Popular, Inc. (NASDAQ:BPOP) Q3 2019 Earnings Conference Call October 23, 2019 11:00 AM ET
Paul Cardillo - Investor Relations Officer
Ignacio Alvarez - Chief Executive Officer
Carlos Vázquez - Chief Financial Officer
Lidio Soriano - Chief Risk Officer
Conference Call Participants
Brett Rabatin - Piper Jaffray
Scott Valentin - Compass Point
Alex Twerdahl - Sandler O’Neill
Mark Palmer - BTIG
Glen Manna - Keefe, Bruyette & Woods
Good day and welcome to the Popular Inc. Q3 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Paul Cardillo, Investor Relations Officer. Please go ahead sir.
Thank you. Good morning and thank you for joining us on today's call. With us today is our CEO, Ignacio Alvarez; our CFO, Carlos Vázquez; and our CRO, Lidio Soriano. They will review our results for the third quarter and then answer your questions. Other members of our management team will also be available during the Q&A session.
Before we start, I would like to remind you that on today's call we may make forward-looking statements that are based on management's current expectations and are subject to risks and uncertainties.
Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today's earnings press release and are detailed in our SEC filings. You may find today's press release and our SEC filings on our webpage at popular.com.
I will now turn the call over to our CEO, Ignacio Alvarez.
Good morning and thank you for joining the call. We had a solid third quarter and continued to build upon the success achieved in the first half of the year. I will address highlights and key events in the quarter, then give an update on our business, and provide some thoughts around the environment in Puerto Rico. Carlos will comment on the quarter's financial results and Lidio will provide an update on credit trends and metrics.
Please turn to Slide 3. We reported quarterly net income of $165 million, which is $6 million lower than the previous quarter, but $25 million or 17.5% higher than in the third quarter of 2018. This quarter's results were impacted by higher expenses and higher taxes, partially offset by higher non-interest income and lower provision.
Net income was -- net interest income was flat sequentially. Increases in investment in money market involvement made up for lower yield in our portfolio. Credit quality results were stable, however, some metrics were mixed. We saw lower NPLs and lower position, but NPL inflows and net charge-offs were higher. Lidio will provide more detail during his commentary. Tangible book value per share increased by approximately $2 to $53.41.
Now, I'd like to give you an update on the business environment in Puerto Rico. Please turn to Slide 4. In general, economic activity in 2019 had leveled off after a post-hurricane rebound year in 2019. However, this activity continues to trend well above what was observed in 2016 and 2017.
With respect to migration trends, the most recently released passenger data from the San Juan Airport reflects that the net number of people who left the island through July was approximately 20,000.
Excluding 2018, which was substantially impacted by the inflow of people coming back to Puerto Rico following the hurricanes, the data for 2019 reflects a favorable variance compared to the same periods in 2015, 2016, and 2017 which averaged outflows of 63,000 people.
Employment trends continue to be positive. In September, total employment which includes self-employed individuals was up 1% compared to September 2018. The unemployment rate decreased to 7.6% in September after remaining steady in the mid-8% range during the prior year. This is the lowest unemployment rate in Puerto Rico going back at least 55 years.
Salaried employment grew by 0.8% year-over-year. The improvement was driven by an increase of 1.3% in the private sector offset by a 1.1% decline in public sector employment.
The auto industry continued to perform well. 75,000 new units have been sold year-to-date through September down 2% compared to 2018, but up 30% and 25% versus comparable periods in 2017 and 2016 respectively.
Cement sales were down 8% when compared to the first nine months of 2018, though there was a considerable surge in activity in early 2018 following the hurricane. However, sales were 23% and 14% higher in comparable periods in 2017 and 2016 respectively.
Internal metrics we track to monitor economic and client activity continue to show positive signs. Our customers' debit and credit card purchases in the third quarter grew by 4% compared to the third quarter of 2018 and 2% compared to the first nine months of 2018.
Consumer loan origination trends in Puerto Rico have also been solid, especially in the auto sector. Mortgage originations were 3% lower than the previous quarter, but 2% higher year-to-date compared to 2018, and were driven primarily by higher home purchase activity.
On the commercial loan side, balances declined sequentially on higher payouts. However, we continue to expect that incremental lending activities will be tied to the performance of the local economy.
Popular's customers in Puerto Rico grew by 12,000 this quarter and have increased by 37,000 since December 2018. As we have commented before, the sustainability and pace of further progress in the Puerto Rico economy will be heavily dependent on the magnitude and timing of federal recovery funds flowing into the island.
The disbursements of these funds has been slower than many had hoped or anticipated. This delay is related to concerns regarding appropriate local oversight of the disbursement of federal funds and the political uncertainty that we experienced during the summer.
It is difficult to predict whether this increased scrutiny will ultimately impact the amount of federal funds received. However, we continue to believe that these funds will be significant and they will have a very positive impact on the local economy.
I will now turn the call over to Carlos, who will discuss the financial results in more detail.
Thank you, Ignacio. Good morning. Please turn to slide 5 for third quarter results. Note that additional information is provided in the appendix to the slide deck. Today's earnings press release details various hits from the second quarter, primarily higher operating expenses offset in part by higher non-interest income and lower provision.
Net interest income for the quarter was $477 million, flat to the second quarter. This number benefited from higher commercial loans in the U.S., higher volume of investment securities and higher consumer and auto loans at BPPR. There was also one more day in the quarter, which added $3.8 million to net interest income.
These benefits were offset by lower commercial loan balances in Puerto Rico and higher interest expense. While deposit costs were lower in the quarter, the increase in interest expense was primarily driven by higher volume of deposits through Popular Bank's digital channel and from the public sector in Puerto Rico.
We continue to be asset-sensitive, so lower interest rates negatively impact our result by $4 million to $5 million per quarter for every 25 basis points drop in rates. Other factors like asset mix and the shape of the yield curve, also impact this estimate.
The $4.4 million increase in non-interest income was primarily driven by a $12.3 million improvement in mortgage banking results, mainly due to a favorable variance in deferred value adjustment of our MSR, plus $1.4 million higher deposit service charges as well as higher credit card fees in Puerto Rico.
This benefit was partially offset by two items: $2.7 million lower other service fees, mainly driven by $3.5 million in contingent insurance commissions received during the second quarter; an adjustment to indemnity reserves on previously sold loans increasing by $5.3 million due to the release of a $4.4 million reserve in the second quarter.
Total operating expenses were $376 million, an increase of $13.5 million from the prior quarter. Personnel cost increased by $6.2 million in the quarter, $3.9 million of which was due to annual merit increases and higher headcount while $3.2 million was related to annual incentives including the corporation's profit-sharing plan. Through the first three quarters of 2019, we have accrued a total of $19.4 million in anticipated profit-sharing expenses.
Technology and professional fees increased by $3.3 million, primarily due to higher expenditures in regulatory, accounting and technology fees, offset in part by lower legal fees. Other operating expenses were $6 million higher, mainly as a result of increased legal contingency reserves, as well as a $2.6 million loss related to an undeveloped corporate site moved to held-for-sale during the quarter. Other expenses were down $1.4 million sequentially, reflecting a small gain in the third quarter, due to higher gain on sale of properties. These increased expenses were partially offset by our lower FDIC deposit insurance of $2.4 million, mainly due to a credit received at Popular Bank.
We estimate fourth quarter expenses of approximately $385 million. As a result, we now expect our quarterly average expenses for the year to be approximately $368 million, which is slightly above our original guidance of $364 million. The overage is mainly due to expenses associated with our profit-sharing plan.
Our effective tax rate for the quarter was 20%, which includes a benefit of $4.3 million related to increases to the amount of exempt income for the current year. Excluding this adjustment, our effective tax rate was 22%. For 2019, we now expect the effective tax rate to be between 20% and 22% compared to the prior estimate of 22% to 24%. This change results from expected higher levels of tax-exempt income at BPPR.
In the fourth quarter of 2019, in connection with the filing and true-up of our 2018 Puerto Rico tax return, the corporation will also amend its tax returns for the years 2015 through 2017, revising up the amount of exempt income for those years. We expect these amendments to result in a positive 4Q tax adjustment of $15 million to $20 million.
Please turn to slide six. Our net interest margin was 4%, down 11 basis points from last quarter. Asset yields were down 14 basis points in the quarter, driven by higher cash and investment portfolio, plus the impact of two 25 basis point decrease in rates. The higher investment volumes added to our net income, but reduced our overall asset yields.
Loan yields were down slightly less, at 11 basis points to 6.7%. Total deposit cost in the quarter decreased 2 basis points to 73 basis points. The cost of our interest-bearing deposits was down 2 basis points to 92 basis points, mostly due to a lower rate but a higher volume of Puerto Rico public sector deposits, offset by higher deposit cost in the U.S., driven by mix. The cost of retail and corporate deposits in Puerto Rico was flat with Q2.
During the third quarter, Puerto Rico public deposits increased to roughly $11.4 billion. However, since the end of the quarter, deposits have decreased by around $1 billion. As Ignacio mentioned earlier, third quarter auto sales in Puerto Rico were strong, even as the market normalizes from higher volumes in 2018. Our portfolio grew by $45 million in the period.
The Puerto Rico mortgage business originated $177 million of loans in the third quarter, $6 million lower than the second quarter, but $5 million higher than the same quarter of 2018. Loan balances were basically flat quarter-over-quarter.
At BPPR we continued to see elevated levels of commercial loan repayment that exceeded our strong origination levels. In the U.S., commercial and mortgage loan balances grew by $76 million and $37 million respectively.
For the first nine months of 2019, Popular's loan portfolio has grown by $500 million. We expect to end the year with loan balances similar to the levels at the end of the third quarter, fulfilling our outlook of slight growth in overall loan balances for 2019.
Please turn to slide seven. Our capital levels remain strong, relative to mainland peer banks as well as with respect to well-capitalized regulatory requirements. Our common equity Tier 1 ratio was 17.5%, up from 16.8%. And tangible book value in the quarter increased by $1.97 per share to $53.41.
The increase was driven by our quarterly net income and higher unrealized gains on investments, which more than offset the impact of our common and preferred dividends. We will continue to pursue our target of maintaining and improving, our double-digit return on tangible equity.
Please turn to slide 8. We are continuing our evaluation and implementation efforts for CECL. Based on our preliminary analysis, as of June 30, we estimate that the allowance for loan and lease losses, were increased by $360 million to $400 million or 85% to 90% of the existing reserves, excluding purchased credit-impaired loans.
This estimated increase is driven by Puerto Rico mortgage, credit card and auto loan portfolios. Based on these preliminary estimates, the day one impact of the adoption of CECL would result in a decrease tangible book value of approximately $3 per share.
Following existing regulation, and assuming no regulatory changes, given that Popular's allowance already exceeds 1.25% of loans, the incremental allowance resulting from CECL, will be excluded from total capital.
As such, we estimate this day one impact will result in a 30 basis point reduction in CET1 and total capital. After the adoption of CECL, Popular will continue to be well capitalized under Basel III.
In accordance with present regulatory guidance, we plan to phase in the day one effects of CECL, on regulatory capital, over a three-year period.
We will continue to work on our models, assumptions and implementation plans, through the adoption date, in the first quarter of 2020. We expect further changes, disclosures and update, as we refine these estimates.
With that, I turn this call over to Lidio.
Thank you, Carlos. Good morning, to all. During the third quarter of 2019, the corporation's credit quality results continue to show stable trends, although, certain events caused NPL inflows and charge-off in Puerto Rico to increase this quarter.
First, we sold a $40 million troubled loan, that resulted in a $7 million charge-off and an $8 million reserve release. Second, we moved to non-accrual certain previously reserved, commercial real estate troubled debt, restructured loans, that resulted in an increase to NPL, and NPL inflows of $25 million. And a $5 million charge-off, for the impairments.
Finally, we revised and aligned our auto loan charge-off policy, in connection with the Reliable systems conversion during the third quarter that resulted in a $7 million increase in net charge-off. The credit quality metrics of our U.S. operation, remained favorable with lower NPLs, lower NPL inflows, and lower net charge-offs.
Please turn to slide number 9 to begin the discussion. Non-performing assets, decreased by $7 million to $676 million this quarter, driven by a decrease of $7 million in non-performing loans, coupled with a slight decrease of $1 million in OREOs. The declines were mainly driven by improvements in both Puerto Rico and the U.S.
Non-performing loans in Puerto Rico decreased by $2 million, driven by lower mortgage NPLs of $13 million, and lower consumer NPLs of $4 million, offset in part by higher commercial NPLs of $17 million.
The increase in commercial NPLs was mainly related to a TDR commercial real estate loans that were partially charged off during the quarter. In the U.S., NPLs decreased by $5 million mainly related to charge-offs. At the end of the third quarter, the ratio of NPLs to total loans held in portfolio, remained flat at 2.1%.
Please turn to slide number 10 to discuss NPL inflows. Compared to the previous quarter, inflows of NPLs increased by $40 million, primarily related to higher inflows in Puerto Rico, driven by the previously mentioned, TDRs commercial real estate loans.
Mortgage inflows in Puerto Rico, continued to be considerably lower than in previous years, driven by lower early delinquency. Inflows to NPLs in the U.S., decreased slightly to $4 million from $6 million in the prior quarter.
Turning to slide number 11. Net charge-offs for the quarter amounted to $68 million or 1.01% of average loans held in portfolio, compared to $47 million or 71 basis points in the prior quarter. The increase in net charge-off was driven by an increase of $23 million in Puerto Rico offset in part by a decrease of $2 million in the U.S. The increase in Puerto Rico was driven by higher commercial net charge-off of $10 million and higher consumer net charge-off of $9 million.
The commercial net charge-off increase was driven mainly by the previously mentioned TDRs and troubled loans sold. The increase in consumer net charge-off was largely due to the revision and alignment of the auto loans charge-off policy in connection with the Reliable system conversion. The decrease in the U.S. was mainly driven by lower consumer net charge-off.
The corporation allowance for loan losses decreased by $30 million from the prior quarter to $512 million, driven by a decrease of $25 million in Puerto Rico coupled with a decrease of $6 million in the U.S. The decrease in Puerto Rico was principally driven by charge-off on previously reserved loans of $13 million; reserve releases from the troubled loans sold of $8 million and continued improvement in the loss trends of the mortgage portfolio.
These decreases were in part offset by higher reserves for auto loans mainly related to the growth of the portfolio. The decrease in the U.S. reflects settlements and charge-off related to the taxi medallion portfolio.
As of the end of the third quarter, the ratio of allowance for loan losses to NPLs stood at 92% compared to 96% in the previous quarter. The provision for loan losses totaled $36 million, slightly down from $40 million in the prior quarter. Notwithstanding, the increase in net charge-offs, the provision decreased due to the effects of the loans sold and the improvements in the Puerto Rico mortgage portfolio.
To summarize, credit quality results for the third quarter continued to show stable trends, although certain events affected NPL inflows and charge-offs in Puerto Rico. The credit quality metrics of our U.S. operation remained favorable with strong performance for the quarter.
With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.
Thank you, Lidio and Carlos for your updates. The third quarter was another solid one as we continued to build on the strong performance of the first half of the year. Our Puerto Rico franchise is unrivaled. We've consistently grown our retail and commercial customer base and serve approximately 1.8 million customers.
We do not take our leadership position for granted, however, and we remain focused on enhancing our customers' experience across all our channels. Our unmatched branch network is enhanced by innovative digital solutions. Approximately 893,000 of our clients are active online and 78% of these clients use mobile devices to interact with us.
In September this year, 52% of our deposit transactions in Puerto Rico were processed through smart ATMs and mobile devices, a figure that has been growing consistently. The breadth and depth of our retail and commercial product offerings in Puerto Rico allow us to meet the evolving banking needs of our customers.
Our operation in the mainland United States while more focused provides diversification to our footprint. We have a strong commercial lending unit that is complemented by two specialized national lending businesses; Condo association banking and health care. Our investments in Evertec and BHD León contribute to earnings and also represent unrecognized value. We are encouraged by our results and remain focused on enhancing shareholder value.
We are now ready to answer your questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Brett Rabatin of Piper Jaffray. Please go ahead.
Hi, guys. Good morning.
I've got a ton of questions. Let me just start with the balance sheet. And talking about money market, it was up $2 billion in the period -- $1 billion on average and $2 billion deposit growth. I assume a lot of that was government deposits. Can you just talk about one the deposits in the quarter? And then kind of what you plan on doing with the excess liquidity relative to the buildup in 3Q?
Yeah. Your -- I think your assumption is correct, Brett. A big -- the biggest part of the delta in deposits was public deposits. As I mentioned, we closed the quarter with public deposit balances of $11.4 billion. That has actually gone down by about $1 billion since in the end of the quarter.
As we do not have still a lot of visibility on exactly how that money will be used by the government, we are keeping a lot of it in short -- cash and short-term investments, which explains why that balance went up.
Okay. And then CECL ended up being just a little bit less than we saw it. Maybe a tough question here, but it would seem like you'll be in a net reserve release position next year. Is there a possibility that provisioning could be pretty modest relative to the buildup in CECL in 2020?
I mean, we – Brett, this is Lidio. I mean, we tend not to provide forward-looking provision numbers. And I think provision exercise was -- provision forecasting was difficult prior to CECL. I think after CECL, there are so many moving factors that it would be even more difficult. I think we're still going through our modeling and understanding sensitivity, so there are not much information that we can provide you at this time.
Okay. And then just thinking about capital, you have Evertec the excess reserves. The goal is to get to 11% to 12% CET1, you're at 17.5%. CECL doesn't impact it that much. How do you -- and I know that payout ratio is not expected to be even 100%? How are you guys going to deploy capital in the next year to kind of absorb some of that excess level?
Yeah. I think the answer to that hasn't changed very much from the one you've heard us convey before Brett unfortunately. We're going to have to try to pull all the levers available to us. We're going to have to hopefully find some assets that we can purchase.
Hopefully, we get some organic growth both in the mainland and Puerto Rico. And that will be the best -- partial deployment of capital obviously is our highest-return business. We are in the midst of our discussions with regulators with respect to capital return.
By the way, since I -- probably the next question will be timing of that. Timing hasn't changed. We're in discussions and we are still hopeful that we'll be in a position to share something with the market in our fourth quarter webcast in January.
So, hopefully, we can continue to share more of that with our shareholders. And in due course -- as you know, we can really do M&A in Puerto Rico in due course. We'll look at opportunities in that front as well.
So we're going to have to try to pull all the levers. And over time, hopefully, our capital levels will trend in the direction of our industry peers.
Okay. Just one last quick one and I'll hop back in the queue. Were you guys -- did you guys get a look at the card portfolio that Santander did not include in the transaction with FBP?
No. We don't…
No. We don't comment on deals until they're announced.
Okay. Great. Thank you.
Your next question will come from Scott Valentin with Compass Point. Please go ahead.
Thanks for taking my question. Just with regard to non-interest expense, there were a couple of items. Professional fees were up. And Carlos you gave guidance for -- of $385 million in the fourth quarter. I assume that includes the added incentive accruals in that...
Yes that includes everything, Scott.
Okay, it's everything. Okay. And then just -- I know you don't want to comment on 2020, but when we think about a base rate for non-interest expense, if we exclude the accrual, is that then kind of a good base rate to go forward? And then it would assume grow a little bit with inflation and maybe some investment. But that would be a good base rate ex the accrual?
I mean, we are still in the midst of trying to finalize our own budget. And that is usually the basis on which we share with the market, our estimate for card expenses, I believe for this year, so we haven't concluded that yet. So I can't give you and tell you an answer quite yet. You have to give me a few more weeks for that.
Okay. Fair enough. And then on the change in auto policy, I assume that was I guess, Reliable's policy now is in effect the same as BPOP's policy. I assume that that was the driver?
In charge-off policy.
Yes in charge off policy.
We're aligned for both groups.
Okay. But it was Reliable moving to BPOP and not BPOP moving to Reliable, I assume?
There were two changes. One of the changes was Reliable moving to BPOP and the other one's I think the reverse.
Okay. And then last question and I'll hop back in the queue. Carlos, you mentioned, I guess, a legal expense that was in non-interest expense. Is that a one-time item or is that something to watch going forward?
No, that's mostly related to the securities arbitration case is the accrual increase in accruals. As you know the FINRA has like a six-year statute of limitations and that was coming up I believe in August. And so we had a number of new cases were filed before the deadline. So we've increased the reserve for securities arbitration related to mostly the Puerto Rico bonds.
Okay, all right. Thanks very much.
The next question will come from Alex Twerdahl with Sandler O'Neill. Please go ahead.
Hey, good morning, guys.
I was just hoping maybe you could shed a little bit more light on the expectations for loan growth. I guess I was kind of a little bit surprised to hear you say that you're really expecting loans to be flat in the fourth quarter just given some of the positive economic trends that you were citing earlier in the call.
And unemployment seems like it's -- or employment seems like it's kind of broken through that stubborn level of 1 million jobs recently and money coming to the island. What you think is going to really be -- when are we going to start to see loan growth pick up in a more meaningful fashion from some of the sectors that are not just the consumer piece?
This is Ignacio. That's very hard to predict. I mean, we have seen when you go around and you talk to clients, you see a more sort a positive attitude and you see people looking at things. Obviously, like I said early on the call, the flow of federal funds has been slower, so that has stopped the construction industry a bit. But we continue to see hotels added or going to be added next year, so that should help employment and some loan growth.
But there's still a lot of liquidity in the system. And we are originating a lot of loans but we're getting a lot of payoffs. So again we're -- I don't see this is going to be like a one-moment jump-off. I think it's going to be a gradual increase.
We are still optimistic that loan growth will pick up eventually in 2020 as the economy picks up. But again, we've been -- it's tough, because there's a lot of liquidity and a lot of loan payoffs. So we're working very hard to originate loans. We do see a positive sentiment in our clients so -- but I don't think you're going to see an immediate jump from one quarter to the other like that.
I mean, our bank is very busy Alex. They're actually disbursing a lot of loans. But as Ignacio said, part of the challenge is our clients have a lot of money as well. And actually we've seen that in the increase in our commercial deposits. So the level of pay-offs continued to be high. So that's our best guess for this quarter. I mean, hopefully, it ends up better than that. But it's our best guess what we're seeing right now.
Okay. And then just a little bit more color on the deposit flows. I know you said, you had already seen $1 billion or so of deposits flow out quarter-to-date or since the end of the last quarter to now. Do you think that's kind of the start of a long trend of deposits flowing out? Or is there some specific payments that the government had to make that caused that outflow? Or I mean, do you have any visibility just over at least the next couple of quarters?
No, specific payment. As you know the final adjustment has been filed with the court which would provide for certain payments that need to be made for retirement plans and the beginning of the payment of debt. But that has not been approved so there really hasn't been any change in that. The government obviously from time to time relocates -- reallocates its deposits from -- with different banking institutions. So not only is it the use you can't assume we get all the deposits. So they may reallocate some of those funds.
With time we all expect the government deposits to go down. We know that eventually a plan adjustment will be reached. The money will be used. They will have less excess liquidity. And sort of very, very, very hard to predict that. So we'll see. I think we're getting closer to a plan of adjustment we -- maybe some time 2020. But that's -- there's going to be all kinds of litigation all kinds of complications. So very, very difficult to predict when. But in the long-term we know those funds will go out. But nothing specific has happened other than I would say certain reallocations among different depository institutions.
Okay. Thanks for taking my questions.
The next question will come from Mark Palmer with BTIG. Please go ahead.
Yes. Thank you. Wanted to see if you could comment on the pipeline for asset acquisitions, which is one of the means through which you would deploy capital both in Puerto Rico and also on the mainland?
No, we're always looking for asset acquisitions, Mark. In Puerto Rico it's a little bit easier because almost all financial assets are in our bucket list. There's very few segments in Puerto Rico where we don't participate. In the U.S., it's a bit less so because we have a more focused operation in the U.S. There is always things we work on nothing specific that I can comment on right now.
And the ones I can say is that we don't seem to be working anything at the magnitude of Reliable unfortunately. So working a bunch of things that we're always looking at. They are not of that magnitude. They tend to be smaller pockets of assets, but nothing specific right now.
Okay. And also if you could comment on what impact you see from consolidation on the island. And in particular the just-announced Santander deal with FirstBank Corp as pertains to BPOP and opportunities?
Well, yes, I think that obviously we're seeing a big change in the local banking industry that obviously, I think, many of us including you anticipated. So you will be seeing two big international banks Scotia and Santander assuming all regulatory approvals are acquired will be exiting the market by the first half of next year. Obviously, we think that will create a lot of opportunities for us.
Clients will have to deal with the disruption of these mergers as well as the institutions themselves. You never know that some clients may have been inclined to be at either one or both of these banks because they wanted to be with a big international bank. You don't know what motivates customers. So that -- it will be an opportunity for us to go after clients. And that -- they have been in those banks for a specific reason that no longer apply. So we see a lot of opportunity maybe opportunity to pick up good talent also. And there's going to be synergies in these mergers so there won't presumably there will some talent that will be available.
So we think there's a lot of opportunities. And obviously in most large transactions we're a player already. We may become a larger player have a better chance at those that we're not. Now that said we're always going to have to up our game. Eventually after these conversions are done we're going to have two local competitors that are going to be very focused on this market. So we're going to have to up our game and become very, very -- just executing even better than we've done in the past. So we see lots of opportunities, but we're also going to be on our toes.
The next question will come from Glen Manna with Keefe, Bruyette & Woods. Please go ahead.
Hi. Good morning.
I just have a question on the CECL on the impact the $360 million to $400 million. Does that include both the originated book and kind of the PCI to PCD? And then when I take the $360 million to $400 million and divide it by the 85% to 95% I get in the $420 million for a reserve. But I think your reserve is over $500 million. So, I guess what am I missing there on that math?
I mean, we stated that we are excluding from the analysis purchased impaired loans. So the answer to the first – to your first question and also the answer to the second question.
Okay. Thank you. And also, Ignacio you had cited better auto sales. Some of auto sales this year have been fleet sales. Does Reliable and BPOP participate in that market also?
Yeah. We participate in that market. Every year, there's fleet sales so some of that is seasonal. But I would – I don't think – I wouldn't make the deltas or the difference of the years. Fleet sales are always important, but yes we do participate in that market.
Okay. Thank you.
[Operator Instructions] Our next question will come from Brett Rabatin of Piper Jaffray. Please go ahead.
Hey, thanks for the follow-up. Wanted to talk about the margin a little more for a second. I know there is a lot of components that go into it but given your stated asset sensitivity and the liquidity on the balance sheet can you give us some color on how you're thinking about the margin in the fourth quarter? And then Fed cuts from here kind of impact that you would see from that?
Yeah. I mean the – sorry, we don't give guidance on margin, but I can talk about the components of what stands up in our margin. There's sort of three pieces to our margin. The first piece is mix. And that is driven by when we have a significant influx in deposits that tends to be in the – at least in the short-term – in short term investments. So investments are lower yielding than loans. So, when this happens with the mix our margin will suffer even though we'll make more money, and we'll make higher net income, but our margin will suffer. Again, the asset side of the mix will very much depend on deposit flows. The second part of the margin is loan yields. And if you look at the loan yields this quarter, the change in loan yields is sort of in the right ballpark. If you think about third of our loans are variable and the Fed cut rates twice, but the actual market rates went down more than by 25 basis points for the quarter.
The average market rates probably went down mid-30s or low-30 basis points. So a third of that – it sounds about right given our loan mix. And that's what you sort of saw on our – on the loan yields. To the extent that, there is no change in mix of loans and to the extent that the changes in rates going forward are the same as have in the third quarter then the effect on loan yields will be similar. And the last piece is the core cost of deposits that's composed of two pieces.
Our personal/commercial deposit book in Puerto Rico that as we commented had no change in cost this quarter; and then our public deposits in Puerto Rico that we commented previously had a beta of one it really is market-linked. But to the extent that that – the balance of those deposits go up and down, it will affect our overall reported cost of funds meaning that sensitivity will be reduced. So, overall the sensitivity of our cost of deposit is low as you know. So the outcome depends on these three pieces. Depending on what your assumptions are for those three pieces you'll get the answer.
Okay. Thanks, Carlos. And then I guess going back to credit. Maybe Lidio, can you talk a little bit – you talked about credit some, the $41 million of TDR commercial estate loans. Was there anything that was similar with all three of them? Or what – I guess I sort of – I can't remember how many they were. But what kind of resulted in those becoming inflows in the NPL category?
Those were – I mean there are two or three big ones in the number and that were just CRE loans that were in the process of being renegotiated. Under that process, we made the determination that given the outlook they were not -- we're putting them on accrual. Nothing specific that I would add other than the fact that they are non-occupied so they are unrelated.
But on the other hand, I think important to note that they have continue to pay. I mean we just based on current accounting guidance and regulatory guidance we felt that a movement to non-accrual was appropriate.
Okay, fair enough. And then one last one just on competition. Some banks in the U.S. have noted another ratcheting of competitive pressures relative to the decline we've had in rates. And now Puerto Rico essentially has three institutions. Can you talk maybe a bit about where rates have gone on new originations versus the decline in interest rates and kind of how you see that playing out?
Well, I think it depends on -- as you've seen our variable rate book, obviously, goes down with market rate. So, as Carlos was saying about a third of our book is tied to variable rates, so it's going to go down with the market.
In Puerto Rico, then you have different sub-segments of the market, right? You have the residential mortgage market which you have the one that's basically conforming which is based on really almost national pricing from Fannie Freddie and Ginnie; and the other non-conforming book.
I think that probably we've been able to protect our loan yields better than some banks in the states. But there is competition in Puerto Rico, so we have to be competitive.
Yes, I mean one thing to keep in mind is that we have -- our competition is really sector-dependent, so it's not necessarily only the local banks in the middle and smaller commercial segment. I think the local banks are our core competition.
In the large commercial segment, we compete with stateside banks and pension funds and hedge funds and everybody else. So, that competition actually will not change as a result of the local consolidation.
In some of the consumer products, we compete -- for example in auto, we compete with the captives from the different auto companies.
And the credit unions.
And the credit unions very big. In the personal loan business, we compete at one level with national offers from markets and other people in other level with local credit unions.
Credit cards is really a national market, so we compete with American Express, and Bank of America, and JPMorgan, and et cetera. So, the -- some of the pricing competition we deal with every day is not all necessarily local.
Okay. Not to belabor it too much, but maybe a better way to ask the question. Your U.S. operations versus your Puerto Rico operations have loan spreads in Puerto Rico held up better than what you've see the U.S.?
Yes, yes. The answer is an always yes.
Yes. Easy answer. Especially, the CRE market in the U.S. which has been the most competitive of all.
Okay, great. Thanks for additional color.
This concludes our question-and-answer session. I will like to turn the conference back over to Ignacio Alvarez for any closing remarks. Please go ahead.
Thank you for joining us today and for your questions. We are pleased with our results and look forward to share our results for the full year in January. Thank you very much.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.