Popular, Inc.: Provision Reversals To Boost Earnings
Summary
- The provision expense will likely remain subdued in the year ahead because allowances currently appear excessive. Further, Puerto Rico's economy has considerably improved.
- The federal stimulus will likely boost deposits, which in turn will likely drive earnings growth in the remainder of the year.
- A shift in the asset mix towards lower-yielding assets will likely pressurize the net interest margin.
- The December 2021 target price suggests a downside from the current market price. Further, Popular Inc. is offering a low dividend yield.
Earnings of Popular Inc. (NASDAQ:BPOP) will likely surge this year mostly on the back of net reversals of provisions for loan losses. Further, the stimulus-driven deposit growth will likely boost earning asset growth in the year ahead. On the other hand, the shift in asset mix towards lower-yielding assets will likely pressurize the average earning asset yield, which will pressurize the bottom line. Overall, I'm expecting the company to report earnings of $6.04 per share in the last three quarters of 2021, taking full-year earnings to $9.16 per share, up 56% year over year. The year-end target price suggests a downside from the current market price. Based on the price downside and a low dividend yield, I'm adopting a neutral rating on Popular Inc.
Net Provision Reversals Likely for This Year
Popular reversed a large part of its provisions for loan losses in the first quarter of 2021. I'm expecting the provision expense to remain subdued in the year ahead because the company has built up a large level of reserves last year that may be excessive. Allowances made up 2.75% of total loans at the end of March 2021, as mentioned in the first quarter's earnings release. In comparison, net charge-offs made up 0.29% of average loans in the first quarter.
Moreover, bankruptcies in Puerto Rico are on the downtrend because of economic recovery in the territory. Data by Economic Development Bank for Puerto Rico shows that bankruptcies have declined throughout the last year. The following chart shows the trend of bankruptcies.
Considering the factors mentioned above, I'm expecting Popular to report net reversals of provisions of $22 million in 2021 as compared to a provisions expense of $293 million for 2020.
Earning Asset Growth to Boost Net Interest Income
The management mentioned in the first quarter's conference call that it expects the federal stimulus and tax revenues to boost public deposit balance in the year ahead. As a result, I'm expecting deposits to grow by 3% by the end of December from the end of March 2021. For the full year, I'm expecting the deposit balance to increase by 6% year-over-year.
Meanwhile, the loan portfolio will likely decline this year because of limited credit demand. The management mentioned in the conference call that its clients have unprecedented levels of liquidity, which will likely keep the demand for credit subdued this year. The management does not expect material loan growth before next year.
Further, the forgiveness of Paycheck Protection Program ("PPP") loans funded last year under round one is likely to constrain loan growth. As mentioned in the conference call, Popular had round one PPP loans totaling $670 million at the end of March, representing 2.3% of total loans. As the round one PPP loans do not make up a large part of the total loan portfolio, the impact of the forgiveness on the loan portfolio size will be limited. Meanwhile, the accelerated recognition of the unamortized portion of PPP fees totaling $50 million will likely boost the net interest income at the time of forgiveness, which will most probably happen in the second quarter. The net interest income will likely decline in the second half of the year following the forgiveness of the round one PPP loans.
Due to the anticipated decline in loans and decent growth in deposits, I'm expecting Popular to invest in securities and other interest-earning assets. This growth in earning assets will likely drive earnings in the year ahead. The following table shows my estimates for loans, deposits, and other balance sheet items.
A Shift in Earning Asset Mix to Drag Earnings
Due to the anticipated decline in the loan portfolio and growth in other earning assets, the asset mix will likely shift towards lower-yielding assets. As a result, the average earning asset yield will likely face pressure in the year ahead. Moreover, the reinvestment of funds from maturing loans at lower rates will likely pressurize the average portfolio yield.
The management mentioned in the conference call that it expects the margin to be stable for the remainder of the year. In my opinion, the management's outlook is too optimistic given that the asset mix is likely to shift towards lower-yielding assets. Overall, I'm expecting the net interest margin to decline by six basis points in the last three quarters of 2021, excluding the impact of the accelerated PPP fees. This will result in the average net interest margin for 2021 being 28 basis points below the average margin for 2020.
Expecting Full-Year Earnings of $9.16 per Share
The net reversals of provisions and earning assets growth will likely boost earnings this year. On the other hand, pressure on the average earning asset yield will likely drag earnings. Overall, I'm expecting Popular Inc. to report earnings of $6.04 per share in the last three quarters of 2021, taking full-year earnings to $9.16 per share, up 56% year-over-year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and new variants.
December 2021 Target Price Below the Current Market Price
Popular is offering a dividend yield of 2.2%, assuming the company maintains its quarterly dividend at the current level of $0.40 per share. The management mentioned in the conference call that a dividend increase is unlikely in the remainder of the year.
I'm using the historical price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Popular Inc. The stock has traded at an average P/TB ratio of 0.90 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $66.5 gives a target price of $59.8 for the end of 2021. This price target implies a 19.2% downside from the April 30 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 7.7x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $9.16 gives a target price of $70.1 for the end of 2021. This price target implies a 5.2% downside from the April 30 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $64.9, which implies a 12.2% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 10.0%. Hence, I'm adopting a neutral rating on Popular Inc.
The company's earnings are set to surge this year because of net reversals of provision for loan losses and earning assets growth. Unfortunately, the current market price appears high.
This article was written by
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