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spk08: Hello and welcome to today's Popula fourth quarter 2022 earnings call. My name is Bailey and I'll be the moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star followed by one on your telephone keypad. I would now like to pass the conference over to our host, Paul Cardillo, Investor Relations Officer at Popula. Please go ahead.
spk10: Good morning and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez, our COO, Javier Ferrer, our CFO, Carlos Vasquez, and our CRO, Lidio Soriano. They will review our results for the full year and fourth quarter and then answer your questions. Other members of our management team will also be available during the Q&A session. Before we begin, 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.
spk03: Good morning, and thank you for joining the call. Our results for the quarter and the full year were solid and reflect the strength of our franchise. Our record annual net income of $1.1 billion reflects an increase of 168 million above our 2021 annual net income of 935 million. The increase was largely driven by the benefit of the Evertech transactions and the partial reversal of the DTA valuation allowance. The results also reflect higher net interest income, partially offset by higher provision expense and higher operating expenses. The 2021 results included a provision benefit of 193 million. During the summer, we completed the acquisition of key customer-facing channels from Evertech and also made important changes to our contractual relationship with them. Leveraging these transactions, we have embarked on a broad-based, multi-year technological and business process transformation. The needs and expectations of our clients, as well as the competitive landscape, have evolved, requiring us to make important investments in our technological infrastructure and adopt more agile practices. Our technology and business transformation will be a significant priority for the company over the next three years and beyond. We believe that there continues to be an opportunity for growth in our primary market as well as within our existing customer base, and these efforts will help capitalize upon that opportunity. We are confident that these investments will make us a stronger, more efficient, and profitable company. Throughout 2022, we continue to return capital to our shareholders. During the year, we repurchased 8.25 million shares of common stock for 631 million, which surpassed our original expectation of 500 million. We also increased our quarterly common stock dividend to 55 cents per share, representing nearly 164 million in dividends paid in 2022. Credit quality remained strong throughout 2022. We are pleased with how our portfolios have continued to perform particularly with net charge-offs well below historical levels and a lower level of non-performing loans. Our capital levels are strong with year-end common equity Tier 1 ratio of 16.4%. Our tangible book value ended 2022 at $44.97, a 31% decrease year-over-year, primarily due to unrealized losses on investment securities. However, during the fourth quarter, tangible value increased by 16%. Please turn to slide four. Our quarterly net income, excluding the partial reversal of the DTA valuation allowance, was 189 million, or 7 million lower than the adjusted third quarter net income of 196 million. Fourth quarter results were impacted by lower net interest income, which reflected higher loan income but was more than offset by the higher cost of public deposits as well as a higher provision for credit losses. Loan growth was strong and broad-based during the quarter, both geographically and across most loan segments. Total loan balances held in portfolio grew by $560 million. Commercial loan growth in particular was healthy at most banks in the fourth quarter. Our net interest margin decreased by four basis points to 3.28% in the quarter. Higher deposit costs, particularly in our Puerto Rico public deposit portfolio and a popular bank, impacted the margin. This was offset in part by an improvement in asset mix due to loan growth and a reduction in the investment portfolio. Credit quality trends remained favorable during the period. Non-performing loans decreased in the quarter and net charge-offs have remained well below pre-pandemic levels. Please turn to slide five. Our customer base in Puerto Rico with approximately 28,000 during the year, reaching 1.98 million unique customers. Adoption of digital channels among our retail customers continues to be strong. Active users on our Mediuncle platform exceeded 1.1 million, or 56% of our customer base. Additionally, we continue to capture more than 60% of our deposits through digital channels. This trend remains significantly higher than pre-pandemic levels and well above our island peers. Commercial loan growth was strong. Commercial loan balances at BPPR and Popular Bank increased by $118 million and $255 million, respectively. Credit card and auto loan and lease balances at BPPR increased by $53 million and $31 million, respectively. In the fourth quarter, the dollar value of credit and debit card sales of our customers increased by 11% sequentially, and we're 6% above the fourth quarter of 2021. As on the mainland, mortgage originations in Puerto Rico have been impacted by rising rates and limited inventory of available properties. The dollar value of mortgage originations at BPPR decreased by 29% compared to the fourth quarter of last year, driven by lower refinance activity due to the interest rate environment. However, loans to finance the purchase of homes decreased only 11% during the same period. The local economy continued to perform well during the fourth quarter and business activity has remained strong. We remain encouraged by solid employment levels. In December, total non-farm employment in Puerto Rico increased slightly from its level in September and was 4% higher than in December of 2021. New auto sales increased by 3% in the fourth quarter compared to the same period in 2021. While auto sales declined by 4% in the year, 2022 was the second highest year of sales since 2006, easily surpassing pre-pandemic levels, evidencing continued robust demand for cars. The industry is forecasting new car sales of 118,000 for 2023 well above pre-pandemic levels. The tourism and hospitality sector continues to be a source of strength for the local economy, as Puerto Rico is a popular destination for mainland residents. Airport traffic has remained robust. Year-to-date through December, total passenger traffic increased by 7% compared to 2021. Hotel demand has also remained strong. Occupancy rates were up more than 500 basis points in 2022 and the average daily room rate continues to compare favorably to historical results. In short, we are pleased with the results of the year, particularly our robust loan growth and continued strength in credit quality. We are mindful of the global economic uncertainty and market volatility, but remain optimistic about the future of Puerto Rico, our primary market, and our ability to manage through any potential challenges that may lie ahead. I now turn the call over to Carlos for more detail on financial results.
spk04: Thank you, Ignacio. Good morning. Before we turn to fourth quarter results, let me expand on Popular's 2022 full-year performance, which is included in the appendix to this presentation and today's press release. In 2022, we reported record annual net income of $1.1 billion, $168 million of our 2021 annual net income. The increase was largely driven by the benefit of the Evertech transactions and the partial reversal of the DTA valuation allowance, somewhat offset by provision expense. Our net interest income increased by 11% year-over-year to 2.17 billion due to higher rates, loan growth, and the change in the mix of earning assets. For the year, we reported an 83 million provision for credit losses, which compares to a provision benefit of 193 million in 2021. Non-interest income increased by $254 million year over year, primarily driven by the impact of the Evertech transactions. Operating expenses increased 13% in 2022 to $1.75 billion, with higher personnel, technology, professional fees, and regulatory costs. Please turn to slide six. Net income for the fourth quarter was $257 million, This compares to $422 million in Q3. Excluding the impact of the Evertech transactions in Q3 and the DTA reversal in Q4, net income decreased $7 million to $189 million in Q4. Net interest income for the fourth quarter was $560 million, a decrease of $20 million from Q3. Interest income grew by $62 million from loan growth at both banks, as well as higher yields on loans and investment securities. This was more than by upset by higher interest expense on deposits, resulting from increased deposit rates, mainly from Puerto Rico public deposits and to a lesser extent, popular banks. Non-interest income was 158 million, a decrease of 268 million from Q3. The results of the third quarter included a 258 million pre-tax gain on the Aerotech transactions and a favorable fair value purchase price adjustment of 92 million related to the U.S. equipment finance business we acquired in 2021. Excluding these items, the remaining variance in non-interest income resulted mainly from lower deposit service fees. The fourth quarter non-interest income results fully embed the changes in overdraft policies and the reduction in equity pickup from the sale of our Evertech shares. The results also include an $8.2 million gain on the sale of a previously written-off investment Excluding this gain, the non-interest income for the quarter would have been approximately $150 million. For 2023, we expect non-interest income to continue around this $150 million per quarter run rate, or approximately $600 million for the year. The provision for credit losses in the fourth quarter was $50 million compared to $40 million in the third quarter. Total operating expenses for $462 million in the quarter, a decrease of $14 million from the prior quarter. Q3 included $17 million in expenses related to the Ameritech transactions and a $9 million goodwill impairment on our U.S. equipment finance business. Excluding these items, expenses increased by $12 million, mostly resulting from a $10 million increase in technology expenses, seasonally higher business promotional expenses by $4 million, higher other processing and transactional services by $4 million, mainly due to higher network incentives received during the prior quarter, and higher professional fees. For 2023, we expect annual expenses of approximately $1.87 billion, compared to our expenses of $1.75 billion during 2022. The drivers of the $120 million increase will be, first, continued increase in personnel expenses driven primarily by the previously announced increase in our minimum hourly wage from $13 to $15, which took effect on January 1st. This will add approximately $15 million to expenses in 2023. Additionally, the market salary adjustments that were made effective on July 1st of last year will be in effect for the full year 2023. There will also be a 2023 merit increase that traditionally is granted in the summer. These two items will add approximately $24 million to expenses in 2023. These actions are necessary to keep our compensation competitive. Second, we expect that the FDIC's two basis point increase in assessment rate to all depository institutions will add $14 million to expenses. Pension and retirement health care expenses will also increase by $19 million. Finally, As Ignacio described in his opening remarks, we have undertaken a significant multi-year corporate transformation initiative. As part of this transformation, we aim to expand our digital capabilities, modernize our technology platform, and to implement agile and efficient business processes across the entire company. Since completing the Evertech transactions on July 1st through the end of last year, we invested $24 million towards this effort. primarily in professional fees and technology expenses. In 2023, we anticipate transformational data expenses of $50 million. These technological ways of working and operational investments will result in an enhanced data experience for our clients, as well as better technology and more efficient processes for our employees. We expect these efforts to contribute to higher earnings and better efficiencies. resulting on a sustainable 14% ROTCE target by the end of 2025. To facilitate the transparency of our progress in some of these efforts, we have now separated technology, professional fees, and transactional activities as stand-alone items in our income statement. Our effective tax rate for the quarter was a benefit of 24% compared to an expense of 14% in the third quarter. The income tax benefit in Q4 was mainly due to the $68 million partial reversal of the DTA evaluation allowance of the U.S. operation. Excluding this impact, the effective tax rate for the fourth quarter was 12% compared to 14% in the third quarter. This partial reversal was based on our evaluation of the sustained profitability of the U.S. operation over the last two years, as well as evidence of stable credit metrics while considering the remaining life of the net operating losses. As of December 31, 2022, the DTA related to the U.S. operations was $278 million, net of evaluation allowance of $423 million. For the four-year 2023, we expect the effective tax rate to be in a range of 18 to 22 percent. Please turn to slide seven. Net interest income was $560 million. On a taxable equivalent basis, it was $622 million, $25 million lower than in the third quarter. Net interest margin decreased by four basis points to 3.28% in Q4. On a taxable equivalent basis, NIM was 3.64%, a decrease of seven basis points. The decrease is driven by higher interest expense on deposits due to a significant though anticipated 159 basis point increase in the cost of public deposits. It was partially upset by higher loan balances and yields, plus an improved mix of earning assets. At the end of the fourth quarter, public deposits were roughly 15.2 billion, a decrease of 2.2 billion from Q3. We expect public deposits to be in a range of 13 to 15 billion during 2023. Over the next couple of quarters, the balance of public deposits should increase given the cyclical nature of tax collections. However, the balances should decrease during the second half of 2023. Excluding Puerto Rico public deposits, deposit balances declined by $1.4 billion in the quarter, mainly from excess cash balances of corporate clients. These declines are reflective of clients pursuing better yields on excess equities. Popular continues to have a strong relationship with these clients. Our Puerto Rico commercial deposit balances remain $5 billion higher than they were in December of 2019. We will continue to actively manage the cost of commercial deposits, taking into consideration the overall client relationship and our liquidity position. Retail deposit balances remain stable. Our ending loan balances increased by $560 million, or almost 2%, compared to Q3 and are up by 2.8 billion or just under 10% year to date. Commercial loan growth was particularly strong and all other low segments were higher in the quarter except for construction. We are encouraged by credit demand at BPPR and PB. We will continue to take advantage of opportunities to extend credit, thereby improving the use and yield of our existing liquidity. While we expect to see continued strong loan growth in 2023. We do not anticipate it will replicate 2022's exceptional growth rate. Please turn to slide eight. Year to date, our retail deposit franchise, particularly in Puerto Rico, has continued to track below its historical beta. Commercial deposit betas have remained low, but are now tracking slightly above the prior cycle. Retail and commercial deposits represent a lower proportion of total deposits compared to the last rate cycle due to the increase in public deposits. As we discussed last quarter, during the rapid shift up to higher short-term interest rates, we expected a significant increase in the cost of public deposits. In the fourth quarter, the cost increased by 159 basis points. We expect the magnitude of the increase in cost upon deposits to moderate in Q1 to approximately 120 basis points. As we have described in the past, the deposit pricing agreement with Puerto Rico public sector clients is market linked with a lag. This source of funding results in an attractive spread under market rates. Please turn to slide nine. In 2022, we reported a decrease in fair value of the investment portfolio that we expect to be temporary. Our investment portfolio is almost entirely comprised of Treasury and agency mortgage-backed securities, which carry minimal credit risk. The bond portfolio has an average duration of approximately 2.8 years. As the positions roll down the yield curve, their fair value will converge to par, and the mark will go down to zero. As discussed in our last webcast, given the rapid increase in interest rates in 2022, as well as the uncertain outlook for interest rates, In October, we transferred to health and maturity $6.5 billion of US Treasuries in the four to six year term, thereby reducing the future impact of rates on tangible book value. At the time, this action reduced AOCI exposure to interest rates by about a third. When transferred to HTM, these positions had a pre-tax unrealized loss of $873 million, which will be amortized back into capital throughout the life of the transferred positions. As of the end of the fourth quarter, the balance of the unrealized loss stood at $832 million, a reduction of $42 million. We expect a similar quarterly amortization through 2026. The yield on transfer securities remains the same and no losses were recognized as a result of this move. This transfer doesn't have a material effect on our liquidity, as we continue to maintain a large available for sale portfolio in short-term treasuries and cash at the Fed. The changes in real life gains and losses in AOCI have an impact on the corporation's tangible capital ratios, as well as those of our wholly owned banking subsidiaries, but they do not impact regulatory capital ratios. Please turn to slide 10. Our return on tangible equity was 19.2% in the quarter. Regulatory capital levels remain strong. Our common equity 3-1 ratio increased by 35 basis points in Q4 to 16.4%. In December, we completed our previously announced $231 million ASR, repurchasing approximately 3.2 million shares, an average purchase price of $72.66. To summarize our capital actions last year, we repurchased $631 million common stock, or 8.25 million shares via two separate ASRs and increased our quality dividend by 10 cents per share to 55 cents per share. Tangible book value at quarter end was $44.97 per share, an increase of $6.28 per share from Q3. We were mostly by quarterly net income of 257 million and a favorable variance of 193 million in unrealized losses on securities available for sale. This is partially upset by dividends of 40 million declared in the quarter. Our outlook on capital return has not changed, anchored in our strong regulatory capital ratios. Over time, we expect our regulatory capital ratios to gravitate towards the levels of our mainland peers plus a spread. Given the continued economic uncertainty, we still plan to revisit our future capital actions in the second half of 2023, once we have more clarity around the outlook for interest rates and the economy. With that, I turn the call over to Miguel.
spk01: Thank you, Carlos, and good morning. Overall, Popular continues to reflect stable credit quality trends with low levels of net charge-off and decreasing non-performing loans. We remain encouraged by the performance of our loan book post-pandemic, specifically early delinquency, net charge-off, and non-performing loan formation continue to trend significantly below pre-pandemic levels. We also believe that the improvement in the risk profile of the corporation's loan portfolio positions Popular to operate successfully on the more difficult economic conditions. We remain vigilant and continue to closely monitor changes in borrower performance and the macroeconomic environment, given potential economic headwinds, rising interest rate and geopolitical uncertainty. Turning to slide number 11, non-performing assets decreased by 18 million to 520 million this quarter, driven by an NPL decrease of 14 million, coupled with an overall decrease of 4 million. In Puerto Rico, NPLs decreased by 8 million, driven by lower mortgage NPLs of 10 million and lower commercial NPLs by 5 million. in part upset by higher auto MPLs by 7 million. In the US, MPLs decreased by 6 million, mainly due to a 9 million charge off on a previously reserved commercial borrower in the health care industry. Compared to the third quarter, MPL inflows excluding consumer loans decreased by 3 million, driven by the US health care relationship mentioned previously that was placed in non-accrual in the prior quarter, offset in part by higher mortgage inflows in Puerto Rico. At the end of the quarter, the ratio of MPLs to total loans held in portfolio remained flat at 1.4% compared to the previous quarter. Turning to slide number 12, net charge-off amounted to $31 million, or our annualized 39 basis points of average loans held in portfolio compared to 18 million or 24 basis points in the prior quarter. The results for the quarter were impacted by the 9 million charge-offs on the previously reserved healthcare relationship in the U.S. Excluding this item, net charge-off ratio was comparable to last quarter at 28 basis points. In Puerto Rico, net charge-off remained stable. increasing by 1.5 quarter-over-quarter, mainly driven by higher consumer nature jobs by 5.5 million, mostly due to the auto portfolio, in part offset by lower mortgage nature jobs by 4 million. The corporation allowance for credit losses increased by 17 million, or 2.5%, to 720 million, driven by changes in macroeconomic scenarios, higher loan volumes, and changes in credit quality. The ratio of allowance for credit losses to loans held in portfolio remained stable at 2.25% compared to 2.23% in the previous quarter. The ratio of allowance for credit losses to MPLs held in portfolio was 164% compared to 155% in the prior quarter. The provision for credit losses was an expense of $48 million compared to $40 million in the previous quarter, reflecting the changes in the allowance for credit losses and then in charge of activity. In Puerto Rico, the provision for query losses was 44 million compared to 29 million in the prior quarter, and in the U.S., the provision was 44 million compared to 11 million in the prior quarter. Please turn to slide number 13. As discussed in prior webcasts, we leveraged Moody's analytics for the U.S. and Puerto Rico economic forecasts. Notwithstanding general economic uncertainty, Moody's baseline outlook remains for the US economy to continue recession-free. Moody's fourth quarter forecast, however, reflects a slowdown in the economy with lower 2023 GDP growth for both Puerto Rico and the US. The baseline scenarios assume a 2023 annual GDP growth for Puerto Rico and the US of 1.3% and 0.7% respectively, compared to 2.2% and 1.5% in the previous quarter. The reduction is due to the expected slowdown in the economy as a result of tight monetary policy. The 2023 average unemployment rate remained consistent quarter over quarter. Our framework for the allowance incorporates multiple economic scenarios. In the fourth quarter, we assigned the highest probability to the baseline scenario, followed closely by the more pessimistic recession scenario S3. The quarter-over-quarter difference in the allowance for credit losses was driven by the macroeconomic scenarios and portfolio changes, which includes loan growth and changes in credit quality. To summarize, our loan portfolio continues to exhibit strong credit quality metrics in the fourth quarter, with low net charge-offs and decreasing non-performing loans. We remain attentive to the evolving environment, but remain encouraged by the post-pandemic performance of our loan book. With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.
spk03: Thank you, Lidio and Carlos, for your updates. 2022 was an outstanding year for Popular. In addition to record earnings, we achieved strong credit quality, continued customer growth, closed the Evertech transactions, launched our transformation, and successfully executed on our capital actions. Our franchise provides a powerful platform to go beyond serving our customers. It also affords us the opportunity to positively impact the lives of our colleagues and communities and create value for our shareholders. In 2022, we reached key milestones, including participating in the Bloomberg Gender Equality Index, issuing our ninth corporate sustainability report, also following Hurricane Fiona, we provided immediate relief to affected communities and clients and assisted impacted employees. Looking ahead, I am optimistic about the economic outlook in Puerto Rico, our primary market. While we are aware of the macroeconomic headwinds related to inflation and geopolitical risk, we are confident that given the amount of stimulus support from federal funds, Puerto Rico will continue its growth path, albeit perhaps at a slower pace. 2023 marked Popular's 130th anniversary. Since 1893, we have successfully adapted and led through changing conditions, and we are proud of our history and the legacy that made Poplar what it is today, a strong, vibrant organization with deep-rooted values. Leveraging these strengths, we will continue to transform our organization to ensure its success for many years to come. This entails meeting the rapidly changing needs of our customers, providing our colleagues a workplace where they can thrive, promoting progress in the communities we serve, and generating sustainable value for our shareholders. The team is energized and looking forward to another strong year. We are now ready to answer your questions.
spk08: Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, please press star followed by one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before you ask a question. Our first question today comes from the line of Timor-Brasila from Wells Fargo. Please go ahead. Your line is now open.
spk02: Hi, good morning. Thanks for the questions. Maybe starting on expenses and the technology and business process transformation that has been laid out, I guess on the back end of that, how should we think about Popular? Is this investment in kind of standing up Evertech and getting that investment kind of up to where you expect it to be? Or is this getting Popular more broadly on pace with a broader group? Or do you expect at the back end of 25 for Popular to be an industry leader when it comes to tech and innovation?
spk03: Yeah, I think this is Ignacio. I think, thank you for the question. I think Evertech was the initial phase. It's more than just Evertech. Obviously, Evertech has positioned ourselves to be able to begin to transform our technological foundation. So it's more than just taking over the services Evertech was providing for us. That was an essential step. But obviously, our goal is is to be able to compete with the different entities that are coming to the market, especially in terms of giving digital options to our clients. So yeah, we aspire to be, if not best in class, top quartile in terms of the services and the products we can offer our clients. And Popolar has traditionally been a leader in technology in Puerto Rico. And given what's happening now, I think it's more important than ever That we take this initiative on.
spk02: Okay, and then, in terms of investing into this initiative is the expectation kind of 50 million per year through 25 or does that ramp higher as you get closer to completion.
spk04: yeah i'm not sure we we we. Carlos Ortiz- Being able to nail that down at this point in time timer I think the what what we we expect will happen over time is that the expense will shift. Carlos Ortiz- From from the present expense, which is more weighted towards professional services and consultants and people that are trying to help help us stand up and set up. what we want to do and where we want to go, it will shift to execution. So, again, we haven't nailed down the number, you know, looking forward to 25. The composition of the expense will change into execution and putting in place the systems and the technology that we're designing and selecting right now.
spk02: Okay, great. And then maybe moving to NII and NIM, looks like the inflection point happened here in the fourth quarter. Just maybe an outlook for the magnitude of the remaining inflection as those public funds continue to lag, already happened in interest rate hikes. And then more importantly, kind of once that lag is complete, what's the outlook for NII and NIM growth from there?
spk04: Yes, the components that led to our margin coming down this quarter, those pressures still exist for the first quarter. Moving forward, you described them properly, that the most important one being the increasing cost of public deposits. As we said last quarter, we expect NIM to retake an upward trend in 2023. Exactly when in 2023 it happens will depend on the interaction of the drivers, and you know what the drivers are. The rate of loan growth, the rate of change in interest rates, and deposit balances are the biggest three drivers, and the interaction between those three will dictate exactly when it happens in the year, but we do expect NEM to retake an upward trend in the year 2030.
spk02: Okay, then maybe one last one for me, if I can, just circling back on fee income, the guide for around $150 a quarter. I'm just wondering, when does that inflect and when do we start seeing some of the positive attributes from the combination with Evertech and getting those assets back in-house?
spk04: Well, the biggest driver of the move down from our prior guidance to this 23 guidance is the change in the fact that we don't own the shares of Neurotech anymore, number one. Number two, the change in overdraft policies. And number three, the change on our practice of setting mortgages that we are not setting anymore. So those are... the biggest drivers of the shift down to 150 per quarter, roughly. Obviously, remember, there's always some seasonality in that number. So it goes up and down for different things during the year. But that is the right range. We continue initiatives on our business initiatives to try to continue to move rates up in different fronts. So hopefully, as those initiatives succeed, we can start moving rates up from the 150. And some of those are already being designed and implemented. If everything works well, we may start seeing some of that in 23. But our best guess right now is 150 per quarter. Thank you.
spk08: Thank you. Our next question today comes from the line of Alex Twirdle from Piper Sandler. Please go ahead. Your line is now open.
spk09: Hey, good morning, guys. Good morning. I just want to ask some of the questions the team has asked a little bit differently. I'm just curious, when you put out a target for 2025, why 2025? Does that represent sort of an inflection point or an endpoint in some of these initiatives? Or how can you pick that date or that year?
spk03: This is Ignacio. Basically, we picked that year. The transformation initiative it's going to be an ongoing effort. It's going to change the way we work. But obviously to sort of measure our success, we wanted to pick an initial three-year period where we see where we're going to be at the end of the three-year period. And basically that's how we reached 25. It was kind of arbitrary, but we felt three years gave us enough time to implement the measures that we're doing and to give them time to bear fruit. So that's how we picked it. But obviously, this is where we're all going. And obviously, we expect all these efforts to be sustainable, not only sustainable, so it's not like we're going to reach that and stop, but keep growing incrementally over time.
spk09: Right. And then, you know, is Popular a leaner institution at that point? Or, you know, like what's going to be different? I mean, obviously, every bank is investing in technology meaningfully, but, you know, does it allow you to operate with a reduced branch count or? So what would we see that would be different at that point?
spk03: I'm not sure branch count is the thing you expect to see the most. I mean, that will depend on traffic. We could talk about branches separately, but I think obviously we're aiming to do a lot more things digitally, and we're also aiming to do a lot more things self-service. So, for example, making our underwriting more automatic so you don't have to have as much manual intervention or This is across especially our businesses, but it will apply to everything. Hopefully, you know, we will do our, it will help us with our compliance. We're investing also in technology, which is very manual today, very people-oriented. So really, you know, I can't give you a specific date, but definitely over time, we should see a lot less manual intervention in many of our processes, be the underwriting, be the compliance, be the everything. So I think that's the goal. The goal is to be more digital. uh, more, more, uh, you know, have more self, uh, self servers for our clients. And hopefully over time, that's going to impact us favorably.
spk09: Okay. Are there any sort of chunks of the initiative that might hit at any certain point in time? You mentioned that, you know, a lot of the fees right now are being conducted towards the planning phase, and then there's going to be implementation phase, which maybe is more of a 2024 thing, but are there segments that you kind of, we can sort of look at over the next couple of, um, you know, maybe even more in the near term. to sort of get a good sense for how to track the progress?
spk03: Well, I'm not sure within the near term, but one of the things that we obviously are going to want to be able to report to you is what percentage of our loan applications will be digitally enhanced. And obviously, we will be able to give you numbers on that. We'll be tracking that. And obviously, that will reflect on efficiencies. We've already implemented some things that are less technology-oriented because, again, this is more than just technologies. It's also process improvement in terms of how do we make sure that our pricing strategy for products and services, including cash management, are coherent across the organization. We expect that to bear fruit pretty much immediately. It won't necessarily be a game changer, but that'll bear fruit immediately. So we'll be watching very carefully that in terms of revenues that we're getting from cash management. We're going to make important investments in that area. Now, the technological area in cash management will take us a few years. I mean, when you change a system for cash management, that'll be a couple-year process. But we're very hopeful that will derive benefits for us. But again, we'll be following and closely tracking things about digitally enhanced applications, self-service applications. Those are things that we will be tracking.
spk04: Yeah, I mean, Alex, one of the things that we have a very strong belief that there is still a big opportunity for growth in Puerto Rico by deepening the relationships we have with our existing clients. So a lot of the effort that's going into transformation is for us to execute on that belief, meaning that we will be in a position to provide clients quicker and better service to offer them products that fit their need in a more efficient way. And with that, we increase the satisfaction of our clients. That means we have more happy clients. We have more employees that can actually execute with excellence what we're trying to do as far as client service and all those things add up to positive outcomes as far as the contribution of all those clients to the bank. As Ignacio said, these are incremental efforts. Some small things will start happening in a few months. Other things will start happening next year. So the bigger things that are technology-dependent will probably be a bit back-ended because we have to make the investment and implement the systems to achieve what we want to achieve. But we expect that there will be some quick wins starting soon.
spk03: Yeah. To add to what Carla was saying, one of the big initiatives is designed at what we call personalization and segmentation. And that involves a lot of investment in our data abilities also. But the idea is that we'll be able to offer our clients products that they need faster. And as you know, we have by far the largest client base in Puerto Rico, both retail and commercial. And if we can just penetrate that market, our cost of acquisition will be much below any possible competitors. So we are going to put a lot of effort into the personalization and segmentation.
spk04: And the last comment, for you to get a sense of what we're talking about, I believe we think we have the best digital banking offering in Puerto Rico already. But what we're seeking is to be able to provide more products and services to our clients through that offering and to allow us to roll out new offerings a lot faster than we can do it now. So we're changing the architecture of what is a market-leading digital offering so that we can be a lot more effective in providing more and new services quicker to our clients than we are today. So the client will never see the change in back-end architecture, but they will see the more efficient and bigger offering once we've done that.
spk09: Okay. And then with the 14% ROTC, obviously there's a lot of pieces to that, and it could mean a lot of different things. So can you give us some of the assumptions on capital levels or, you know, like anything else to kind of help us really figure out what it actually means for profitability?
spk04: No. At this point in time, we've chosen that one because it sort of encompasses the result of everything. Alex, you are correct. There's a lot of pieces that compose that. We are not in a position to talk about the pieces specifically yet or right now. But, you know, we think this is the most comprehensive measure of everything that we do. So we've chosen to hang our hat on that one for the moment. But at this point in time, we haven't disclosed the components that will get us there. There's a lot of things that can change along the way as well.
spk09: Okay. And then just one final one for me before I get back in the queue. You gave us the increase in the government deposits in the first quarter of 120. Assuming we get two more hikes, where do those peak out? I mean, can you just spell it out for us?
spk04: I'm afraid where they peak out, you'll have to ask the Fed. If it's true that they go down to 25, there's two more 25s, and that's it, and then they sit tight, then, you know, a quarter after that, you know, you also go in the process of 50 basis points more expenses. But, you know, it really is market length, so it depends on the Fed. Again, our best guess of the Fed increases, it will give us 120. Again, roughly, if it's two more 25s, that will end up being about 50 basis points higher the quarter after that. And once the rates start moving in the other direction, then we'll see that we start seeing the benefit the quarter after that. So I would love to be able to answer your question, but I can't read the mind of the Fed very well.
spk09: But they do, they do peak out below. I mean, last time they peaked at 125 basis points, but below where the Fed peaked out. Is that a reasonable assumption for this tightening cycle?
spk04: It is timing. I mean, we, ultimately, the question you're asking is what's the spread that we make on the deposit. We have never answered that question purposely, and we're not going to start today. But, you know, obviously we do make a positive spread on this, On these deposits.
spk09: OK. Thanks for taking my questions.
spk08: Thank you. As a reminder, if you would like to ask a question, please press star followed by 1 on your telephone keypad. The next question today comes from the line of Kelly Motta from KBW. Please go ahead. Your line is now open.
spk06: Hi. Good morning. Thanks for the question. I may be asking the government deposits question a little bit differently. I appreciate the color around margin and how you expect that to, I believe, start to inflect at some point this year. Does that commentary there require a certain amount of roll-off of the government deposits, or is that irrespective of levels? Just trying to get a sense of how much that may be a driver of that inflecting name you speak of.
spk04: That commentary incorporates the outlook we expressed on the balance of government deposits, that they will remain between 13 and 15 for the year. Again, it's not a constant 13 to 15. They're probably going to be slightly higher than that in the first half of the year, and then maybe slightly lower than that in the second half of the year. But that is what is incorporated in the components of that commentary, Kelly.
spk06: Thank you, appreciate it. And just a point of clarification on your expense guidance, that $1.87 billion that you gave, just want to confirm that includes the innovation stuff that you're doing and that $50 million isn't on top of that $1.87? That number includes the $50 million.
spk04: Yes, definitely incorporated within it.
spk06: Okay, excellent. Thank you so much. Maybe last one for me, I appreciate the time, is on capital. I know you reiterated that you plan to revisit your capital plans in the second half of this year. Wondering if that kind of your decision to do that is there's a certain level of TCE where you would feel comfortable stepping back in. Is there any sort of parameters around that you'd be willing to share? That's part one. And then part two of the question is, you know, by second half of the year, do you think maybe by sometime in July, given the accretion back on AOCI, is that kind of the timing we're looking at here? Yeah.
spk04: We try to answer both questions. There is no TCE target that would trigger us to do something or not do something. What I think, if anything, what will be more important on how we think about this is, again, getting a more clear consensus of what's happening with the economy and what's going to happen with interest rates moving forward. So I think those two components are probably more important. Again, there's no magic number of TCE that will get us there. As Ignacio said last quarter, Our best guess is that we'll get that clarity we're looking for in the summer, and that's where our comment comes from the second half of the year. But you know, if that clarity comes in May, then we're a couple of months ahead. If that clarity comes in September, we may be a couple of months behind, but no specific target. The outlook and there being consensus, a consensus outlook on the economy and interest rates are probably the two most important inputs into the timing of our revisiting of the capital plan. Again, the overall view of capital is unchanged. We're only slightly adjusting the timing here and when we execute, not our intent of what we want to do.
spk06: Great. I appreciate all the color. I'll step back.
spk04: Thank you.
spk08: Thank you. The next question today comes from the line of Gerard Cassidy from RBC. Please go ahead. Your line is now open.
spk05: Hi, National. Hi, Carlos.
spk03: Good morning. Good morning. Happy New Year.
spk05: Happy New Year to you, too. Carlos, on the OCI or AOCI, I should say, when you look at it, you had in the available for sale portfolio about $1.8 billion of unrealized losses. Can you share with us what kind of interest rate environment would we need to see for that number to fall materially from here? Lower. I agree with that.
spk07: The portfolio has about a 2.8 year duration, so that can give you some sensitivity. on the entire piece, right? So you could probably run some calculations based on the duration and the size of the portfolio should give you an idea of, roughly speaking, where the unrealized could move.
spk04: Yeah. Obviously, as Juanpig said, the portfolio is sourced on the short end, so we're the biggest bang for the buck, you'll probably get if short-end rates and intermediate rates move lower. I think everybody's going to be happy if the 30-year comes down, but the 30-year does not have as big an effect on our AOCI as the shorter and intermediate terms do.
spk07: Yeah, the other thing is that there's a significant amount of uh, bonds that mature every quarter. So, uh, you know, the portfolio is laddered out, you know, all the way up to the six years. But, you know, in fact, we probably have about a billion or so that, that mature every given quarter. So that also shortens the duration as time passes.
spk03: Got it.
spk05: And even though, cause yeah, I'm sorry, go ahead.
spk03: And even, and those get reinvested at current rates. Right.
spk05: Right. Right. Um, No, the reason I ask is that I noticed that the agency portion of the portfolio, which has the largest unrealized loss, has a maturity of seven and a half years. And even though I know the total AFS is under three, I didn't know if that meant that part of the portfolio, the longer end of the curve, is something we've got to watch.
spk07: Yeah, that portion of the portfolio is mostly agency pass-throughs. So we put the weighted average life of the instruments. It's a mix of 15-year and 30-year mortgage-backed securities. That has a slightly different basis than Treasury. So that will be a function of where intermediate rates move as well as where the mortgage-backed to Treasury basis moves as well. So we had some relief for that in the fourth quarter.
spk05: Very good. And then following up on the technology commentary that you guys gave us, Ignacio, I think you said in your prepared remarks or actually in response to a question that Popular has traditionally been a leader in technology in Puerto Rico. So somewhat surprising that this overhaul is coming, but be it as it is. Were you guys seeing or are you seeing evidence that other entrants are making headway against your core customers and you're starting to lose some of these customers? Or what was the real, or is that part of the reason for the big spend that's coming?
spk03: No, I think that when I say we are traditionally a bad leader in the technology, that's true. But we feel the world is changing much faster and we may have been a little bit behind where we normally would be on this kind of a curve. We haven't lost customers yet, but we're not going to wait to lose customers. There are certain areas where you see more U.S. entrants, for example, credit cards, where you see more of the U.S. issuers coming in with features and different things that we may be a little bit behind. But really, we want to get ahead of this. We don't want to leave ourselves open to future digital entrants taking away our clients. So basically, we really think that if we offer a top-notch digital experience, and you combine that with our branch network, and you combine that with the diverse services we offer our client, that we have an unbeatable solution. If we fall in any of those areas, then, you know, we could become vulnerable, and we're not about to let that happen. So, yes, we know that technology is a tough game, and we may not be able to match the investments of, you know, some of the bigger, huge banks, but we have to stay at least giving our clients, you know, what they expect in today's world. And our clients in Puerto Rico, just like anywhere else, they expect a better digital experience, and they expect a more personalized digital experience. And we're going to We're going to work hard to give them that.
spk04: To give some more color in NASA's comment, Gerard, when I talked about our data offered to our clients, I said it was market leading, which it is. And I spoke about the back end, the architecture of it. We find ourselves wanting to roll out more things at a faster speed than our present architecture allows us to do. So again, what we're doing is doing a lot of work in the backend. The client will never even knew this was happening, but the client will feel it because the speed at which we'll be able to offer new things and more things will go up. So that is the kind of thing we're talking about. It is improving the core of our technology. And again, the client may not see that in their phone app, but they'll see it in our capacity to offer them more personalized offerings, more personalized services, and new services faster than we can do today.
spk05: Very good. And then, Lidio, you mentioned you gave us some insights into the credit, and credit obviously has been strong for you folks and your peers. Two questions. You gave us some of the assumptions, I think, in the Moody's Outlook on real GDP growth. What kind of unemployment rates are you factoring in? I think you said they're constant, but what are those numbers? And two, are there any sectors within the portfolio that you're currently spending more time really focusing on just to make sure nothing gets tripped up if we go into some sort of shallow recession?
spk01: We have On a yearly basis, you have on page 13 of the deck the assumptions for unemployment rates both for Puerto Rico and the U.S. under the baseline, stronger growth and recession scenarios. So I would leave you to look at those. What was the second part of the question? I'm sorry, Gerard.
spk05: No, that's okay. And just what parts of the portfolio are you guys really focused on to make sure that if we do go into a shallow recession, you're prepared to handle it.
spk01: I would say small business lending is an area of focus. I mean, we continue to be pleased how the portfolio has continued to behave post-pandemic, but it's an area where increases in interest rate, inflationary pressures, increases in energy prices could have a potential higher impact than other sectors. I think it's important to highlight that One area where we see a lot of press in the US in terms of office space, we don't have any significant exposure to the office space in Puerto Rico in the US.
spk05: Very good. Thank you.
spk08: Thank you. The next question today is a follow up from Alex Tweddle from Piper Sandler. Please go ahead. Your line is now open.
spk09: Hey, I just wanted to ask for the loan growth that you guys are seeing, what kind of yields new production is coming on in the various categories?
spk04: Yeah, I'm sorry I don't. I don't have that number right now. I think we can we can try to dig it out. But I don't have that stuff in my head or in my notes. My apologies. You can see that the overall loan yield of our book did go up 31 basis points in the quarter, so obviously we are originating our new vintages at a higher rate, but I don't have the answer to your question. We'll get back to you.
spk09: Okay. Are you able to give us a little bit more color? Like if you look in the commercial growth, sort of the percentage or, you know, just a rough breakdown of what might be the larger corporate customer that's based off of SOFR. And we saw some press releases this quarter on sort of pricing that maybe we could apply to that in Puerto Rico versus what might be more tied to Prime.
spk04: Yeah, with the the and Leo may be able to correct me that the take up of sulfur in Puerto Rico has been pretty slow. So I think big picture assumptions for the moment, Alex, is that whatever part of our book is floating is still linked to the old floating rates. Again, the pickup of sulfur has been I've seen slow so far.
spk09: Okay. And then I just wanted to clarify your comments on the timing for capital return. It sounded like you guys go through this process every year where you engage the Fed and then a quarter later or four months later you wind up actually telling us what you guys have all decided for the capital return. Is it the second half of this year that you engage the Fed or do you intend to have an announcement the second half of the year?
spk03: I think our plan would be to do both. We would engage the Fed at some point, but the announcement, I think when we talk about second half of the year, would be an announcement.
spk09: Okay. So you engage the Fed at some point in the next couple months, and realistically, July, we could still expect a capital update.
spk04: We will... make the decision of what we want to do once we have clarity on the outlook for interest rates and the economy, Alex. So that is the starting point. So again, our guess is that that point in time will come in the summer, and that's how we ended up talking about the second half of the year. So that's the starting point, and from there we would, you know, do our modeling and discuss the opportunities, all the alternatives with our regulator. We would have to decide how we want to execute anything we want to execute. We want to revisit what has been our practice in the past of having very structured. Every January we have an announcement. We may choose to change that moving forward. So we're going to, again, the underlying thing we want to do that has not changed, which is to move in the direction of our mainland peers plus a buffer, but exactly how we execute that will be re-evaluated, and we may decide to execute it in a different path than we did in the past. So don't assume we'll be back to getting an announcement and that's it for the year. Again, we may choose to manage our capital return
spk09: slightly different moving forward if and when we choose to make a change obviously we'll discuss it with the market okay but it's it is the same process that you've gone through there's nothing changing about you know how often or the regularity that you would engage the fed to include in this and i guess you know the question that i got from a lot of investors after last quarter is why not go through the process as normal last year and then get approval but just say we're not going to implement it as quickly You know, maybe we'll wait and not do an ASR, you know, but we have it and the Fed is comfortable with our capital levels and all these things that seem, you know, exceedingly healthy from the surface.
spk04: You are describing some of the alternatives that we are considering as we revisit how we want to do this. I always caution everybody when we speak about this. The Fed does not give conditional approvals to anything. They will only approve things when you request an approval, and they will not approve things as long as things work out in the future this way. So again, we try to manage the Fed the best way we can. I think over the last four or five years, we've been pretty effective in our dealing with the Fed, and we'll try to continue that. But some banks manage it differently. Some banks have quarterly capital plans that they discussed with the Fed instead of a yearly capital plan, which has been our practice in the past. Again, we want to go and revisit all those alternatives, Alex, to be frank with you. So we'll be doing that when we re-engage. Again, we think what we did in the past has been pretty successful for us as far as dealing with the Fed. We are analyzing if there is that is even better for us and for our shareholders moving forward.
spk09: Okay. Thank you for taking my follow-ups.
spk04: You're welcome.
spk08: Thank you. The final question today is a follow-up question from Jared Cassidy from RBC. Please go ahead. Your line is now open.
spk05: Thank you. Actually, I didn't pull myself out of the queue. I didn't understand the instructions. I'm all set. Thank you, Carlos. Thank you, Gerard.
spk08: That concludes today's question and answer session. So I'd like to pass the conference over to Ignacio Alvarez for any closing remarks. Please go ahead.
spk03: OK. Thank you for joining us today and for your questions. We look forward to updating you on our progress in April. Thank you.
spk08: This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.
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