Popular Inc. (Nasdaq: BPOP) stock has declined by 25% in last one month after almost doubling from last year. Much of this volatility is caused by the broader concerns about the Puerto Rico economy.
As a Financial Holding Company, Popular Inc. with 72% assets in Puerto Rico is affected by both the broader economic weakness of the territory and the recent government initiatives to correct the high debt scenario, including the increased corporate tax rates undertaken by the local government.
Investors, concerned about the Puerto Rico economy, have sold out of both the government bonds, which are offering yields of around 10%, and stocks like Popular. The Popular Inc. stock is now trading at 35% discount to its book value and 20% discount to its tangible book value, creating an opportunity for investors.
The company, after years of restructuring, has created a solid balance sheet with 17% of Tier 1 capital, which is good not just for Basel III norms but also 5.5% higher than average CCAR (Comprehensive Capital Analysis and Review) & CapPR (Capital Plan Review). Tier 1 Common Equity capital ratio of 13.1% exceeds the current CCAR target requirement of 5% by $1.9 billion, which positions it well for double-digit earnings growth going forward.
Besides the strong balance sheet, this might be the right time to focus on the company's specific catalysts like TARP refund or the monetization of assets like EVERTEC Inc. (Nasdaq: EVTC) at a profit, which may help the stock trade close to its book value of $40.
Macro Puerto Rican economic issues are a drag on the stock
Popular Inc. has 72% of its assets in Puerto Rico and 25% in the U.S. Out of its total loans and deposits, Puerto Rico has 73% exposure with the U.S. making up for most of the rest.
Like many states in the U.S., Puerto Rico's economy is suffering due to high debt and high unemployment. Debt to GDP is at 84% and per capita debt is more than $18,000 with unemployment rates of around 13.5%. The local economy contracted almost 5 percent this year through July. Yields on government bonds have doubled from last year.
Being a territory that uses U.S. dollars as its currency, Puerto Rico cannot inflate its way out of the debt problem, as it does not have its own currency. Factors working for it are, 20% of the population working for the government and government bonds enjoying a tax-exempt status as well as qualifying for the state-specific funds.
Conservative value of the business is closer to its book value
The stock is trading at .80 times tangible book value and .65 times the book value of $40. A conservative estimate of the value of the franchise is closer to the book value, which offers a 55% upside from the current trading range.
Usually the primary reason for the bank stocks to trade below the book value is either the credibility of the book value or the profitability of the book value. In either case book value is expected to decline as the assets decline and liabilities run up. Popular, after five years of restructuring, is well positioned to survive and benefit from these market conditions.
Non Performing Loan inflows were stable for the last few quarters. Mortgage NPLs are at the lowest level in last 3 years. Non Performing Assets as part of Assets, an important metric to gauge risk profile of the balance sheet, has been declining (lower the better) steadily over the last few years, as shown by the chart.
Source: Popular Inc. quarterly results
Similar improvement is visible in the Tier 1 Capital as well, which has increased from 14.5% in 2010, to 17.3% currently. The company's Tier 1 capital is among the best not just among its Puerto Rican peers but other quality banks too. Even relative to other Puerto Rican banks listed in the U.S., balance sheet and value is worthy of merit as shown by the worksheet.
P/ tangible book
Tier 1 capital
Good metric for
Risk adjusted capital
(click to enlarge)
Data source: SEC filings and company releases
Agility to grow earnings keeping the balance sheet strong
The company's Net Interest Margins (NIM), an important metric to measure operational performance of a bank, has been improving from approximately 3.9% in 2010 to the current levels of 4.7%. Return on Average Equity (ROAE) has improved many folds from 4.22% levels in 2010, to an average 11% level currently.
The company has the ability to leverage this improved operational performance with excess Tier 1 Capital Equity of $1.9 billion. With the excess capital and Non Performing Loans (NPL) well provided for (Allowance for Loan Lease Losses/NPL is at 86%), the company should be able to drive earnings growth in double digits going forward.
Undervalued assets on books - EVERTEC
The company has recently divested its stake in its subsidiary - EVERTEC Inc., for which the company received approximately $270 million in cash from the IPO proceeds. EVERTEC also repaid the debt held by Popular. This transaction alone increased the company's Tier 1 Capital Equity by 67 bps.
The company still has a stake of 32.4% (26.5M shares), which is being carried on its books at $64 million but if we calculate the current value of the stake, it's clearly many times that, as shown in the calculation.
EVERTEC Stake worth 9/23/13
Market Cap ($M)
BPOP Stake %
Stake current worth ($M)
Value on Books ($M)
Profit to be booked ($M)
If the company were to sell its stake, it can significantly improve all its capital ratios but the company recorded only $18.5 million in earnings from the investment in the last 2 quarters.
Undervalued assets on books - BHD
The company also has almost a 20% stake in the BHD Financial Group, one of the largest banking and financial services groups in the Dominican Republic. The carrying amount for the investment on the books is $78 million, which may garner more than twice if the company plans to offload to a strategic buyer. The company recorded $10.6 million in earnings from the investment in the first 2 quarters.
During 2008, like most other banks, Popular Inc. was made to participate in the Capital Purchase Program (CPP) as part of the TARP. The company is expected to refund the TARP money (approx. $940 million) back to the Federal Reserve as the dividend payment on the preferred stock that banks are required to pay the U.S. would increase (from 5% to 9%) at the 5th anniversary, which is in 2013. This can significantly improve the flexibility of the company. The company has total assets of around $37 billion so paying the money back would not affect the balance sheet negatively.
Recent tax changes
Recent tax increases by the Government of Puerto Rico is another significant concern that has affected the investor confidence in the territory. The corporate tax rate was increased to a top rate of 39%. A new tax on gross income with special focus on financial institutions was created.
For the company, with the revised changes, the tax on gross income will be 0.5% and the effective tax rate will be approximately 35%. There is a tax net benefit of $216 million due to the revaluation of the Deferred Tax Asset.
Like airlines, banks throw off a lot of data and numbers but at the end of the day it all boils down to the credibility of the balance sheet for security, and strength of the balance sheet for growth and timing. Macro concerns are offering a 35% discount on a balance sheet that has been thoroughly cleaned, able to grow and has assets valued much less than their market value. Target is the current book value of $40.