nonperforming assets continue to decline and are at the lowest levels in 2009 and 2010, respectively. Since peaking the third quarter of 2010, NPLs are down approximately $920 million or 39%, while NPAs are down $725 million or 29%. NPL inflows reached their lowest levels in 3 years during the fourth quarter of 2012. For the year, inflows decreased approximately $437 million or 27%.

In line with the improvement of NPLs and NPAs, the corporation net charge-off ratio also improved significantly and finished the year at 1.97%, an improvement of 62% compared to the ratios 2 years ago. In dollar terms, the net charge-off for 2012 totaled $403 million, an improvement of $131 million or 25% compared to the previous year. The decrease in net charge-off was mainly driven by improvement in commercial and construction in both Puerto Rico and the U.S.

In line with the decrease in the net charge-off ratio, the corporation allowance for loan losses and provision for loan losses also decreased during the year. So now that was -- that is the credit picture as we stood at the end of 2012. As we announced earlier today, we reached an agreement on the bulk sale of this great assets with net book value of approximately $568 million.

So we're already there, so let's discuss the details on some of the pro forma ratios based on that transactions. The bulk sale will decrease commercial nonperforming loans by approximately 57% or $392 million, construction NPL by approximately 45% or $55 million and other real estate loans by approximately 45% or $121 million. As discussed by Richard, the sale of this distressed assets is an important and strategic plan in our continued effort to further strengthen our balance sheet and improve asset quality. After the sale, non-covered NPLs to loans ratio on a pro forma basis decreased to 5% from 6.79% at the end of 2012. And our NPA rate -- total NPA ratio decreased to 3.95% compared to 5.48% at the end of 2012. After the sale, non-covered NPLs stand at $1 billion.

We feel comfortable with the risk remaining in our balance sheet. I would like to take the last slide to discuss precisely the risk remaining and why we feel comfortable with the risk remaining on our portfolio. So please turn to the next slide.

After the sale, the remaining nonperforming loans are mainly composed of Puerto Rico mortgage and U.S. [indiscernible] NPLs. As discussed by Gilberto today, delinquency level on our Puerto Rico mortgage portfolio remained stable to slightly decreasing, mainly due to aggressive collection efforts and successful loss mitigation strategies. The level of delinquency in the Mortgage portfolio is driven by repurchases from our recourse portfolio. In 2010 and 2011, the corporation experienced an increase in mortgage loan to repurchase from such portfolio that led to the increasing NPLs.

Repurchase activity peaked in 2011 with approximately $60 million per quarter. In 2012, we have averaged approximately $40 million and expect this decreasing trend to continue. Excluding repurchases, credit trends in the regular portfolio have improved since 2010.

Equally important is that our average realization of loans foreclosed continues to be above 80% of the unpaid principal balance at default. This is significantly better than peers in the U.S. and fully explains the reasons for the variance in net charge-offs between the Puerto Rico Mortgage business, our Puerto Rico Mortgage business and the difficult business in the U.S.

The remaining commercial NPLs in Puerto Rico is mostly comprised of loans that are either subject to a resolution agreement with borrowers guaranteed by small business, held outside of Puerto Rico or were reported after the deal cut off. In other words, the exclusion from the bulk sale is not a reflection of their quality.

In the U.S., the improving economy and our derisking strategies have driven significant improvements. Commercial and construction NPLs are below $150 million and NPL inflows are the lowest levels in the last 3 years. The U.S. is in the right track to continue to improve credit quality.

To summarize, we have made significant progress in strengthening our risk management practices. The announced sales strengthens our balance sheet by improved asset quality and we feel comfortable with the remaining exposures and risks.

With that, I would like to turn the presentation and podium over to Jorge Junquera, to discuss normalized earnings and capital ratio. Thank you.

Jorge A. Junquera

Thank you, Lidio. Good morning, everyone. During the next few minutes, I will be giving you an update on our pro forma capital position, taking into account the sale of the nonperforming assets and our estimated normalized earnings. Please turn to Slide 35 to take a look at our pro forma capital ratios, which are shown on the left-hand side of the slide.

The NPL transaction will result in a reduction in capital of approximately $250 million. This reduces the capital ratios from the levels that we reported to you at year end. But as you can see, they still remain quite strong. Expect the future earnings enhanced after the sale will recoup this capital reduction.

On the right-hand side, we show you pro forma excess capital relative to the well-capitalized Basel I threshold. Here, you can see that excess capital is well above the well-capitalized requirement. As we have stated in the past, we anticipate maintaining strong capital levels during the next several years as the Basel III rules are implemented. On the Basel III, the rate of growth over excess capital will be reduced. However, it should remain above the current excess level of right now of $1.7 billion.

In summary, our capital position remains strong and our balance sheet continues to get stronger. Our continued progress in improving the risk profile, complemented by the potential benefit of a successful EVERTEC IPO brings us closer to exceed TARP in the most stockholder-friendly manner.

Please turn to the next slide. This slide provides an update on potential normalized net income, which we estimate at $370 million or $3.54 per share, assuming no material change in our share count. This estimate is the same as the one we provided to you during our last Investor Day at the end of 2011 and it equates to a 12% return on common equity Tier 1 and a 1% return on assets. To be clear, this is neither a forecast or a 2013 guidance and we're not specifying a time frame for achieving this level of earnings. It is our estimate of what we believe our potential would be in a more normalized environment.

In the table in the left-hand side, we show a summary income statement for the normalized earnings estimate and compare this figure to the fourth quarter 2012 net income, which we have analyzed and we have adjusted to exclude the impact of the EVERTEC tax agreement of approximately $27 million here in the fourth quarter.

Let's talk through some of the assumptions here. First, we assume there is no change in the interest rate environment. We assume a modest increase in earning assets that is offset by the expected decline in the net interest margin, principally as the covered loan portfolio runs off and is replaced with lower-yielding assets. We assume an increase in net noninterest income from lower FDIC loss share agreement expenses and lower recourse indemnity reserve adjustments.

Also, we assume that expenses are reduced by lower FDIC assessment costs, lower credit-related expenses in the covered and non-covered portfolios and continued cost control initiatives in our Puerto Rico operations. We assume that the provision for loan losses is reduced to 1% to reflect improved asset quality. To put this in perspective, our provision average of around 1% for several years preceding the financial and economic crisis. Finally, we assume higher taxes due to higher pretax income in the Puerto Rico operations while the net income from the U.S. operations is expected to approximate about 10% of their pretax normalized earnings.

As we move forward, we remain focused on executing on all of the earnings drivers of this framework that are under our control. What this number show is that the strength of our franchise generate the revenues needed to provide above average return. We already have the strong revenues. Now as the credit conditions continue improving, we will get much closer to our potential profitability.

With that, I would like to turn the floor to Richard for some closing comments. Thank you.

Richard L. Carrion

Thank you, Jorge. Please turn to Slide 38. Before we open the floor to your questions, I'd like to take a minute and just sum up the presentation. I hope that over the course of the morning, you have seen clear evidence of the fundamental strength of the franchise and how that drives consistently strong revenues. And as credit quality normalizes, we expect to see more of those revenues reach the bottom line. And that's really the primary driver of our estimated normalized earnings.

I hope it's also been clear that we're executing significant actions on many fronts to drive shareholder value. We've substantially improved our credit metrics. We expect continued progress in 2013 and, when you factor in the additional improvement that will result from the NPA sale that we announced today, we're getting closer to that normalized credit environment.

As Lidio discussed in his presentation, we've also substantially strengthened our credit processes and our analytics to support a better credit performance going forward. We've built a $1.9 billion excess capital position and while the sale will release -- will reduce that somewhat, we expect to replenish that amount going forward. These earnings will reflect a lower provision, as well as lower credit-related expenses as a result of the sale.

In addition, with the filing of a registration statement for an IPO of EVERTEC by its majority owner, we may be able to realize additional value from that investment and further boost our capital. We've made significant progress in restructuring, improving the profitability of our U.S. operations and we'll continue to work to enhance our returns and enhance our flexibility. We're prepared to act decisively when there is a clear path to create value for our shareholders.

At the same time, while the Puerto Rico economy and the economic recovery remains tepid, we're seeing some areas of opportunity for profitable growth and some quality loans and our total assets are certainly stabilizing. All of these actions are bringing us closer to potential normalized earnings level that Jorge just talked about. They're also moving us along a path to exit TARP in the most shareholder-friendly fashion.

So with that, I'd like to thank you for taking part in our Investor Day and I'll open the floor to questions. I'll take the easy ones and will pass the hard ones to the guys here.

Question-and-Answer Session

Unknown Attendee

In previous conference calls, Jorge, you had talked about the expenses related to the NPLs. And in a normalized environment, you gave some figures about where expenses or how much they could be reduced. How much of that should we expect maybe now in 2013 with this morning's announcement and the reduction of NPLs?

Jorge A. Junquera

Yes. The references made to comments regarding where we expect to be, expenses related to managing credit, on a quarterly basis, that we have said, they're around $19 million and that in a fully normalized credit environment, we should aim to reduce about half of that or $19 million per quarter. This transaction goes a long way, but it doesn't achieve the whole level of nonperforming. But it is -- we are on our way. These are the steps that we're taking that as far as we continue to bring down level of nonperforming, we will be able to get to that number. So these are the steps that have to be required. The amount it's difficult to say. This transaction actually closed last night, late last night. But it's a good number. It's a good number that is going to improve earnings as early as the second quarter of this year.

Richard L. Carrion

Yes. And that figure, by the way, does not include provision expense. And I don't -- I'm not going to put Lidio on the spot but there is clearly some impact on the provision as well as non-provision credit-related expenses, so it should be a good boost.

Enrique Martel

We have a number of questions from the Web.

Richard L. Carrion

Fire away.

Enrique Martel

First question comes from Ken Zerbe. And we've -- Jorge touched on it a little bit, can you go over again -- can you quantify the net expense benefit in 2013 related to the NPA sale?

Richard L. Carrion

I just think we just quantified about as much as we can. We've identified, as Jorge said, roughly $19 million a quarter in non-provision credit-related expenses. We think in a normalized environment, we'd get about half of that to come out. So this is a step closer to that and then you'd have to add any provision expense.

Enrique Martel

Next question comes from Alex Twerdahl who has a number of questions. Can you tell us please what the level of accruing TDR was at the end of the quarter?

Richard L. Carrion

I don't know. That's why I let you have it.

Jorge A. Junquera

$640 million.

Enrique Martel

All right. From Alex as well, just wanted to talk a little bit more about the commercial and construction portfolios and how it relates to the held-for-sales and held-for-investment.

Richard L. Carrion

Commercial and construction portfolio and how it relates to held-for-sale and held-for-investments?

Enrique Martel

I think he's talking about the breakdown in the NPL sale.

Richard L. Carrion

How much is left in? That's in the slide. And how much is left in held-for-sale, I'll have to get Ileana to give us the number.

Enrique Martel

[indiscernible] on the webcast. Next question. I just wonder if you could us give a little bit more color on the resolution of some of the construction loans during the quarter.

Richard L. Carrion

We're basically almost out of the construction, as you can tell from Slide 33. We're basically out of the nonperforming construction loans from the U.S. and we have remaining, after the sale, $32 million in construction loans in Puerto Rico, of which a good portion already has some resolution back.

Enrique Martel

We have 2 more questions. Christopher [ph], when do you believe you will pay dividends from common shares?

Richard L. Carrion

Well, it's another one of our goals. But what -- I think if we had to outline things, I think the TARP exit would come before that clearly and how far that is will depend on a series of things.

Enrique Martel

And the last question also related to normalized earnings from Susan Rice [ph]. Here's a question regarding Jorge's Slide #36. What levels can the bank use to achieve the approximately 6.8% reduction of expenses in a normalized model? Put another way, is this solely from attrition and process reengineering?

Richard L. Carrion

No. I think there are other things. Obviously, the credit normalization is a big piece of it. There is quite a lot of process reengineering going on, but we'll get some more, both in our retail operations as well as our centralized operations. But a good chunk of that will be in credit-related expenses.

Enrique Martel

Okay. Just one last one come in -- came in. More color and what was the composition of assets sold? It looks like there's a portion there in U.S. mortgage assets, which obviously wasn't [indiscernible].

Richard L. Carrion

No. I'll just -- what was sold in terms of book value was $380 million in commercial loans, $57 million in construction loans, $46 million in commercial REO, $79 million in residential REO and $1 million in an SPV, which is sort of a commercial OREO. So that totals your $563 million.

Enrique Martel

That's it for the questions.

Richard L. Carrion

Okay. We're good. One more here?

Unknown Attendee

I don't know about one more but -- a credit question, interest rate question. First off, Lidio, maybe remind us just in terms of the residual portfolio, commercial construction, just kind of the average mark in the held-for-investment, kind of where that stands today post the actions over the back half of last year and the sale today.

Lidio V. Soriano

Lifetime charge-off for the NPL commercial portfolio is about 30% more or less, so there are $0.70 on the dollar, altogether, I mean we already alluded to, we just finished the transaction last night. So we are adding a level leeway in the remaining of that number, but on average, about $0.70 on the dollar.

Unknown Attendee

Okay. And then, Jorge, I guess 2 questions. One, just in terms of interest rates, yield curve has started to steepen. The sale obviously has an impact on spread. But can you give us a sense, for example, a 100-basis-point move in rate, what that could potentially mean for spread income? What are magnitude anyway?

Jorge A. Junquera

It's -- definitely, we have probably been somewhat conservative in anticipating no change in the interest rate environment. We believe that eventually, yes, rates will rise from these current levels. And we are in a position that we will benefit. We will certainly benefit from a rise in interest rates, not only because we have a slightly positive asset sensitivity, slightly positive, but also because that we have such a high proportion of our liabilities, our deposit, core deposits, that as rates go up, being the market leader here in Puerto Rico, we will be able to manage the rise in rate and that will certainly give way for some widening of the margins. I don't have the number for it precisely, about 100 basis points, but we could talk later and give you an idea of it. But it will be positive, any increases in rates that we may see in the future and it's not included here. Also, it opens up the possibility for us and other banks here in Puerto Rico to leverage the balance sheet and buying federal paper, which is tax-free to us. So on an after-tax basis, we will be able to increase yields at a very good return with very little risk assumption, both in credit, of course, U.S. government and interest rate risk. So the rise in interest rates, it does favor tremendously the benefit for the company.

Unknown Attendee

Okay. And then the last question I have, it just relates to the DTA, which it always gets beat to death, but you mentioned there's a number of initiatives that were mentioned in terms of -- particularly on the lending side in terms of improving profitability and you've talked in the past about potential acquisitions as it relates to that DTA. But I guess the question is, number one, there are certain businesses, to my understanding, that have exited or you've sold outside of the company that you no longer have that may have been a part of that DTA. And then secondly, it is -- with the EVERTEC IPO, is there any optionality with that and -- or that remaining entity that it may be able -- that it could potentially have a contribution in terms of potential structure in the future? So at the end of the day, as we look at the existing DTA, how much, a, is essentially recoverable given some of the businesses that have been sold and potentially optionality tied to EVERTEC going forward and future structure?

Jorge A. Junquera

It's the deferred tax asset but it's with a full valuation allowance. [indiscernible] before. And right now, it is difficult to think of being able to recover that deferred tax asset. For sure, we're going to have our U.S. operations tax-free for the foreseeable future, but the goal as far as to take that out, we are in a position that we see the potential being able to reverse some of that deferred tax asset. It's difficult because of the earnings potential under the current business platform. That's why you heard Carlos expressing we are looking at this continuously. But the numbers right now, given the value for deposit and assets and future growth of our assets [ph] in the U.S., it is -- numbers are not just compelling to do a transaction, so we continue to watch it. But under the current platform, it is difficult because profitability will be, as we mentioned, we expect around 10% of pretax normalized earnings. So that's a number of around $40 million. And with that, it's really not sufficient to convince the external auditors for you to make a case that you're going to be able to substantially use within the next 5 years that deferred tax asset. On the other hand and unfortunately, we are in different tax jurisdictions. The U.S. is -- that's where the deferred tax asset is and the gain that will be realized from the -- from any potential sale of any of our position in -- if there is an IPO for EVERTEC, will be booked for Puerto Rico tax purposes, but we cannot consolidate income tax returns. So that's not -- we just won't be able to benefit from that.

Unknown Attendee

Just in terms of like on the acquisition, I'm assuming at least in the current period just from a regulatory perspective, it's more kind of portfolio acquisitions as opposed to anything outside of -- as a terms of like an entity, if you will.

Jorge A. Junquera

No, it is the old-fashioned way of doing business. You got to earn your way out in order to be able to use reverse deferred tax assets. You do it for earnings and those earnings have to be abhorrent from businesses that are related to the businesses that caused that deferred tax asset. So in the financial industry, it could be portfolio acquisitions or it could be businesses that are related to -- in the financial industry. Financial institutions would probably be the best alternative, institutions that do complement and supplement our current business. But the point is that they have to generate income in order to be able to then make a case that will use the deferred tax asset within a reasonable period of time.

Enrique Martel

We have a couple more questions that came in. First one is from Melvin Mercado [ph]. When do you expect to pay out TARP?

Richard L. Carrion

As soon as possible. But clearly, this is not a one-sided conversation. We're going to need regulatory approval. We think the steps that we announced today gets us closer to that. It's something we want to do, but we're not going to rush to do it until it just makes sense from a value creation viewpoint. So I think we're closer to it. If some other event that we've talked about, such as the EVERTEC IPO, brings some money in, it's definitely on our top 10 list of things to do with proceeds from an EVERTEC IPO, but we need to work our way to that.

Enrique Martel

The next question, can you discuss your long-term tax rate assumptions for both the U.S. and Puerto Rico business?

Richard L. Carrion

The short answer is no in the sense that it's extremely, extremely complex. As Jorge just talked about in our DTA, what we're trying to do is build more optionality in our U.S. operations so that there's things we can do. We do not give up on that DTA. It's just -- right now, under the current environment, things are very difficult to recover it. But we look at this every month and we are trying to find what's the best strategy for the U.S. Until we find something more compelling than what we're doing, we're going to keep on improving our operation and increasing the optionality. In Puerto Rico, we use a 30% rate. Obviously, that is -- we do some tax planning by the use of quite a lot of tax-exempt income and whatnot. I see my controller and my former controller nodding, so I must be saying the right thing.

Enrique Martel

All right. We have another question from Ken Zerbe of Morgan Stanley. What are your long-term plans for your EVERTEC ownership? Will you sell some of the IPO? Do you plan to continue to sell EVERTEC -- are you planning to continue to sell EVERTEC after the IPO?

Richard L. Carrion

Well, obviously, we're going to have to wait until we get a little bit more clarity. I think the plan right now would be to do an IPO. If that IPO will include some proceeds for the existing shareholders, we'll sell into that. But longer term, we'll have to see what is -- what are the pricing, what is the -- our best option here. We like the asset, it's a great asset but we also would like to realize some of the value. We're not prepared at this point until we have a little more information to say how much or how little we're going to keep. Be aware, we're not the majority shareholder here, we're not driving the bus here. We like where the bus is going, but we are not the main driver here.

Enrique Martel

That's it for today.

Richard L. Carrion

Okay. One more. Gerard. Gerard, go ahead.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

In today's announcement, you mentioned that there won't be any profit distribution or capital return to the joint venture until after the credit or the debt is paid off. Do you have an idea how -- when that may -- how long that will take?

Richard L. Carrion

Well, I can only tell you that, that's the same, exactly the same structure that we used for the previous transaction we did in late 2011. And in that case, the loans have been paid down faster than was originally planned and that transaction is not 2 years old, it's about 1 year and some months. The loans have been paid down faster and the value of our equity investment has been positive. So hopefully, this will happen in this case as well.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

And another question is on Slide 24 where you guys showed the net charge-offs for monthly evolution. What caused the Auto charge-offs to rise the way they did in the second half of 2012?

Richard L. Carrion

It was really non-Automobile. But, I'll tell -- I'll let...

Jorge A. Junquera

It was non-Auto related, it was other products if you find there [indiscernible].

Richard L. Carrion

We have some bulk loans in there, Gerard. We have some bulk in there.

Jorge A. Junquera

But overall, it's still below 50% and we did clean up the Auto -- the book, but in a lot of ways that [indiscernible].

Unknown Attendee

I just wanted to ask again about the remaining composition of NPLs. Given now that you've got a lot of the construction and commercial stuff off your books, a lot of what's remaining is residential mortgages. And just maybe talk a little bit about how -- if it still is something that we could consider for those as well given that one, the loss contents are much smaller than the commercial and the construction; and two, just the number of customers that those NPLs consist of.

Richard L. Carrion

Okay. All right. You have the composition right there. As you can see, almost north of 70% is mortgage, residential mortgage-related. So far, as you can see from the graph below, we are realizing an average of roughly a little north of 80% of UPB upon disposition. And so we are comfortable that we can recover a good chunk of the value there. That said, I'll give you the same answer we've given throughout the past couple of years. If there's a bulk sale that makes sense, we're going to go ahead and do it. And we're going to do it for a few reasons. We see what regulators are looking at and they are more focused on NPLs to assets than they are impressed by our excess capital. So this is why we think it's a good use of capital. Secondly, the structures that we've done for these sales allow us to have some upside on this. So we're just present valuing our misery, if you will, in terms of the disposition of these assets. And third, I cannot put a value, although one does, but I cannot put a value on what this does for the organization in terms of the mindset, in terms of the optionality that it creates for us. So if we can find ways to accelerate it, yes, we will. So we want to get down to an NPA to asset ratio that's got a 2-handle on it, without a doubt.

Unknown Attendee

Question on the servicing business. You mentioned that there's some reengineering/restructuring going in, in terms of how you're looking at servicing overall. The question is, with that portfolio, how do you see some of the optionality there, again, meaning that either outside purchases, outside of your own portfolio and similarly, potential sales within the existing portfolio, those that may be severely delinquent or so forth? You've certainly been seeing that among a few banks in the U.S.

Richard L. Carrion

Well, clearly, we've a servicing portfolio north of $20 billion. The bulk of it is not our own held-in-portfolio mortgages. So we do have -- we do see this business as a good fee-generating business. That said, as Gilberto mentioned, there are a couple of things going on. One is, we're moving to a different platform. So that's going to change the economics of the operation. And secondly, in conjunction with that, we're doing a lot of reengineering there. So any sales of delinquent mortgages will contribute to lower the expense, but we still like the servicing business and we are by far the largest on the island. We want to continue to do that business. It chews up very little capital, so this is a good fee income.

We're good? Okay. I think we have lunch at noon. Thank you all for joining us. We'll say goodbye to the webcast piece and we're happy to stay here with you and answer any more questions you may have. Thank you.

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