SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2012
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 001-34084
POPULAR, INC.
Incorporated in the Commonwealth of Puerto Rico
IRS Employer Identification No. 66-0667416
Principal Executive Offices:
209 Muñoz Rivera Avenue
Hato Rey, Puerto Rico 00918
Telephone Number: (787) 765-9800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class | Name of Each Exchange
on which Registered | |
Common Stock ($0.01 par value) |
The NASDAQ Stock Market LLC | |
6.70% Cumulative Monthly Income Trust Preferred Securities |
The NASDAQ Stock Market LLC | |
6.125% Cumulative Monthly Income Trust Preferred Securities |
The NASDAQ Stock Market LLC |
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No ¨.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No X.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ¨.
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). X
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer X | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No X
As of June 29, 2012, the aggregate market value of the Common Stock held by non-affiliates of Popular, Inc. was approximately $1,633,095,200 based upon the reported closing price of $16.61 on the NASDAQ Global Select Market on that date.
As of February 25, 2013, there were 103,206,380 shares of Popular, Inc.s Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of Popular, Inc.s Annual Report to Stockholders for the fiscal year ended December 31, 2012 (the Annual Report) are incorporated herein by reference in response to Item 1 of Part I, Items 5 through 8 of Part II and Item 15 (a)(1) of Part IV.
(2) Portions of Popular, Inc.s definitive proxy statement relating to the 2013 Annual Meeting of Stockholders of Popular, Inc. (the Proxy Statement) are incorporated herein by reference in response to Items 10 through 14 of Part III. The Proxy Statement will be filed with the Securities and Exchange Commission (the SEC) on or about March 15, 2013.
Forward-Looking Statements
The information included in this Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those forward-looking statements may relate to Popular, Inc.s (Popular, we, us, our) financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to expected earnings levels, the adequacy of the allowance for loan losses, delinquency trends, market risk and the impact of interest rate changes, capital markets conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on Populars financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words anticipate, believe, continues, expect, estimate, intend, project and similar expressions and future or conditional verbs such as will, would, should, could, might, can, may, or similar expressions are generally intended to identify forward-looking statements.
These statements are not guarantees of future performance are based on managements current expectations and involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which by their nature are beyond our control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to:
| the rate of growth in the economy and employment levels, as well as general business and economic conditions; |
| changes in interest rates, as well as the magnitude of such changes; |
| the fiscal and monetary policies of the federal government and its agencies; |
| changes in federal bank regulatory and supervisory policies, including required levels of capital and the impact of proposed capital standards on our capital ratios; |
| the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) on our businesses, business practices and cost of operations; |
| the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets in Puerto Rico and the other markets in which borrowers are located; |
| the performance of the stock and bond markets; |
| competition in the financial services industry; |
| additional Federal Deposit Insurance Corporation (FDIC) assessments; and |
| possible legislative, tax or regulatory changes. |
Other possible events or factors that could cause results or performance to differ materially from those expressed in these forward-looking statements include the following: negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of non-performing assets, charge-offs and provision expense; changes in interest rates and market liquidity which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets; adverse movements and volatility in debt and equity capital markets; changes in market rates and prices which may adversely impact the
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value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; changes in accounting standards, rules and interpretations; increased competition; our ability to grow our core businesses; decisions to downsize, sell or close units or otherwise change our business mix; and managements ability to identify and manage these and other risks. Moreover, the outcome of legal proceedings, as discussed in Part I, Item 3. Legal Proceedings, is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries.
All forward-looking statements included in this Form 10-K are based upon information available to Popular as of the date of this Form 10- K, and other than as required by law, including the requirements of applicable securities laws, we assume no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
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Item 1B |
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Item 2 |
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Item 3 |
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Item 4 |
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Item 5 |
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Item 6 |
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Item 7 |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
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Item 7A |
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Item 8 |
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Item 9 |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
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Item 9A |
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Item 9B |
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Item 10 |
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Item 11 |
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Item 12 |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
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Item 13 |
Certain Relationships and Related Transactions, and Director Independence |
50 | ||||
Item 14 |
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Item 15 |
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51 |
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General
Popular is a diversified, publicly-owned financial holding company, registered under the Bank Holding Company Act of 1956, as amended (the BHC Act) and subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board). Popular was incorporated in 1984 under the laws of the Commonwealth of Puerto Rico and is the largest financial institution based in Puerto Rico, with consolidated assets of $36.5 billion, total deposits of $27.0 billion and stockholders equity of $4.1 billion at December 31, 2012. At December 31, 2012, we ranked 36th among bank holding companies based on total assets according to information gathered and disclosed by the Federal Reserve Board.
We operate in two principal markets:
Puerto Rico: We provide retail and commercial banking services through our principal banking subsidiary, Banco Popular de Puerto Rico (BPPR), as well as auto and equipment leasing and financing, mortgage loans, investment banking, broker-dealer and insurance services through specialized subsidiaries.
Mainland United States: We operate Banco Popular North America (BPNA), including its wholly-owned subsidiary E-LOAN, Inc. (E-LOAN). BPNA is a community bank providing a broad range of financial services and products to the communities it serves. BPNA operates branches in New York, California, Illinois, New Jersey and Florida, under the name of Popular Community Bank. E-LOAN markets deposit accounts under its name for the benefit of BPNA.
Our two reportable business segments for accounting purposes, BPPR and BPNA, correspond to the Puerto Rico and mainland United States businesses, respectively. Following the sale in the third quarter of 2010 of a 51% ownership interest in EVERTEC, Inc. (EVERTEC), our financial transaction processing and technology services business, we report our remaining 48.5% ownership interest in this business in our Corporate group, which also includes the holding company operations and certain other equity investments.
The sections that follow provide a description of significant transactions that impacted or will impact our current and future operations.
Significant Transactions During 2012
Reverse stock split
On May 29, 2012, the Corporation completed a 1-for-10 reverse split of its common stock, $0.01 par value per share. Pursuant to the reverse stock split, each ten shares of authorized and outstanding common stock have been reclassified and combined into one new share of common stock. In connection with the reverse stock split, the number of shares of common stock authorized under the Corporations Restated Certificate of Incorporation was reduced from 1,700,000,000 to 170,000,000 shares, without any change in par value per common share. The reverse split did not change the number of shares of the Corporations preferred stock authorized, which remains at 30,000,000.
The number of common shares into which the Corporations outstanding stock options and restricted stock as well as the options relevant exercise price per share were proportionally adjusted to reflect the reverse split. The number of shares authorized for issuance under the Corporations equity incentive plans were also proportionally reduced to reflect the reverse split.
Please note that all share and per share information presented in this Form 10-K has been adjusted to reflect the reverse stock split.
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Closing Agreement with the Puerto Rico Department of Treasury
During the second quarter of 2012, the Corporation recognized a tax benefit of $72.9 million related to the reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank (the Acquired Loans). In June 2012, the Puerto Rico Department of the Treasury (the P.R. Treasury) and the Corporation entered into a Closing Agreement (the Closing Agreement) to clarify that the Acquired Loans are a capital asset and any gain resulting from such loans will be taxed at the capital gain tax rate of 15% instead of the ordinary income tax rate of 30%, thus reducing the deferred tax liability on the estimated gain. As part of the Closing Agreement, the Corporation prepaid to the P.R. Treasury the estimated tax of $72.9 million related to these estimated capital gains.
Early extinguishment of debt
During the quarter ended June 30, 2012, the Corporation recognized a loss on the early extinguishment of debt of $25.0 million related to the early termination of $350 million in outstanding repurchase agreements (repos) with contractual maturities between March 2014 and May 2014, with an average cost of 4.36%. The Corporation replaced these repos with short-term borrowings at current market rates.
Capital distributions and earnings from EVERTEC
During 2012, the Corporation received cash distributions from its investment in EVERTECs parent company amounting to $155 million ($131 million during the second quarter and $24 million during the fourth quarter). As a result of the distributions, which included $5 million in dividends, the Corporations equity investment balance in the entity was reduced and stands at $73.9 million as of year-end. The Corporations participation interest in the entity was 48.5% as of year-end. Also, during December 2012, the Corporation recorded a pre-tax income of approximately $31.6 million related to its proportionate share of the tax benefit from a tax grant received by EVERTEC from the Puerto Rico Government.
Puerto Rico Business
General.
We offer in Puerto Rico a complete array of retail and commercial banking services through our principal bank subsidiary, BPPR. BPPR was organized in 1893 and is Puerto Ricos largest bank with consolidated total assets of $27.2 billion, deposits of $21.0 billion and stockholders equity of $2.8 billion at December 31, 2012. BPPR accounted for 75% of our total consolidated assets at December 31, 2012. BPPR has the largest retail franchise in Puerto Rico, with 175 branches and 597 ATMs. BPPR also operates eight branches in the U.S. Virgin Islands, one branch in the British Virgin Islands and one branch in New York. In the Virgin Islands, BPPR had 20 ATMs at the end of 2012. BPPRs deposits are insured under the Deposit Insurance Fund (DIF) of the FDIC.
BPPR had two principal subsidiaries: Popular Auto, Inc., a vehicle and equipment financing, leasing and daily rental company, and Popular Mortgage, Inc., a mortgage loan company with 37 offices in Puerto Rico. Effective on December 31, 2012, Popular Mortgage, Inc. was merged with and into BPPR as part of an internal reorganization. The Corporations mortgage origination business will continue to be conducted under the brand name Popular Mortgage. In addition, BPPR has various subsidiaries holding specific assets acquired in satisfaction of loans for real estate development projects and commercial loans.
Our Puerto Rico operations also include financial advisory, investment and securities brokerage services for institutional and retail customers through Popular Securities, Inc., a wholly-owned subsidiary of Popular. Popular Securities, Inc. is a securities broker-dealer with operations in Puerto Rico. As of December 31, 2012, Popular Securities had $317.4 million in total assets and $4.6 billion in assets under management.
We offer insurance and reinsurance services through Popular Insurance, Inc., a general insurance agency, and Popular Life RE, a reinsurance company, with total revenues of $29.9 million and $17.7 million, respectively, for the year ended December 31, 2012. We also own Popular Risk Services, Inc., an insurance broker, and Popular Insurance V.I., Inc., an insurance agency operating in the Virgin Islands.
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Lending Activities.
Unless otherwise stated, all references in this Form 10-K to total loan portfolio, total credit exposure or loan portfolios, exclude covered loans, which represent loans acquired in the Westernbank FDIC-assisted transaction that are covered under loss sharing agreements with the FDIC and non-covered loans held-for-sale. Loans held-for-sale in Puerto Rico amounted to $350 million at December 31, 2012.
We concentrate our lending activities in the following areas:
(1) | Commercial. Commercial loans are comprised of (i) commercial and industrial (C&I) loans to commercial customers for use in normal business operations finance working capital needs, equipment purchases or other projects, and (ii) commercial real estate (CRE) loans (excluding construction loans) for income producing real estate properties as well as owner occupied properties. C&I loans are underwritten individually and usually secured with the assets of the company and the personal guarantee of the business owners. CRE loans consist of loans for income producing real estate properties and real estate developers and the financing of owner-occupied facilities if there is real estate as collateral. We mitigate our risk on these loans by requiring collateral values that exceed the loan amount and underwriting the loan with cash flow sustainability that exceeds debt service requirements. Non owner-occupied CRE loans are generally made to finance office and industrial buildings and retail shopping centers and are repaid through cash flows related to the operation, sale or refinancing of the property. |
Total commercial loans in Puerto Rico were $6.3 billion as of December 31, 2012, and represented 41% of our total loan portfolio in Puerto Rico. For greater detail of the breakdown of our Commercial portfolio refer to the Table under the caption Business Concentration.
(2) | Construction. Construction loans are CRE loans to companies or developers used for the construction of a commercial or residential property for which repayment will be generated by the sale or permanent financing of the property. Our construction loan portfolio primarily consists of retail, residential (land and condominiums), office and warehouse product types. These loans are generally underwritten and managed by a specialized real estate group that actively monitors the construction phase and manages the loan disbursements according to the predetermined construction schedule. |
Total construction loans in Puerto Rico were $212.3 million as of December 31, 2012, and represented 1% of our total loan portfolio in Puerto Rico. BPPR is currently originating a limited amount of new construction loans.
(3) | Lease Financings. Lease financings are primarily comprised of automobile loans/leases made through automotive dealerships and equipment lease financings. |
Total lease financings in Puerto Rico were $540.5 million as of December 31, 2012, and represented 4% of our total loan portfolio in Puerto Rico.
(4) | Mortgage. Mortgage loans include residential mortgage loans to consumers for the purchase or refinancing of a residence and also includes residential construction loans made to individuals for the construction or refurbishment of their residence. The majority of these loans are financed over a 15 to 30 year term, and in most cases, the loans are extended to borrowers to finance their primary residence. In some cases, government agencies or private mortgage insurers guarantee the loan. Our general practice is to sell a significant majority of our fixed-rate originations in the secondary mortgage market. |
Total mortgage loans in Puerto Rico were $4.9 billion as of December 31, 2012, and represented 32% of our total loan portfolio in Puerto Rico.
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(5) | Consumer. Consumer loans include personal loans, credit cards, home equity lines of credit (HELOCs) and other loans made by banks to individual borrowers. In this area, BPPR offers four unsecured products: personal loans, credit cards, personal credit lines and overdraft protection. All other consumer loans are secured. HELOCs include both home equity loans and lines of credit secured by a first or second mortgage on the borrowers residence, which allows customers to borrow against the equity in their homes. Real estate market values as of the time HELOCs are granted directly affect the amount of credit extended and, in addition, changes in these values impact our exposure to losses in this type of loan. |
Total consumer loans in Puerto Rico were $3 billion as of December 31, 2012, and represented 21% of our total loan portfolio in Puerto Rico.
Covered Loans.
We refer to the loans acquired in the Westernbank FDIC-assisted transaction, except credit cards, as covered loans, as BPPR will be reimbursed by the FDIC for a substantial portion of any future losses on such loans under the terms of the loss sharing agreements. Foreclosed other real estate properties are also covered under the loss sharing agreements. Pursuant to the terms of the loss sharing agreements, the FDICs obligation to reimburse BPPR for losses with respect to assets covered by such agreements (the covered assets) begins with the first dollar of loss incurred. On a combined basis, the FDIC will reimburse BPPR for 80% of all qualifying losses with respect to the covered assets during the covered period. BPPR will reimburse the FDIC for 80% of qualifying recoveries with respect to losses for which the FDIC reimbursed BPPR. The loss sharing agreement applicable to single-family residential mortgage loans provides for FDIC loss sharing and BPPR reimbursement to the FDIC for ten years, and the loss sharing agreement applicable to commercial and other assets provides for FDIC loss sharing and BPPR reimbursement to the FDIC for five years, with additional recovery sharing for three years thereafter.
Because of the loss protection provided by the FDIC, the risks of the covered loans are significantly different from other loans in our portfolio, thus we have determined to segregate them in our financial statements and in the Managements Discussion and Analysis of Financial Condition and Results of Operations. Covered loans are reported in loans exclusive of the estimated FDIC loss share indemnification asset. During the quarter ended December 31, 2010, retrospective adjustments were made to the estimated fair values of the covered loans to reflect new information obtained during the measurement period (as defined by ASC Topic 805), about facts and circumstances that existed as of the acquisition date that, if known, would have affected the acquisition-date fair value measurements. The retrospective adjustments were mostly driven by revisions in credit loss assumptions because of new information that became available. The revisions principally resulted in a decrease in the estimated credit losses, thus increasing the fair value of acquired loans and reducing the FDIC loss share indemnification asset. Refer to Note 4, Business Combination, to the consolidated financial statements for additional information on the Westernbank FDIC-assisted transaction.
Covered loans are, and will continue to be, reviewed for collectability, based on the expectations of cash flows on these loans. If there is a decrease in expected cash flows on the covered loans accounted for under ASC Subtopic 310-30 (consisting of all covered loans except for revolving lines of credit) due to an increase in estimated credit losses compared to the estimate made at the April 30, 2010 acquisition date, we will record a charge to the provision for loan losses and an allowance for loan losses will be established. If there is an increase in inherent losses on the covered loans accounted for under ASC Subtopic 310-20 (consisting of revolving lines of credit), an allowance for loan losses will also be established to record the loans at their net realizable value. In both cases, a related credit to income and an increase in the FDIC loss share indemnification asset will be recognized at the same time, measured based on the loss share percentages described above.
At December 31, 2012, covered loans totaled $3.8 billion, or 10% of total assets of Popular.
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True-up payment obligation to the FDIC
BPPR agreed to make a true-up payment obligation (the true-up payment) to the FDIC on the date that is 45 days following the last day (the true-up measurement date) of the final shared loss month, or upon the final disposition of all covered assets under the loss sharing agreements in the event losses on the loss sharing agreements fail to reach expected levels. The estimated fair value of such true-up payment obligation is recorded as contingent consideration, which is included in the caption of other liabilities in the consolidated statements of financial condition. Under the loss sharing agreements, BPPR will pay to the FDIC 50% of the excess, if any, of: (i) 20% of the intrinsic loss estimate of $4.6 billion (or $925 million) (as determined by the FDIC) less (ii) the sum of: (A) 25% of the asset discount (per bid) ($1.1 billion)); plus (B) 25% of the cumulative shared loss payments (defined as the aggregate of all of the payments made or payable to BPPR minus the aggregate of all of the payments made or payable to the FDIC); plus (C) the sum of the period servicing amounts for every consecutive twelve month period prior to and ending on the true-up measurement date in respect of each of the loss sharing agreements during which the loss sharing provisions of the applicable loss sharing agreement is in effect (defined as the product of the simple average of the principal amount of shared loss loans and shared loss assets at the beginning and end of such period times 1%). At December 31, 2012, the carrying amount of the true up payment obligation amounted to $112 million.
Mainland United States Business
General.
Popular North America, Inc. (PNA) functions as the holding company for our operations in the mainland United States. PNA, a wholly-owned subsidiary of Popular, was organized in 1991 under the laws of the State of Delaware and is a registered bank holding company under the BHC Act. As of December 31, 2012, PNA had one principal subsidiary which was BPNA, a full service commercial bank incorporated in the state of New York.
The banking operations of BPNA in the United States mainland are based in five states and are conducted under the name of Popular Community Bank. The following table contains information of BPNAs operations:
State |
Branches |
ATMs |
Aggregate Assets ($ in billions) |
Total Deposits ($ in billions) | ||||
New York |
31 | 61 | $2.60 | $2.10 | ||||
Illinois |
12 | 16 | 1.4 | 0.9 | ||||
California |
21 | 24 | 2.2 | 1.4 | ||||
Florida |
20 | 23 | 1.7 | 1.4 | ||||
New Jersey |
8 | 10 | 0.4 | 0.4 |
In addition, BPNA owns all of the outstanding stock of E-LOAN, Popular Equipment Finance, Inc., and Popular Insurance Agency USA, Inc. E-LOANs business currently consists solely of providing an online platform to raise deposits for BPNA. At December 31, 2012, E-LOANs total assets amounted to $367.4 million. Popular Equipment Finance, Inc. sold a substantial portion of its lease financing portfolio during the quarter ended March 31, 2009 and also ceased originations as part of the BPNA restructuring plan implemented in late 2008. As a result of these initiatives, the total assets of Popular Equipment Finance, Inc. were reduced to $12.3 million at December 31, 2012. Popular Insurance Agency USA, Inc. acts as an insurance agent or broker for offering insurance across the BPNA branch network. Total revenues of Popular Insurance Agency USA, Inc. for the year ended December 31, 2012 totaled $5.4 million.
Lending Activities.
We concentrate our lending activities in the following areas:
(1) | Commercial. Commercial loans are comprised of (i) commercial and industrial (C&I) loans to commercial customers for use in normal business operations finance working capital needs, equipment purchases or other projects, and (ii) commercial real estate (CRE) loans (excluding construction loans) for income producing real estate properties as well as owner occupied properties. C&I loans are underwritten individually and usually |
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secured with the assets of the company and the personal guarantee of the business owners. CRE loans consist of loans for income producing real estate properties and real estate developers and the financing of owner-occupied facilities if there is real estate as collateral. We mitigate our risk on these loans by requiring collateral values that exceed the loan amount and underwriting the loan with cash flow sustainability that exceeds debt service requirements. Non owner-occupied CRE loans are generally made to finance office and industrial buildings and retail shopping centers and are repaid through cash flows related to the operation, sale or refinancing of the property. |
Total commercial loans at BPNA were $3.6 billion as of December 31, 2012, and represented 62% of our total loan portfolio in the U.S.
(2) | Construction. Construction loans are CRE loans to companies or developers used for the construction of a commercial or residential property for which repayment will be generated by the sale or permanent financing of the property. Our construction loan portfolio primarily consists of retail, residential (land and condominiums), office and warehouse product types. These loans are generally underwritten and managed by a specialized real estate group that actively monitors the construction phase and manages the loan disbursements according to the predetermined construction schedule. |
Total construction loans at BPNA were $40.6 million as of December 31, 2012, and represented 1% of our total loan portfolio in the U.S.
(3) | Legacy. The legacy portfolio is comprised of commercial loans, construction loans and lease financings related to certain lending products exited by the Corporation as part of restructuring efforts carried out in prior years at BPNA. |
Total legacy portfolio at BPNA was $384.2 million as of December 31, 2012, and represented 7% of our total loan portfolio in the U.S.
(4) | Mortgage. Mortgage loans include residential mortgage loans to consumers for the purchase or refinancing of a residence and also includes residential construction loans made to individuals for the construction or refurbishment of their residence. The majority of these loans are financed over a 15 to 30 year term, and in most cases, the loans are extended to borrowers to finance their primary residence. In some cases, government agencies or private mortgage insurers guarantee the loan. Our general practice is to sell a significant majority of our fixed-rate originations in the secondary market. |
In response to current economic conditions, we exited the origination of non-conventional mortgage market in the U.S. mainland.
Total mortgage loans at BPNA were $1.1 billion as of December 31, 2012, and represented 20% of our total loan portfolio in the U.S.
(5) | Consumer. Consumer loans include personal loans, credit cards, auto loans, HELOCs and other loans made by banks to individual borrowers. In this area, BPNA offers four unsecured products: personal loans, credit cards, personal credit lines and overdraft protection. All other consumer loans are secured. |
As a result of our restructuring of the E-LOAN operations in prior years, consumer loans continue to decrease as the remaining closed-end second mortgages and HELOCs originated through the E-LOAN platform continue to amortize, in addition to a reduction in the loan origination activity since E-LOAN no longer operates as a direct lender.
Total consumer loans at BPNA were $634.6 million as of December 31, 2012, and represented 11% of our total loan portfolio in the U.S.
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Credit Administration and Credit Policies
Interest from our loan portfolios is our principal source of revenue. Whenever we make loans, we expose ourselves to credit risk. At December 31, 2012, our credit exposure was centered in our $21.0 billion non-covered loan portfolio which represented 66% of our earning assets excluding covered loans. Credit risk is controlled and monitored through active asset quality management, including the use of lending standards, thorough review of potential borrowers and active asset quality administration.
Business activities that expose us to credit risk are managed within the Boards established limits that consider factors such as maintaining a prudent balance of risk-taking across diversified risk types and business units, compliance with regulatory guidance, controlling the exposure to lower credit quality assets, and limiting growth in, and overall exposure to, any product or risk segment where we do not have sufficient experience and a proven ability to predict credit losses.
Our Credit Strategy Committee (CRESCO) is managements top policy-making body with respect to credit-related matters and credit strategies. CRESCO reviews the activities of each subsidiary to ensure a proactive and coordinated management of credit granting, credit exposures and credit procedures. CRESCOs principal functions include reviewing the adequacy of the allowance for loan losses and periodically approving appropriate provisions, monitoring compliance with charge-off policy, establishing portfolio diversification, yield and quality standards, establishing credit exposure reporting standards, monitoring asset quality, and approving credit policies and amendments thereto for the subsidiaries and/or business lines, including special lending approval authorities when and if appropriate. The analysis of the allowance adequacy is presented to the Risk Management Committee of the Board of Directors for review, consideration and ratification on a quarterly basis.
We also have a Corporate Credit Risk Management Division (CCRMD). The CCRMD is a centralized unit, independent of the lending function. The CCRMDs functions include identifying, measuring and controlling credit risk independently from the business units, evaluating the credit risk rating system and reviewing the adequacy of the allowance for loan losses in accordance with Generally Accepted Accounting Principles (GAAP) and regulatory standards. The CCRMD also ensures that the subsidiaries comply with the credit policies and applicable regulations, and monitors credit underwriting standards. Also, the CCRMD performs ongoing monitoring of the portfolio, including potential areas of concern for specific borrowers and/or geographic regions.
We have a Credit Process Review Group within the CCRMD, which performs annual comprehensive credit process reviews of several commercial, construction, consumer and mortgage lending groups in BPPR. This group evaluates the credit risk profile of each originating unit along with each units credit administration effectiveness, including the assessment of the risk rating representative of the current credit quality of commercial and construction loans and the evaluation of collateral documentation. The monitoring performed by this group contributes to assess compliance with credit policies and underwriting standards, determine the current level of credit risk, evaluate the effectiveness of the credit management process and identify control deficiencies that may arise in the credit- granting process. Based on its findings, the Credit Process Review Group recommends corrective actions, if necessary, that help in maintaining a sound credit process. In the U.S. mainland, the Credit Process Review Group evaluates the consumer and mortgage lending groups. CCRMD has contracted an outside loan review firm to perform the credit process reviews for the commercial and construction loan portfolios in the U.S. mainland operations. The CCRMD participates in defining the review plan with the outside loan review firm and actively participates in the discussions of the results of the loan reviews with the business units. The CCRMD may periodically review the work performed by the outside loan review firm. The CCRMD reports the results of the credit process reviews to the Risk Management Committee of our Board of Directors.
We maintain comprehensive credit policies for all lines of business in order to mitigate credit risk. Our credit policies are ratified by our Board of Directors and set forth, among other things, underwriting standards and procedures for monitoring and evaluating loan portfolio quality. Our credit policies also require prompt identification and quantification of asset quality deterioration or potential loss in order to ensure the adequacy of the allowance for loan losses. Included in these policies, primarily determined by the amount, type of loan and risk characteristics of the credit facility, are various approval levels and lending limit constraints, ranging from the branch or department level to those that are more centralized.
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Our credit policies and procedures establish strict documentation requirements for each loan and related collateral type, when applicable, during the underwriting, closing and monitoring phases. During the initial loan underwriting process, the credit policies require, at a minimum, historical financial statements or tax returns of the borrower and any guarantor, an analysis of financial information contained in a credit approval package, a risk rating determination in the case of commercial and construction loans, reports from credit agencies and appraisals for real estate-related loans. We currently do not make no doc or stated income loans where there is no income or asset verification by the lender. The credit policies also set forth the required closing documentation depending on the loan and the collateral type.
Although we originate most of our loans internally in both the Puerto Rico and mainland United States markets, we occasionally purchase or participate in loans originated by other financial institutions. When we purchase or participate in loans originated by others, we conduct the same underwriting analysis of the borrowers and apply the same criteria as we do for loans originated by us. This also includes a review of the applicable legal documentation. As December 31, 2012, loans originated internally accounted for 86% and 90%, respectively, of our loan portfolio for Puerto Rico and the United States mainland.
Set forth below are the general parameters under which we analyze our major loan categories:
Commercial and Construction: Commercial and construction loans are underwritten using a comprehensive analysis of the borrowers operations, including the borrowers business model, management, financial statements, pro-forma financial condition including financial projections, use of funds, debt service capacity, leverage and the financial strength of any guarantor. Most of our commercial and construction loans are secured by real estate and other collateral. A review of the quality and value of collateral, including independent third-party appraisals of machinery and equipment and commercial real estate, as appropriate, is also conducted. Physical inspection of the collateral and audits of receivables is conducted when appropriate. Our credit policies provide maximum loan-to-value ratios that limit the size of a loan to a maximum percentage of the value of the real estate collateral securing the loan. The loan-to-value percentage varies by the type of collateral. Our loan-to value limitations are, in certain cases, determined by other risk factors such as the financial strength of the borrower or guarantor, the equity provided to the project and the viability of the project itself. Most CRE loans are originated with full recourse or limited recourse to all principals and owners. Non-recourse lending is limited to borrowers with very solid financial capacity.
As of December 31, 2012, $3.7 billion, or 57%, of our commercial and construction loans in Puerto Rico were secured by real estate, while in the mainland United States these figures totaled $3.1 billion, or 78%, respectively.
Consumer, Mortgage and Lease Financings: Our consumer, mortgage and lease financings are originated consistent with the underwriting approach described above, but also include an assessment of each borrowers personal financial condition, including verification of income, assets and FICO score. Credit reports are obtained and reconciled with the financial statements provided to us. Although, a standard industry definition for subprime loans (including subprime mortgage loans) does not exist, for risk assessment purposes, Popular defines subprime loans as borrowers with one or a combination of certain credit risk factors, such as FICO scores (generally less than 620 for secured products and 660 for unsecured products), high debt to income ratios (higher than 50%) and inferior payment history, including factors such as defaults and limited credit history. Popular does not target subprime borrowers and does not offer products specifically designed for subprime borrowers. In Puerto Rico, as of December 31, 2012, consumer and mortgage loans with subprime characteristics consisted of $660.6 million (20% of the Puerto Rico consumer loan portfolio) and $1.1 billion (23% of the Puerto Rico mortgage loans portfolio), respectively. BPPRs loans are normally fixed-rate, fully amortizing, full documentation loans that do not have the level of layered risk associated with subprime loans offered by certain major U.S. mortgage loan originators. As of December 31, 2012, our mainland United States consumer and mortgage loans with subprime characteristics consisted of $73.8 million (or 12 % of the U.S. mainland consumer loan portfolio) and $500 million (or 44% of U.S. mainland mortgage loans portfolio). As part of the restructuring of our U.S. mainland operations, we discontinued originating loans with subprime characteristics in those operations, including the U.S. non-conventional mortgage loan portfolio and E-LOAN.
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As of December 31, 2012, there was a nominal amount of interest only loans in our consumer loans portfolio and $94.2 million of interest-only loans in our mortgage loan portfolio, all of which were at BPPR. Also, we did not have any adjustable rate mortgage loans in our Puerto Rico portfolio. In Puerto Rico, we offer a special step loan mortgage product to purchasers of units within construction projects financed by BPPR. This product, with a term of up to 40 years, provides for 100% financing at a 2.99% interest rate for the first five years of the term of the loan and 5.88% fixed-rate for the remaining term. Consistent with our credit policies, the underwriting and loan approval process for our step loan mortgage product is based on a number of factors, including an assessment of each borrowers personal financial condition (including verification of income, assets and FICO score), as well as debt-to-equity ratio, reserves, loan-to-value and prior mortgage experience. While Popular has not established specific limits for FICO scores, debt-to-income ratios and loan-to-values applicable to this product, the underwriting parameters applied to this product are generally similar to the standards used for the underwriting of our non-conforming loans, except for higher loan-to-value ratios (90% or higher). As of December 31, 2012, Popular had $441.9 million of these step loans.
As of December 31, 2012, $5.0 billion, or 61%, of our total consumer loans in Puerto Rico were secured by real estate, including mortgage loans. In the United States mainland, these figures totaled $1.6 billion, or 91%, respectively. Lease financings are also secured.
Loan extensions, renewals and restructurings
Loans with satisfactory credit profiles can be extended, renewed or restructured. Many commercial loan facilities are structured as lines of credit, which are mainly one year in term and therefore are required to be renewed annually. Other facilities may be restructured or extended from time to time based upon changes in the borrowers business needs, use of funds, timing of completion of projects and other factors. If the borrower is not deemed to have financial difficulties, extensions, renewals and restructurings are done in the normal course of business and not considered concessions, and the loans continue to be recorded as performing.
We evaluate various factors in order to determine if a borrower is experiencing financial difficulties. Indicators that the borrower is experiencing financial difficulties include, for example: (i) the borrower is currently in default on any of its debt or it is probable that the borrower would be in payment default on any of its debt in the foreseeable future without the modification; (ii) the borrower has declared or is in the process of declaring bankruptcy; (iii) there is significant doubt as to whether the borrower will continue to be a going concern; (iv) currently, the borrower has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange; and (v) based on estimates and projections that only encompass the current business capabilities, the borrower forecasts that its entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity; and absent the current modification, the borrower cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a non-troubled debtor.
We have specialized workout officers who handle substantially all commercial loans that are past due 90 days and over, borrowers experiencing financial difficulties, and those that are considered problem loans based on their risk profile. As a general policy, we do not advance additional money to borrowers that are 90 days past due or over. In commercial and construction loans, certain exceptions may be approved under certain circumstances, including (i) when past due status is administrative in nature, such as expiration of a loan facility before the new documentation is executed, and not as a result of payment or credit issues; (ii) to improve our collateral position or otherwise maximize recovery or mitigate potential future losses; and (iii) with respect to certain entities that, although related through common ownership, are not cross defaulted nor cross-collateralized and are performing satisfactorily under their respective loan facilities. Such advances are underwritten following our credit policy guidelines and approved up to prescribed policy limits, which are dependent on the borrowers financial condition, collateral and guarantee, among others.
While we monitor lending concentration to a single borrower or a group of related borrowers, we do not have specific lending limits based on industry or other criteria, such as a percentage of the banks capital, except for the legal lending limit established under applicable state banking law, discussed in detail below.
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Loans to borrowers with financial difficulties can be modified as a loss mitigation alternative. New terms and conditions of these loans are individually evaluated to determine a feasible loan restructuring. In many consumer and mortgage loans, a trial period is established where the borrower has to comply with three consecutive monthly payments under the new terms before implementing the new structure. Loans that are restructured, renewed or extended due to financial difficulties and the terms reflect concessions that would not otherwise be granted are considered as Troubled Debt Restructurings (TDRs). These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. These concessions stem from an agreement between the creditor and the debtor or are imposed by law or a court. TDRs also include loans for which the Corporation has entered into liquidation proceedings with borrowers in which neither principal or interest is forgiven, but the Corporation accepts payments which are different than the contractual payment schedule. Refer to additional information on TDRs on Note 11 to the consolidated financial statements included in the Annual Report for the year ended December 31, 2012.
Loans classified as TDRs are reported in non-accrual status if the loan was in non-accruing status at the time of the modification. The TDR loan will continue in non-accrual status until the borrower has demonstrated a willingness and ability to make the restructured loan payments (at least six months of sustained performance after classified as TDR and management has concluded whether it is probable that the borrower would not be in payment default in a foreseeable future). If the loan was appropriately on accrual status prior to the restructuring, the borrower has demonstrated performance under the previous terms (for a period of at least six months, as defined), and the banks credit evaluation shows the borrowers capacity to continue to perform under the restructured terms (both principal and interest payments), it is likely that the appropriate conclusion is for the loan to remain on accrual at the time of the restructuring. Loans classified as TDRs are excluded from TDR status if performance under the restructured terms exists for a reasonable period (at least twelve months of sustained performance after being classified) and the loan yields a market rate.
Business Concentration
Since our business activities are currently concentrated primarily in Puerto Rico, our results of operations and financial condition are dependent upon the general trends of the Puerto Rico economy and, in particular, the residential and commercial real estate markets. The concentration of our operations in Puerto Rico exposes us to greater risk than other banking companies with a wider geographic base. Our asset and revenue composition by geographical area is presented in Financial Information about Geographic Areas below and in Note 41, Segment Reporting, to the consolidated financial statements included in the Annual Report.
Our loan portfolio is diversified by loan category. However, approximately 64% of our non-covered loan portfolio at December 31, 2012 consisted of real estate-related loans, including residential mortgage loans, construction loans and commercial loans secured by commercial real estate. The table below presents the distribution of our non-covered loan portfolio by loan category at December 31, 2012. Legacy refers to loans remaining from lines of businesses we exited as a result of the restructuring of our U.S. operations in 2008 and 2009.
Loan category (non-covered) | ||||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||
BPPR | % | BPNA | % | POPULAR | % | |||||||||||||||||||
C&I |
$ 2,788 | 18 | $ 805 | 14 | $ 3,593 | 17 | ||||||||||||||||||
CRE |
3,508 | 23 | 2,757 | 48 | 6,265 | 30 | ||||||||||||||||||
Construction |
212 | 1 | 41 | 1 | 253 | 1 | ||||||||||||||||||
Legacy |
- | - | 384 | 7 | 384 | 2 | ||||||||||||||||||
Leases |
541 | 4 | - | - | 541 | 3 | ||||||||||||||||||
Consumer |
3,234 | 21 | 634 | 11 | 3,868 | 18 | ||||||||||||||||||
Mortgage |
4,949 | 32 | 1,130 | 20 | 6,079 | 29 | ||||||||||||||||||
Total |
$ 15,232 | 100 | $ 5,751 | 100 | $ 20,983 | 100 |
Except for the Corporations exposure to the Puerto Rico Government sector, no individual or single group of related accounts is considered material in relation to our total assets or deposits, or in relation to our overall business. At December 31, 2012, the Corporation had approximately $0.9 billion of credit facilities granted to the Puerto Rico Government, its municipalities and public corporations, of which $75 million were uncommitted lines of credit (2011 - $1.0 billion and $215 million, respectively). Of the total credit facilities granted, $749 million was outstanding at December 31, 2012, of which $61 million were uncommitted lines of credit (2011 - $799 million and $0, respectively). As part of its investment securities portfolio, the Corporation had $217 million in obligations issued or guaranteed by the Puerto Rico Government, its municipalities and public corporations at December 31, 2012 (2011 - $269 million).
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Additionally, the Corporation holds consumer mortgage loans with an outstanding balance of $294 million at December 31, 2012 that are guaranteed by the Puerto Rico Housing Authority (2011 - $294 million). These mortgage loans are secured by the underlying properties and the guarantees serve to cover any shortfall in collateral in the event of a borrower default.
For further discussion of our loan portfolio and geographical concentration, see Financial Condition Loans and Credit Risk Management and Loan Quality-Geographical and Government Risk in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of the Annual Report.
Evolution of Business during the Financial Crisis
We have taken significant steps during the past years to counter the effect of the broad economic slowdown in the United States and the prolonged economic recession in Puerto Rico, our principal market, where the economy entered into recession in the second quarter of 2006. In 2008, we considered it prudent to participate in the TARP Capital Purchase Program in order to strengthen our capital and liquidity position. In December 2008, we received $935 million from the U.S. Department of the Treasury (U.S. Treasury) as part of the TARP Capital Purchase Program in exchange for senior Perpetual Preferred Stock and a warrant to purchase 2,093,283 shares of our Common Stock at an exercise price of $67 per share (adjusted to reflect the 1-for-10 reverse stock split effective on May 29, 2012). The shares of Preferred Stock qualified as Tier 1 regulatory capital and paid cumulative dividends quarterly at a rate of 5% per annum for the first five years, and 9% per annum thereafter.
The TARP Capital Purchase Program gave us the opportunity to raise capital quickly and improve our liquidity position, at a low cost, with limited shareholder dilution, at a time when the unprecedented market instability made it difficult, if not impossible, for us to raise capital. We have used proceeds from the TARP, together with other available moneys, to make capital contributions and loans to our banking subsidiaries to ensure they remain well-capitalized, and strengthen their ability to continue creditworthy lending in our home markets.
In August 2009, we completed an exchange offer in order to increase our common equity capital to accommodate the more adverse economic and credit scenarios assumed under the Supervisory Capital Assessment Program (the SCAP), as applied to regional banking institutions. With the exchange offer we issued 35.7 million new shares of Common Stock and increased our Tier 1 common equity by $1.4 billion.
In connection with the public exchange offer, we agreed with the U.S. Treasury to exchange the $935 million senior perpetual preferred stock issued to it pursuant to the TARP Capital Purchase Program for $935 million of newly issued perpetual trust preferred securities, with the same distribution rate as that of the Preferred Stock. This exchange was completed in August 2009. The trust preferred securities have a distribution rate of 5% until December 5, 2013 and 9% thereafter. The warrant initially issued to the U.S Treasury in connection with the issuance of the Preferred Stock in December 2008 remained outstanding without amendment and currently represents 2% of our Common Stock outstanding.
In addition to our participation in the TARP Capital Purchase Program and the completion of the exchange offer, during 2008 and 2009, we carried out various restructurings plans for our operations in the U.S. mainland to improve our U.S. operations, address credit quality, contain controllable costs, maintain well capitalized ratios and improve capital and liquidity positions. Most of these plans were successfully completed at the end of 2009.
During 2010 the Corporation enhanced its capital position with an equity offering in which it raised $1.15 billion of new common equity capital. This capital raise, along with the after-tax gain of $531.0 million, net of transaction costs, on the sale of a 51% interest in EVERTEC, substantially strengthened the Corporations capital ratios, placing it in a position to participate in the consolidation of the Puerto Rico banking market and to pursue strategies to improve the credit quality of its loan portfolio. Furthermore, the Westernbank FDIC-assisted transaction proved to be an important strategic transaction that further solidified the Corporations leadership position in Puerto Rico amid a contracting market and has contributed with a positive financial impact.
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We have also carried out a series of actions to improve our Puerto Rico operations, credit quality and profitability. During 2009, we implemented cost-cutting measures such as the reduction in hiring and pension plan freezes and the suspension of matching contributions to retirement plans. During 2011, further steps were taken to improve our profitability, including the implementation of a voluntary employee retirement window at the end of 2011. As a result of this initiative in December 2011, we recorded $15.6 million in pension costs related to 369 employees that were eligible and elected to participate in the retirement program. The retirement was effective on January 31, 2012. When compared to the fourth quarter of 2011, salary expenses in the fourth quarter of 2012 were down $2.2 million or $8.8 million on an annualized basis. Also, during 2011 the Corporation executed sales of $457 million (unpaid principal balance) non-performing mortgage loans at BPNA and $358 million in unpaid principal balance of construction and commercial real estate loans at BPPR as part of its de-risking strategy.
During 2012, we continued to make significant progress in improving our credit quality. By effectively managing asset exposure through loss mitigation strategies and aggressively resolving non-performing loans, we were able to reduce the balance of non-performing assets, excluding covered assets, by $384 million from December 31, 2011. Also, we continued to look for synergies and efficiencies within our operations. On December 2012, Popular Mortgage, Inc. was merged into Banco Popular de Puerto Rico. This consolidation, among other things, is expected to bring us cost savings of approximately $10 million annually.
Competition
The financial services industry in which we operate is highly competitive. In Puerto Rico, our primary market, the banking business is highly competitive with respect to originating loans, acquiring deposits and providing other banking services. Most of our direct competition for our products and services comes from commercial banks. The Puerto Rico market is dominated by locally based commercial banks with assets between $7 million and $27 billion as of December 31, 2012, including BPPR, and a few large U.S. and foreign banks. On April 30, 2010, the FDIC closed three commercial banks and entered into los-s-share purchase and assumption agreements with three other commercial banks with operations in Puerto Rico, including us with respect to Westernbank Puerto Rico. Those transactions involved the acquisition of most of the assets and liabilities of the closed banks, including the assumption of all of the non-brokered deposits. While these transactions have reduced the number of banking competitors in Puerto Rico, they have allowed some of our competitors to gain greater resources, such as a broader range of products and services. On December 18, 2012, there was another banking consolidation in Puerto Rico when Oriental Financial Group, a locally based financial institution, acquired the Puerto Rico operations of Banco Bilvao Vizcaya Argentaria S.A. (BBVA), a foreign bank. As of December 31, 2012, there were 9 commercial banks operating in Puerto Rico.
We also compete with specialized players in the local financial industry that are not subject to the same regulatory restrictions as domestic banks and bank holding companies. Those competitors include brokerage houses, mortgage companies, insurance companies, credit unions (locally known as cooperativas), credit card companies, consumer finance companies, institutional lenders and other financial and non-financial institutions and entities. Credit unions generally provide basic consumer financial services. Some of those competitors are significantly larger than us, have lower cost structures and many have fewer regulatory constraints.
In the United States, our competition is primarily from community banks operating in our footprint and national banking institutions. Those include institutions with much more resources than we have that can exert substantial competitive pressure.
In both Puerto Rico and the United States, the primary factors in competing for business include pricing, convenience of office locations and other delivery methods, range of products offered, and the level of service delivered. We must compete effectively along all these parameters to be successful. We may experience pricing pressure as some of our competitors seek to increase market share by reducing prices. Competition is particularly acute in the market for deposits, where pricing is very aggressive. Increased competition could require that we increase the rates offered on deposits or lower the rates charged on loans, which could adversely affect our profitability.
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Economic factors, along with legislative and technological changes, will have an ongoing impact on the competitive environment within the financial services industry. We work to anticipate and adapt to dynamic competitive conditions whether it may be developing and marketing innovative products and services, adopting or developing new technologies that differentiate our products and services, cross-marketing, or providing personalized banking services. We strive to distinguish ourselves from other community banks and financial services providers in our market place by providing a high level of service to enhance customer loyalty and to attract and retain business. However, we can provide no assurance as to the effectiveness of these efforts on our future business or results of operations, as to our continued ability to anticipate and adapt to changing conditions, and as to sufficiently improving our services and/or banking products in order to successfully compete in our primary service areas.
Employees
At December 31, 2012, we employed 8,072 full time equivalent employees of which 6,671 were located in Puerto Rico and the Virgin Islands and 1,401 in the U.S. mainland. None of our employees is represented by a collective bargaining group.
Financial Information About Segments
Our corporate structure consists of two reportable segments BPPR and BPNA. A Corporate group has been defined to support the reportable segments. On September 30, 2010, we completed the sale of a 51% ownership interest in EVERTEC, which included the merchant acquiring business of BPPR. EVERTEC was reported as a reportable segment prior to such date, while the merchant acquiring business was originally included in the BPPR reportable segment through June 30, 2010. As a result of the sale, we no longer present EVERTEC as a reportable segment and therefore, historical financial information for the processing and merchant acquiring businesses has been reclassified under the Corporate group for all periods presented. Additionally, we retained Tarjetas y Transacciones en Red Tranred, C.A. (TRANRED) (formerly EVERTEC DE VENEZUELA, C.A). and its equity investments in CONTADO and Serfinsa, which were included in the EVERTEC reportable segment through June 30, 2010. As indicated in Note 30, Related Party Transactions, we sold our equity investments in CONTADO and Serfinsa during 2011. In 2011, we recorded $4.3 million in operating expenses because of the write-off of our investment in TRANRED as we determined to wind-down these operations. The results for the equity investments are included in the Corporate group for all periods presented. Revenue from the remaining 48.5% ownership interest in EVERTEC is reported as non-interest income in the Corporate group.
Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. The segments were determined based on the organizational structure, which focuses primarily on the markets the segments serve, as well as on the products and services offered by the segments.
For further information about our segments, see Reportable Segment Results on Management Discussion and Analysis of the Annual Report and Note 41, Segment Reporting to the consolidated financial statements included in the Annual Report.
About Financial Information About Geographic Areas
Our revenue composition by geographical area is presented in Note 41, Segment Reporting to the consolidated financial statements included in the Annual Report.
The following table presents our long-lived assets by geographical area, other than financial instruments, long-term customer relationships, mortgage and other servicing rights and deferred tax assets. Long-lived assets located in foreign countries represent the investments under the equity method in the Dominican Republic.
Long-lived assets | 2012 | 2011 | 2010 | |||||||||
(Dollars in thousands) | ||||||||||||
Puerto Rico |
||||||||||||
Premises and equipment |
$ | 471,821 | $ | 475,356 | $ | 480,957 | ||||||
Goodwill |
245,680 | 246,273 | 245,310 | |||||||||
Other intangible assets |
30,070 | 35,560 | 41,229 | |||||||||
Investments under the equity method |
156,305 | 236,426 | 214,180 | |||||||||
|
|
|||||||||||
$ | 903,876 | $ | 993,615 | $ | 981,676 | |||||||
|
|
|||||||||||
United States |
||||||||||||
Premises and equipment |
$ | 63,972 | $ | 63,130 | $ | 62,216 | ||||||
Goodwill |
402,077 | 402,077 | 402,077 | |||||||||
Other intangible assets |
10,364 | 13,084 | 15,805 | |||||||||
Investments under the equity method |
11,395 | 11,689 | 12,643 | |||||||||
|
|
|||||||||||
$ | 487,808 | $ | 489,980 | $ | 492,741 | |||||||
|
|
|||||||||||
Foreign Countries |
||||||||||||
Premises and equipment |
$ | - | $ | - | $ | 2,280 | ||||||
Goodwill |
- | - | - | |||||||||
Other intangible assets |
- | - | - | |||||||||
Investments under the equity method |
79,076 | 65,037 | 72,362 | |||||||||
|
|
|||||||||||
$ | 79,076 | $ | 65,037 | $ | 74,642 | |||||||
|
|
Regulation and Supervision
Described below are the material elements of selected laws and regulations applicable to Popular, PNA and their respective subsidiaries. Such laws and regulations are continually under review by Congress and state legislatures and federal and state regulatory agencies. Any change in the laws and regulations applicable to Popular and its subsidiaries could have a material effect on the business of Popular and its subsidiaries.
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General
Popular and PNA are bank holding companies subject to consolidated supervision and regulation by the Federal Reserve Board under the BHC Act. BPPR and BPNA are subject to supervision and examination by applicable federal and state banking agencies including, in the case of BPPR, the Federal Reserve Board and the Office of the Commissioner of Financial Institutions of Puerto Rico (the Office of the Commissioner), and in the case of BPNA, the Federal Reserve Board and the New York State Department of Financial Services.
On December 20, 2011, the Federal Reserve Board issued for public comment a notice of proposed rulemaking under Title I of the Dodd-Frank Act, which we refer to as the Proposed SIFI Rules, establishing enhanced prudential standards for:
| Risk-based capital requirements and leverage limits; |
| Stress testing of capital; |
| Liquidity requirements; |
| Overall risk management requirements; |
| Resolution plan (so-called living wills) and credit exposure reporting; and |
| Concentration/credit exposure limits. |
The Proposed SIFI Rules address a wide, diverse array of regulatory areas, each of which is highly complex. In some cases they would implement financial regulatory requirements being proposed for the first time (for example, an enterprise-wide limit on exposures to any one counterparty and certain of its affiliates established at 25% of the capital and surplus of the covered company) and others overlap with other regulatory reforms (for example, the Basel III capital and liquidity reforms discussed below in this section). The Proposed SIFI Rules also address the Dodd-Frank Acts early remediation requirements applicable to bank holding companies that have total consolidated assets of $50 billion or more. The proposed remediation rules are modeled after the prompt corrective action regime, described below, but are designed to require action beginning in the earlier stages of a companys financial distress by mandating action on the basis of arranged triggers, including capital and leverage, stress test results, liquidity and risk management. The Proposed SIFI Rules requirements generally will become effective on the first day of the fifth calendar quarter after the effective date of the final rule, although certain requirements have different transition periods. Although by their terms most of the Proposed SIFI Rules requirements apply only to bank holding companies with at least $50 billion in total consolidated assets, the Proposed SIFI Rules require bank holding companies and member banks with more than $10 billion in total consolidated assets to conduct their own annual stress tests and publish a summary of the results of the stress tests. In addition, it is possible that the Federal Reserve may determine in the future to apply some or all of the Proposed SIFI Rules to smaller bank holding companies.
In October 2012, the Federal Reserve Board issued final rules implementing the requirements of Section 165(i)(1) of the Dodd-Frank Act concerning supervisory stress tests to be conducted by the Federal Reserve Board (the Annual Supervisory Stress Test Rule) and Section 165(i)(2) of the Dodd-Frank Act regarding semi-annual company-run stress tests (the Semi-Annual Company-Run Stress Test Rule, and, together with the Annual Supervisory Stress Test Rule, the Stress Test Rules). The Stress Test Rules, effective on November 15, 2012, apply to bank holding companies with average total consolidated assets of $50 billion or more and nonbank financial companies designated by the Financial Stability Oversight Council. Concurrent with the Stress Test Rules, the Federal Reserve Board issued final rules implementing other requirements of Section 165(i)(2) of the Dodd-Frank Act regarding annual company-run stress tests (the Annual Company-Run Stress Test Rules). The Annual Company-Run Stress Test Rules, effective on November 15, 2012, apply to, bank holding companies with average total consolidated assets of greater than $10 billion but less than $50 billion and any state member bank that has average total consolidated assets of more than $10 billion. The Stress Test Rules and the Annual Company-Run Stress Test Rules set forth, among other things, the requirements on the methodology and scenarios for the stress tests and related publication requirements. On November 15, 2012, the Federal Reserve Board released the economic and financial market scenarios that will be used in the next round of stress tests.
In addition, in May 2012, the Federal Reserve Board, the Office of the Comptroller of the Currency (the OCC), and the FDIC issued a supervisory guidance regarding stress-testing practices at banking organizations with total consolidated assets of more than $10 billion. The guidance outlined general principles for a satisfactory stress testing framework and described how stress testing should be used at various levels within an organization. The guidance also discussed the importance of stress testing in capital and liquidity planning, and the importance of strong internal governance and controls in an effective stress-testing framework.
As of December 31, 2012, Popular had total consolidated assets of $36.5 billion. As of the same date, BPPR and BPNA had total consolidated assets of $27.2 billion and $8.6 billion, respectively.
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Prompt Corrective Action
The Federal Deposit Insurance Act (the FDIA) requires, among other things, the federal banking agencies to take prompt corrective action in respect of insured depository institutions that do not meet minimum capital requirements. The FDIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The relevant capital measures are the total risk-based capital ratio, the Tier 1 risk- based capital ratio and the leverage ratio.
Rules adopted by the federal banking agencies provide that an insured depository institution will be deemed to be (1) well capitalized if it maintains a leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10% and is not subject to any written agreement or directive to meet a specific capital level; (2) adequately capitalized, if it is not well capitalized, but maintains a leverage ratio of at least 4% (or at least 3% if given the highest regulatory rating in its most recent report of examination and not experiencing or anticipating significant growth), a Tier 1 risk-based capital ratio of at least 4% and a total risk-based capital ratio of at least 8%; (3) undercapitalized if it fails to meet the standards for adequately capitalized institutions (unless it is deemed significantly or critically undercapitalized); (4) significantly undercapitalized if it has a leverage ratio of less than 3%, a Tier 1 risk-based capital ratio of less than 3% or a total risk-based capital ratio of less than 6%; and (5) critically undercapitalized if it has tangible equity equal to 2% or less of total assets.
The FDIC generally prohibits an insured depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company, if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institutions holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institutions assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institutions capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.
Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.
The capital-based prompt corrective action provisions of the FDIA apply to the FDIC-insured depository institutions such as BPPR and BPNA, but they are not directly applicable to holding companies such as Popular and PNA, which control such institutions. As noted above, the Proposed SIFI Rules address the Dodd-Frank Acts early remediation requirements applicable to bank holding companies that have total consolidated assets of $50 billion or more.
Section 202(g) of the Dodd-Frank Act required the Government Accountability Office (GAO) to conduct a study of the implementation of the prompt corrective action provisions by the federal banking agencies and make recommendations to make them a more effective tool. The GAO Study, released on June 23, 2011, noted that capital can lag behind other indicators of bank health and, therefore, recommended that alternative Prompt Corrective Action triggers be considered, including indicators based on earnings, asset quality, liquidity, reliance on unstable funding, and sector loan concentration.
In June 2012, the federal banking agencies proposed revisions to the prompt corrective action framework by incorporating newly proposed regulatory capital requirements as more fully discussed in Capital Adequacy below.
Transactions with Affiliates
BPPR and BPNA are subject to restrictions under Section 23A of the Federal Reserve Act that limit the amount of extensions of credit and certain other covered transactions (as defined in Section 23A) between BPPR or BPNA, on the one hand, and Popular, PNA or any of our other non-banking subsidiaries, on the other, and that impose collateralization requirements on such credit extensions. A bank may not engage in any covered transaction if the aggregate amount of the banks covered transactions with that affiliate would exceed 10% of the banks capital stock and surplus or the aggregate amount of the banks covered transactions with all affiliates would exceed 20% of the banks capital stock and surplus. In addition, Section 23B of the Federal Reserve Act requires that any transaction between BPPR or BPNA, on the one hand, and Popular, PNA or any of our other non-banking subsidiaries, on the other, be carried out on an arms length basis.
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Source of Financial Strength
Under the Federal Reserve Boards Regulation Y, a bank holding company such as Popular or PNA is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each subsidiary bank. This support may be required at times when, absent such policy, the bank holding company might not otherwise provide such support. In addition, any capital loans by a bank holding company to any of its subsidiary depository institutions are subordinated in right of payment to deposits and to certain other indebtedness of such subsidiary depository institution. In the event of a bank holding companys bankruptcy, any commitment by the bank holding company to a federal banking agency to maintain the capital of a subsidiary depository institution will be assumed by the bankruptcy trustee and entitled to a priority of payment. BPPR and BPNA are currently the only insured depository institution subsidiaries of Popular and PNA.
Section 616 of the Dodd-Frank Act obligates the Federal Reserve Board to require bank holding companies to serve as a source of financial strength for any subsidiary depository institution. The term source of financial strength is defined as the ability of a company to provide financial assistance to its insured depository institution subsidiaries in the event of financial distress at such subsidiaries. The source-of-strength amendments in Section 616 took effect on July 21, 2011, and the appropriate federal banking agencies were required to jointly adopt implementing regulations not later than one year after that date. To date, however, the federal banking agencies have not proposed any regulations to implement Section 616. Prior to the Dodd-Frank Act, there was no explicit authority in the BHC Act for the source of strength provision in the Federal Reserve Boards Regulation Y.
Living Will
As required by Section 165(d) of the Dodd-Frank Act, the Federal Reserve Board and the FDIC have jointly issued a final rule, which became effective on November 1, 2011, that requires certain organizations, including each bank holding company with consolidated assets of $50 billion or more, to report periodically to the FDIC and the Federal Reserve Board the companys plan for its rapid and orderly resolution in the event of material financial distress or failure. The final rule sets specific standards for the resolution plans, including requiring a strategic analysis of the plans components, a description of the range of specific actions the company proposes to take in resolution and a description of the companys organizational structure, material entities, interconnections and interdependencies, and management information systems, among other elements.
In addition, the FDIC has issued a final rule, which became effective on April 1, 2012, that requires insured depository institutions with total assets of $50 billion or more to submit to the FDIC periodic contingency plans for resolution in the event of the institutions failure. The rule requires these institutions to submit a resolution plan that will enable the FDIC, as receiver, to resolve the institution in a manner that ensures that depositors receive access to their insured deposits within one business day of the institutions failure (two business days if the failure occurs on a day other than a Friday), maximizes the net-present-value return from the sale or disposition of its assets, and minimizes the amount of any loss to be realized by the institutions creditors.
As of December 31, 2012, BPPR and BPNA had total consolidated assets of $27.2 billion and $8.6 billion, respectively.
Dividend Restrictions
The principal sources of funding for the holding companies have included dividends received from their banking and non-banking subsidiaries, asset sales and proceeds from the issuance of medium-term notes, junior subordinated debentures and equity. Various statutory provisions limit the amount of dividends an insured depository institution may pay to its holding company without regulatory approval. A member bank must obtain the approval of the Federal Reserve Board for any dividend, if the total of all dividends declared by the member bank during the calendar year would exceed the total of its net income (as reportable in its Report of Condition and Income) for that year, combined with its retained net income (as defined by regulation) for the preceding two years, less any required transfers to surplus or to a fund for the retirement of any preferred stock. In addition, a member bank may not declare or pay a dividend in an amount greater than its undivided profits as reported in its Report of Condition and Income, unless the member bank has received the approval of the Federal Reserve Board. A member bank also may not permit any portion of its permanent capital to be withdrawn unless the withdrawal has been approved by the Federal Reserve Board. Subject to the Federal Reserves ability to establish more stringent specific requirements under its supervisory or enforcement authority, at December 31, 2012, BPPR could have declared a dividend of approximately $404 million. However, on July 25, 2011, PIHC and BPPR entered into a Memorandum of Understanding with the Federal Reserve Bank of New York and the Office of the Commissioner of Financial Institutions of Puerto Rico that requires the approval of these entities prior to the payment of any dividends by BPPR to PIHC. BPNA could not declare any dividends without the approval of the Federal Reserve Board.
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It is Federal Reserve Board policy that bank holding companies generally should pay dividends on common stock only out of net income available to common shareholders over the past year and only if the prospective rate of earnings retention appears consistent with the organizations current and expected future capital needs, asset quality and overall financial condition. Moreover, under Federal Reserve Board policy, a bank holding company should not maintain dividend levels that place undue pressure on the capital of depository institution subsidiaries or that may undermine the bank holding companys ability to be a source of strength to its banking subsidiaries. The Federal Reserve Board has indicated that in the capital plans submitted by bank holding companies with total consolidated assets of $50 billion or more, requests that imply common dividend payout ratios above 30% of projected after-tax net income will receive particularly close scrutiny. Popular is also subject to dividend restrictions because of our participation in the TARP Capital Purchase Program. For further information please refer to Part II, Item 5, Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Under the American Jobs Creation Act of 2004, subject to compliance with certain conditions, distributions of U.S. sourced dividends to a corporation organized under the laws of the Commonwealth of Puerto Rico are subject to a withholding tax of 10% instead of the 30% applied to other foreign corporations.
See Puerto Rico RegulationGeneral below for a description of certain restrictions on BPPRs ability to pay dividends under Puerto Rico law.
FDIC Insurance
BPPR and BPNA are subject to FDIC deposit insurance assessments. The Federal Deposit Insurance Reform Act of 2005 (the Reform Act) created a single DIF, increased the maximum amount of FDIC insurance coverage for certain retirement accounts, and provided for possible inflation adjustments in the maximum amount of coverage available with respect to other insured accounts. Under the Reform Act, the FDIC made significant changes to its risk-based assessment system so that effective January 1, 2007, the FDIC imposed insurance premiums based upon a matrix that is designed to more closely tie what banks pay for deposit insurance to the risks they pose.
The Emergency Economic Stabilization Act of 2008 (EESA) temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. Section 335 of the Dodd-Frank Act made permanent the $250,000 standard maximum limit for federal deposit insurance. In addition, from December 31, 2010 until January 1, 2013, Section 335 provided temporary unlimited federal deposit insurance protection for non-interest bearing transaction accounts that are payable on demand at insured depository institutions. The temporary unlimited federal deposit insurance protection for non-interest bearing transaction accounts expired on January 1, 2013.
Section 334 of the Dodd-Frank Act eliminated the ceiling on the size of the DIF (1.5 percent of estimated insured deposits prior to the enactment of the Dodd-Frank Act). Section 334 also raised the statutorily required floor for the DIF from 1.15 % of estimated insured deposits to 1.35 % of estimated insured deposits, or a comparable percentage of the revised assessment base required by the Dodd-Frank Act, which is based on average total assets less average tangible equity. Section 334 required the FDIC to take the steps necessary for the DIF to meet this revised reserve ratio by September 30, 2020.
On October 19, 2010, the FDIC adopted a new Federal Deposit Insurance Corporation Restoration Plan (the Restoration Plan) for the DIF to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by Section 334 of the Dodd-Frank Act. Under the Restoration Plan, the FDIC has foregone the uniform three-basis point increase in initial assessment rates previously scheduled to take place on January 1, 2011. On December 14, 2010, the FDIC adopted a final rule, which became effective on January 1, 2011, to set the DIFs designated reserve ratio at 2% of estimated insured deposits.
As required by Sections 331 and 332 of the Dodd-Frank Act, on February 7, 2011, the FDIC adopted a final rule relating to deposit insurance assessment base, assessment rate adjustments, deposit insurance assessment rates, dividends, and large bank pricing methodology, which became effective on April 1, 2011. Under the final rule, the assessment base for an insured depository institution is the average consolidated total assets of the insured depository institution minus the average tangible equity of the institution during the assessment period. Prior to April 1, 2011, only deposits payable in the United States were included in determining the premium paid by an institution.
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The Deposit Insurance Funds Act of 1996 separated the Financing Corporation (FICO) assessment to service the interest on its bond obligations from the DIF assessment. The amount assessed on individual institutions by the FICO is in addition to the amount paid for deposit insurance according to the FDICs risk-related assessment rate schedules. The FICO assessment rate for the first quarter of 2013 was 0.64 cents per $100 of deposits.
As of December 31, 2012, we had a DIF average total assets less average tangible equity assessment base of approximately $32 billion.
Brokered Deposits
The FDIA governs the receipt of brokered deposits. Section 29 of the FDIA and the regulations adopted thereunder restrict the use of brokered deposits and the rate of interest payable on deposits for institutions that are less than well capitalized. There are no such restrictions on a bank that is well capitalized. Popular does not believe the brokered deposits regulation has had or will have a material effect on the funding or liquidity of BPPR and BPNA.
Capital Adequacy
Under the Federal Reserve Boards risk-based capital guidelines for bank holding companies and member banks, the minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies and member banks. These guidelines provide for a minimum ratio of Tier 1 capital to total assets, less goodwill and certain other intangible assets (the leverage ratio) of 3% for bank holding companies and member banks that have the highest regulatory rating or have implemented the Federal Reserve Boards market risk capital measure. All other bank holding companies and member banks are required to maintain a minimum leverage ratio of 4%. See Consolidated Financial Statements, Note 24 Regulatory Capital Requirements for the capital ratios of Popular, BPPR and BPNA. Failure to meet capital guidelines could subject Popular and our depository institution subsidiaries to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC and to certain restrictions on our business. See Prompt Corrective Action.
Section 171 of the Dodd-Frank Act (the Collins Amendment) required the federal banking agencies to establish minimum leverage and risk-based capital requirements that apply on a consolidated basis for insured depository institutions and their holding companies. In effect, the Collins Amendment applied to bank holding companies the same leverage and risk-based capital requirements that apply to insured depository institutions. Because the capital requirements must be the same for insured depository institutions and their holding companies, the Collins Amendment excludes trust preferred securities from Tier 1 capital, subject to phase-out from Tier 1 qualification for trust preferred securities issued before May 19, 2010, with the phase-out commencing on January 1, 2013 and to be implemented incrementally over a three-year period commencing on that date. Debt or equity instruments issued to the United States or any agency or instrumentality thereof prior to October 10, 2010, pursuant to the EESA, are exempted from the requirements of the Collins Amendment. Under the rules in place prior to the Collins Amendment, trust preferred securities (in addition to, among others, common equity, retained earnings, minority interests in equity accounts of consolidated subsidiaries) could be included in Tier 1 capital for bank holding companies, provided that not more than 25% of qualifying Tier 1 capital could consist of noncumulative perpetual preferred stock, trust preferred securities or other so-called restricted core capital elements.
As required by the Collins Amendment, the OCC, the Federal Reserve Board and the FDIC jointly issued a final rule related to risk-based capital standards. Pursuant to the final rule, which became effective on July 28, 2011, a banking organization operating under the agencies advanced approaches risk-based capital rules is required to meet the higher of the minimum requirements under the general risk-based capital rules and the minimum requirements under the advanced approaches risk-based capital rules.
In addition, the Federal Reserve Board issued a final rule, which became effective on December 30, 2011, requiring top-tier U.S. bank holding companies with total consolidated assets of $50 billion or more to submit annual capital plans, with their related stress test requirements, to the appropriate Federal Reserve Bank for review and to generally obtain regulatory approval before making capital distributions, which include dividends and purchases of capital securities and instruments.
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Banking organizations are expected to maintain at least 50 percent of their Tier 1 capital as common equity. In addition, senior perpetual preferred stock issued to the U.S. Treasury under the Troubled Asset Relief Program (TARP) Capital Purchase Program may be included, without limit, as Tier 1 capital. Tier 2 capital consists of, among other things, a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan and lease loss reserves.
At December 31, 2012, Popular had $427 million in trust preferred securities (capital securities) that are subject to the phase-out. Popular has not issued any trust preferred securities since May 19, 2010. At December 31, 2012, the remaining trust preferred securities corresponded to capital securities issued to the U.S. Treasury pursuant to the EESA. The Collins Amendment includes an exemption from the phase-out provision that applies to these capital securities because they were issued prior to October 4, 2010.
In 2004, the Basel Committee on Banking Supervision (the Basel Committee) published a new set of risk-based capital standards (Basel II) in order to update the original international capital standards that had been put in place in 1988 (Basel I). A definitive final rule for implementing the advanced approaches of Basel II in the United States, which applies only to certain large or internationally active or core banking organizations (defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more) became effective on April 1, 2008. Other U.S. banking organizations may elect to adopt the requirements of this rule (if they meet applicable qualification requirements), but are not required to do so. The advanced approaches rules establish a series of transitional floors to provide a smooth transition to the advanced approaches rules and to limit temporarily the amount by which a banking organizations risk-based capital requirements could decline relative to the general risk-based capital rules.
On December 12, 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, released its final framework for strengthening international capital and liquidity regulation (Basel III). According to Basel III, commencing on January 1, 2013, banks should be required to meet the following minimum capital ratios: 3.5% common equity Tier 1 (CET1) to risk-weighted assets; 4.5% Tier 1 capital to risk-weighted assets; and 8.0% total capital to risk-weighted assets. When fully phased in on January 1, 2019, banks should be required to maintain: a minimum 4.5% CET1 to risk-weighted assets, plus a 2.5% capital conservation buffer (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%); a minimum 6.0% Tier 1 capital to risk-weighted assets, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5%); and a minimum 8.0% total capital to risk-weighted assets, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5%); a minimum leverage ratio of 3%; and a countercyclical capital buffer, generally to be imposed when regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).
The Basel III final capital framework provides for a number of new deductions from and adjustments to CET1, the implementation of which will begin on January 1, 2014 and will be phased in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).
The Basel III final liquidity framework requires banks to comply with two measures of liquidity risk exposure: the Liquidity Coverage Ratio, or LCR, based on a 30-day time horizon and calculated as the ratio of the stock of high-quality liquid assets divided by total net cash outflows over the next 30 calendar days, which must be at least 100%; and the Net Stable Funding Ratio, or NSFR, calculated as the ratio of the available amount of stable funding divided by the required amount of stable funding, which must be at least 100%. On January 6, 2013, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision announced amendments to the LCR as a minimum standard. The LCR will be introduced as planned on January 1, 2015. However, the minimum LCR requirement will begin at 60% and will be phased in over the next four years in 10% increments, reaching 100% on January 1, 2019.
On June 7, 2012, the OCC, the Federal Reserve Board and the FDIC jointly issued a final rule to implement changes to the market risk capital rule, which requires banking organizations with significant trading activities to adjust their capital requirements to better account for the market risks of those activities. The final rule, which became effective on January 1, 2013, implements certain revisions made by the Basel Committee on Banking Supervision to its market risk framework between 2005 and 2010. The final rule applies to banking organizations with aggregated trading assets and trading liabilities equal to 10 percent or more of quarter-end total assets or $1 billion or more.
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Also on June 7, 2012, the Federal Reserve Board and the FDIC jointly issued three proposed rules that would implement in the United States the Basel III regulatory capital reforms from the Basel Committee and changes required by the Dodd-Frank Act. Comments on the three proposed rules were due by October 22, 2012.
The first proposed rule, titled Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions, would apply to all depository institutions, bank holding companies with total consolidated assets of $500 million or more. Consistent with Basel III, this proposed rule would require that banking organizations comply with the following minimum capital ratios: (1) A CET1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6.0 percent; (3) a total capital ratio of 8.0%; and (4) a Tier 1 capital to average consolidated assets of 4.0% and, for advanced approaches banking organizations only, an additional requirement Tier 1 capital to total leverage exposure ratio of 3.0%. The proposed rule would also revise the agencies prompt corrective action framework by incorporating the new regulatory capital minimums and updating the definition of tangible common equity.
The second proposed rule, titled Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements, also would apply to all banking organizations subject to minimum capital requirements. This proposed rule would revise and harmonize the agencies rules for calculating risk-weighted assets to enhance risk sensitivity.
The third proposed rule, titled Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule, would apply to banking organizations that are subject to the agencies advanced approaches rule or to their market risk rule. This proposed rule would enhance the risk sensitivity of the current rule for internationally active firms to better address counterparty credit risk and interconnectedness among financial institutions.
Due to the large volume of comments received on the three proposed rules and the wide range of views expressed during the comment period, on November 9, 2012, the agencies jointly issued a statement that they did not expect that any of the proposed rules would become effective on January 1, 2013.
Although Popular does not meet the thresholds for the advanced approaches and market risk capital rules, the ultimate impact of the new capital and liquidity standards applicable to us cannot be determined at this time and will depend on a number of factors, including the treatment and implementation by the U.S. banking regulators. However, a requirement that Popular and our depository institution subsidiaries maintain more capital, with common equity as a more predominant component, or manage the configuration of their assets and liabilities in order to comply with formulaic liquidity requirements, could significantly affect our financial condition, operations, capital position and ability to pursue business opportunities.
Interstate Branching
Section 613 of the Dodd-Frank Act amended the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Banking Act) to authorize national banks and state banks to branch interstate through de novo branches. This section became effective on July 22, 2010. Prior to the enactment of the Dodd-Frank Act, the Interstate Banking Act provided that states may make an opt-in election to permit interstate branching through de novo branches. A majority of states did not opt in. Section 613 of the Dodd-Frank Act eliminated such required opt-in election. For purposes of the Interstate Banking Act, BPPR is treated as a state bank and is subject to the same restrictions on interstate branching as are other state banks.
Activities and Acquisitions
Under the BHC Act, the activities of bank holding companies and their non-banking subsidiaries have been limited to the business of banking and activities closely related to banking, and no bank holding company could directly or indirectly acquire ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company in the United States, including a bank, without the prior approval of the Federal Reserve Board. In addition, bank holding companies generally have been prohibited under the BHC Act from engaging in non-banking activities, unless such activities were found by the Federal Reserve Board to be closely related to banking.
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The Gramm-Leach-Bliley Act allows bank holding companies whose subsidiary depository institutions meet management, capital and Community Reinvestment Act standards to engage in a substantially broader range of nonbanking financial activities than is permissible for bank holding companies that fail to meet those standards, including securities underwriting and dealing, insurance underwriting and making merchant banking investments in nonfinancial companies. In order for a bank holding company to engage in the broader range of activities that are permitted by the Gramm-Leach-Bliley Act (i) all of its depository institution subsidiaries must be well capitalized (as described above), and well managed and (ii) it must file a declaration with the Federal Reserve Board that it elects to be a financial holding company. In addition, Section 606 of the Dodd-Frank Act requires that a bank holding company that is a financial holding company and therefore may engage in the expanded financial activities authorized by the Gramm-Leach-Bliley Act be and remain well-capitalized and well managed. Popular and PNA have elected to be treated as financial holding companies. A depository institution is deemed to be well managed if at its most recent inspection, examination or subsequent review by the appropriate federal banking agency (or the appropriate state banking agency), the depository institution received at least a satisfactory composite rating and at least a satisfactory rating for the management component of the composite rating. If, after becoming a financial holding company, the company fails to continue to meet any of the capital or managerial requirements for financial holding company status, the company must enter into a confidential agreement with the Federal Reserve Board to comply with all applicable capital and management requirements. If the company does not return to compliance within 180 days, the Federal Reserve Board may extend the agreement or may order the company to divest its subsidiary banks or the company may discontinue, or divest investments in companies engaged in, activities permissible only for a bank holding company that has elected to be treated as a financial holding company.
Pursuant to Section 619 of the Dodd-Frank Act, commonly called the Volcker Rule, which became effective on July 21, 2012, the U.S. financial regulatory agencies are required to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). In October 2011 and January 2012, Federal regulators proposed rules to implement the Volcker Rule that included an extensive request for comments on the proposal. Comments on the October proposal were due by February 13, 2012; comments on the January proposal, which was substantially identical to the October proposal, were due by April 16, 2012. In April 2012, the Federal Reserve Board issued a guidance regarding the two-year conformance period (two years from July 21, 2012) for compliance with the Volcker Rule. The guidance confirmed that banking entities have the full two-year statutory conformance period to conform fully their activities and investments to the prohibitions of the Volcker Rule. The proposed rules, if adopted, could adversely affect the activities and materially increase the cost of compliance of Popular Securities and the mortgage trading activities.
The Federal Reserve Board has the authority to limit and may in certain circumstances limit our ability to conduct activities and make acquisitions that would otherwise be permissible for a financial holding company. In addition, we are required to obtain prior Federal Reserve Board approval before engaging in certain banking and other financial activities both in the United States and abroad.
Pursuant to Section 163 of the Dodd-Frank Act, bank holding companies with total consolidated assets greater than $50 billion (regardless of whether such bank holding companies have elected to be treated as financial holding companies) must provide prior written notice to the Federal Reserve Board before acquiring shares of certain financial companies with assets in excess of $10 billion, unless an exception applies. In addition, Section 604 of the Dodd-Frank Act, which became effective on July 21, 2011, added a new application requirement before a financial holding company (regardless of its size) may acquire a nonbank company with $10 billion or more in total consolidated assets. As of December 31, 2012, Popular had total consolidated assets of $36.5 billion.
Anti-Money Laundering Initiative and the USA PATRIOT Act
A major focus of governmental policy relating to financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 (the USA PATRIOT Act) strengthened the ability of the U.S. government to help prevent, detect and prosecute international money laundering and the financing of terrorism. Title III of the USA PATRIOT Act imposed significant compliance and due diligence obligations, created new crimes and penalties and expanded the extra-territorial jurisdiction of the United States. Failure of a financial institution to comply with the USA PATRIOT Acts requirements could have serious legal and reputational consequences for the institution.
Community Reinvestment Act
The Community Reinvestment Act requires banks to help serve the credit needs of their communities, including extending credit to low- and moderate-income individuals and geographies. Should Popular or our bank subsidiaries fail to serve adequately the community, potential penalties may include regulatory denials of applications to expand branches, relocate, add subsidiaries and affiliates, expand into new financial activities and merge with or purchase other financial institutions.
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Interchange Fees Regulation.
Section 1075(a) of the Dodd-Frank Act added a new Section 920 of the Electronic Fund Transfer Act, which gives the Federal Reserve Board the authority to establish rules regarding interchange fees charged by payment card issuers for electronic debit transactions, and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer, with specific allowances for the costs of fraud prevention. On June 29, 2011, the Federal Reserve Board issued a final rule establishing standards for debit card interchange fees and prohibiting network exclusivity arrangements and routing restrictions. The final rule regarding debit card interchange fees became effective on October 1, 2011. Under the final rule, the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. Also on June 29, 2011, the Federal Reserve Board approved an interim final rule that allows for an upward adjustment of no more than 1 cent to an issuers debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed to achieve the fraud-prevention standards set out in the interim final rule. The interim final rule regarding fraud-prevention adjustment also became effective on October 1, 2011.
Consumer Financial Protection Act of 2010
Title X of the Dodd-Frank Act, also known as the Consumer Financial Protection Act of 2010 or CFPA, created a new consumer financial services regulator, the Bureau of Consumer Financial Protection, commonly called the CFPB, which has assumed most of the consumer financial services regulatory responsibilities currently exercised by federal banking regulators and other agencies. The CFPBs primary functions include the supervision of covered persons (broadly defined to include any person offering or providing a consumer financial product or service and any affiliated service provider) for compliance with federal consumer financial laws. The CFPB also has the broad power to prescribe rules applicable to a covered person or service provider identifying as unlawful, unfair, deceptive, or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. We are subject to examination and regulation by the CFPB.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the OFAC rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (OFAC). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Puerto Rico Regulation
As a commercial bank organized under the laws of Puerto Rico, BPPR is subject to supervision, examination and regulation by the Office of the Commissioner, pursuant to the Puerto Rico Banking Act of 1933, as amended (the Banking Law).
Section 27 of the Banking Law requires that at least ten percent (10%) of the yearly net income of BPPR be credited annually to a reserve fund. The apportionment must be done every year until the reserve fund is equal to the total of paid-in capital on common and preferred stock. During 2012, $17 million was transferred to the statutory reserve account. During 2012, BPPR was in compliance with the statutory reserve requirement.
Section 27 of the Banking Law also provides that when the expenditures of a bank are greater than its receipts, the excess of the former over the latter must be charged against the undistributed profits of the bank, and the balance, if any, must be charged against the reserve fund. If the reserve fund is not sufficient to cover such balance in whole or in part, the outstanding amount must be charged against the capital account and no dividend may be declared until capital has been restored to its original amount and the reserve fund to 20% of the original capital.
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Section 16 of the Banking Law requires every bank to maintain a legal reserve that, except as otherwise provided by the Office of the Commissioner, may not be less than 20% of its demand liabilities, excluding government deposits (federal, state and municipal) which are secured by collateral. If a bank is authorized to establish one or more bank branches in a state of the United States or in a foreign country, where such branches are subject to the reserve requirements of that state or country, the Office of the Commissioner may exempt said branch or branches from the reserve requirements of Section 16. Pursuant to an order of the Federal Reserve Board dated November 24, 1982, BPPR has been exempted from the reserve requirements of the Federal Reserve System with respect to deposits payable in Puerto Rico. Accordingly, BPPR is subject to the reserve requirements prescribed by the Banking Law.
As previously mentioned in the Business section, Section 17 of the Banking Law permits a bank to make loans to any one person, firm, partnership or corporation, up to an aggregate amount of fifteen percent (15%) of the paid-in capital and reserve fund of the bank. As of December 31, 2012, the legal lending limit for BPPR under this provision was approximately $217 million. In the case of loans which are secured by collateral worth at least 25% more than the amount of the loan, the maximum aggregate amount is increased to one third of the paid-in capital of the bank, plus its reserve fund. If the institution is well capitalized and had been rated 1 in the last examination performed by the Office of the Commissioner or any regulatory agency, its legal lending limit shall also include 15% of 50% of its undivided profits and for loans secured by collateral worth at least 25% more than the amount of the loan, the capital of the bank shall also include 33 1/3% of 50% of its undivided profits. Institutions rated 2 in their last regulatory examination may include this additional component in their legal lending limit only with the previous authorization of the Office of the Commissioner. There are no restrictions under Section 17 on the amount of loans that are wholly secured by bonds, securities and other evidence of indebtedness of the Government of the United States or Puerto Rico, or by current debt bonds, not in default, of municipalities or instrumentalities of Puerto Rico.
Section 14 of the Banking Law authorizes a bank to conduct certain financial and related activities directly or through subsidiaries, including finance leasing of personal property and originating and servicing mortgage loans. BPPR engages in these activities through its wholly-owned subsidiaries, Popular Auto, Inc. and Popular Mortgage, Inc., respectively. Both companies are organized and operate in Puerto Rico.
Available Information
We maintain an Internet website at www.popular.com. Via the Investor Relations link at our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8 -K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You may obtain copies of our filings on the SEC site.
We have adopted a written code of ethics that applies to all directors, officers and employees of Popular, including our principal executive officer and senior financial officers, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the SEC promulgated thereunder. Our Code of Ethics is available on our corporate website, www.popular.com, in the section entitled Corporate Governance. In the event that we make changes in, or provide waivers from, the provisions of this Code of Ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate website in such section. In the Corporate Governance section of our corporate website, we have also posted the charters for our Audit Committee, Compensation Committee and Corporate Governance and Nominating Committee, as well as our Corporate Governance Guidelines. In addition, information concerning purchases and sales of our equity securities by our executive officers and directors is posted on our website.
All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.
Popular, like other financial institutions, faces a number of risks inherent to our business, financial condition, liquidity, results of operations and capital position. These risks could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.
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The risks described in this report are not the only risks facing us. Additional risks and uncertainties not currently known by us or that we currently deem to be immaterial, or that are generally applicable to all financial institutions, also may materially adversely affect our business, financial condition or results of operations.
RISKS RELATING TO THE BUSINESS ENVIRONMENT AND OUR INDUSTRY
Weakness in the economy and in the real estate market in our geographic footprint has adversely impacted and may continue to adversely impact us.
Popular is exposed to geographical and government risk. A significant portion of our financial activities and credit exposure is concentrated in Puerto Rico, which entered into a recession in the second quarter of 2006. The latest figures from the Puerto Rico Planning Board (PB) cut projected gross product growth for the current 2013 fiscal year (ends June 30) nearly in half, to 0.6% from 1.1%. The PB also cut the estimated economic growth rate during fiscal 2012 (ended June 30, 2012) to 0.4% from 0.9%. This was the first full year with a stable, but weak economy in Puerto Rico, following a six-year steep decline in economic activity. Employment continued to be a weak spot with the economy losing 13,000 jobs in 2012 and the unemployment rate at 13.4% by year-end. Puerto Ricos fiscal situation is expected to continue to be challenging in 2013. The Commonwealths credit rating was downgraded by Moodys in December 2012, to Baa3 with a negative outlook, with various factors noted, including the lack of clear growth catalysts, the fiscal budget deficits and the financial condition of the public sector employee pension plans, which are significantly underfunded. The Puerto Rico economy, however, continues to be susceptible to fluctuations in the price of crude oil due to its high dependence on fuel oil for energy production. Populars assets and revenue composition by geographical area and by business segment reporting are presented in Note 41, Segment Reporting to consolidated financial statements.
The lingering effects of the prolonged recession are still reflected in limited loan demand and high levels of non-performing assets, loan loss provisions and charge-offs, particularly in our commercial loan portfolio in Puerto Rico, an increase in the rate of foreclosures and delinquencies on mortgage loans granted in Puerto Rico, and a reduction in the value of our loans and loan servicing portfolio, all of which have adversely affected our profitability. If the price of crude oil increases and if global economic conditions worsen, those adverse effects could continue. Also, a potential reduction in consumer spending may also impact growth in our non-interest revenues.
For additional information regarding the Puerto Rico economy, refer to Geographical and government risk in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of the Annual Report.
Further deterioration in collateral values of properties securing our construction, commercial and mortgage loan portfolios would result in increased credit losses and continue to harm our results of operations.
Further deterioration of the value of real estate collateral securing our construction, commercial and mortgage loan portfolios would result in increased credit losses. As of December 31, 2012, approximately 1%, 30% and 29% of our non-covered loan portfolio consisted of construction, commercial secured by real estate and mortgage loans, respectively.
Substantially our entire loan portfolio is located within the boundaries of the U.S. economy. Whether the collateral is located in Puerto Rico, the U.S. Virgin Islands, the British Virgin Islands or the U.S. mainland, the performance of our loan portfolio and the collateral value backing the transactions are dependent upon the performance of and conditions within each specific real estate market. Recent economic reports related to the real estate market in Puerto Rico indicate that certain pockets of the real estate market are subject to reductions in value related to general economic conditions. In certain mainland markets like southern Florida, Illinois and California, we have experienced the negative impact associated with low absorption rates and property value adjustments due to overbuilding. We measure loan impairment based on the fair value of the collateral, if the loan is collateral dependent, which is derived from estimated collateral values, principally obtained from appraisal reports that take into consideration prices in observed transactions involving similar assets in similar locations, size and supply and demand. An appraisal report is only an estimate of the value of the property at the time the appraisal is made. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. In addition, given the current slowdown in the real estate market in Puerto Rico, the properties securing these loans may be difficult to dispose of, if foreclosed.
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Construction and commercial loans, mostly secured by commercial and residential real estate properties entail a higher credit risk than consumer and residential mortgage loans, since they are larger in size, may have less collateral coverage, concentrate more risk in a single borrower and are generally more sensitive to economic downturns. As of December 31, 2012, non-covered commercial and construction loans secured by commercial real estate properties, amounted to $6.5 billion or 31% of the total non-covered loan portfolio.
BPPR has various subsidiaries holding specific assets acquired in satisfaction of loans for real estate development projects. Total assets of those subsidiaries amounted to $82.8 million as of December 31, 2012, of which $37.3 million or 45% of total assets are foreclosed properties.
During the year ended December 31, 2012, net charge-offs specifically related to values of properties securing our non-covered construction, commercial, legacy and mortgage loan portfolios totaled $6.1 million, $101.9 million, $4.1 million and $9.4 million, respectively. Continued deterioration on the fair value of real estate properties for collateral dependent impaired loans would require increases in our provision for loan losses and allowance for loan losses. Any such increase would have an adverse effect on our future financial condition and results of operations. For more information on the credit quality of our construction, commercial and mortgage portfolio see the Credit Risk Management and Loan Quality section of the Managements Discussion and Analysis included in this Form 10-K.
Difficult market conditions have adversely affected the financial industry and our results of operations and financial condition.
Market instability and lack of investor confidence have led many lenders and institutional investors to reduce or cease providing funding to borrowers, including other financial institutions. This has led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity in general. The resulting economic pressures on consumers and uncertainty about the financial markets have adversely affected our industry and our business, results of operations and financial condition. We do not expect a material improvement in the financial environment in the near future. A worsening of these difficult conditions would exacerbate the economic challenges facing us and others in the financial industry. In particular, we face the following risks in connection with these events:
| We expect to face increased regulation of our industry, including as a result of the EESA and the Dodd-Frank Act. Compliance with those regulations may increase our costs and limit our ability to pursue business opportunities. |
| Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage and underwrite our customers become less predictive of future behavior. |
| The processes we use to estimate losses inherent in our credit exposure requires difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The reliability of these processes might be compromised if these variables are no longer capable of accurate estimation. |
| Competition in our industry could intensify as a result of increasing consolidation of financial services companies in connection with current market conditions. |
| The FDIC increased the assessments that we have to pay on our insured deposits during 2009 because market developments led to a substantial increase in bank failures and an increase in FDIC loss reserves, which in turn led to a depletion of the FDIC insurance fund reserves. We may be required to pay in the future significantly higher FDIC assessments on our deposits if market conditions do not improve or continue to deteriorate. |
| We may suffer higher credit losses because of federal or state legislation or other regulatory action that either (i) reduces the amount that our borrowers are required to pay us, or (ii) limits our ability to foreclose on properties or collateral or makes foreclosures less economically viable. |
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Financial services legislative and regulatory reforms may have a significant impact on our business and results of operations and on our credit ratings.
Popular is subject to extensive regulation, supervision and examination by federal and Puerto Rico banking authorities. Any change in applicable federal or Puerto Rico laws or regulations could have a substantial impact on our operations. Additional laws and regulations may be enacted or adopted in the future that could significantly affect Populars powers, authority and operations, which could have a material adverse effect on Populars financial condition and results of operations. Further, regulators in the performance of their supervisory and enforcement duties, have significant discretion and power to prevent or remedy unsafe and unsound practices or violations of laws by banks and bank holding companies. The exercise of this regulatory discretion and power would have a negative impact on Popular.
Current economic conditions, particularly in the financial markets, have resulted in government regulatory agencies and political bodies placing increased focus and scrutiny on the financial services industry. The U.S. Government has intervened on an unprecedented scale, responding to what has been commonly referred to as the financial crisis. Several funding and capital programs by the Federal Reserve Board and the U.S. Treasury were launched in 2008 and 2009, with the objective of enhancing financial institutions ability to raise liquidity. It is expected that these programs may have the effect of increasing the degree or nature of regulatory supervision to which we are subjected. These and other potential regulation and scrutiny may, or proposed legislative and regulatory changes could, significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital and, limit our ability to pursue business opportunities in an efficient manner or otherwise adversely affect our results of operations or earnings.
Our participation in TARP subjects us to increased scrutiny and imposes limitations on our business.
We face increased regulation and regulatory scrutiny as a result of our participation in the TARP. Unless we have redeemed all of the trust preferred securities issued to the U.S. Treasury or the U.S. Treasury has transferred all of its trust preferred securities to third parties, the consent of the U.S. Treasury will be required for us to, among other things, increase the dividend rate per share of Common Stock above $0.80 per share or to repurchase or redeem equity securities, including our Common Stock, subject to certain limited exceptions. Popular has also granted registration rights and offering facilitation rights to the U.S. Treasury pursuant to which we have agreed to lock-up periods during which it would be unable to issue equity securities. Our participation in TARP also imposes limitations on the payments we may make to our senior leaders. For more details on the implications of TARP please refer to the risks factors titled as follow: Our business could suffer if we are unable to attract, retain and motivate skilled senior leaders and dividends on our Common Stock and Preferred Stock have been suspended and stockholders may not receive funds in connection with their investment in our Common Stock or Preferred Stock without selling their shares.
The Dodd-Frank Act imposes new capital requirements, assessments and restrictions on our businesses, impacting the profitability of our business activities and changing certain of our business practices, and could expose us to additional costs, including increased compliance costs.
On July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike including several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.
The Dodd-Frank Act, among other things, imposes new capital requirements on bank holding companies; changes the base for FDIC insurance assessments to a banks average consolidated total assets minus average tangible equity, rather than upon its deposit base, and permanently raises the current standard deposit insurance limit to $250,000; and expands the FDICs authority to raise insurance premiums. The legislation also calls for the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to offset the effect of increased assessments on insured depository institutions with assets of less than $10 billion. The Dodd-Frank
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Act also limits interchange fees payable on debit card transactions, establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will have broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards, and contains provisions on mortgage-related matters such as steering incentives, determinations as to a borrowers ability to repay and prepayment penalties. The Dodd-Frank Act also includes provisions that affect corporate governance and executive compensation at all publicly-traded companies and allows financial institutions to pay interest on business checking accounts. The legislation also restricts proprietary trading, places restrictions on the owning or sponsoring of hedge and private equity funds, and regulates the derivatives activities of banks and their affiliates.
These provisions, or any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities or change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition, and results of operations. Our management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our operations. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and us in particular, is uncertain at this time.
Capital and liquidity proposals and legislation, if adopted, would change banking laws and our operating environment and that of our subsidiaries in substantial and unpredictable ways.
On December 12, 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, released its final framework for strengthening international capital and liquidity regulation (Basel III). The implementation of the Basel III final capital framework will commence January 1, 2013. On that date, banks will be required to meet the following minimum capital ratios: 3.5% common equity Tier 1 (CET1) to risk-weighted assets; 4.5% Tier 1 capital to risk-weighted assets; and 8.0% total capital to risk-weighted assets. When fully phased in on January 1, 2019, banks will be required to maintain: a minimum 4.5% CET1 to risk-weighted assets, plus a 2.5% capital conservation buffer (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%); a minimum 6.0% Tier 1 capital to risk-weighted assets, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5%); and a minimum 8.0% total capital to risk-weighted assets, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5%); a minimum leverage ratio of 3%; and a countercyclical capital buffer, generally to be imposed when regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).
The Basel III final capital framework provides for a number of new deductions from and adjustments to CET1, the implementation of which will begin on January 1, 2014 and will be phase-din over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).
The Basel III final liquidity framework requires banks to comply with two measures of liquidity risk exposure: the Liquidity Coverage Ratio, or LCR, based on a 30-day time horizon and calculated as the ratio of the stock of high-quality liquid assets divided by total net cash outflows over the next 30 calendar days, which must be at least 100%; and the Net Stable Funding Ratio, or NSFR, calculated as the ratio of the available amount of stable funding divided by the required amount of stable funding, which must be at least 100%. Although the Basel Committee has not asked for additional comment on the LCR and NSFR, both are subject to observation periods and transitional arrangements, with the Basel III liquidity framework providing that revisions to the LCR will be made by mid-2013, and the LCR will be introduced as a requirement on January 1, 2015; and revisions to the NSFR will be made by mid 2016, and the NSFR will be introduced as a requirement on January 1, 2018.
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Such proposals and legislation, if finally adopted, would change banking laws and our operating environment and that of our subsidiaries in substantial and unpredictable ways. These changes may also require us to invest significant management attention and resources to make any necessary changes. We cannot determine whether such proposals and legislation will be adopted. We anticipate that, based on our current level of assets, non-performing assets and the composition of these, the implementation of the rules as currently proposed would lower our regulatory capital ratios. Although we expect to continue to exceed the minimum requirements for well capitalized status following the implementation of the rules as proposed, there can be no assurances that we will remain well capitalized.
RISKS RELATING TO OUR BUSINESS
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to us. There can be no assurance that any such losses would not materially and adversely affect our results of operations or earnings.
We have procedures in place to mitigate the impact of a default among our counterparties. We request collateral for most credit exposures with other financial institutions and monitor these on a regular basis. Nonetheless, market volatility could impact the valuation of collateral held by us and results in losses.
Our ability to raise financing is dependent in part on market confidence. In times when market confidence is affected by events related to well-known financial institutions, risk aversion among participants may increase, substantially and makes it more difficult to borrow in the credit markets. Our credit ratings were reduced substantially in 2009, and our senior unsecured ratings are now non-investment grade with the three major rating agencies. This may make it more difficult for Popular to borrow in the capital markets and at a higher cost.
We are subject to default risk in our loan portfolio.
We are subject to the risk of loss from loan defaults and foreclosures with respect to the loans originated or acquired. We establish provisions for loan losses, which lead to reductions in the income from operations, in order to maintain the allowance for loan losses at a level which is deemed appropriate by management based upon an assessment of the quality of the loan portfolio in accordance with established procedures and guidelines. This process, which is critical to our financial results and condition, requires difficult, subjective and complex judgments about the future, including forecasts of economic and market conditions that might impair the ability of our borrowers to repay the loans. There can be no assurance that management has accurately estimated the level of future loan losses or that Popular will not have to increase the provision for loan losses in the future as a result of future increases in non-performing loans or for other reasons beyond our control. Any such increases in our provisions for loan losses or any loan losses in excess of our provisions for loan losses would have an adverse effect on our future financial condition and result of operations. We will continue to evaluate our provision for loan losses and allowance for loan losses and may be required to increase such amounts.
Rating downgrades on the Government of Puerto Ricos debt obligations could affect the value of our loans to the Government and our portfolio of Puerto Rico Government securities.
Even though Puerto Ricos economy is closely integrated to that of the U.S. mainland and its government and many of its instrumentalities are investment grade-rated borrowers in the U.S. capital markets, the fiscal situation of the Government of Puerto Rico led nationally recognized rating agencies to downgrade its debt obligations.
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The Commonwealths credit rating was downgraded by Moodys in December 2012, to Baa3 with a negative outlook, with various factors noted, including the lack of clear growth catalysts, the fiscal budget deficits and the financial condition of the public sector employee pension plans, which are significantly underfunded. On November 9, 2012, Standard & Poors Ratings Services affirmed their BBB-/Negative rating to the outstanding general obligation (GO) bonds of the Commonwealth of Puerto Rico and on December 18, 2002, Fitch Ratings affirmed its BBB+ rating for the subject debt. On February 21, 2013, Fitch placed the ratings of the Commonwealths general obligation bonds and related debt on rating Watch Negative.
Factors such as the governments ability to implement meaningful steps to control operating expenditures and maintain the integrity of the tax base will be key determinants of future ratings stability. Also, the inability to agree on future fiscal year Commonwealth budgets could result in ratings pressure from the rating agencies.
It is uncertain how the financial markets may react to any potential future ratings downgrade in Puerto Ricos debt obligations. However, deterioration in the fiscal situation with possible negative ratings implications, could adversely affect the value of Puerto Ricos Government obligations.
At December 31, 2012, the Corporation had approximately $0.9 billion of credit facilities granted to the Puerto Rico Government, its municipalities and public corporations, of which $75 million were uncommitted lines of credit (2011 - $1.0 billion and $215 million, respectively). Of the total credit facilities granted, $749 million was outstanding at December 31, 2012, of which $61 million were uncommitted lines of credit (2011 - $799 million and $0, respectively). A substantial portion of our credit exposure to the Government of Puerto Rico is either collateralized loans or obligations that have a specific source of income or revenues identified for its repayment. Some of these obligations consist of senior and subordinated loans to public corporations that obtain revenues from rates charged for services or products, such as water and electric power utilities. Public corporations have varying degrees of independence from the Central Government and many receive appropriations or other payments from it. We also have loans to various municipalities for which the good faith, credit and unlimited taxing power of the applicable municipality has been pledged to their repayment. These municipalities are required by law to levy special property taxes in such amounts as shall be required for the payment of all of its general obligation bonds and loans. Another portion of these loans consists of special obligations of various municipalities that are payable from the basic real and personal property taxes collected within such municipalities. The good faith and credit obligations of the municipalities have a first lien on the basic property taxes.
Furthermore, as of December 31, 2012, we had outstanding $218 million in obligations issued or guaranteed by the Puerto Rico Government, its municipalities and public corporations as part of our investment securities portfolio. We continue to closely monitor the political and economic situation of Puerto Rico and evaluate the portfolio for any declines in value that management may consider being other-than-temporary.
We are exposed to credit risk from mortgage loans that have been sold or are being serviced subject to recourse arrangements.
Popular is generally at risk for mortgage loan defaults from the time it funds a loan until the time the loan is sold or securitized into a mortgage-backed security. In the past, we have retained, through recourse arrangements, part of the credit risk on sales of mortgage loans, and we also service certain mortgage loan portfolios with recourse. At December 31, 2012, we serviced $2.9 billion in residential mortgage loans subject to credit recourse provisions, principally loans associated with FNMA and Freddie Mac programs. In the event of any customer default, pursuant to the credit recourse provided, we are required to repurchase the loan or reimburse the third party investor for the incurred loss. The maximum potential amount of future payments that we would be required to make under the recourse arrangements in the event of nonperformance by the borrowers is equivalent to the total outstanding balance of the residential mortgage loans serviced with recourse and interest, if applicable. During 2012, we repurchased approximately $157 million in mortgage loans subject to the credit recourse provisions. In the event of nonperformance by the borrower, we have rights to the underlying collateral securing the mortgage loan. As of December 31, 2012, our liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $52 million. We may suffer losses on these loans when the proceeds from a foreclosure sale of the property underlying a defaulted mortgage loan are less than the outstanding principal balance of the loan plus any uncollected interest advanced and the costs of holding and disposing of the related property.
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Defective and repurchased loans may harm our business and financial condition.
In connection with the sale and securitization of loans, we are required to make a variety of customary representations and warranties regarding Popular and the loans being sold or securitized. Our obligations with respect to these representations and warranties are generally outstanding for the life of the loan, and they relate to, among other things:
compliance with laws and regulations;
underwriting standards;
the accuracy of information in the loan documents and loan file; and
the characteristics and enforceability of the loan.
A loan that does not comply with these representations and warranties may take longer to sell, may impact our ability to obtain third party financing for the loan, and be unsaleable or saleable only at a significant discount. If such a loan is sold before we detect non-compliance, we may be obligated to repurchase the loan and bear any associated loss directly, or we may be obligated to indemnify the purchaser against any loss, either of which could reduce our cash available for operations and liquidity. Management believes that it has established controls to ensure that loans are originated in accordance with the secondary markets requirements, but mistakes may be made, or certain employees may deliberately violate our lending policies. We seek to minimize repurchases and losses from defective loans by correcting flaws, if possible, and selling or re-selling such loans. We have established specific reserves for probable losses related to repurchases resulting from representation and warranty violations on specific portfolios. At December 31, 2012, Populars reserve for estimated losses from representation and warranty arrangements amounted to $16.2 million, which was included as part of other liabilities in the consolidated statement of financial condition. Nonetheless, we do not expect any such losses to be significant, although if they were to occur, they would adversely impact our results of operations or financial condition.
Increases in FDIC insurance premiums may have a material adverse effect on our earnings.
During 2008 and continuing in 2009, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the DIF. In addition, the FDIC instituted two temporary programs, to further insure customer deposits at FDIC-member banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000) and non-interest-bearing transaction accounts are fully insured (unlimited coverage) as a result of our participation in the Transaction Account Guarantee Program. These programs have placed additional stress on the DIF.
In order to maintain a strong funding position and restore reserve ratios of the DIF, the FDIC increased assessment rates of insured institutions uniformly by 7 cents for every $100 of deposits beginning with the first quarter of 2009, with additional changes in April 1, 2009, which required riskier institutions to pay a larger share of premiums by factoring in rate adjustments based on, among other things, secured liabilities and unsecured debt levels. In May 2009, the FDIC adopted a final rule, effective June 30, 2009, that imposed a special assessment of 5 cents for every $100 on each insured depository institutions assets minus its Tier 1 capital as of June 30, 2009, subject to a cap equal to 10 cents per $100 of assessable deposits for the second quarter 2009 risk-based capital assessment. This special assessment applied to us and resulted in a $16.7 million expense in our second quarter of 2009. On November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years worth of premiums to replenish its depleted insurance fund. In December 30, 2009, Popular prepaid $221 million and reduced our year-end liquidity at our banking subsidiaries.
With the enactment of the Dodd-Frank Act, major changes were introduced to the FDIC deposit insurance system. Under the Dodd-Frank Act, the FDIC now has until the end of September 2020 to bring its reserve ratio to the new statutory minimum of 1.35%. New rules amending the deposit insurance assessment regulations under the requirements of the Dodd-Frank Act have been adopted, including a final rule designating 2% as the designated reserve ratio and a final rule extending temporary unlimited deposit insurance to non-interest bearing transaction accounts maintained in connection with lawyers trust accounts. On February 7, 2011, the FDIC adopted regulations effective for the 2011 second quarter assessment and payable in September 2011, which outline significant changes in the risk-based premiums approach for
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banks with over $10 billion of assets and creates a Scorecard system. The Scorecard system uses a performance score and loss severity score, which aggregate to an initial base assessment rate. The assessment base also changes from deposits to an institutions average total assets minus its average tangible equity. For 2012 the FDIC deposit insurance expense of Popular totaled $86 million and the prepaid FDIC insurance assessment as of December 31, 2012 amounted to $28 million.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or our capital position is further impaired, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future increases or special assessments may materially adversely affect our results of operations.
If our goodwill or amortizable intangible assets become impaired, it may adversely affect our financial condition and future results of operations
As of December 31, 2012 we had approximately $648 million and $48 million of goodwill and amortizable intangible assets recorded on our balance sheet related to our Puerto Rico and United States operations, respectively. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. Under GAAP, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances, indicating that the carrying value of the goodwill or amortizable intangible assets may not be recoverable, include reduced future cash flow estimates and slower growth rates in the industry.
The goodwill impairment evaluation process requires us to make estimates and assumptions with regards to the fair value of our reporting units. Actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact our results of operations and the reporting unit where the goodwill is recorded. Critical assumptions that are used as part of these evaluations include:
selection of comparable publicly traded companies, based on nature of business, location and size;
selection of comparable acquisition and capital raising transactions;
the discount rate applied to future earnings, based on an estimate of the cost of equity;
the potential future earnings of the reporting unit; and
the market growth and new business assumptions.
We conducted our annual evaluation of goodwill during the third quarter of 2012 using July 31, 2012 as the annual evaluation date. This evaluation is a two-step process. The Step 1 evaluation of goodwill allocated to BPNA, our United States operations segment, indicated potential impairment of goodwill. The Step 1 fair value for the unit was below the carrying amount of its equity book value as of the September 30, 2012 valuation date, requiring the completion of Step 2. Step 2 required a valuation of all assets and liabilities of the BPNA unit, including any recognized and unrecognized intangible assets, to determine the fair value of net assets. To complete Step 2, we subtracted from the units Step 1 fair value the determined fair value of the net assets to arrive at the implied fair value of goodwill. The results of the Step 2 analysis indicated that the implied fair value of goodwill exceeded the goodwill carrying value of $402 million, resulting in no goodwill impairment.
If we are required to record a charge to earnings in our consolidated financial statements because an impairment of the goodwill or amortizable intangible assets is determined, our results of operations could be adversely affected.
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Our business could suffer if we are unable to attract, retain and motivate skilled senior leaders
Our success depends, in large part, on our ability to retain key senior leaders, and competition for such senior leaders can be intense in most areas of our business. As TARP recipients, we are subject to the executive compensation provisions of the EESA, including amendments to such provisions implemented under the American Recovery and Reinvestment Act of 2009, which are expected to limit the types of compensation arrangements that Popular may enter into with our most senior leaders upon adoption of implementing standards by the U. S. Treasury. Our competitors may be in an advantageous position to retain and attract senior leaders since we are one of only two institutions in Puerto Rico that have received TARP money and are subject to TARP related compensation provisions. Our compensation practices are subject to review and oversight by the Federal Reserve Board. We also may be subject to limitations on compensation practices by the FDIC or other regulators, which may or may not affect our competitors. Limitations on our compensation practices could have a negative impact on our ability to attract and retain talented senior leaders in support of our long term strategy.
Our compensation practices are subject to oversight by the Federal Reserve Board. Any deficiencies in our compensation practices may be incorporated into our supervisory ratings, which can affect our ability to make acquisitions or perform other actions.
Our compensation practices are subject to oversight by the Federal Reserve Board. In October 2009, the Federal Reserve Board issued a comprehensive proposal on incentive compensation policies that applies to all banking organizations supervised by the Federal Reserve Board, including Popular and our banking subsidiaries. The proposal sets forth three key principles for incentive compensation arrangements that are designed to help ensure that incentive compensation plans do not encourage excessive risk-taking and are consistent with the safety and soundness of banking organizations. The three principles provide that a banking organizations incentive compensation arrangements should provide incentives that do not encourage risk-taking beyond the organizations ability to effectively identify and manage risks, be compatible with effective internal controls and risk management, and be supported by strong corporate governance. The proposal also contemplates a detailed review by the Federal Reserve Board of the incentive compensation policies and practices of a number of large, complex banking organizations. Any deficiencies in compensation practices that are identified may be incorporated into the organizations supervisory ratings, which can affect its ability to make acquisitions or perform other actions. The proposal provides that enforcement actions may be taken against a banking organization if its incentive compensation arrangements or related risk-management control or governance processes pose a risk to the organizations safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies. Separately, the FDIC has solicited comments on whether to amend its risk-based deposit insurance assessment system to potentially increase assessment rates on financial institutions with compensation programs that put the FDIC deposit insurance fund at risk, and proposed legislation would subject compensation practices at financial institutions to heightened standards and increased scrutiny.
The scope and content of the U.S. banking regulators policies on executive compensation are continuing to develop and are likely to continue evolving in the near future. It cannot be determined at this time whether compliance with such policies will adversely affect the ability of Popular and our subsidiaries to hire, retain and motivate our and their key employees.
As a holding company, we depend on dividends and distributions from our subsidiaries for liquidity.
We are a bank holding company and depend primarily on dividends from our banking and other operating subsidiaries to fund our cash needs. These obligations and needs include capitalizing subsidiaries, repaying maturing debt and paying debt service on outstanding debt. Our banking subsidiaries, BPPR and BPNA, are limited by law in their ability to make dividend payments and other distributions to us based on their earnings and capital position. A failure by our banking subsidiaries to generate sufficient cash flow to make dividend payments to us may have a negative impact on our results of operation and financial position. Also, a failure by the bank holding company to access sufficient liquidity resources to meet all projected cash needs in the ordinary course of business, may have a detrimental impact on our financial condition and ability to compete in the market.
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Actions by the rating agencies or having capital levels below well-capitalized could raise the cost of our obligations, which could affect our ability to borrow or to enter into hedging agreements in the future and may have other adverse effects on our business.
Actions by the rating agencies could raise the cost of our borrowings since lower rated securities are usually required by the market to pay higher rates than obligations of higher credit quality.
The market for non-investment grade securities is much smaller and less liquid than for investment grade securities. Therefore, if we were to attempt to issue preferred stock or debt securities into the capital markets, it is possible that there would not be sufficient demand to complete a transaction and the cost could be substantially higher than for more highly rated securities.
In addition, changes in our ratings and capital levels below well-capitalized could affect our relationships with some creditors and business counterparties. For example, a portion of our hedging transactions include ratings triggers or well-capitalized language that permit counterparties to either request additional collateral or terminate our agreements with them based on our below investment grade ratings. Although we have been able to meet any additional collateral requirements thus far and expect that we would be able to enter into agreements with substitute counterparties if any of our existing agreements were terminated, changes in our ratings or capital levels below well capitalized could create additional costs for our businesses. In addition, servicing, licensing and custodial agreements that we are party to with third parties include ratings covenants. Servicing rights represent a contractual right and not a beneficial ownership interest in the underlying mortgage loans. Upon failure to maintain the required credit ratings, the third parties could have the right to require Popular to engage a substitute fund custodian and/or increase collateral levels securing the recourse obligations. Popular services residential mortgage loans subject to credit recourse provisions. Certain contractual agreements require us to post collateral to secure such recourse obligations if our required credit ratings are not maintained. Collateral pledged by us to secure recourse obligations approximated $135 million at December 31, 2012. We could be required to post additional collateral under the agreements. Management expects that we would be able to meet additional collateral requirements if and when needed. The requirements to post collateral under certain agreements or the loss of custodian funds could reduce Populars liquidity resources and impact its operating results. The termination of those agreements or the inability to realize servicing income for our businesses could have an adverse effect on those businesses. Other counterparties are also sensitive to the risk of a ratings downgrade and the implications for our businesses and may be less likely to engage in transactions with us, or may only engage in them at a substantially higher cost, if our ratings remain below investment grade.
We are subject to regulatory capital adequacy guidelines, and if we fail to meet these guidelines our business and financial condition will be adversely affected.
Under regulatory capital adequacy guidelines, and other regulatory requirements, Popular and our banking subsidiaries must meet guidelines that include quantitative measures of assets, liabilities and certain off balance sheet items, subject to qualitative judgments by regulators regarding components, risk weightings and other factors. If we fail to meet these minimum capital guidelines and other regulatory requirements, our business and financial condition will be materially and adversely affected. If we fail to maintain well-capitalized status under the regulatory framework, or are deemed not well managed under regulatory exam procedures, or if we experience certain regulatory violations, our status as a financial holding company and our related eligibility for a streamlined review process for acquisition proposals, and our ability to offer certain financial products will be compromised and our financial condition and results of operations could be adversely affected.
In July 2011, the Corporation and BPPR entered into a Memorandum of Understanding (the Corporation/BPPR MOU) with the Federal Reserve Bank of New York (the FRB-NY) and the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico (the Office of the Commissioner). On the same date, BPNA entered into a Memorandum of Understanding (the BPNA MOU and collectively with the Corporation/BPPR MOU, the MOUs) with the FRB-NY and the New York State Banking Department (the Banking Department). The MOUs generally apply to the Corporation, the applicable bank subsidiary and the Corporations nonbank subsidiaries. The MOUs provide, among other things, for the Corporation to take steps to improve its credit risk management practices and asset quality, and for the Corporation to develop strategic plans to improve earnings and to develop capital plans. The Corporation does not expect the capital plans to require it to maintain capital ratios in excess of those it currently has achieved. The MOUs require the Corporation to obtain approval from the applicable MOU counterparties prior to, among other things, declaring or paying dividends, purchasing or redeeming any shares of its stock, consummating acquisitions or mergers, or making any distributions on its trust preferred securities or subordinated debentures.
Certain of the provisions contained in our Certificate of Incorporation have the effect of making it more difficult to change the Board of Directors, and may make the Board of Directors less responsive to stockholder control.
Our certificate of incorporation provides that the members of the Board of Directors are divided into three classes as nearly equal as possible. At each annual meeting of stockholders, one-third of the members of the Board of Directors will be elected for a three-year term, and the other directors will remain in office until their three-year terms expire. Therefore, control of the Board of Directors cannot be changed in one year, and at least two annual meetings must be held before a majority of the members of the Board of Directors can be changed. Our certificate of incorporation also provides that a director, or the entire Board of Directors, may be removed by the stockholders only for cause by a vote of at least two-thirds of the combined voting power of the outstanding capital stock entitled to vote for the election of directors. These provisions have the effect of making it more difficult to change the Board of Directors, and may make the Board of
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Directors less responsive to stockholder control. These provisions also may tend to discourage attempts by third parties to acquire Popular because of the additional time and expense involved and a greater possibility of failure, and, as a result, may adversely affect the price that a potential purchaser would be willing to pay for the capital stock, thereby reducing the amount a stockholder might realize in, for example, a tender offer for our capital stock.
The resolution of significant pending litigation, if unfavorable, could have material adverse financial effects or cause significant reputational harm to us, which in turn could seriously harm our business prospects.
We face legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against us could have material adverse financial effects or cause significant reputational harm to us, which in turn could seriously harm our business prospects. For further information relating to our legal risk, see Note 27, Commitments & Contingencies, to the Consolidated Financial Statements.
We and our subsidiaries and affiliates, as well as EVERTEC, conduct business with financial institutions and/or card payment networks operating in countries whose nationals, including some of our customers customers, engage in transactions in countries that are the targets of U.S. economic sanctions and embargoes. If we or our subsidiaries or affiliates or EVERTEC are found to have failed to comply with applicable U.S. sanctions laws and regulations in these instances, we could be exposed to fines, sanctions and other penalties or other governmental investigations.
We and our subsidiaries and affiliates, as well as EVERTEC, conduct business with financial institutions and/or card payment networks operating in countries whose nationals, including some of our customers customers, engage in transactions in countries that are the target of U.S. economic sanctions and embargoes, including Cuba. As U.S.-based entities, we and our subsidiaries and affiliates, as well as EVERTEC, are obligated to comply with the economic sanctions regulations administered by OFAC. These regulations prohibit U.S.-based entities from entering into or facilitating unlicensed transactions with, for the benefit of, or in some cases involving the property and property interests of, persons, governments or countries designated by the U.S. government under one or more sanctions regimes. Failure to comply with U.S. sanctions and embargoes may result in material fines, sanctions or other penalties being imposed on us. In addition, various state and municipal governments, universities and other investors maintain prohibitions or restrictions on investments in companies that do business involving countries or entities, and this could adversely affect the market for our securities.
For these reasons, we have established risk-based policies and procedures designed to assist us and our personnel in complying with applicable U.S. laws and regulations. EVERTEC has also done this. These policies and procedures employ software to screen transactions for evidence of sanctioned-country and persons involvement. Consistent with a risk-based approach and the difficulties in identifying all transactions of our customers customers that may involve a sanctioned country, there can be no assurance that our policies and procedures will prevent us from violating applicable U.S. laws and regulations in transactions in which we engage, and such violations could adversely affect our reputation, business, financial condition and results of operations.
In June 2010, EVERTEC discovered potential violations of the Cuban Assets Control Regulations (CACR), which are administered by OFAC, due to an oversight in which the screening parameters for two customers located in Haiti and Belize were not activated. EVERTEC conducted an internal review and submitted a final voluntary self-disclosure to OFAC in September 2010. We have agreed to indemnify EVERTEC for claims or damages related to the economic sanctions regulations administered by OFAC, including these potential violations of the CACR.
Separately, in November 2010 EVERTEC submitted a final voluntary self-disclosure to OFAC regarding the processing of certain Cuba related credit card transactions involving Costa Rica and Venezuela that EVERTEC believed could not be rejected under governing local law and policies, but which nevertheless may have not been consistent with the CACR. The voluntary self-disclosure also covered the transmission, through EVERTECs Costa Rica subsidiary, of data relating to debit card payment initiated by non-sanctioned persons traveling to Cuba. Notwithstanding the risk of violations of applicable governing local law and policies, around September 2010, EVERTEC ceased processing the credit card transactions and transmitting the data referred to in the two preceding sentences. We have agreed to indemnify
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EVERTEC for claims or damages related to these potential violations of the CACR. We cannot predict the timing, total costs or ultimate outcome of any OFAC review, or to what extent, if at all, we could be subject to indemnification claims, fines, sanctions or other penalties.
RISKS RELATED TO THE FDIC-ASSISTED TRANSACTION
Risks Related to the FDIC-assisted Transaction
We entered into an FDIC-assisted transaction involving Westernbank, which could present additional risks to our business. On April 30, 2010, BPPR acquired certain assets and assumed certain liabilities of Westernbank from the FDIC in an assisted transaction. Although this transaction provides for FDIC assistance to BPPR to mitigate certain risks, such as sharing exposure to loan losses (80% of the losses in substantially all the acquired portfolio will be borne by the FDIC) and providing indemnification against certain liabilities of the former Westernbank, we are still subject to some of the same risks we would face in acquiring another bank in a negotiated transaction. Such risks include risks associated with maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we expect. In addition, because the FDIC-assisted transaction was structured in a manner that did not allow bidders the time and access to information normally associated with preparing for and evaluating a negotiated transaction, we may face additional risks in the FDIC-assisted transaction.
The success of the FDIC-assisted transaction will depend on a number of uncertain factors.
The success of the FDIC-assisted transaction will depend on a number of factors, including, without limitation:
our ability to limit the outflow of deposits held by our new customers in the acquired branches and to successfully retain and manage interest-earning assets (i.e., loans) acquired in the FDIC-assisted transaction;
our ability to attract new deposits and to generate new interest-earning assets in the areas previously served by the former Westernbank branches;
our ability to control the incremental non-interest expense from the former Westernbank branches and other units in a manner that enables us to maintain a favorable overall efficiency ratio;
our ability to collect on the loans acquired and satisfy the standard requirements imposed in the loss sharing agreements; and
our ability to earn acceptable levels of interest and non-interest income, including fee income, from the acquired branches.
The FDIC-assisted transaction increased BPPRs commercial real estate and construction loan portfolio, which have a greater credit risk than residential mortgage loans.
With the acquisition of most of the former Westernbanks loan portfolio, the commercial real estate loan and construction loan portfolios represent a larger portion of BPPRs total loan portfolio than prior to the FDIC-assisted transaction. This type of lending is generally considered to have more complex credit risks than traditional single-family residential or consumer lending, because the principal is concentrated in a limited number of loans with repayment dependent on the successful operation or completion of the related real estate or construction project. Consequently, these loans are more sensitive to the current adverse conditions in the real estate market and the general economy. These loans are generally less predictable, more difficult to evaluate and monitor, and their collateral may be more difficult to dispose of in a market decline. Furthermore, since these loans are to Puerto Rico based borrowers, Populars credit exposure concentration in Puerto Rico increased as a result of the acquisition. Although, the negative economic aspects of these risks are substantially reduced as a result of the FDIC loss sharing agreements, changes in national and local economic conditions could lead to higher loan charge-offs in connection with the FDIC-assisted transaction all of which would not be totally supported by the loss sharing agreements with the FDIC.
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We acquired significant portfolios of loans in the FDIC-assisted transaction. Although these loan portfolios will be initially accounted for at fair value, there is no assurance that the loans we acquired will not become impaired, which may result in additional charge-offs to this portfolio. The fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs that we make to our loan portfolio, and consequently, reduce our net income, and may also increase the level of charge-offs on the loan portfolio that we have acquired and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition even if other favorable events occur.
Although we have entered into loss sharing agreements with the FDIC which provide that 80% of losses related to specified loan portfolios that we have acquired in connection with the FDIC-assisted transaction will be borne by the FDIC, we are not protected for all losses resulting from charge-offs with respect to those specified loan portfolios. Additionally, the loss sharing agreements have limited terms; therefore, any charge-off of related losses that we experience after the term of the loss sharing agreements will not be reimbursed by the FDIC and will negatively impact our results of operations. The loss sharing agreements also impose standard requirements on us which must be satisfied in order to retain loss share protections. The FDIC has the right to refuse or delay payment for loan losses if the loss sharing agreements are not managed in accordance with their terms.
Our decisions regarding the fair value of assets acquired could be inaccurate and our estimated loss share indemnification asset in the FDIC-assisted transaction may be inaccurate, which could materially and adversely affect our business, financial condition, results of operations, and future prospects.
Management makes various assumptions and judgments about the collectability of acquired loan portfolios, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of secured loans. In the FDIC-assisted transaction, we recorded a loss share indemnification asset that we consider adequate to absorb future losses which may occur in the acquired loan portfolio. In determining the size of the loss share indemnification asset, we analyze the loan portfolio based on historical loss experience, volume and classification of loans, volume and trends in delinquencies and nonaccruals, local economic conditions, and other pertinent information. If our assumptions are incorrect, our actual losses could be higher than estimated and increased loss reserves may be needed to respond to different economic conditions or adverse developments in the acquired loan portfolio. Any increase in future loan losses could have a negative effect on our operating results. However, in the event expected losses from the Westernbank portfolio were to increase more than originally expected, the related increase in loss reserves would be largely offset by higher than expected indemnity payments from the FDIC. Refer to the Westernbank FDIC-assisted transaction section in the Annual Report and Note 4, Business Combination, to the consolidated financial statements for additional information on the Westernbank FDIC-assisted transaction, including the accounting for assets acquired and liabilities assumed as well as information on the breakdown and accounting of the acquired loan portfolio.
Our ability to obtain reimbursement under the loss sharing agreements on covered assets depends on our compliance with the terms of the loss sharing agreements.
The loss share agreements contain specific terms and conditions regarding the management of the covered assets that BPPR must follow to receive reimbursement on losses from the FDIC. Under the loss share agreements, BPPR must:
| manage and administer the covered assets and collect and effect charge-offs and recoveries with respect to such covered assets in a manner consistent with its usual and prudent business and banking practices and, with respect to single family shared-loss loans, the procedures (including collection procedures) customarily employed by BPPR in servicing and administering mortgage loans for its own account and the servicing procedures established by FNMA or FHLMC, as in effect from time to time, and in accordance with accepted mortgage servicing practices of prudent lending institutions; |
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| exercise its best judgment in managing, administering and collecting amounts on covered assets and effecting charge-offs with respect to the covered assets; |
| use commercially reasonable efforts to maximize recoveries with respect to losses on single family shared-loss assets and best efforts to maximize collections with respect to commercial shared-loss assets; |
| retain sufficient staff to perform the duties under the loss share agreements; |
| adopt and implement accounting, reporting, record-keeping and similar systems with respect to the commercial shared-loss assets; |
| comply with the terms of the modification guidelines approved by the FDIC or another federal agency for any single-family shared loss loan; |
| provide notice with respect to proposed transactions pursuant to which a third party or affiliate will manage, administer or collect any commercial shared-loss assets; and |
| file monthly and quarterly certificates with the FDIC specifying the amount of losses, charge-offs and recoveries. |
Under the loss share agreements, BPPR is also required to maintain books and records sufficient to ensure and document compliance with the terms of the loss share agreements.
Under the terms of the loss share agreements, BPPR is also required to deliver certain certificates regarding compliance with the terms of each of the loss share agreements and the computations required thereunder. The required terms of the agreements are extensive and failure to comply with any of the guidelines could result in a specific asset or group of assets permanently losing their loss sharing coverage. No assurances can be given that we will manage the covered assets in such a way as to always maintain loss share coverage on all such assets and fully recover the value of our loss share asset.
BPPR has received all reimbursements requested from the FDIC through its submission for the quarter ended June 30, 2012, except for approximately $71.1 million in requested shared-loss claims related to the June 30, 2012 quarter, which have not been paid because of a difference of approximately $26.2 million related to the methodology for the computation of charge-offs for certain late stage real estate collateral dependent loans. Our methodology is consistent with our charge-off policy for non-covered assets and conforms with our regulatory supervisory criteria. We are currently in discussion with the FDIC regarding our charge-off policy and the commercial loss share agreement with the FDIC. To the extent we are not able to successfully resolve this matter, a material difference could result in the timing and amount of charge-offs recorded by us and the amount of charge-offs reimbursed by the FDIC under the commercial loss share agreement. We have not submitted claims for reimbursement for periods subsequent to June 30, 2012, pending resolution of this matter. Through December 31, 2012, we had unbilled shared-loss claims of approximately $158.8 million under the commercial loss share agreement with the FDIC related to late stage real estate collateral dependent loans, determined as described above. If the reimbursement amount for these additional claims through December 31, 2012 were calculated in accordance with the FDICs methodology, the amount of such claims would be reduced by approximately $54.7 million. No assurance can be given that we would be able to claim reimbursement from the FDIC for such difference prior to the expiration of the commercial loss share agreement in April 2015, which could require us to make a material adjustment to the value of our loss share asset and the related true up payment obligation to the FDIC and could have a material adverse effect on our financial results for the period in which such adjustment is taken.
RISKS RELATING TO AN INVESTMENT IN OUR SECURITIES
Potential issuance of additional shares of our Common Stock could further
dilute existing holders of our Common Stock.
The potential issuance of additional shares of our Common Stock or common equivalent securities in future equity offerings, or as a result of the exercise of the warrant the U.S. Treasury holds, would dilute the ownership interest of our existing common stockholders.
Dividends on our Common Stock and Preferred Stock have been or may be suspended and stockholders may not receive funds in connection with their investment in our Common Stock or Preferred Stock without selling their shares.
Holders of our Common Stock and Preferred Stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. During 2009, we suspended dividend payments on our Common Stock and Preferred Stock. In December 2010, we resumed payment of dividends on our Preferred Stock, subject to certain conditions agreed to with our regulators. In connection with the resumption of payment of dividends on our Preferred Stock, we agreed to fund the dividend payments out of newly-issued Common Stock issued to employees under Populars existing savings and investment plans or, if such issuances are insufficient, other common equity capital raised by Popular. It is anticipated that sufficient Common Stock will be issued under those plans to cover the dividend payment. There can be no assurance that any dividends will be declared on the Preferred Stock in any future
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periods. Furthermore, unless we have redeemed all of the trust preferred securities issued to the U.S. Treasury or the U.S. Treasury has transferred all of its trust preferred securities to third parties, the consent of the U.S. Treasury will be required for us to, among other things, increase the dividend rate per share of Common Stock above $0.80 per share or to repurchase or redeem equity securities, including our Common Stock, subject to certain limited exceptions. Popular has also granted registration rights and offering facilitation rights to the U.S. Treasury pursuant to which we have agreed to lock-up periods during which it would be unable to issue equity securities.
This could adversely affect the market price of our Common Stock. Also, we are a bank holding company and our ability to declare and pay dividends is dependent on certain Federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends. Moreover, the Federal Reserve Board and the FDIC have issued policy statements stating that the bank holding companies and insured banks should generally pay dividends only out of current operating earnings. In the current financial and economic environment, the Federal Reserve Board has indicated that bank holding companies should carefully review their dividend policy and has discouraged dividend pay-out ratios that are at the 100% or higher level unless both asset quality and capital are very strong.
In addition, the terms of our outstanding junior subordinated debt securities held by each trust that has issued trust preferred securities, prohibit us from declaring or paying any dividends or distributions on our capital stock, including our Common Stock and Preferred Stock. The terms also prohibit us from purchasing, acquiring, or making a liquidation payment on such stock, if we have given notice of our election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
Accordingly, shareholders may have to sell some or all of their shares of our Common Stock or Preferred Stock in order to generate cash flow from their investment. Shareholders may not realize a gain on their investment when they sell the Common Stock or Preferred Stock and may lose the entire amount of their investment.
RISKS RELATING TO OUR OPERATIONS
Cyber-attacks, system risks and data protection breaches could present significant reputational, legal and regulatory costs.
Popular is under continuous threat of cyber-attacks especially as we continue to expand customer services via the internet and other remote service channels. The most significant cyberattack risks that we may face are e-fraud, denial-of-service and computer intrusion that might result in loss of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds from customer or bank accounts. Denial-of-service disrupts services available to our customers through our on-line banking system. Computer intrusion attempts might result in the breach of sensitive customer data, such as account numbers and social security numbers, and could present significant reputational, legal and/or regulatory costs to Popular if successful. Our risk and exposure to these matters remains heightened because of the evolving nature and complexity of the threats from organized cybercriminals and hackers, and our plans to continue to provide e-banking and mobile banking services to our customers. We have not, to date, experienced any material losses as a result of cyber-attacks.
If personal, non-public, confidential or proprietary information of customers in our possession were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage and financial loss. Such mishandling or misuse could include, for example, if such information were erroneously provided to parties who are not permitted to have the information, either by fault of our systems, employees, or counterparties, or where such information is intercepted or otherwise inappropriately taken by third parties.
We rely on other companies to provide key components of our business infrastructure
Third parties provide key components of our business operations such as data processing, information security, recording and monitoring transactions, online banking interfaces and services, Internet connections and network access. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to
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handle current or higher volumes, failure of a vendor to provide services for any reason or poor performance of services, failure of a vendor to notify us of a reportable event, could adversely affect our ability to deliver products and services to our customers and otherwise conduct our business. Financial or operational difficulties of a third party vendor could also hurt our operations if those difficulties interfere with the vendors ability to serve us. Replacing these third party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations.
Hurricanes and other weather-related events, as well as man-made disasters, could cause a disruption in our operations or other consequences that could have an adverse impact on our results of operations.
A significant portion of our operations are located in a region susceptible to hurricanes. Such weather events can cause disruption to our operations and
could have a material adverse effect on our overall results of operations. We maintain hurricane insurance, including coverage for lost profits and extra expense; however, there is no insurance against the disruption to the markets that we serve that a catastrophic hurricane could produce. Further, a hurricane in any of our market areas could adversely impact the ability of borrowers to timely repay their loans and may adversely impact the value of any collateral held by us. Man-made disasters and other events connected with the region in which we are located could have similar effects. The severity and impact of future hurricanes and other weather-related events are difficult to predict and may be exacerbated by global climate change. The effects of past or future hurricanes and other weather-related events could have an adverse effect on our business, financial condition or results of operations.
For further information of other risks faced by Popular please refer to the Management Discussion & Analysis section of the Annual Report.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
As of December 31, 2012, BPPR owned and wholly or partially occupied approximately 63 branch premises and other facilities throughout Puerto Rico. It also owned 6 parking garage buildings and approximately 36 lots held for future development or for parking facilities also in Puerto Rico, one building in the U.S. Virgin Islands and one in the British Virgin Islands. In addition, as of such date, BPPR leased properties mainly for branch operations in approximately 113 locations in Puerto Rico and 7 locations in the U.S. Virgin Islands. At December 31, 2012, BPNA had 97 offices (principally bank branches) of which 17 were owned and 80 were leased. These offices were located in New York, Illinois, New Jersey, California and Florida. Included in this figure is a leased six story office building in Rosemont, Illinois that is the site of BPNAs headquarters. Our management believes that each of our facilities are well maintained and suitable for its purpose. The principal properties owned by Popular for banking operations and other services are described below:
Popular Center, the twenty-story BPPR headquarters building, located at 209 Muñoz Rivera Avenue, Hato Rey, Puerto Rico. In addition, it has an adjacent parking garage with capacity for approximately 1,095 cars. BPPR operates a full service branch at the plaza level and our centralized units and subsidiaries occupy approximately 51% of the office floors space. Approximately 31% of the office space is leased to outside tenants and 15% is available for office and retail use. In addition, 3% of the tenants occupy part of the recently redeveloped ground and promenade levels, while other contract negotiations are underway to establish additional retail businesses including sit-down restaurants and other food vendors.
Popular Center North Building, a five-story building, on the same block as Popular Center. These facilities are connected to the main building by the parking garage and to the Popular Street building by a pedestrian bridge. It provides additional office space and parking for 100 cars. It also houses six movie theatres with stadium type seating for approximately 600 persons total.
Popular Street Building, a parking and office building located at Ponce de León Avenue and Popular Street, Hato Rey, Puerto Rico. The six stories of office space and the basement are occupied by BPPR units and the Corporate Credit Risk Division. At the ground level, Popular Auto occupies approximately 10% of the retail type space and the remaining spaces are leased or available for leasing to outside tenants. It has parking facilities for approximately 1,165 cars.
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Cupey Center Complex, one building, three stories high, and three buildings, two stories high each, located in Cupey, Río Piedras, Puerto Rico. This building is leased to EVERTEC. BPPR maintains a full service branch and some support services in these facilities. The Complex also includes a parking garage building with capacity for approximately 1,000 cars and houses a recreational center for our employees.
Stop 22 Building, a twelve story structure located in Santurce, Puerto Rico. A BPPR branch, the Our People Division, the Asset Protection Division, the Auditing Division and the International Banking Center and Foreign Exchange Department are the main occupants of this facility.
Centro Europa Building, a seven-story office and retail building in Santurce, Puerto Rico. The BPPRs training center and loss mitigation unit occupies approximately 38% of this building. The remaining space is leased or available for leasing to outside tenants. The building also includes a parking garage with capacity for approximately 613 cars.
Old San Juan Building, a twelve-story structure located in Old San Juan, Puerto Rico. BPPR occupies approximately 36% of the building for a branch operation, an exhibition room and other facilities. The rest of the building is leased or available for leasing to outside tenants.
Guaynabo Corporate Office Park Building, a two-story building located in Guaynabo, Puerto Rico. This building is fully occupied by Popular Insurance, Inc. as its headquarters. The property also includes an adjacent four-level parking garage with capacity for approximately 300 cars, a potable water cistern and a diesel storage tank.
Altamira Building, a nine-story office building located in Guaynabo, Puerto Rico. A seven-level parking garage with capacity for approximately 550 cars is also part of this property that houses the centralized offices of Popular Mortgage, Inc. and Popular Auto, Inc. It also includes a full service branch and the Mortgage Servicing Division of BPPR.
El Señorial Center, a four-story office building and a two-story branch building located in Río Piedras, Puerto Rico. The property also includes an eight-level parking garage adjacent to the office building and four-levels of underground parking in the branch building, which together with the available ground parking space, provide for approximately 977 automobiles. As of December 31, 2012, a BPPR branch and the Río Piedras regional office operate in the branch building while a number of centralized BPPR offices occupy the main building. The Customer Contact Center and the Operations, Comptroller, Retail Credit Products and Services, and Card Products divisions are some of its occupants.
BPPR Virgin Islands Center, a three-story building located in St. Thomas, U.S. Virgin Islands housing a BPPR branch and centralized offices. The building is fully occupied by BPPR personnel.
Popular Center -Tortola, a four-story building located in Tortola, British Virgin Islands. A BPPR branch is located in the first story while the commercial credit department occupies the second story. Part of the third floor has been leased to an outside tenant while the remaining space is reserved for BPPR V.I. Regions expansion. The fourth floor is available for outside tenants.
For a discussion of Legal proceedings, see Note 27, Commitments and Contingencies, to the Consolidated Financial Statements.
ITEM 4. MINE SAFETY DISCLOSURE
Not applicable.
44
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock
Populars Common Stock is traded on the NASDAQ Global Select Market under the symbol BPOP. On May 29, 2012, the Corporation completed a 1-for-10 reverse split of its common stock, $0.01 par value per share. Pursuant to the reverse stock split, each ten shares of authorized and outstanding common stock have been reclassified and combined into one new share of common stock. In connection with the reverse stock split, the number of shares of common stock authorized under the Corporations Restated Certificate of Incorporation was reduced from 1,700,000,000 to 170,000,000 shares, without any change in par value per common share. The reverse split did not change the number of shares of the Corporations preferred stock authorized, which remains at 30,000,000. All per share information presented in this Form10-K has been adjusted to reflect the reverse stock split.
Information concerning the range of high and low sales prices for the Common Stock for each quarterly period during 2012 and the previous four years, as well as cash dividends declared, is contained under Table 4, Common Stock Performance, in the Management Discussion and Analysis of the Annual Report, and is incorporated herein by reference.
In June 2009, Popular announced the suspension of dividends on the Common Stock. Popular has no current plans to resume dividend payments on the Common Stock. The Common Stock ranks junior to all series of Preferred Stock as to dividend rights and/or as to rights on liquidation, dissolution or winding up of Popular. Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, the Common Stock is subject to certain restrictions in the event that Popular fails to pay or set aside full dividends on the Preferred Stock for the latest dividend period.
Additional information concerning legal or regulatory restrictions on the payment of dividends by Popular, BPPR and BPNA is contained under the caption Regulation and Supervision in Item 1 herein.
As of February 25, 2013, Popular had 9,658 stockholders of record of the Common Stock, not including beneficial owners whose shares are held in record names of brokers or other nominees. The last sales price for the Common Stock on that date was $27.30 per share.
Preferred Stock
Popular has 30,000,000 shares of authorized Preferred Stock that may be issued in one or more series, and the shares of each series shall have such rights and preferences as shall be fixed by the Board of Directors when authorizing the issuance of that particular series. Populars Preferred Stock issued and outstanding at December 31, 2012 consisted of:
885,726 shares of 6.375% non-cumulative monthly income Preferred Stock, Series A, no par value, liquidation preference value of $25 per share.
1,120,665 shares of 8.25% non-cumulative monthly income Preferred Stock, Series B, no par value, liquidation preference value of $25 per share.
All series of Preferred Stock are pari passu.
Dividends on each series of Preferred Stock are payable if declared by our Board of Directors. Our ability to declare and pay dividends on the preferred stock is dependent on certain Federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends. The Board of Directors is not obligated to declare dividends and dividends do not accumulate in the event they are not paid.
In June 2009, Popular announced the suspension of dividends on its Series A and B Preferred Stock. On December 21, 2010, Popular announced that its Board of Directors declared monthly cash dividends of $0.1328125 per share of 6.375% non-cumulative monthly income Preferred Stock, Series A, and of $0.171875 per share of 8.25% non-cumulative monthly income preferred stock, Series B, paid on December 31, 2010 to holders of record as of December 28, 2010.
In connection with the resumption of payment of monthly dividends on the Preferred Stock, which amounted $3.7 million for 2012, Popular has committed to the Board of Governors of the Federal Reserve System to fund the dividend payments out of newly-issued Common Stock issued to employees under Populars existing savings and investment plans or, if such issuances are insufficient, other common equity capital raised by Popular. During 2012 the Common Stock issued under those plans was $9.4 million that was well above the dividend payment. There can be no assurance that any dividends will be declared on the Preferred Stock in any future periods.
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2010 Capital Raise
In April 2010, Popular raised $1.15 billion through the sale of 46,000,000 depositary shares, each representing a 1/40th interest in a share of contingent convertible perpetual non-cumulative preferred stock, Series D, no par value, $1,000 liquidation preference per share. The Preferred Stock represented by depositary shares automatically converted into the Common Stock at a conversion rate of .83333 shares of Common Stock for each depositary share on May 11, 2010, which was the 5th business day after Populars common shareholders approved the amendment to Populars restated certificate of incorporation to increase the number of authorized shares of Common Stock. The conversion of the depositary shares of Preferred Stock resulted in the issuance of 38,333,333 additional shares of Common Stock. The net proceeds from the public offering amounted to approximately $1.1 billion, after deducting the underwriting discount and estimated offering expenses. Note 34, Net income (loss) per common share, to the audited consolidated financial statements provides information on the impact of the conversion on net (loss) income per common share.
Dividend Reinvestment and Stock Purchase Plan
Popular offers a dividend reinvestment and stock purchase plan for our stockholders that allows them to reinvest their dividends in shares of the Common Stock at a 5% discount from the average market price at the time of the issuance, as well as purchase shares of Common Stock directly from Popular by making optional cash payments at prevailing market prices. No shares will be sold directly by us to participants in the dividend reinvestment and stock purchase plan at less than the par value of our Common Stock. No additional shares were issued under the dividend reinvestment during 2012.
Equity Based Plans
For information about the securities authorized for issuance under our equity based plans, refer to Part III, Item 12.
In April 2004, our shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan. The maximum number of shares of Common Stock issuable under this Plan is 1,000,000.
In connection with our participation in the Capital Purchase Program under the Troubled Asset Relief Program, the consent of the U.S. Department of the Treasury is required for Popular to repurchase its Common Stock other than in connection with benefit plans consistent with past practice and certain other specified circumstances.
The following table sets forth the details of purchases of Common Stock during the quarter ended December 31, 2012 under the 2004 Omnibus Incentive Plan.
Issuer Purchases of Equity Securities
Not in thousands | ||||||||||||||||
Period |
Total Number of Shares Purchased |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum Number of Plans or Programs |
||||||||||||
November 1 November 30 |
3,374 | $ 19.27 | - | - | ||||||||||||
Total December 31, 2012 |
3,374 | $ 19.27 | - | - |
Stock Performance Graph (1)
The graph below compares the cumulative total stockholder return during the measurement period with the cumulative total return, assuming reinvestment of dividends, of the Nasdaq Bank Index and the Nasdaq Composite Index.
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The cumulative total stockholder return was obtained by dividing (i) the cumulative amount of dividends per share, assuming dividend reinvestment since the measurement point, December 31, 2007, plus (ii) the change in the per share price since the measurement date, by the share price at the measurement date.
COMPARISON OF FIVE YEAR CUMULATIVE RETURN
Total Return as of December 31
December 31, 2007 = 100
(1) Unless Popular specifically states otherwise, this Stock Performance Graph shall not be deemed to be incorporated by reference and shall not constitute soliciting material or otherwise be considered filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item appears in Table 1, Selected Financial Data, and the text under the caption Statement of Operations Analysis in the Management Discussion and Analysis, and is incorporated herein by reference.
Our ratio of earnings to fixed charges and of earnings to fixed charges and Preferred Stock dividends on a consolidated basis for each of the last five years is as follows:
Year ended December 31, | ||||||||||
Ratio of Earnings to Fixed Charges: | 2012 | 2011 | 2010 | 2009 (1) | 2008 (1) | |||||
Including Interest on Deposits |
1.4 | 1.5 | 1.4 | (A) | (A) | |||||
Excluding Interest on Deposits |
1.8 | 2.0 | 1.7 | (A) | (A) | |||||
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends:
|
||||||||||
Including Interest on Deposits |
1.4 | 1.4 | 1.4 | (A) | (A) | |||||
Excluding Interest on Deposits |
1.8 | 1.9 | 1.7 | (A) | (A) |
(1) | The computation of earnings to fixed charges and preferred stock dividends excludes the results of discontinued operations. |
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(A) | During 2008 and 2009, earnings were not sufficient to cover fixed charges or preferred stock dividends and the ratios were less than 1:1. The Corporation would have had to generate additional earnings of approximately $235 million and $625 million to achieve ratios of 1:1 in 2008 and 2009, respectively. |
For purposes of computing these consolidated ratios, earnings represent income before income taxes, plus fixed charges. Fixed charges represent all interest expense and capitalized (ratios are presented both excluding and including interest on deposits), the portion of net rental expense, which is deemed representative of the interest factor and the amortization of debt issuance expense. The interest expense includes changes in the fair value of the non-hedging derivatives.
Our long-term senior debt and Preferred Stock on a consolidated basis as of December 31 of each of the last five years is:
Year ended December 31, | ||||||||||
(in thousands) | 2012 | 2011 | 2010 | 2009 | 2008 | |||||
Long-term obligations |
$ 1,777,721 | $ 1,856,372 | $ 4,170,183 | $ 2,648,632 | $ 3,386,763 | |||||
Non-cumulative Preferred Stock |
50,160 | 50,160 | 50,160 | 50,160 | 586,875 | |||||
Fixed rate cumulative Perpetual Preferred Stock |
896,650 |
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this item appears on page 2 through 102 in the Annual Report under the caption Management Discussion and Analysis, and is incorporated herein by reference.
Table 30, Maturity Distribution of Earning Assets, in the Management Discussion and Analysis, takes into consideration prepayment assumptions as determined by management based on the expected interest rate scenario.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information regarding the market risk of our investments appears on page 57 through 64 in the Management Discussion and Analysis in the Annual Report, and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item appears on pages 105 through 255, in the Annual Report and under the caption Statistical Summary 2011-2012 Quarterly Financial Data in the Annual Report, and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Popular in the reports that we file or submit under the Exchange Act and such information is accumulated and communicated to management, as appropriate, to allow timely decisions regarding required disclosures.
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Assessment on Internal Control Over Financial Reporting
Managements Assessment of Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm are on pages 103 through 104 of our Annual Report and are incorporated by reference herein.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended on December 31, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information contained under the captions Shares Beneficially Owned by Directors and Executive Officers of the Corporation, Section 16 (A) Beneficial Ownership Reporting Compliance, Corporate Governance, Nominees for Election as Directors and Other Directors and Executive Officers in the Proxy Statement are incorporated herein by reference. The Board has adopted a Code of Ethics to be followed by our employees, officers (including the Chief Executive Officer, Chief Financial Officer and Corporate Comptroller) and directors to achieve conduct that reflects our ethical principles. The Code of Ethics is available on our website at www.popular.com. We will post on our website any amendments to the Code of Ethics or any waivers to the Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer or directors.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions Compensation of Directors, Compensation Committee Interlocks and Insider Participation and Executive Compensation Program, including the Compensation Discussion and Analysis in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
The information under the captions Principal Stockholders and Shares Beneficially Owned by Directors and Executive Officers of the Corporation in the Proxy Statement is incorporated herein by reference.
The following table set forth information as of December 31, 2012 regarding securities issued and issuable to directors and eligible employees under our equity based compensation plans.
Plan Category | Plan | Number of to be Issued Upon Exercise of Outstanding Options |
Weighted Average Exercise Price of Outstanding |
Number of Securities) Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in the First Column) |
||||||||||
Equity compensation plans approved by security holders | 2001 Stock Option Plan | 114,533 | $203.74 | |||||||||||
2004 Omnibus Incentive Plan | 46,453 | $269.50 | 127,441 | |||||||||||
Total |
160,986 | $222.71 | 127,441 |
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information under the caption Board of Directors Independence, Family Relationships and Other Relationships, Transactions and Events in the Proxy Statement is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and services is set forth under Disclosure of Auditors Fees in the Proxy Statement, which is incorporated herein by reference.
ITEM 15. EXHIBITS AND, FINANCIAL STATEMENT SCHEDULES
(a). The following financial statements and reports included on pages 105 through 255 of the Financial Review and Supplementary Information of Populars Annual Report to Shareholders are incorporated herein by reference:
(1) | Financial Statements |
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of December 31, 2012 and 2011
Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2012
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2012
Consolidated Statements of Changes in Stockholders Equity for each of the years in the three-year period ended December 31, 2012
Consolidated Statements of Comprehensive Income (Loss) for each of the years in the three-year period ended December 31, 2012
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules: No schedules are presented because the information is not applicable or is included in the Consolidated Financial Statements described in (a).1 above or in the notes thereto.
(3) Exhibits
The exhibits listed on the Exhibits Index on page 52 of this report are filed herewith or are incorporated herein by reference.
50
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POPULAR, INC. | ||||
(Registrant) | ||||
By: | S/ RICHARD L. CARRIÓN | |||
Richard L. Carrión | ||||
Chairman of the Board, President | ||||
and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
S/ RICHARD L. CARRIÓN |
Chairman of the Board, President, |
|||||
Richard L. Carrión |
Chief Executive Officer and |
|||||
Principal Executive Officer |
02-28-13 | |||||
S/ JORGE A. JUNQUERA |
Principal Financial Officer |
02-28-13 | ||||
Jorge A. Junquera |
||||||
Senior Executive Vice President |
||||||
S/ JORGE J. GARCÍA |
Principal Accounting Officer |
02-28-13 | ||||
Jorge J. García |
||||||
Senior Vice President |
||||||
S/ ALEJANDRO M. BALLESTER |
||||||
Alejandro M. Ballester |
Director |
02-28-13 | ||||
S/ MARÍA LUISA FERRÉ |
||||||
María Luisa Ferré |
Director |
02-28-13 | ||||
S/ C. KIM GOODWIN |
||||||
C. Kim Goodwin |
Director |
02-28-13 | ||||
S/ MANUEL MORALES JR. |
||||||
Manuel Morales Jr. |
Director |
02-28-13 | ||||
S/ WILLIAM J. TEUBER JR |
||||||
William J. Teuber Jr. |
Director |
02-28-13 | ||||
S/ CARLOS A. UNANUE |
||||||
Carlos A. Unanue |
Director |
02-28-13 | ||||
S/ JOSÉ R. VIZCARRONDO |
||||||
José R. Vizcarrondo |
Director |
02-28-13 | ||||
S/ DAVID E. GOEL |
||||||
David E. Goel |
Director |
02-28-13 |
51
Exhibit Index
2.1 |
Purchase and Assumption Agreement; Whole Bank; All Deposits, among the Federal Deposit Insurance Corporation, receiver of Westernbank, Mayaguez Puerto Rico, the Federal Deposit Insurance Corporation and Banco Popular de Puerto Rico, dated as of April 30, 2010. The Purchase and Assumption Agreement includes as Exhibit 4.15A the Single Family Shared Loss Agreement and as Exhibit 4.15B the Commercial Shared- Loss Agreement (incorporated by reference to Exhibit 2.1 of Popular, Inc.s Current Report on Form 8-K dated April 30, 2010 and filed on May 6, 2010). | |
2.2 |
Agreement and Plan of Merger dated as of June 30, 2010, among Popular, Inc., AP Carib Holdings Ltd., Carib Acquisition, Inc. and EVERTEC, Inc. (incorporated by reference to Exhibit 2.1 of Popular, Inc.s Current Report on Form 8-K dated July 1, 2010 and filed on July 8, 2010). | |
2.3 |
Second Amendment to the Agreement and Plan of Merger, dated as of August 8, 2010, among Popular, Inc., EVERTEC, Inc., AP Carib Holdings, Ltd. and Carib Acquisition, Inc. (incorporated by reference to Exhibit 2.1 of Popular, Inc.s Current Report on Form 8-K dated August 8, 2010 and filed on August 12, 2010). | |
2.4 |
Third Amendment to the Agreement and Plan of Merger, dated as of September 15, 2010, among Popular, Inc., EVERTEC, Inc., AP Carib Holdings, Ltd. And Carib Acquisition, Inc. (incorporated by reference to Exhibit 2.1 of Popular, Inc.s Current Report on Form 8-K dated September 15, 2010 and filed on September 21, 2010). | |
2.5 |
Fourth Amendment to the Agreement and Plan of Merger, dated as of September 30, 2010, among Popular, Inc., EVERTEC, Inc., AP Carib Holdings, Ltd. and Carib Acquisition, Inc. (incorporated by reference to Exhibit 2.1 of Popular, Inc.s Current Report on Form 8-K dated September 30, 2010 and filed on October 6, 2010). | |
3.1 |
Composite Certificate of Incorporation of Popular, Inc. (incorporated by reference to Exhibit 3.1 of the Corporations Quarterly Report on Form 10-Q for the quarter ended June 30, 2012). | |
3.2 |
Amended and Restated Bylaws of Popular, Inc., as amended (incorporated by reference to Exhibit 3.1 of Popular, Inc.s Current Report on Form 8-K, dated June 19, 2012 and filed on June 22, 2012). | |
4.1 |
Specimen of Physical Common Stock Certificate of Popular, Inc. (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8-K dated May 29, 2012 and filed on May 30, 2012). | |
4.2 |
Senior Indenture, dated as of February 15, 1995, as supplemented by the First Supplemental Indenture thereto, dated as of May 8, 1997, each between Popular, Inc. and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as trustee (incorporated by reference to Exhibit 4(d) to the Registration Statement No. 333-26941 of Popular, Inc., Popular International Bank, Inc., and Popular North America, Inc., as filed with the SEC on May 12, 1997). | |
4.3 |
Second Supplemental Indenture, dated as of August 5, 1999, between Popular, Inc. and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as trustee (incorporated by reference to Exhibit 4(e) to Popular, Inc.s Current Report on Form 8-K (File No. 002-96018), dated August 5, 1999, as filed with the SEC on August 17, 1999). | |
4.4 |
Subordinated Indenture dated as of November 30, 1995, between Popular, Inc. and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as trustee (incorporated by reference to Exhibit 4(e) of Popular, Inc.s Registration Statement No. 333- 26941, dated May 12, 1997). | |
4.5 |
Indenture of Popular North America, Inc., dated as of October 1, 1991, as supplemented by the First Supplemental Indenture thereto, dated as of February 28, 1995, and the Second Supplemental Indenture thereto, dated as of May 8, 1997, each among Popular North America, Inc., as issuer, Popular, Inc., as guarantor, and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as successor trustee, (incorporated by reference to Exhibit 4(f) to the Registration Statement No. 333-26941 of Popular, Inc., Popular International Bank, Inc. and Popular North America, Inc., as filed with the SEC on May 12, 1997). |
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4.6 | Third Supplemental Indenture of Popular North America, Inc., dated as of August 5, 1999, among Popular North America, Inc., Popular, Inc., as guarantor, and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as successor trustee (incorporated by reference to Exhibit 4(h) to Popular, Inc.s Current Report on Form 8-K, dated August 5, 1999, as filed with the SEC on August 17, 1999). | |
4.7 | Form of Fixed Rate Medium-Term Note, Series F, of Popular North America, Inc., endorsed with the guarantee of Popular, Inc.(incorporated by reference to Exhibit 4(g) of Popular, Inc.s Current Report on Form 8-K, dated June 23, 2004 and filed on July 2, 2004). | |
4.8 | Form of Floating Rate Medium-Term Note, Series F, of Popular North America, Inc., endorsed with the guarantee of Popular, Inc. (incorporated by reference to Exhibit 4(h) of Popular, Inc.s Current Report on Form 8-K, dated June 23, 2004 and filed on July 2, 2004). | |
4.9 | Administrative Procedures governing Medium-Term Notes, Series F, of Popular North America, Inc., guaranteed by Popular, Inc. (incorporated by reference to Exhibit 10(b) of Popular, Inc.s Current Report on Form 8-K, dated June 23, 2004 and filed on July 2, 2004). | |
4.10 | Junior Subordinated Indenture, among Popular North America, Inc., as issuer, Popular, Inc., as guarantor, and JP Morgan Chase Bank (formerly known as The First National Bank of Chicago), as trustee (incorporated by reference to Exhibit (4)(a) of Popular, Inc.s Current Report on Form 8-K, dated and filed on February 19, 1997). | |
4.11 | Supplemental Indenture, dated as of August 31, 2009, among Popular North America, Inc., as issuer, Popular, Inc., as guarantor, and The Bank of New York Mellon, as successor trustee (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.12 | Amended and Restated Trust Agreement of BanPonce Trust I, dated as of August 31, 2009, among Popular North America, Inc., as depositor, Popular, Inc., as guarantor, The Bank of New York Mellon, as property trustee, BNY Mellon Trust of Delaware, as Delaware trustee, the Administrative Trustees named therein, and the several Holders, as defined therein (incorporated by reference to Exhibit 4.5 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.13 | Certificate of Trust of BanPonce Trust I (incorporated by reference to Exhibit 4.5 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit A of the Amended and Restated Trust Agreement). | |
4.14 | Form of Capital Securities Certificate for BanPonce Trust I (incorporated by reference to Exhibit (4)(g) of Popular, Inc.s Current Report on Form 8-K, dated and filed on February 19, 1997). | |
4.15 | Guarantee Agreement, dated as of August 31, 2009, by and among Popular North America, Inc., as guarantor, Popular, Inc., as additional guarantor, and The Bank of New York Mellon, as guarantee trustee, relating to BanPonce Trust I (incorporated by reference to Exhibit 4.9 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.16 | Form of Junior Subordinated Deferrable Interest Debenture for Popular North America, Inc. (incorporated by reference to Exhibit (4)(i) of Popular, Inc.s Current Report on Form 8-K (File No. 000- 13818), dated and filed on February 19, 1997). | |
4.17 | Form of Certificate representing Popular, Inc.s 6.375% Non-Cumulative Monthly Income Preferred Stock, 2003 Series A. (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Form 8-A filed on February 25, 2003). | |
4.18 | Certificate of Designation, Preference and Rights of Popular, Inc.s 6.375% Non-Cumulative Monthly Income Preferred Stock, 2003 Series A (incorporated by reference to Exhibit 3.3 of Popular, Inc.s Form 8-A filed on February 25, 2003). |
53
4.19 | Form of Certificate of Trust of Popular Capital Trust III and Popular Capital Trust IV dated September 5, 2003 (incorporated by reference to Exhibit 4.3 to the Registration Statement filed with the SEC on September 5, 2003). | |
4.20 | Certificate of Amendment to the Certificate of Trust of Popular Capital Trust IV (incorporated by reference to Exhibit 4.15 to the Automatic Shelf Registration Statement on Form S-3ASR filed with the SEC on June 16, 2012). | |
4.21 | Supplemental Indenture, dated as of August 31, 2009, between Popular, Inc., as Issuer, and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 4.3 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.22 | Amended and Restated Declaration of Trust and Trust Agreement of Popular Capital Trust I, dated as of August 31, 2009, among Popular, Inc., as depositor, The Bank of New York Mellon, as property trustee, BNY Mellon Trust of Delaware, as Delaware trustee, the Administrative Trustees named therein, and the several Holders, as defined therein (incorporated by reference to Exhibit 4.7 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.23 | Certificate of Trust of Popular Capital Trust I (incorporated by reference to Exhibit 4.7 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit A of the Amended and Restated Declaration of Trust and Trust Agreement). | |
4.24 | Form of Global Capital Securities Certificate for Popular Capital Trust I (incorporated by reference to Exhibit 4.7 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit C of the Amended and Restated Declaration of Trust and Trust Agreement). | |
4.25 | Guarantee Agreement, dated as of August 31, 2009, between Popular, Inc., as guarantor and The Bank of New York Mellon, as guarantee trustee, relating to Popular Capital Trust I (incorporated by reference to Exhibit 4.11 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.26 | Certificate of Junior Subordinated Debenture relating to Popular, Inc.s 6.70% Junior Subordinated Debentures, Series A Due November 1, 2033 (incorporated by reference to Exhibit 4.6 of Popular, Inc.s Current Report on Form 8-K dated October 31, 2003, as filed with the SEC on November 4, 2003). | |
4.27 | Indenture dated as of October 31, 2003, between Popular, Inc. and JP Morgan Chase Institutional Services (formerly Bank One Trust Company, N.A.) Debenture (incorporated by reference to Exhibit 4.2 of Popular, Inc.s Current Report on Form 8-K dated October 31,2003, as filed with the SEC on November 4, 2003). | |
4.28 | First Supplemental Indenture, dated as of October 31, 2003, between Popular, Inc. and JP Morgan Chase Institutional Services (formerly Bank One Trust Company, N.A.) (Incorporated by reference to Exhibit 4.3 of Popular, Inc.s Current Report on Form 8-K dated October 31, 2003, as filed with the SEC on November 4, 2003). | |
4.29 | Form of Junior Subordinated Indenture among Popular North America, Inc., Popular, Inc. and The Bank of New York Mellon, as successor trustee (incorporated by reference to Exhibit 4.10 to the Automatic Shelf Registration Statement on Form S-3ASR filed with the SEC on June 16, 2012). | |
4.30 | Supplemental Indenture dated as of August 31, 2009, among Popular North America, Inc., as issuer, Popular, Inc., as guarantor, and The Bank of New York Mellon, as successor trustee (incorporated by reference to Exhibit 4.2 of Popular, Inc.s Current Report on Form 8- K dated August 31, 2009, and filed on September 3, 2009). | |
4.31 | Amended and Restated Trust Agreement of Popular North America Capital Trust I, dated as of August 31, 2009, among Popular North America, Inc., as depositor, Popular, Inc., as guarantor, The Bank of New York Mellon, as property trustee, BNY Mellon Trust of Delaware, as Delaware trustee, the Administrative Trustees named therein, and the several Holders, as defined therein (incorporated by reference to Exhibit 4.6 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). |
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4.32 | Certificate of Trust of Popular North America Capital Trust I (incorporated by reference to Exhibit 4.6 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit A of the Amended and Restated Trust Agreement). | |
4.33 | Form of Capital Securities Certificate for Popular North America Capital Trust I (incorporated by reference to Exhibit 4.6 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit E of the Amended and Restated Trust Agreement). | |
4.34 | Guarantee Agreement, dated as of August 31, 2009, by and among Popular North America, Inc., as guarantor, Popular, Inc., as additional guarantor and The Bank of New York Mellon, as guarantee trustee, relating to Popular North America Capital Trust I (incorporated by reference to Exhibit 4.10 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.35 | Certificate of Junior Subordinated Debenture relating to Popular, Inc.s 6.125% Junior Subordinated Debentures, Series A due December 1, 2034 (incorporated by reference to Exhibit 4.6 of Popular, Inc.s Current Report on Form 8-K dated November 30, 2004, as filed with the SEC on December 3, 2004). | |
4.36 | Second Supplemental Indenture, dated as of November 30, 2004, between Popular, Inc. and JP Morgan Trust Company, National Association (formerly Bank One Trust Company, N.A.) (incorporated by reference to Exhibit 4.3 of Popular, Inc.s Current Report on Form 8-K dated November 30, 2004, as filed with the SEC on December 3, 2004). | |
4.37 | Supplemental Indenture, dated as of August 31, 2009, between Popular, Inc., as Issuer, and The Bank of New York Mellon, as successor trustee (incorporated by reference to Exhibit 4.4 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.38 | Amended and Restated Declaration of Trust and Trust Agreement of Popular Capital Trust II, dated as of August 31, 2009, among Popular, Inc., as depositor, The Bank of New York Mellon, as property trustee, BNY Mellon Trust of Delaware, as Delaware trustee, the Administrative Trustees named therein, and the several Holders, as defined therein (incorporated by reference to Exhibit 4.8 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.39 | Certificate of Trust of Popular Capital Trust II (incorporated by reference to Exhibit 4.8 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit A of the Amended and Restated Declaration of Trust and Trust Agreement). | |
4.40 | Form of Global Capital Securities Certificate for Popular Capital Trust II (incorporated by reference to Exhibit 4.8 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009 and filed on September 3, 2009, included as Exhibit C of the Amended and Restated Declaration of Trust and Trust Agreement). | |
4.41 | Guarantee Agreement, dated as of August 31, 2009, between Popular, Inc., as guarantor, and The Bank of New York Mellon, as guarantee trustee (incorporated by reference to Exhibit 4.12 of Popular, Inc.s Current Report on Form 8-K dated August 31, 2009, and filed on September 3, 2009). | |
4.42 | Certificate of Designation of the Popular, Inc.s 8.25% Non-Cumulative Monthly Income Preferred Stock, Series B (incorporated by reference to Exhibit 3 to Popular, Inc.s Form 8-A filed with the SEC on May 28, 2008). | |
4.43 | Form of certificate representing the Popular, Inc.s 8.25% Non-Cumulative Monthly Income Preferred Stock, Series B (incorporated by reference to Exhibit 4 to Popular, Inc.s Form 8-A filed with the SEC on May 28, 2008). | |
4.44 | Warrant dated December 5, 2008 to purchase shares of Common Stock of Popular, Inc. (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8-K dated December 5, 2008, as filed with the SEC on December 8, 2008). |
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4.45 | Indenture between Popular, Inc. and The Bank of New York Mellon, as trustee, dated August 24, 2009 (incorporated by reference to Exhibit 4.2 of Popular, Inc.s Current Report on Form 8-K dated August 21, 2009 and filed on August 26, 2009). | |
4.46 | First Supplemental Indenture between Popular, Inc. and Bank of New York Mellon, as trustee, dated August 24, 2009 (incorporated by reference to Exhibit 4.3 of Popular, Inc.s Current Report on Form 8-K dated August 21, 2009 and filed on August 26, 2009). | |
4.47 | Amended and Restated Declaration of Trust and Trust Agreement of Popular Capital Trust III among Popular, Inc., as depositor, The Bank of New York Mellon, as property trustee, BNY Mellon Trust of Delaware, as Delaware trustee, and the several Holders as defined therein, dated as of August 24, 2009 (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8-K dated August 21, 2009 and filed on August 26, 2009). | |
4.48 | Form of Capital Securities Certificate of Popular Capital Trust III (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on form 8-K dated August 21, 2009 and filed on August 26, 2009, included as Exhibit C of the Amended and Restated Declaration of Trust and Trust Agreement). | |
4.49 | Guarantee Agreement by and between Popular, Inc. and The Bank of New York Mellon, dated as of August 24, 2009 (incorporated by reference to Exhibit 4.4 of Popular, Inc.s Current Report on Form 8-K dated August 21, 2009 and filed on August 26, 2009). | |
4.50 | Sixth Supplemental Indenture, dated March 15, 2010, between Popular, Inc. and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 99.1 of Popular Inc.s Current Report on Form 8-K dated March, 15, 2010 and filed on March 19, 2010). | |
4.51 | Seventh Supplemental Indenture, dated March 15, 2010, between Popular, Inc. and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 99.2 of Popular Inc.s Current Report on Form 8-K dated March, 15, 2010 and filed on March 19, 2010). | |
4.52 | Purchase Money Note, issued on April 30, 2010 (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8- K dated April 30, 2010 and filed on May 6, 2010). | |
4.53 | Value Appreciation Instrument, issued on April 30, 2010 (incorporated by reference to Exhibit 4.2 of Popular, Inc.s Current Report on Form 8-K dated April 30, 2010 and filed on May 6, 2010). | |
4.54 | Popular North America, Inc. 7.47% Senior Note Due 2014 (incorporated by reference to Exhibit 4.1 of Popular, Inc.s Current Report on Form 8-K dated June 10, 2011 and filed on June 13, 2011). | |
4.55 | Popular North America, Inc. 7.66% Senior Note Due 2015 (incorporated by reference to Exhibit 4.2 of Popular, Inc.s Current Report on Form 8-K dated June 10, 2011 and filed on June 13, 2011). | |
4.56 | Popular North America, Inc. 7.86% Senior Note Due 2016 (incorporated by reference to Exhibit 4.3 of Popular, Inc.s Current Report on Form 8-K dated June 10, 2011 and filed on June 13, 2011). | |
4.57 | Certificate of Trust of Popular North America Capital Trust II (incorporated by reference to Exhibit 4.22 to the Automatic Shelf Registration Statement on Form S-3ASR filed with the SEC on June 16, 2006). | |
4.58 | Declaration of Trust and Trust Agreement of each of Popular North America Capital Trust II and Popular North America Capital Trust III dated June 16, 2006 (incorporated by reference to Exhibit 4.20 to the Automatic Shelf Registration Statement on Form S-3ASR filed with the SEC on June 16, 2012). |
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4.59 | Certificate of Amendment to Certificate of Trust of each of Popular North America Capital Trust II and Popular North America Capital Trust III (incorporated by reference to Exhibit 4.24 to the Automatic Shelf Registration Statement on Form S-3ASR filed with the SEC on June 16, 2012). | |
10.1 | Popular, Inc. Senior Executive Long-Term Incentive Plan, dated April 23, 1998 (incorporated by reference to Exhibit 10.8.2. of Popular, Inc.s Annual Report on Form 10-K for the fiscal year ended December 31, 1998. | |
10.2 | Popular, Inc. 2001 Stock Option Plan (incorporated by reference to Exhibit 4.4 of Popular, Inc.s Registration Statement on Form S-8 (No. 333-60666), filed on May 10, 2001). | |
10.3 | Popular, Inc. 2004 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.21 of Popular, Inc.s Annual Report on Form 10-K for the fiscal year ended December 31, 2004). | |
10.4 | Form of Compensation Agreement for Directors Elected Chairman of a Committee (incorporated by reference to Exhibit 10.1 of Popular, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). | |
10.5 | Form of Compensation Agreement for Directors not Elected Chairman of a Committee (incorporated by reference to Exhibit 10.2 of Popular, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). | |
10.6 | Compensation Agreement for Frederic V. Salerno as director of Popular, Inc. (incorporated by reference to Exhibit 10.3 of Popular, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). | |
10.7 | Compensation Agreement for William J. Teuber as director of Popular, Inc. (incorporated by reference to Exhibit 10.4 of Popular, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004). | |
10.8 | Compensation agreement for Michael Masin as director of Popular, Inc., dated January 25, 2007, (incorporated by reference to Exhibit 10.20 of Popular, Inc.s Annual Report on Form 10-K for the fiscal year ended December 31, 2007). | |
10.9 | Compensation agreement for Alejandro M. Ballester as director of Popular, Inc. dated January 28, 2010 (incorporated by reference to Exhibit 10.9 of Popular, Inc.s Annual Report on Form 10-K for the year ended December 31, 2009). | |
10.10 | Compensation agreement for Carlos A. Unanue as director of Popular, Inc. dated January 28, 2010 (incorporated by reference to Exhibit 10.10 of Popular, Inc.s Annual Report on Form 10-K for the year ended December 31, 2009). | |
10.11 | Compensation agreement for C. Kim Goodwin as director of Popular, Inc. dated May 10, 2011 (incorporated by reference to Exhibit 10.1 of Popular, Inc.s Quarterly Annual Report on Form 10-Q for the quarter ended June 30, 2011). | |
10.12 | Form of Letter Agreement Regarding Standards for Incentive Compensation to Executive Officers under the TARP Capital Purchase Program (incorporated by reference to Exhibit 10.33 of Popular, Inc.s Annual Report of Form 10-K for the fiscal year ended December 31, 2008). | |
10.13 | Purchase Agreement dated as of December 5, 2008 between Popular, Inc. and the United States Department of the Treasury (incorporated by reference to Exhibit 10.1 of Popular, Inc.s Current Report on Form 8-K dated December 5, 2008, as filed with the SEC on December 8, 2008). | |
10.14 | Exchange Agreement by and among Popular, Inc., Popular Capital Trust III and the United States Department of Treasury, dated as of August 21, 2009 (incorporated by reference to Exhibit 10.1 of Popular, Inc.s Current Report on Form 8-K dated August 21, 2009 and filed on August 26, 2009). | |
10.15 | IP Purchase and Sale Agreement, dated as of June 30, 2010, between Popular, Inc. and EVERTEC, Inc. (incorporated by reference to Exhibit 10.1 of Popular, Inc.s Current Report on Form 8-K dated July 1, 2010 and filed on July 8, 2010). |
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10.16 | Stockholder Agreement, dated as of September 30, 2010, among Carib Holdings, Inc., and each of the holders of Carib Holdings, Inc. (incorporated by reference to Exhibit 99.2 of Popular, Inc.s Current Report on Form 8-K dated September 30, 2010 and filed on October 6, 2010). | |
10.17 | Amended and Restated Master Services Agreement dated as of September 30, 2010, among Popular, Banco Popular de Puerto Rico and EVERTEC, Inc. (incorporated by reference to Exhibit 99.1 of Popular, Inc.s Current Report on Form 8-K dated and filed on October 14, 2011). | |
10.18 | Technology Agreement, dated as of September 30, 2010, between Popular, Inc. and EVERTEC, Inc. (incorporated by reference to Exhibit 99.4 of Popular, Inc.s Current Report on Form 8-K dated September 30, 2010 and filed on October 6, 2010). | |
10.19 | Employment Offer to Carlos J. Vázquez, as President of Banco Popular North America (incorporated by reference to Exhibit 99.4 of Popular, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010). | |
10.20 | Agreement dated August 11, 2011 between Amílcar Jordán and his wife Leslie González and Popular, Inc. (incorporated by reference to Exhibit 99.1 of Popular, Inc.s Current Report on Form 8-K dated August 15, 2011 and filed August 17, 2011). | |
10.21 | Stockholder Agreement dated as of April 17, 2012, among Carib Latam Holdings, Inc., and each of the holders of Carib Latam Holdings, Inc. (incorporated by reference to Exhibit 99.1 of Popular, Inc.s Current Report on Form 8-K dated April 17, 2012 and filed on April 23, 2012). | |
10.22 | Form of Popular, Inc. TARP Long-Term Restricted Stock Award Agreement. (1) | |
12.1 | Popular, Inc.s Computation of Ratio of Earnings to Fixed Charges. (1) | |
13.1 | Popular, Inc.s Annual Report to Shareholders for the year ended December 31, 2012. (1) | |
21.1 | Schedule of Subsidiaries of Popular, Inc. (1) | |
23.1 | Consent of Independent Registered Public Accounting Firm. (1) | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (1) | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (1) | |
32.1 | Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. (1) | |
32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. (1) | |
99.1 | Certification of Principal Executive Officer Pursuant to 31 C.F.R. § 30.15(1) | |
99.2 | Certification of Principal Financial Officer Pursuant to 31 C.F.R. § 30.15(1) | |
101.INS | XBRL Instance Document(1) | |
101.SCH | XBRL Taxonomy Extension Schema Document(1) | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document(1) | |
101.DEF | XBRL Taxonomy Extension Definitions Linkbase Document(1) | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document(1) | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document(1) |
(1) | Included herewith |
Popular, Inc. has not filed as exhibits certain instruments defining the rights of holders of debt of Popular, Inc. not exceeding 10% of the total assets of Popular, Inc. and its consolidated subsidiaries. Popular, Inc. hereby agrees to furnish upon request to the Commission a copy of each instrument defining the rights of holders of senior and subordinated debt of Popular, Inc., or of any of its consolidated subsidiaries.
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Exhibit 10.22
FORM OF
POPULAR, INC.
TARP LONG-TERM RESTRICTED STOCK AWARD AGREEMENT
Recipient:
The Compensation Committee of the Board of Directors of Popular, Inc. (the Committee) has granted you this award of TARP Restricted Stock (Restricted Stock). This award agreement (this Award Agreement) sets forth the terms and conditions of your Award. This Award is made under the Popular, Inc. 2004 Omnibus Incentive Plan (the Plan) and, except as otherwise provided herein, is subject to the terms of the Plan. Capitalized terms used but not otherwise defined in this Award Agreement have the meanings given in the Plan.
1. Award. The number of shares of Restricted Stock subject to this Award is set forth at the end of this Award Agreement. This Award of Restricted Stock will vest as set forth below.
2. Vesting; Payout.
(a) Vesting. Except as provided in this Paragraph 2 and in Paragraphs 3 and 4, you shall become vested in the Restricted Stock on the second anniversary of the Date of Grant specified at the end of this Award Agreement (the Scheduled Vesting Date). Except as provided in this Paragraph 2 and Paragraph 4, if your employment terminates for any reason prior to the Scheduled Vesting Date, your rights in respect of all of your shares of Restricted Stock shall terminate.
(b) Payment Dates. In order for any payment under this Paragraph 2 to become payable, the Corporation must have achieved a net profit during any fiscal year after the date hereof and before the initial payment described in Paragraph 2(b)(i) below. Thereafter, the Restricted Stock shall become payable according to the following schedule:
(i) 25% of the Restricted Stock shall become payable as soon as practicable following the Corporations repayment of 25% of the aggregate financial assistance received under the Troubled Asset Relief Program;
(ii) An additional 25% of the Restricted Stock (for an aggregate total of 50% of the Restricted Stock) shall become payable as soon as practicable following the Corporations repayment of 50% of the aggregate financial assistance received under the Troubled Asset Relief Program;
(iii) An additional 25% of the Restricted Stock (for an aggregate total of 75% of the Restricted Stock) shall become payable as soon as practicable following the Corporations repayment of 75% of the aggregate financial assistance received under the Troubled Asset Relief Program; and
(iv) The remainder of the Restricted Stock shall become payable as soon as practicable following the Corporations repayment of 100% of the aggregate financial assistance received under the Troubled Asset Relief Program (such date and the payment dates set forth in clauses (i), (ii) and (iii) of this Paragraph 2(b), each a Permitted Payment Date).
(c) Payout. Except as provided in this Paragraph 2 and in Paragraphs 3, 4, 6 and 7, the transfer restrictions on the applicable number of whole shares of Restricted Stock shall lapse on the later of the Scheduled Vesting Date or the applicable Permitted Payment Date with respect to such shares (Payout Date).
(d) Death. Notwithstanding any other provision of this Award Agreement, if you die prior to the Scheduled Vesting Date, and provided your rights in respect of your shares of Restricted Stock have not previously terminated, the shares corresponding to your outstanding Restricted Stock shall immediately vest and be paid to the representative of your estate promptly after the later of your death and the applicable Permitted Payment Date.
(e) Change of Control. Notwithstanding any other provision of this Award Agreement, in the event of a Change of Control or other corporate transaction, in each case, that constitutes a change in control event (as defined in 26 CFR 1.280G-1, Q&A 27 through Q&A 29 or as defined in 26 CFR 1.409A-3(i)(5)(i)) prior to a Scheduled Vesting Date, and provided your rights in respect of your Restricted Stock have not previously terminated, the shares of your outstanding Restricted Stock shall immediately vest and be paid to you promptly after the later of the Change of Control event and the applicable Permitted Payment Date.
3. Termination of Restricted Stock. Except as provided in Paragraphs 2(d), 2(e) and 4, your rights in respect of your outstanding shares of Restricted Stock shall immediately terminate, and no shares shall be paid in respect thereof, if at any time prior to the Scheduled Vesting Date your employment with the Corporation terminates for any reason.
4. Disability. Notwithstanding any other provision of this Award Agreement, but subject to Paragraph 5, if you become subject to Disability, the condition set forth in Paragraph 3 shall be waived with respect to your then outstanding shares of Restricted Stock (as a result of which any such then unvested outstanding shares of Restricted Stock shall vest) and the shares corresponding to your outstanding Restricted Stock shall be paid to you after the later of your Disability and the applicable Permitted Payment Date.
5. Non-transferability. This Award (or any rights and obligations hereunder) may not be sold, exchanged, transferred, assigned, pledged, hypothecated or otherwise disposed of or hedged, in any manner (including through the use of any cash-settled instrument), whether voluntarily or involuntarily and whether by operation of law or otherwise, other than by will or by the laws of descent and distribution.
6. Withholding, Consents and Legends.
(a) You shall be solely responsible for any applicable taxes (including, without limitation, income and excise taxes) and penalties, and any interest that accrues thereon, incurred in connection with your Award. Unless you otherwise direct, the Corporation will satisfy applicable tax withholdings and make applicable deductions in respect of your Award (at the minimum applicable statutory rate) and cause the restrictions on the remainder of the shares subject to your Award to lapse pursuant to Paragraph 2(c). In the alternative, you may remit cash to the Corporation (through payroll deduction or otherwise), in each case in an amount sufficient in the opinion of the Corporation to satisfy such withholding obligation.
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(b) Your right to receive shares pursuant to the Award is conditioned on the receipt to the reasonable satisfaction of the Committee of any required consent that the Committee may reasonably determine to be necessary or advisable. By accepting delivery of the shares, you acknowledge that you are subject to Corporations Insider Trading Policy.
7. Section 409A. Restricted Stock awarded under this Award Agreement is intended to be exempt from Section 409A of the U.S. Code, to the extent applicable, and this Award Agreement is intended to, and shall be interpreted, administered and construed consistent therewith. The Committee shall have full authority to give effect to the intent of this Paragraph 7.
8. No Rights to Continued Employment. Nothing in this Award Agreement shall be construed as giving you any right to continued employment by the Corporation or any of its affiliates or affect any right that the Corporation or any of its affiliates may have to terminate or alter the terms and conditions of your employment.
9. Successors and Assigns of the Corporation. The terms and conditions of this Award Agreement shall be binding upon, and shall inure to the benefit of, the Corporation and its successor entities.
10. Committee Discretion. Subject to Paragraph 11, the Committee shall have full discretion with respect to any actions to be taken or determinations to be made in connection with this Award Agreement, and its determinations shall be final, binding and conclusive.
11. Amendment. The Committee reserves the right at any time to amend the terms and conditions set forth in this Award Agreement; provided that, notwithstanding the foregoing, no such amendment shall materially adversely affect your rights and obligations under this Award Agreement without your consent (or the consent of your estate, if such consent is obtained after your death), and provided, further, that the Committee may not accelerate or postpone the payout of shares to occur at a time other than the applicable time provided for in this Award Agreement. Any amendment of this Award Agreement shall be in writing signed by an authorized member of the Committee or a person or persons designated by the Committee.
12. Adjustment; Other Plan Provisions. Subject to Paragraph 11, the Committee shall adjust equitably the terms of this Award in accordance with Section 5.4 of the Plan, if applicable. Subject to the terms of this Award Agreement, this Award shall be subject to the terms of the Plan, including, but not limited to, the provisions of Section 8.4 related to dividends and voting rights. Cash dividends paid on the Restricted Stock, and all of the Common Stock that may be subsequently acquired with such cash dividends, will be invested in the purchase of additional shares of Common Stock of the Corporation in accordance with the Popular, Inc. Dividend Reinvestment and Stock Purchase Plan (DRIP). Such shares are not subject to the restrictions and are immediately vested.
13. The Restricted Stock shall be held in custody by the Fiduciary Services Division of Banco Popular de Puerto Rico.
14. Governing Law. This award shall be governed by and construed in accordance with the laws of Puerto Pico, without regard to principles of conflicts of laws.
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15. TARP Restrictions. Compensation under this Award Agreement is subject to applicable regulations issued by the U.S. Department of the Treasury and applicable requirements of agreements between the Corporation and the U.S. government, as the same are in effect from time to time. You may receive compensation under this Award Agreement only to the extent that it is consistent with those regulations and requirements.
16. Headings. The headings in this Award Agreement are for the purpose of convenience only and are not intended to define or limit the construction of the provisions hereof.
IN WITNESS WHEREOF, POPULAR, INC. has caused this Award Agreement to be duly executed and delivered as of the Date of Grant.
POPULAR, INC. | ||||||
By: |
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Recipient:
Dollar Value of Award:
Market Price:
Shares of Restricted Stock (#):
Date of Grant:
Scheduled Vesting Date:
Acknowledged | ||||
and Agreed to: |
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Signature | ||||
Address: |
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Street | ||||
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City, State Zip Code | ||||
Employee Number: |
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Exhibit 12.1
POPULAR, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Dollars in thousands)
Year ended December 31, | ||||||||||||||||||
2012 |
2011 | 2010 | 2009 (1) | 2008 (1) | ||||||||||||||
Income (loss) from continuing operations before income taxes and cumulative effect of accounting changes |
$160,282 | $239,148 | $242,942 | ($579,694) | ($232,959) | |||||||||||||
Fixed charges: |
||||||||||||||||||
Interest expense and capitalized interest |
379,086 | 505,523 | 653,603 | 754,506 | 994,919 | |||||||||||||
Estimated interest component of net rental payments |
9,752 | 13,470 | 26,688 | 28,866 | 34,975 | |||||||||||||
Total fixed charges including interest on deposits |
388,838 | 518,993 | 680,291 | 783,372 | 1,029,894 | |||||||||||||
Less: Interest on deposits |
184,089 | 269,487 | 350,881 | 501,262 | 700,122 | |||||||||||||
Total fixed charges excluding interest on deposits |
204,749 | 249,506 | 329,410 | 282,110 | 329,772 | |||||||||||||
Income before income taxes and fixed charges (including interest on deposits) |
$549,120 | $758,141 | $923,233 | $203,678 | $796,935 | |||||||||||||
Income (loss) before income taxes and fixed charges (excluding interest on deposits) |
$365,031 | $488,654 | $572,352 | ($297,584) | $96,813 | |||||||||||||
Ratio of earnings to fixed charges |
||||||||||||||||||
Including interest on deposits |
1.4 | 1.5 | 1.4 | (A) | (A) | |||||||||||||
Excluding interest on deposits |
1.8 | 2.0 | 1.7 | (A) | (A) | |||||||||||||
Ratio of earnings to fixed charges and preferred stock dividends |
||||||||||||||||||
Including interest on deposits |
1.4 | 1.4 | 1.4 | (A) | (A) | |||||||||||||
Excluding interest on deposits |
1.8 | 1.9 | 1.7 | (A) | (A) |
(1) The computation of earnings to fixed charges and preferred stock dividends excludes the results of discontinued operations.
(A) During 2008 and 2009, earnings were not sufficient to cover fixed charges or preferred stock dividends and the ratios were less than 1:1. The Corporation would have had to generate additional earnings of approximately $235 million and $625 million to achieve ratios of 1:1 in 2008 and 2009, respectively.
SECTION 3: EX-13.1 (EX-13.1)
Financial Review and
Supplementary Information
Managements Discussion and
Analysis of Financial Condition
and Results of Operations
2
The following Managements Discussion and Analysis (MD&A) provides information which management believes is necessary for understanding the financial performance of Popular, Inc. and its subsidiaries (the Corporation or Popular). All accompanying tables, consolidated financial statements, and corresponding notes included in this Financial Review and Supplementary Information - 2012 Annual Report (the report) should be considered an integral part of this MD&A.
FORWARD-LOOKING STATEMENTS
The information included in this report contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to the Corporations financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to expected earnings levels, the adequacy of the allowance for loan losses, delinquency trends, market risk and the impact of interest rate changes, capital market conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Corporations financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words anticipate, believe, continues, expect, estimate, intend, project and similar expressions and future or conditional verbs such as will, would, should, could, might, can, may, or similar expressions are generally intended to identify forward-looking statements.
Forward-looking statements are not guarantees of future performance, are based on managements current expectations and, by their nature, involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond the Corporations control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to, the rate of growth in the economy and employment levels, as well as general business and economic conditions; changes in interest rates, as well as the magnitude of such changes; the fiscal and monetary policies of the federal government and its agencies; changes in federal bank regulatory and supervisory policies, including required levels of capital; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act) on the Corporations businesses, business practices and costs of operations; the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets in Puerto Rico and the other markets in which borrowers are located; the performance of the stock and bond markets; competition in the financial services industry; additional Federal Deposit Insurance Corporation (FDIC) assessments; and possible legislative, tax or regulatory changes. Other possible events or factors that could cause results or performance to differ materially from those expressed in such forward-looking statements include the following: negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of non-performing assets, charge-offs and provision expense; changes in interest rates and market liquidity, which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets; adverse movements and volatility in debt and equity capital markets; changes in market rates and prices, which may adversely impact the value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; changes in accounting standards, rules and interpretations; increased competition; the Corporations ability to grow its core businesses; decisions to downsize, sell or close units or otherwise change the business mix of the Corporation; and managements ability to identify and manage these and other risks. Moreover, the outcome of legal proceedings is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries.
All forward-looking statements included in this report are based upon information available to the Corporation as of the date of this report, and other than as required by law, including the requirements of applicable securities laws, management assumes no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
The description of the Corporations business and risk factors contained in Item 1 and 1A of its Form 10-K for the year ended December 31, 2012 discusses additional information about the business of the Corporation and the material risk factors that, in addition to the other information in this report, readers should consider.
OVERVIEW
The Corporation is a diversified, publicly-owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation has operations in Puerto Rico, the United States (U.S.) mainland, and the U.S. and British Virgin Islands. In Puerto Rico, the Corporation provides retail and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (BPPR), as well as mortgage loans, investment banking, broker-dealer, auto and equipment leasing and financing, and insurance services through specialized subsidiaries. Effective December 31, 2012, Popular Mortgage, which was a wholly-owned subsidiary of BPPR prior to that date, was merged with and into BPPR as part of an internal reorganization.
3
The Corporations mortgage origination business will continue to be conducted under the brand name Popular Mortgage. In the U.S. mainland, the Corporation operates Banco Popular North America (BPNA), including its wholly-owned subsidiary E-LOAN. BPNA focuses efforts and resources on the core community banking business. BPNA operates branches in New York, California, Illinois, New Jersey and Florida. E-LOAN markets deposit accounts under its name for the benefit of BPNA. As part of the rebranding of the BPNA franchise, all of its branches operate under a new name, Popular Community Bank. Note 41 to the consolidated financial statements presents information about the Corporations business segments.
The Corporation has several investments which accounts for under the equity method. These include the 48.5% interest in EVERTEC, a 20% interest in Centro Financiero BHD and our 24.9% interest in PRLP 2011 Holdings LLP, among other investments in limited partnerships which mainly hold investment securities. EVERTEC provides transaction processing services throughout the Caribbean and Latin America, including servicing many of the Corporations system infrastructures and transaction processing businesses. Centro Financiero BHD is a diversified financial services institution operating in the Dominican Republic. PRLP 2011 Holdings LLP is a joint venture to which the Corporation sold construction and commercial loans, most of which were non-performing, with a fair value of $148 million during the year 2011. For the year ended December 31, 2012, the Corporation recorded approximately $20.7 million in earnings from these investments on an aggregate basis. The carrying amounts of these investments as of December 31, 2012 were $246.8 million. Refer to Note 16 to the consolidated financial statements for additional information of the Corporations investments at equity.
The Corporations net income for the year ended December 31, 2012 amounted to $245.3 million, compared with net income of $151.3 million and $137.4 million for 2011 and 2010, respectively. The results for 2012 reflect an income tax benefit of $72.9 million related to reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank as a result of the closing agreement with the Puerto Rico Department of Treasury, which established that these would be taxed at a capital gain rate. Also, the results from 2012 reflect a benefit of approximately $26.9 million from the Corporations share of a tax benefit from a grant received by EVERTEC from the Puerto Rico Government. During 2011, the Corporation recorded an income tax expense of $103.3 million as a result of the reduction in the marginal tax rate, which was partially offset by a benefit of $53.6 million recorded as a result of a closing agreement with the Puerto Rico Department of Treasury, which deferred the deduction of charge-offs taken during 2009 and 2010 until the years 2013-2016. The results for 2010 include a $640.8 million gain on the sale of a majority interest in EVERTEC. Table 1 provides selected financial data for the past five years. For purposes of the discussions, assets subject to loss sharing agreements with the FDIC, including loans and other real estate owned, are referred to as covered assets or covered loans since the Corporation expects to be reimbursed for 80% of any future losses on those assets, subject to the terms of the FDIC loss sharing agreements.
During 2012, the Corporation maintained a strong net interest margin, produced solid and stable top line income throughout the challenging credit cycle, and reflected a reduction in its provision for loan losses. For 2012, top line income, defined as net interest income plus non-interest income, remained strong at $1.8 billion, while the provision for loan losses declined by $166.8 million, compared with 2011. Substantial efforts to bring down the cost of deposits helped maintain a strong net interest margin, on a taxable equivalent basis, of 4.47% for the year 2012.
In Puerto Rico, the credit environment appears to be stabilizing although credit costs remain high, but there has been improvement in some of the Corporations Puerto Rico loan portfolios during 2012, which contributed to a decline in the provision for loan losses in the BPPR reportable segment of $130.7 million compared with the year 2011. The improvement is the result of lower level of non-performing loans and improved credit performance. Current conditions in Puerto Rico make loan growth a challenge. However, the Corporation has seen growth in the mortgage lending sector. The Corporation experienced an increase in residential mortgage loan originations during 2012, when compared with 2011. The increase in mortgage loan origination volumes reflect the benefit of a low interest rate environment, the HARP and FHA Streamline programs and the housing incentives in P.R. which helped increase volumes during 2012. Also, the Corporation benefited from its strong position in the mortgage sector, having the highest market share in Puerto Rico. Credit management has remained a primary area of focus in the BPPR reportable segment, principally in the commercial, construction and mortgage lending areas.
The Corporations U.S. mainland operations were profitable during 2012 with net interest income benefiting from lower funding costs in the midst of improving credit conditions. The improved credit performance of BPNA resulted in a reduction in the provision for loan losses of $36.4 million for 2012, when compared to the previous year. The U.S. operations have followed the general credit trends on the mainland demonstrating progressive improvement. Furthermore, the successful disposition of OREOs contributed to reduced operating expenses. Management remains focused on increasing BPNAs customer base, as it continues its strategy to transition from a mainly Hispanic-focused bank to a more broad-based community bank. The biggest challenge for the BPNA reportable segment is achieving healthy loan growth in the markets it serves at an adequate risk-adjusted return.
4
Table 1 - Selected Financial Data | ||||||||||||||||||||
Year ended December 31, | ||||||||||||||||||||
(Dollars in thousands, except per common share data) | 2012 | 2011 | 2010 | 2009 | 2008 | |||||||||||||||
CONDENSED STATEMENTS OF OPERATIONS |
||||||||||||||||||||
Interest income |
$ | 1,751,705 | $ | 1,937,501 | $ | 1,948,246 | $ | 1,854,997 | $ | 2,274,123 | ||||||||||
Interest expense |
379,086 | 505,509 | 653,381 | 753,744 | 994,919 | |||||||||||||||
Net interest income |
1,372,619 | 1,431,992 | 1,294,865 | 1,101,253 | 1,279,204 | |||||||||||||||
Provision for loan losses: |
||||||||||||||||||||
Non-covered loans |
334,102 | 430,085 | 1,011,880 | 1,405,807 | 991,384 | |||||||||||||||
Covered loans |
74,839 | 145,635 | - | - | - | |||||||||||||||
Non-interest income |
466,342 | 560,277 | 1,288,193 | 896,501 | 829,974 | |||||||||||||||
Operating expenses |
1,211,148 | 1,150,297 | 1,325,547 | 1,154,196 | 1,336,728 | |||||||||||||||
Income tax (benefit) expense |
(26,403) | 114,927 | 108,230 | (8,302) | 461,534 | |||||||||||||||
Income (loss) from continuing operations |
245,275 | 151,325 | 137,401 | (553,947) | (680,468) | |||||||||||||||
Loss from discontinued operations, net of tax |
- | - | - | (19,972) | (563,435) | |||||||||||||||
Net income (loss) |
$ | 245,275 | $ | 151,325 | $ | 137,401 | $ | (573,919) | $ | (1,243,903) | ||||||||||
Net income (loss) applicable to common stock |
$ | 241,552 | $ | 147,602 | $ | (54,576) | $ | 97,377 | $ | (1,279,200) | ||||||||||
PER COMMON SHARE DATA[1] |
||||||||||||||||||||
Net income (loss) - basic and diluted: |
||||||||||||||||||||
From continuing operations |
$ | 2.35 | $ | 1.44 | $ | (0.62) | $ | 2.88 | $ | (25.46) | ||||||||||
From discontinued operations |
- | - | - | (0.49) | (20.05) | |||||||||||||||
Total |
$ | 2.35 | $ | 1.44 | $ | (0.62) | $ | 2.39 | $ | (45.51) | ||||||||||
Dividends declared |
$ | - | $ | - | $ | - | $ | 0.20 | $ | 4.80 | ||||||||||
Book value |
39.35 | 37.71 | 36.67 | 38.91 | 63.29 | |||||||||||||||
Market price |
20.79 | 13.90 | 31.40 | 22.60 | 51.60 | |||||||||||||||
Outstanding shares: |
||||||||||||||||||||
Average - basic |
102,429,755 | 102,179,393 | 88,515,404 | 40,822,950 | 28,107,920 | |||||||||||||||
Average - assuming dilution |
102,653,610 | 102,289,496 | 88,515,404 | 40,822,950 | 28,107,920 | |||||||||||||||
End of period |
103,169,806 | 102,590,457 | 102,272,780 | 63,954,011 | 28,200,471 | |||||||||||||||
AVERAGE BALANCES |
||||||||||||||||||||
Net loans [2] |
$ | 24,845,494 | $ | 25,617,767 | $ | 25,821,778 | $ | 24,836,067 | $ | 26,471,616 | ||||||||||
Earning assets |
31,569,702 | 32,931,332 | 34,154,021 | 34,083,406 | 36,026,077 | |||||||||||||||
Total assets |
36,264,031 | 38,066,268 | 38,378,966 | 36,569,370 | 40,924,017 | |||||||||||||||
Deposits |
26,903,933 | 27,503,391 | 26,650,497 | 26,828,209 | 27,464,279 | |||||||||||||||
Borrowings |
4,415,624 | 5,846,874 | 7,448,021 | 5,832,896 | 7,378,438 | |||||||||||||||
Total stockholders equity |
3,843,652 | 3,732,836 | 3,259,167 | 2,852,065 | 3,358,295 | |||||||||||||||
PERIOD END BALANCES |
||||||||||||||||||||
Net loans[2] |
$ | 25,093,632 | $ | 25,314,392 | $ | 26,458,855 | $ | 23,803,909 | $ | 26,268,931 | ||||||||||
Allowance for loan losses |
730,607 | 815,308 | 793,225 | 1,261,204 | 882,807 | |||||||||||||||
Earning assets |
31,906,198 | 32,441,983 | 33,507,582 | 32,340,967 | 36,146,389 | |||||||||||||||
Total assets |
36,507,535 | 37,348,432 | 38,814,998 | 34,736,325 | 38,882,769 | |||||||||||||||
Deposits |
27,000,613 | 27,942,127 | 26,762,200 | 25,924,894 | 27,550,205 | |||||||||||||||
Borrowings |
4,430,673 | 4,293,669 | 6,946,955 | 5,288,748 | 6,943,305 | |||||||||||||||
Total stockholders equity |
4,110,000 | 3,918,753 | 3,800,531 | 2,538,817 | 3,268,364 | |||||||||||||||
SELECTED RATIOS |
||||||||||||||||||||
Net interest margin (taxable equivalent basis) |
4.47 | % | 4.47 | % | 3.82 | % | 3.47 | % | 3.81 | % | ||||||||||
Return on average total assets |
0.68 | 0.40 | 0.36 | (1.57) | (3.04) | |||||||||||||||
Return on average common stockholders equity |
6.37 | 4.01 | 4.37 | (32.95) | (44.47) | |||||||||||||||
Tier I Capital to risk-adjusted assets |
17.35 | 15.97 | 14.52 | 9.81 | 10.81 | |||||||||||||||
Total Capital to risk-adjusted assets |
18.63 | 17.25 | 15.79 | 11.13 | 12.08 |
[1] Per share data is based on the average number of shares outstanding during the periods, except for the book value and market price which are based on the information at the end of the periods. All per share data has been adjusted to retroactively reflect the 1-for-10 reverse stock split effected on May 29, 2012. [2] Includes loans held-for-sale and covered loans. |
5
During 2012, the Corporation strived to mitigate the decline in earning assets amid challenging economic conditions in Puerto Rico, its principal market. The BPPR reportable segments non-covered loans held-in-portfolio increased by $392 million from December 31, 2011 to the same date in 2012, as a result of higher origination volumes and the purchase of high quality loans. Mortgage loan originations for the BPPR reportable segment totalled $1.5 billion, an increase of $272 million from 2011. Also, during 2012, the BPPR reportable segment purchased $265 million (unpaid principal balance) in consumer loans. Furthermore, the U.S. reportable segment recorded mortgage loan purchases of approximately $486 million during 2012, while it did not purchase mortgage loans in 2011.
During the first half of 2011, the Corporation completed two bulk purchases of residential mortgage loans from a Puerto Rico financial institution, adding $518 million in performing mortgage loans to its portfolio. In August 2011, the Corporation completed the purchase of Citibanks AAdvantage co-branded credit card portfolio in Puerto Rico and the U.S. Virgin Islands, which represented approximately $131 million in balances. In addition, BPPR entered into an agreement with American Airlines, Inc. to become the exclusive issuer of AAdvantage co-branded credit cards in those two regions. Also, during 2011 the Corporation executed sales of $457 million (unpaid principal balance) non-performing mortgage loans at BPNA and $358 million in unpaid principal balance of construction and commercial real estate loans at BPPR as part of its de-risking strategy.
The year 2010 was one of several accomplishments for the Corporation that contributed to the Corporations profitability and de-risking in 2011. In an effort to position the Corporation for its participation in an FDIC-assisted transaction in Puerto Rico, during 2010 the Corporation enhanced its capital position with an equity offering in which it raised $1.15 billion of new common equity capital. This capital raise, along with the after-tax gain of $531.0 million, net of transaction costs, on the sale of a 51% interest in EVERTEC, substantially strengthened the Corporations capital ratios, placing it in a position to participate in the consolidation of the Puerto Rico banking market and to pursue strategies to improve the credit quality of its loan portfolio. Furthermore, the Westernbank FDIC-assisted transaction proved to be an important strategic move that further solidified the Corporations leadership position in Puerto Rico amid a contracting market and has contributed with a positive financial impact. Apart from expanding its client base, the covered assets have boosted the Corporations net interest margin and other revenues. The yield on covered loans approximated 7.44% and 8.95% for the years ended December 31, 2012 and 2011, respectively. Table 2 provides a summary of the gross revenues derived from the assets acquired in the FDIC-assisted transaction during 2012, 2011 and 2010.
Table 2 - Financial Information - Westernbank FDIC-Assisted Transaction
Year ended December 31, | ||||||||||||
(In thousands) | 2012 | 2011 | 2010 | |||||||||
|
||||||||||||
Interest income: |
||||||||||||
Interest income on covered loans, except for discount accretion on ASC 310-20 covered loans |
$ | 301,441 | $ | 375,595 | $ | 223,271 | ||||||
Discount accretion on ASC 310-20 covered loans |
- | 37,083 | 79,825 | |||||||||
|
||||||||||||
Total interest income on covered loans |
301,441 | 412,678 | 303,096 | |||||||||
|
||||||||||||
FDIC loss share (expense) income : |
||||||||||||
(Amortization) accretion of loss share indemnification asset |
(129,676 | ) | (10,855 | ) | 73,487 | |||||||
80% mirror accounting on credit impairment losses[1] |
58,187 | 110,457 | - | |||||||||
80% mirror accounting on reimbursable expenses |
29,234 | 5,093 | - | |||||||||
80% mirror accounting on discount accretion for loans and unfunded commitments accounted for under ASC 310-20 |
(969 | ) | (33,221 | ) | (95,383) | |||||||
Change in true-up payment obligation |
(13,178 | ) | (6,304 | ) | (3,855) | |||||||
Other |
191 | 1,621 | - | |||||||||
|
||||||||||||
Total FDIC loss share (expense) income |
(56,211 | ) | 66,791 | (25,751) | ||||||||
|
||||||||||||
Fair value change in equity appreciation instrument |
- | 8,323 | 42,555 | |||||||||
Amortization of contingent liability on unfunded commitments (included in other operating income) |
1,211 | 4,487 | 39,404 | |||||||||
|
||||||||||||
Total revenues |
246,441 | 492,279 | 359,304 | |||||||||
|
||||||||||||
Provision for loan losses |
74,839 | 145,635 | - | |||||||||
|
||||||||||||
Total revenues less provision for loan losses |
$ | 171,602 | $ | 346,644 | $ | 359,304 | ||||||
|
[1] | Reductions in expected cash flows for ASC 310-30 loans, which may impact the provision for loan losses, may consider reductions in both principal and interest cash flow expectations. The amount covered under the FDIC loss sharing agreements for interest not collected from borrowers is limited under the agreements (approximately 90 days); accordingly, these amounts are not subject fully to the 80% mirror accounting. |
6
Average balances | ||||||||||
Year ended December 31, | ||||||||||
(In millions) | 2012 | 2011 | ||||||||
Covered loans |
$ | 4,051 | $ | 4,613 | ||||||
FDIC loss share asset |
1,680 | 2,177 | ||||||||
Note issued to the FDIC |
- | 1,382 |
Interest income on covered loans for the year 2012 amounted to $301.4 million vs. $412.7 million in 2011, reflecting a yield of 7.44% vs. 8.95%, for each year respectively. This portfolio, due to its nature, should continue to decline as scheduled payments are received and workout arrangements are made. The yield variance was impacted by the fact that the interest income for 2011 includes $37.1 million of discount accretion related to covered loans accounted for under ASC 310-20. As previously mentioned, this discount was fully accreted into earnings during 2011. Also, during 2011, resolutions of certain large commercial loan relationships caused the unamortized discount to be recognized into income for one pool and increased the accretable yield to be recognized over a short period of time for another pool. Interest income for the year 2010 reflected only eight months of income vs. a full year of earnings for the year 2011.
The FDIC loss share reflected an expense of $56.2 million for 2012, compared to an income of $66.8 million for 2011. This was the result of a lower provision for loan losses on covered loans by $70.8 million and higher amortization of the FDIC loss share asset due to a decrease in expected losses, partially offset by the favorable mirror accounting on expenses reimbursable from the FDIC and discount accretion on loans and unfunded commitments subject to ASC 310-20 since the discount on these loans had been fully accreted by the end of the third quarter of 2011.
The decrease in the provision for loan losses for covered loans from 2011 to 2012 was mostly driven by certain commercial and construction loan pools accounted for under ASC 310-30 which reflected lower expected loss estimates and reductions in the specific reserves of certain commercial loan relationships accounted for under ASC 310-20. The covered loan portfolio did not require an allowance for loan losses at December 31, 2010.
Although the reduction in estimated loan losses increases the accretable yield to be recognized over the life of the loans, it also has the effect of lowering the realizable value of the loss share asset since the Corporation would receive lower FDIC payments under the loss share agreements. This is reflected in the increased amortization of the loss share asset for 2012. This is also reflected in the increase in the fair value of the true-up payment obligation. The change in the amortization of the loss share asset from 2010 to 2011 also reflected lower estimated losses from year to year.
The discussion that follows provides highlights of the Corporations results of operations for the year ended December 31, 2012 compared to the results of operations of 2011. It also provides some highlights with respect to the Corporations financial condition, credit quality, capital and liquidity. Table 3 presents a five-year summary of the components of net income (loss) as a percentage of average total assets.
Table 3 - Components of Net Income (Loss) as a Percentage of Average Total Assets | ||||||||||||||||||||
2012 | 2011 | 2010 | 2009 | 2008 | ||||||||||||||||
Net interest income |
3.79 | % | 3.76 | % | 3.38 | % | 3.01 | % | 3.13 | % | ||||||||||
Provision for loan losses |
(1.13 | ) | (1.51 | ) | (2.64 | ) | (3.84 | ) | (2.42 | ) | ||||||||||
Net gain on sale and valuation adjustments of investment securities |
- | 0.03 | 0.01 | 0.60 | 0.17 | |||||||||||||||
Net gain (loss) on sale of loans, including adjustments to indemnity reserves, and valuation adjustments on loans held-for-sale |
0.08 | (0.01 | ) | (0.15 | ) | (0.10 | ) | 0.01 | ||||||||||||
Trading account (loss) profit |
(0.05 | ) | 0.01 | 0.04 | 0.11 | 0.11 | ||||||||||||||
FDIC loss share (expense) income |
(0.16 | ) | 0.18 | (0.07 | ) | - | - | |||||||||||||
Fair value change in equity appreciation instrument |
- | 0.02 | 0.11 | - | - | |||||||||||||||
Gain on sale of processing and technology business |
- | - | 1.67 | - | - | |||||||||||||||
Other non-interest income |
1.42 | 1.24 | 1.74 | 1.84 | 1.74 | |||||||||||||||
Total net interest income and non-interest income, net of provision for loan losses |
3.95 | 3.72 | 4.09 | 1.62 | 2.74 | |||||||||||||||
Operating expenses |
(3.34 | ) | (3.02 | ) | (3.45 | ) | (3.16 | ) | (3.27 | ) | ||||||||||
Income (loss) from continuing operations before income tax |
0.61 | 0.70 | 0.64 | (1.54 | ) | (0.53 | ) | |||||||||||||
Income tax benefit (expense) |
0.07 | (0.30 | ) | (0.28 | ) | 0.02 | (1.13 | ) | ||||||||||||
Income (loss) from continuing operations |
0.68 | 0.40 | 0.36 | (1.52 | ) | (1.66 | ) | |||||||||||||
Loss from discontinued operations, net of tax |
- | - | - | (0.05 | ) | (1.38 | ) | |||||||||||||
Net income (loss) |
0.68 | % | 0.40 | % | 0.36 | % | (1.57 | )% | (3.04 | )% |
7
Net interest income on a taxable equivalent basis for the year ended December 31, 2012 amounted to $1.4 billion, a decrease of $64.0 million, compared with 2011. The net interest margin on a taxable equivalent basis remained flat at 4.47% for the years ended December 31, 2012 and 2011. Although there was a decrease in the yield of interest earning assets, this was offset by the decrease in cost of funds. Refer to the Net Interest Income section of this MD&A for a discussion of the major variances in net interest income, including yields and costs.
The provision for loan losses for the year ended December 31, 2012 decreased by $166.8 million, or 29%, compared with 2011, which was the net result of a decrease in the provision for non-covered loans of $96.0 million, coupled with a decrease in the provision for loan losses on covered loans of $70.8 million. The allowance for loan losses was 2.96% of non-covered loans held-in-portfolio at December 31, 2012, compared with 3.35% at December 31, 2011. Total net charge-offs for 2012 decreased $61.1 million, compared with 2011. The reduction in the allowance for loan losses for non-covered loans at December 31, 2012, compared with 2011, was mostly attributable to a lower portfolio balance and net charge-offs from the commercial and construction loan portfolios, and an improvement in the credit quality performance of the Corporations consumer loan portfolios, partially offset by higher specific reserve requirements on the mortgage loan portfolio. Year-over-year, total non-performing assets decreased by $364 million, driven by resolution of non-performing loans and a reduction in non-performing construction loans, offset in part by an increase in other real estate owned. The Corporations non-covered, non-performing loans held-in-portfolio decreased by $313 million from December 31, 2011 to the same date in 2012, reaching $1.4 billion or 6.79% of total non-covered loans held-in-portfolio at December 31, 2012, compared to 8.44% for the same date in 2011. The decrease in non-performing loans held-in-portfolio was reflected in the commercial, construction and residential mortgage loan portfolios of the BPPR reportable segment.
The provision for the Puerto Rico reportable segment for the year ended December 31, 2012 decreased by $130.3 million from the year 2011, driven mainly by a lower provision in the covered portfolio. The provision for the covered portfolio was lower by $70.8 million and reflected lower expected losses in loans accounted by ASC Subtopic 310-30, mainly in commercial and construction loan pools. The provision for the non-covered portfolio decreased by $59.5 million, mainly driven by lower net charge offs and lower allowance for loan losses in the commercial and construction portfolios. This was offset by higher allowance levels for the mortgage loan portfolio due to specific reserves for restructured loans. The BPNA reportable segment reflected lower provisions for the year ended December 31, 2012, compared to 2011 by $36.5 million. This was principally as a result of lower net charge-offs mainly from the legacy, commercial and consumer loan portfolios due to improved credit performance.
Refer to the Provision for Loan Losses and Credit Risk Management and Loan Quality section of this MD&A for information on the allowance for loan losses, non-performing assets, troubled debt restructurings, net charge-offs and credit quality metrics.
Non-interest income for the year ended December 31, 2012 amounted to $466.3 million, a decrease of $93.9 million, compared with 2011, mainly due to the FDIC loss share expense. The FDIC loss share reflected an expense of $56.2 million for 2012, compared to an income of $66.8 million for 2011. This was the result of a lower provision for loan losses on covered loans and higher amortization of the loss share asset due to a decrease in expected losses, partially offset by the favorable mirror accounting on expenses reimbursable from the FDIC and discount accretion on loans subject to ASC 310-20 and unfunded commitments. Non-interest income for the year ended December 31, 2010 was $1.3 billion. The results for 2010 reflected a $640.8 million gain on the sale of the 51% interest in EVERTEC. Refer to the Non-Interest Income section of this MD&A for a table that provides a breakdown of the different categories of non-interest income.
8
Total operating expenses for the year 2012 amounted to $1.2 billion, an increase of $60.9 million, when compared with the previous year. The increase was reflected in the Puerto Rico operations. Higher operating expenses in the Puerto Rico reportable segment were principally due to a loss on early extinguishment of structured repos of approximately $25.0 million; higher professional fees and other operating expenses of $16.0 million and $17.2 million, respectively, some of which are collection and credit related costs reimbursable by the FDIC; and an increase of $14.9 million in OREO expenses due mainly to subsequent fair value adjustments. The U.S. reportable segment reflected a decrease in operating expenses of approximately $11.6 million, principally due to lower OREO expenses due to realized gains on sales of foreclosed properties. Refer to the Operating Expenses section of this MD&A for additional explanations on the major variances in the different categories of operating expenses.
For the year 2012, the Corporation recorded an income tax benefit of $26.4 million, compared to an income tax expense of $114.9 million for the year 2011. During the second quarter of 2012, the Corporation recorded a benefit of $72.9 million, as a reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank, pursuant to a closing agreement with the Puerto Rico Department of Treasury by which these will be taxed at capital gain rates. During 2011, the Corporation recorded an income tax expense of $103.3 million and a decrease in the net deferred tax assets of the Puerto Rico operations resulting from the reduction in the marginal tax rate from 39% to 30% as a result of the enactment of a new Internal Revenue Code in Puerto Rico. This expense in 2011 was partially offset by a tax benefit of $53.6 million recorded in June 2011 for the recognition of certain tax benefits not previously recorded during 2009 (the benefit of reduced tax rates for capital gains) and 2010 (the benefit of the tax-exempt income) as a result of a closing agreement with the Puerto Rico Treasury Department, which also established that the deductions for charge offs during 2009 and 2010 could be deferred until 2013-2016. Refer to the Income Taxes section in this MD&A and Note 39 to the consolidated financial statements for information on the private ruling issued by the Puerto Rico Department of the Treasury to the Corporation, as well as other detailed information such as the changes in the tax rate.
Total assets amounted to $36.5 billion at December 31, 2012, compared with $37.3 billion at December 31, 2011, a decrease of $0.8 billion. Total earning assets at December 31, 2012 amounted to $31.9 billion, a decrease of $0.5 billion, or 1.5%, compared with December 31, 2011.
Total loans, including loans held-for-sale and covered loans, decreased $221 million from December 31, 2011 to the same date in 2012, principally in commercial loans, partially offset by higher volume of mortgage and consumer loans held-in-portfolio. The decrease was principally in the Puerto Rico operations, mainly in the covered loans by $593 million, offset by the increase in the non-covered portfolio of $381 million driven primarily by mortgage loans. The Corporations U.S. mainland operations experienced a reduction in total loans of $12 million, reflecting decreases in legacy loans, offset by increased volume of mortgage loans. The decline in total loans was mainly due to portfolio run-off, loan sales, charge-offs and reclassifications to repossessed properties as part of foreclosure proceedings, coupled with low new loan demand in certain loan segments.
Refer to Table 18 in the Statement of Financial Condition Analysis section of this MD&A for the percentage allocation of the composition of the Corporations financing to total assets. Deposits amounted to $27.0 billion at December 31, 2012, compared with $27.9 billion at December 31, 2011. Table 19 presents a breakdown of deposits by major categories. The decrease in deposits was mostly associated with lower volume of brokered and time deposits, partially offset by higher volume of savings and demand deposits. The decrease in brokered and time deposits was part of the Corporations strategy to replace these with lower cost advances from the Federal Home Loan Bank of New York. The Corporations borrowings amounted to $4.4 billion at December 31, 2012, compared with $4.3 billion at December 31, 2011.
Stockholders equity amounted to $4.1 billion at December 31, 2012, compared with $3.9 billion at December 31, 2011. The Corporation continues to be well-capitalized at December 31, 2012. The Corporations regulatory capital ratios improved from December 31, 2011 to December 31, 2012. The Tier 1 risk-based capital and Tier 1 common equity to risk-weighted assets stood at 17.35% and 13.18%, respectively, at December 31, 2012, compared with 15.97% and 12.10%, respectively, at December 31, 2011. The improvement in the Corporations regulatory capital ratios from the end of 2011 to December 31, 2012 was principally due to a reduction in assets, changes in balance sheet composition including the increase in assets with lower risk-weightings such as mortgage loans, and internal capital generation from earnings.
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In summary, 2012 was a solid year during which the Corporation sustained its strong net interest margin, reflected lower provision for loan losses and reported operational profits. As mentioned above, the Corporation remains over the well-capitalized levels at the end of 2012. The covered loans portfolio has provided better than expected results reflecting lower estimated losses, driving lower provisions. The Corporations leading position in the Puerto Rico market has allowed it to benefit from the improved loan demand in certain sectors. During 2012, there were notable reductions in the levels of non-performing assets, reflecting the continuous efforts to resolve non-performing loans.
Key transactions during the past years, including the reorganization of the U.S. operations to exit high-risk businesses, the acquisition of assets of Westernbank on the FDIC-assisted transaction and the acquisition of Citibanks retail business in Puerto Rico, strengthened the Corporations financial position. The capital raise and sale of EVERTEC positioned the Corporation to participate in the FDIC-assisted transaction.
Operationally, the Corporation is a smaller organization than it was a few years ago. The Corporation is now focused on its core banking business both in Puerto Rico and the U.S. mainland. Heading into 2013, management expects the Puerto Rico economy to remain flat and the U.S. mainland economy to grow moderately.
Moving forward, in Puerto Rico, the Corporation also expects to continue pursuing resolution and sales of non-performing loans, further enhance loss-mitigation areas, redesign processes and consolidate branches to achieve greater efficiencies and continue to identify opportunities to add lower-risk assets that can be managed within the existing business platforms. In the U.S. mainland, the Corporation expects to solidify the trend of improving credit quality by continuing the run-off or disposition of discontinued portfolios, actively managing the existing classified portfolio, and identifying new asset growth in selected loan categories. Also, going forward, BPNA plans to continue improving its client mix, maximizing the value of the rebranding, achieving growth in targeted loan portfolios both organically and through asset acquisitions and continue enhancing its retail network and products offerings.
For further discussion of operating results, financial condition and business risks refer to the narrative and tables included herein.
The shares of the Corporations common stock are traded on the NASDAQ Global Select Market under the symbol BPOP. Table 4 shows the Corporations common stock performance on a quarterly basis during the last five years.
Table 4 - Common Stock Performance
Market Price | Cash Dividends | Book Value | Dividend | Price/ Earnings |
Market/Book | |||||||||||||||||||||||
High | Low | Declared per Share | Per Share | Yield [1] | Ratio | Ratio | ||||||||||||||||||||||
|
||||||||||||||||||||||||||||
2012 |
$ | 39.35 | N.M. | 8.85 | x | 52.83 % | ||||||||||||||||||||||
4th quarter |
$ | 20.90 | $ | 17.42 | $ | - | ||||||||||||||||||||||
3rd quarter |
18.74 | 13.55 | - | |||||||||||||||||||||||||
2nd quarter |
21.20 | 13.58 | - | |||||||||||||||||||||||||
1st quarter |
23.00 | 14.30 | - | |||||||||||||||||||||||||
2011 |
37.71 | N.M. | 9.65 | 36.86 | ||||||||||||||||||||||||
4th quarter |
$ | 19.00 | $ | 11.15 | $ | - | ||||||||||||||||||||||
3rd quarter |
28.30 | 13.70 | - | |||||||||||||||||||||||||
2nd quarter |
32.40 | 26.30 | - | |||||||||||||||||||||||||
1st quarter |
35.33 | 28.70 | - | |||||||||||||||||||||||||
2010 |
36.67 | N.M. | (50.65) | 85.63 | ||||||||||||||||||||||||
4th quarter |
$ | 31.40 | $ | 27.01 | $ | - | ||||||||||||||||||||||
3rd quarter |
29.50 | 24.50 | - | |||||||||||||||||||||||||
2nd quarter |
40.20 | 26.40 | - | |||||||||||||||||||||||||
1st quarter |
29.10 | 17.50 | - | |||||||||||||||||||||||||
2009 |
38.91 | 2.55 | % | 9.46 | 58.08 | |||||||||||||||||||||||
4th quarter |
$ | 28.00 | $ | 21.20 | $ | - | ||||||||||||||||||||||
3rd quarter |
28.30 | 10.40 | - | |||||||||||||||||||||||||
2nd quarter |
36.60 | 21.90 | - | |||||||||||||||||||||||||
1st quarter |
55.20 | 14.70 | 0.20 | |||||||||||||||||||||||||
2008 |
63.29 | 6.17 | (1.13) | 81.53 | ||||||||||||||||||||||||
4th quarter |
$ | 86.10 | $ | 49.00 | $ | 0.80 | ||||||||||||||||||||||
3rd quarter |
111.70 | 51.20 | 0.80 | |||||||||||||||||||||||||
2nd quarter |
130.60 | 65.90 | 1.60 | |||||||||||||||||||||||||
1st quarter |
140.70 | 89.00 | 1.60 |
[1] Based on the average high and low market price for the four quarters.
Note: All per share data has been adjusted to retroactively reflect the 1-for-10 reverse stock split effected on May 29, 2012.
N.M. Not meaningful.
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CRITICAL ACCOUNTING POLICIES / ESTIMATES
The accounting and reporting policies followed by the Corporation and its subsidiaries conform with generally accepted accounting principles (GAAP) in the United States of America and general practices within the financial services industry. The Corporations significant accounting policies are described in detail in Note 2 to the consolidated financial statements and should be read in conjunction with this section.
Critical accounting policies require management to make estimates and assumptions, which involve significant judgment about the effect of matters that are inherently uncertain and that involve a high degree of subjectivity. These estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from those estimates. The following MD&A section is a summary of what management considers the Corporations critical accounting policies / estimates.
Fair Value Measurement of Financial Instruments
The Corporation measures fair value as required by ASC Subtopic 820-10 Fair Value Measurements and Disclosures, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Corporation currently measures at fair value on a recurring basis its trading assets, available-for-sale securities, derivatives, mortgage servicing rights and contingent consideration. Occasionally, the Corporation may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, impaired loans held-in-portfolio that are collateral dependent and certain other assets. These nonrecurring fair value adjustments typically result from the application of lower of cost or fair value accounting or write-downs of individual assets.
The Corporation categorizes its assets and liabilities measured at fair value under the three-level hierarchy. The level within the hierarchy is based on whether the inputs to the valuation methodology used for fair value measurement are observable. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
| Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date. No significant degree of judgment for these valuations is needed, as they are based on quoted prices that are readily available in an active market. |
| Level 2 - Quoted prices other than those included in Level 1 that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and other inputs that are observable or that can be corroborated by observable market data for substantially the full term of the financial instrument. |
| Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value measurement of the financial asset or liability. Unobservable inputs reflect the Corporations own assumptions about what market participants would use to price the asset or liability, including assumptions about risk. The inputs are developed based on the best available information, which might include the Corporations own data such as internally-developed models and discounted cash flow analyses. |
The Corporation requires the use of observable inputs when available, in order to minimize the use of unobservable inputs to determine fair value. The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing on those securities. The amount of judgment involved in estimating the fair value of a financial instrument depends
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upon the availability of quoted market prices or observable market parameters. In addition, it may be affected by other factors such as the type of instrument, the liquidity of the market for the instrument, transparency around the inputs to the valuation, as well as the contractual characteristics of the instrument.
If listed prices or quotes are not available, the Corporation employs valuation models that primarily use market-based inputs including yield curves, interest rate curves, volatilities, credit curves, and discount, prepayment and delinquency rates, among other considerations. When market observable data is not available, the valuation of financial instruments becomes more subjective and involves substantial judgment. The need to use unobservable inputs generally results from diminished observability of both actual trades and assumptions resulting from the lack of market liquidity for those types of loans or securities. When fair values are estimated based on modeling techniques such as discounted cash flow models, the Corporation uses assumptions such as interest rates, prepayment speeds, default rates, loss severity rates and discount rates. Valuation adjustments are limited to those necessary to ensure that the financial instruments fair value is adequately representative of the price that would be received or paid in the marketplace.
The fair value measurements and disclosures guidance in ASC Subtopic 820-10 also addresses measuring fair value in situations where markets are inactive and transactions are not orderly. Transactions or quoted prices for assets and liabilities may not be determinative of fair value when transactions are not orderly and thus may require adjustments to estimate fair value. Price quotes based on transactions that are not orderly should be given little, if any, weight in measuring fair value. Price quotes based upon transactions that are orderly shall be considered in determining fair value and the weight given is based on facts and circumstances. If sufficient information is not available to determine if price quotes are based upon orderly transactions, less weight should be given to the price quote relative to other transactions that are known to be orderly.
The lack of liquidity is incorporated into the fair value measurement based on the type of asset measured and the valuation methodology used. An illiquid market is one in which little or no observable activity has occurred or one that lacks willing buyers or willing sellers. Discounted cash flow techniques incorporate forecasting of expected cash flows discounted at appropriate market discount rates which reflect the lack of liquidity in the market which a market participant would consider. Broker quotes used for fair value measurements inherently reflect any lack of liquidity in the market since they represent an exit price from the perspective of the market participants.
Management believes that fair values are reasonable and consistent with the fair value measurement guidance based on the Corporations internal validation procedure and consistency of the processes followed, which include obtaining market quotes when possible or using valuation techniques that incorporate market-based inputs.
Refer to Note 31 to the consolidated financial statements for information on the Corporations fair value measurement disclosures required by the applicable accounting standard. At December 31, 2012, approximately $ 5.4 billion, or 97%, of the assets measured at fair value on a recurring basis used market-based or market-derived valuation methodology and, therefore, were classified as Level 1 or Level 2. The majority of instruments measured at fair value were classified as Level 2, including U.S. Treasury securities, obligations of U.S. Government sponsored entities, obligations of Puerto Rico, States and political subdivisions, most mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs), and derivative instruments. U.S. Treasury securities were valued based on yields that were interpolated from the constant maturity treasury curve. Obligations of U.S. Government sponsored entities were priced based on an active exchange market and on quoted prices for similar securities. Obligations of Puerto Rico, States and political subdivisions were valued based on trades, bid price or spread, two sided markets, quotes, benchmark curves, market data feeds, discount and capital rates and trustee reports. MBS and CMOs were priced based on a bonds theoretical value from similar bonds defined by credit quality and market sector. Refer to the Derivatives section below for a description of the valuation techniques used to value these derivative instruments.
The remaining 3% of assets measured at fair value on a recurring basis at December 31, 2012 were classified as Level 3 since their valuation methodology considered significant unobservable inputs. The financial assets measured as Level 3 included mostly Puerto Rico tax-exempt GNMA mortgage-backed securities and mortgage servicing rights (MSRs). GNMA tax exempt mortgage-backed securities are priced using a local demand price matrix prepared from local dealer quotes, and other local investments such as corporate securities and local mutual funds which are priced by local dealers. MSRs, on the other hand, are priced internally using a discounted cash flow model which considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Additionally, the Corporation reported $ 104 million of financial assets that were measured at fair value on a nonrecurring basis at December 31, 2012, all of which were classified as Level 3 in the hierarchy.
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Broker quotes used for fair value measurements inherently reflect any lack of liquidity in the market since they represent an exit price from the perspective of the market participants. Financial assets that were fair valued using broker quotes amounted to $ 40 million at December 31, 2012, of which $ 20 million were Level 3 assets and $ 20 million were Level 2 assets. Level 3 assets consisted principally of tax-exempt GNMA mortgage-backed securities. Fair value for these securities was based on an internally-prepared matrix derived from an average of two indicative local broker quotes. The main input used in the matrix pricing was non-binding local broker quotes obtained from limited trade activity. Therefore, these securities were classified as Level 3.
There were $2 million in transfers from Level 2 to Level 3 and $7 million in transfers from Level 3 to Level 2 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2012. The transfers from Level 2 to Level 3 of trading mortgage-backed securities were the result of a change in valuation technique to a matrix pricing model, based on indicative prices provided by brokers. The transfers from Level 3 to Level 2 of trading mortgage-backed securities resulted from observable market data becoming available for these securities. There were no transfers in and/or out of Level 2 and Level 3 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2011. There were $198 million in transfers from Level 3 to Level 2 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2010. These transfers of certain exempt FNMA and GNMA mortgage-backed securities were the result of a change in valuation methodology from an internally-developed matrix pricing to pricing them based on a bonds theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. Pursuant to the Corporations policy, these transfers were recognized as of the end of the reporting period. There were no transfers in and/or out of Level 1 during 2012, 2011, and 2010.
Trading Account Securities and Investment Securities Available-for-Sale
The majority of the values for trading account securities and investment securities available-for-sale are obtained from third-party pricing services and are validated with alternate pricing sources when available. Securities not priced by a secondary pricing source are documented and validated internally according to their significance to the Corporations financial statements. Management has established materiality thresholds according to the investment class to monitor and investigate material deviations in prices obtained from the primary pricing service provider and the secondary pricing source used as support for the valuation results. During the year ended December 31, 2012, the Corporation did not adjust any prices obtained from pricing service providers or broker dealers.
Inputs are evaluated to ascertain that they consider current market conditions, including the relative liquidity of the market. When a market quote for a specific security is not available, the pricing service provider generally uses observable data to derive an exit price for the instrument, such as benchmark yield curves and trade data for similar products. To the extent trading data is not available, the pricing service provider relies on specific information including dialogue with brokers, buy side clients, credit ratings, spreads to established benchmarks and transactions on similar securities, to draw correlations based on the characteristics of the evaluated instrument. If for any reason the pricing service provider cannot observe data required to feed its model, it discontinues pricing the instrument. During the year ended December 31, 2012, none of the Corporations investment securities were subject to pricing discontinuance by the pricing service providers. The pricing methodology and approach of our primary pricing service providers is concluded to be consistent with the fair value measurement guidance.
Furthermore, management assesses the fair value of its portfolio of investment securities at least on a quarterly basis, which includes analyzing changes in fair value that have resulted in losses that may be considered other-than-temporary. Factors considered include, for example, the nature of the investment, severity and duration of possible impairments, industry reports, sector credit ratings, economic environment, creditworthiness of the issuers and any guarantees.
Securities are classified in the fair value hierarchy according to product type, characteristics and market liquidity. At the end of each period, management assesses the valuation hierarchy for each asset or liability measured. The fair value measurement analysis performed by the Corporation includes validation procedures and review of market changes, pricing methodology, assumption and level hierarchy changes, and evaluation of distressed transactions.
At December 31, 2012, the Corporations portfolio of trading and investment securities available-for-sale amounted to $ 5.4 billion and represented 96% of the Corporations assets measured at fair value on a recurring basis. At December 31, 2012, net unrealized gains on the trading and available-for-sale investment securities portfolios approximated $16 million and $ 172 million, respectively. Fair values for most of the Corporations trading and investment securities available-for-sale were classified as Level 2. Trading and investment securities available-for-sale classified as Level 3, which were the securities that involved the highest degree of judgment, represent less than 1% of the Corporations total portfolio of trading and investment securities available-for-sale.
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Mortgage Servicing Rights
Mortgage servicing rights (MSRs), which amounted to $ 154 million at December 31, 2012, and are primarily related to residential mortgage loans originated in Puerto Rico, do not trade in an active, open market with readily observable prices. Fair value is estimated based upon discounted net cash flows calculated from a combination of loan level data and market assumptions. The valuation model combines loans with common characteristics that impact servicing cash flows (e.g. investor, remittance cycle, interest rate, product type, etc.) in order to project net cash flows. Market valuation assumptions include prepayment speeds, discount rate, cost to service, escrow account earnings, and contractual servicing fee income, among other considerations. Prepayment speeds are derived from market data that is more relevant to the U.S. mainland loan portfolios and, thus, are adjusted for the Corporations loan characteristics and portfolio behavior since prepayment rates in Puerto Rico have been historically lower. Other assumptions are, in the most part, directly obtained from third-party providers. Disclosure of two of the key economic assumptions used to measure MSRs, which are prepayment speed and discount rate, and a sensitivity analysis to adverse changes to these assumptions, is included in Note 13 to the consolidated financial statements.
Derivatives
Derivatives, such as interest rate swaps, interest rate caps and indexed options, are traded in over-the-counter active markets. These derivatives are indexed to an observable interest rate benchmark, such as LIBOR or equity indexes, and are priced using an income approach based on present value and option pricing models using observable inputs. Other derivatives are liquid and have quoted prices, such as forward contracts or to be announced securities (TBAs). All of these derivatives held by the Corporation were classified as Level 2. Valuations of derivative assets and liabilities reflect the values associated with counterparty risk and nonperformance risk, respectively. The non-performance risk, which measures the Corporations own credit risk, is determined using internally-developed models that consider the net realizable value of the collateral posted, remaining term, and the creditworthiness or credit standing of the Corporation. The counterparty risk is also determined using internally-developed models which incorporate the creditworthiness of the entity that bears the risk, net realizable value of the collateral received, and available public data or internally-developed data to determine their probability of default. To manage the level of credit risk, the Corporation employs procedures for credit approvals and credit limits, monitors the counterparties credit condition, enters into master netting agreements whenever possible and, when appropriate, requests additional collateral. During the year ended December 31, 2012, inclusion of credit risk in the fair value of the derivatives resulted in a net gain of $2.9 million recorded in the other operating income and interest expense captions of the consolidated statement of operations, which consisted of a loss of $0.5 million resulting from the Corporations own credit standing adjustment and a gain of $3.4 million from the assessment of the counterparties credit risk.
Contingent consideration liability
The fair value of the true-up payment obligation (contingent consideration) to the FDIC as it relates to the Westernbank FDIC-assisted transaction amounted to $112 million at December 31, 2012. The fair value was estimated using projected cash flows related to the loss sharing agreements at the true-up measurement date, taking into consideration the intrinsic loss estimate, asset premium/discount, cumulative shared loss payments, and the cumulative servicing amount related to the loan portfolio. Refer to Note 4 to the consolidated financial statements for a description of the true-up payment formula. The true-up payment obligation was discounted using a term rate consistent with the time remaining until the payment is due. The discount rate was an estimate of the sum of the risk-free benchmark rate for the term remaining before the true-up payment is due and a risk premium to account for the credit risk profile of BPPR. The risk premium was calculated based on a 12-month trailing average spread of the yields on corporate bonds with credit ratings similar to BPPR.
Loans held-in-portfolio considered impaired under ASC Section 310-10-35 that are collateral dependent
The impairment is measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, size and supply and demand. The challenging conditions of the housing markets continue to affect the market activity related to real estate properties. These collateral dependent impaired loans are classified as Level 3 and are reported as a nonrecurring fair value measurement.
Loans measured at fair value pursuant to lower of cost or fair value adjustments
Loans measured at fair value on a nonrecurring basis pursuant to lower of cost or fair value were priced based on secondary market prices and discounted cash flow models which incorporate internally-developed assumptions for prepayments and credit loss estimates. These loans are classified as Level 3.
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Other real estate owned and other foreclosed assets
Other real estate owned includes real estate properties securing mortgage, consumer, and commercial loans. Other foreclosed assets include automobiles securing auto loans. The fair value of foreclosed assets may be determined using an external appraisal, broker price opinion, internal valuation or binding offer. The majority of these foreclosed assets is classified as Level 3 since they are subject to internal adjustments and reported as a nonrecurring fair value measurement.
Loans and Allowance for Loan Losses
Interest on loans is accrued and recorded as interest income based upon the principal amount outstanding.
Non-accrual loans are those loans on which the accrual of interest is discontinued. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is charged against income and the loan is accounted for either on a cash-basis method or on the cost-recovery method. Loans designated as non-accruing are returned to accrual status when the Corporation expects repayment of the remaining contractual principal and interest. The determination as to the ultimate collectability of the loans balance may involve managements judgment in the evaluation of the borrowers financial condition and prospects for repayment.
Refer to the MD&A section titled Credit Risk Management and Loan Quality, particularly the Non-performing assets sub-section, for a detailed description of the Corporations non-accruing and charge-off policies by major loan categories.
One of the most critical and complex accounting estimates is associated with the determination of the allowance for loan losses. The provision for loan losses charged to current operations is based on this determination. The Corporations assessment of the allowance for loan losses is determined in accordance with accounting guidance, specifically guidance of loss contingencies in ASC Subtopic 450-20 and loan impairment guidance in ASC Section 310-10-35.
The accounting guidance provides for the recognition of a loss allowance for groups of homogeneous loans. The determination for general reserves of the allowance for loan losses includes the following principal factors:
| Historical net loss rates (including losses from impaired loans) by loan type and by legal entity adjusted for recent net charge-off trends and environmental factors. The base net loss rates are based on the moving average of annualized net charge-offs computed over a 36-month historical loss window for the commercial and construction loan portfolios, and an 18-month period for the consumer and mortgage loan portfolios. |
| Net charge-off trend factors are applied to adjust the base loss rates based on recent loss trends. The Corporation applies a trend factor when base losses are below recent loss trends. Currently, the trend factor is based on the last 12 months of losses for the commercial, construction and legacy loan portfolios and 6 months of losses for the consumer and mortgage loan portfolios. The trend factor accounts for inherent imprecision and the lagging perspective in base loss rates. The trend factor replaces the base-loss period when it is higher than base loss up to a determined cap. |
| Environmental factors, which include credit and macroeconomic indicators such as employment, price index and construction permits, were adopted to account for current market conditions that are likely to cause estimated credit losses to differ from historical losses. The Corporation reflects the effect of these environmental factors on each loan group as an adjustment that, as appropriate, increases or decreases the historical loss rate applied to each group. Environmental factors provide updated perspective on credit and economic conditions. Correlation and regression analyses are used to select and weight these indicators. |
During the first quarter of 2012, in order to better reflect current market conditions, management revised the estimation process for evaluating the adequacy of the general reserve component of the allowance for loan losses for the Corporations commercial and construction loan portfolios. The change in the methodology is described in the paragraphs below. The net effect of these changes in the first quarter amounted to a $24.8 million reduction in the Corporations allowance for loan losses, resulting from a reduction of $40.5 million due to the enhancements to the allowance for loan losses methodology, offset in part by a $15.7 million increase in environmental factor reserves due to the Corporations decision to monitor recent trends in its commercial loan portfolio at the BPPR reportable segment that although improving, continue to warrant additional scrutiny.
Management made the following principal changes to the methodology during the first quarter of 2012:
| Established a more granular stratification of the commercial loan portfolios to enhance the homogeneity of the loan classes. Previously, the Corporation used loan groupings for commercial loan portfolios based on business lines and collateral types (secured / unsecured loans). As part of the loan segregation, management evaluated the risk profiles |
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of the loan portfolio, recent and historical credit and loss trends, current and expected portfolio behavior and economic indicators. The revised groupings consider product types (construction, commercial multifamily, commercial & industrial, non-owner occupied commercial real estate (CRE) and owner occupied CRE) and business lines for each of the Corporations reportable segments, BPPR and BPNA. In addition, the Corporation established a legacy portfolio at the BPNA reportable segment, comprised of commercial loans, construction loans and commercial lease financings related to certain lending products exited by the Corporation as part of restructuring efforts carried out in prior years. |
The refinement in the loan groupings resulted in a decrease to the allowance for loan losses of $7.9 million at March 31, 2012, which consisted of a $9.7 million reduction related to the BPNA reportable segment, partially offset by an increase of $1.8 million related to the BPPR reportable segment.
| Increased the historical look-back period for determining the loss trend factor. The Corporation increased the look-back period for assessing recent trends applicable to the determination of commercial, construction and legacy loan net charge-offs from 6 months to 12 months. |
Previously, the Corporation used a trend factor based on 6 months of net charge-offs as it aligned the estimation of inherent losses for the Corporations commercial and construction loan portfolios with deteriorating trends.
Given the current overall commercial and construction credit quality improvements noted on recent periods in terms of loss trends, non-performing loan balances and non-performing loan inflows, management concluded that a 12-month look-back period for the trend factor aligns the Corporations allowance for loan losses methodology to current credit quality trends.
The increase in the historical look-back period for determining the loss trend factor resulted in a decrease to the allowance for loan losses of $28.1 million at March 31, 2012, of which $24.0 million related to the BPPR reportable segment and $4.1 million to the BPNA reportable segment.
There were additional enhancements to the allowance for loan losses methodology which accounted for a reduction to the allowance for loan losses of $4.5 million at March 31, 2012, of which $3.9 million related to the BPNA reportable segment and $0.6 million to the BPPR reportable segment. This reduction related to loan portfolios with minimal or zero loss history.
There were no changes in the methodology for environmental factor reserves. There were no changes to the allowance for loan losses methodology for the Corporations consumer and mortgage loan portfolios during the first quarter of 2012.
According to the accounting guidance criteria for specific impairment of a loan, the Corporation defines as impaired loans those commercial and construction borrowers with outstanding debt of $1 million or more and with interest and/or principal 90 days or more past due. Also, specific commercial borrowers with outstanding debt of $1 million or over are deemed impaired when, based on current information and events, management considers that it is probable that the debtor would be unable to pay all amounts due according to the contractual terms of the loan agreement. Commercial and construction loans that originally met the Corporations threshold for impairment identification in a prior period, but due to charge-offs or payments are currently below the $1 million threshold and are still 90 days past due, except for TDRs, are accounted for under the Corporations general reserve methodology. Although the accounting codification guidance for specific impairment of a loan excludes large groups of smaller balance homogeneous loans that are collectively evaluated for impairment (e.g. mortgage and consumer loans), it specifically requires that loan modifications considered troubled debt restructurings (TDRs) be analyzed under its provisions. An allowance for loan impairment is recognized to the extent that the carrying value of an impaired loan exceeds the present value of the expected future cash flows discounted at the loans effective rate, the observable market price of the loan, if available, or the fair value of the collateral if the loan is collateral dependent.
The fair value of the collateral on commercial and construction loans is generally obtained from appraisals or evaluations. The Corporation periodically requires updated appraisal reports for loans that are considered impaired. The frequency of updated appraisals depends on total debt outstanding and type of collateral. Currently, for commercial and construction loans secured by real estate, if the borrowers total debt is equal to or greater than $1 million, the appraisal is updated annually. If the borrowers total debt is less than $1 million, the appraisal is updated at least every two years.
As a general procedure, the Corporation internally reviews appraisals as part of the underwriting and approval process and also for credits considered impaired following certain materiality benchmarks. Appraisals may be adjusted due to their age, property conditions, geographical area or general market conditions. The adjustments applied are based upon internal information, like other appraisals and/or loss severity information that can provide historical trends in the real estate market. Discount rates used may change from time-to-time based on managements estimates. Refer to the Credit Risk Management and Loan Quality section of this MD&A for more detailed information on the Corporations collateral value estimation for other real estate.
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The Corporations management evaluates the adequacy of the allowance for loan losses on a quarterly basis following a systematic methodology in order to provide for known and inherent risks in the loan portfolio. In developing its assessment of the adequacy of the allowance for loan losses, the Corporation must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown such as economic developments affecting specific customers, industries or markets. Other factors that can affect managements estimates are the years of historical data to include when estimating losses, the level of volatility of losses in a specific portfolio, changes in underwriting standards, financial accounting standards and loan impairment measurement, among others. Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses. Consequently, the business, financial condition, liquidity, capital and results of operations could also be affected.
The collateral dependent method is generally used for the impairment determination on commercial and construction loans since the expected realizable value of the loan is based upon the proceeds received from the liquidation of the collateral property. For commercial properties, the as is value or the income approach value is used depending on the financial condition of the subject borrower and/or the nature of the subject collateral. In most cases, impaired commercial loans do not have reliable or sustainable cash flow to use the discounted cash flow valuation method. On construction loans, as developed collateral values are used when the loan is originated since the assumption is that the cash flow of the property once leased or sold will provide sufficient funds to repay the loan. In the case of many impaired construction loans, the as developed collateral value is also used since completing the project reflects the best exit strategy in terms of potential loss reduction. In these cases, the costs to complete are considered as part of the impairment determination. As a general rule, the appraisal valuation used by the Corporation for impaired construction loans is based on discounted value to a single purchaser, discounted sell out or as is depending on the condition and status of the project and the performance of the same.
A restructuring constitutes a TDR when the Corporation separately concludes that both of the following conditions exist: (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. The concessions stem from an agreement between the creditor and the debtor or are imposed by law or a court. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. A concession has been granted when, as a result of the restructuring, the Corporation does not expect to collect all amounts due, including interest accrued at the original contract rate. If the payment of principal is dependent on the value of collateral, the current value of the collateral is taken into consideration in determining the amount of principal to be collected; therefore, all factors that changed are considered to determine if a concession was granted, including the change in the fair value of the underlying collateral that may be used to repay the loan. In addition, in order to expedite the resolution of delinquent construction and commercial loans, the Corporation routinely enters into liquidation agreements with borrowers and guarantors through the regular legal process, bankruptcy procedures and in certain occasions, out of Court transactions. These liquidation agreements, in general, contemplate the following conditions: (1) consent to judgment by the borrowers and guarantors; (2) acknowledgement by the borrower of debt, its liquidity and maturity; (3) acknowledgement of the default payments. The contractual interest rate is not reduced and continues to accrue during the term of the agreement. At the end of the period, borrower is obligated to remit all amounts due or be subject to the Corporations exercise of its foreclosure rights and further collection efforts. Likewise, the borrowers failure to make stipulated payments will grant the Corporation the ability to exercise its foreclosure rights. This strategy procures to expedite the foreclosure process, resulting in a more effective and efficient collection process. Although in general, these liquidation agreements do not contemplate the forgiveness of principal or interest as debtor is required to cover all outstanding amounts when the agreement becomes due, it could be construed that the Corporation has granted a concession by temporarily accepting a payment schedule that is different from the contractual payment schedule. Accordingly, loans under this program are considered TDRs.
Classification of loan modifications as TDRs involves a degree of judgment. Indicators that the debtor is experiencing financial difficulties which are considered include: (i) the borrower is currently in default on any of its debt or it is probable that the borrower would be in payment default on any of its debt in the foreseeable future without the modification; (ii) the borrower has declared or is in the process of declaring bankruptcy; (iii) there is significant doubt as to whether the borrower will continue to be a going concern; (iv) the borrower has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange; (v) based on estimates and projections that only encompass the borrowers current business capabilities, it is forecasted that the entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity; and (vi) absent the current modification, the borrower cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for
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similar debt for a non-troubled debtor. The identification of TDRs is critical in the determination of the adequacy of the allowance for loan losses. Loans classified as TDRs are excluded from TDR status if performance under the restructured terms exists for a reasonable period (at least twelve months of sustained performance) and the loan yields a market rate.
For mortgage loans that are modified with regard to payment terms and which constitute TDRs, the discounted cash flow value method is used as the impairment valuation is more appropriately calculated based on the ongoing cash flow from the individuals rather than the liquidation of the asset. The computations give consideration to probability of default and loss-given-foreclosure on the related estimated cash flows. For consumer loans deemed TDRs, the Corporation also uses a discounted cash flow value methodology, but currently does not incorporate a default rate assumption pre- or post-modification.
Refer to Note 11 to the consolidated financial statements for disclosures on the impact of adopting ASU 2011-02 and to Note 3 for a general description of the ASU 2011-02 guidance.
Acquisition Accounting for Covered Loans and Related Indemnification Asset
The Corporation accounted for the Westernbank FDIC-assisted transaction under the accounting guidance of ASC Topic No. 805, Business Combinations, which requires the use of the purchase method of accounting. All identifiable assets and liabilities acquired were initially recorded at fair value. No allowance for loan losses related to the acquired loans was recorded on the acquisition date as the fair value of the loans acquired incorporated assumptions regarding credit risk. Loans acquired were recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820, exclusive of the shared-loss agreements with the FDIC. These fair value estimates associated with the loans included estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.
Because the FDIC has agreed to reimburse the Corporation for losses related to the acquired loans in the Westernbank FDIC-assisted transaction, subject to certain provisions specified in the agreements, an indemnification asset was recorded at fair value at the acquisition date. The indemnification asset was recognized at the same time as the indemnified loans, and is measured on the same basis, subject to collectability or contractual limitations. The loss share indemnification asset on the acquisition date reflected the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflected counterparty credit risk and other uncertainties.
Refer to Note 4 for a description of the FDIC-assisted transaction and the terms of the loss share agreements.
The initial valuation of these loans and related indemnification asset required management to make subjective judgments concerning estimates about how the acquired loans would perform in the future using valuation methods, including discounted cash flow analyses and independent third-party appraisals. Factors that may significantly affect the initial valuation included, among others, market-based and industry data related to expected changes in interest rates, assumptions related to probability and severity of credit losses, estimated timing of credit losses including the timing of foreclosure and liquidation of collateral, expected prepayment rates, required or anticipated loan modifications, unfunded loan commitments, the specific terms and provisions of any loss share agreements, and specific industry and market conditions that may impact discount rates and independent third-party appraisals.
The Corporation applied the guidance of ASC 310-30 to all loans acquired in the Westernbank FDICE-assisted transaction (including loans that do not meet the scope of ASC 310-30), except for credit cards and revolving lines of credit. ASC 310-30 provides two specific criteria that have to be met in order for a loan to be within its scope: (1) credit deterioration on the loan from its inception until the acquisition date and (2) that it is probable that not all of the contractual cash flows will be collected on the loan. Once in the scope of ASC 310-30, the credit portion of the fair value discount on an acquired loan cannot be accreted into income until the acquirer has assessed that it expects to receive more cash flows on the loan than initially anticipated.
Acquired loans that meet the definition of nonaccrual status fall within the Corporations definition of impaired loans under ASC 310-30. It is possible that performing loans would not meet criteria number 1 above related to evidence of credit deterioration since the date of loan origination, and therefore not fall within the scope of ASC 310-30. Based on the fair value determined for the acquired portfolio, acquired loans that did not meet the Corporations definition of non-accrual status also resulted in the recognition of a significant discount attributable to credit quality.
Given the significant discount related to credit in the valuation of the Westernbank acquired portfolio, the Corporation considered two possible options for the performing loans (1) accrete the entire fair value discount (including the credit portion) using the interest method over the life of the loan in accordance with ASC 310-20; or (2) analogize to ASC 310-30 and only accrete the portion of the fair value discount unrelated to credit.
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Pursuant to an AICPA letter dated December 18, 2009, the AICPA summarized the SEC Staffs view regarding the accounting in subsequent periods for discount accretion associated with loan receivables acquired in a business combination or asset purchase. Regarding the accounting for such loan receivables, in the absence of further standard setting, the AICPA understands that the SEC Staff would not object to an accounting policy based on contractual cash flows (Option 1 - ASC 310-20 approach) or an accounting policy based on expected cash flows (Option 2 - ASC 310-30 approach). As such, the Corporation considered the two allowable options as follows:
| Option 1 - Since the credit portion of the fair value discount is associated with an expectation of cash flows that an acquirer does not expect to receive over the life of the loan, it does not appear appropriate to accrete that portion over the life of the loan as doing so could eventually overstate the acquirers expected value of the loan and ultimately result in recognizing income (i.e. through the accretion of the yield) on a portion of the loan it does not expect to receive. Therefore, the Corporation does not believe this is an appropriate method to apply. |
| Option 2 The Corporation believes analogizing to ASC 310-30 is the more appropriate option to follow in accounting for the credit portion of the fair value discount. By doing so, the loan is only being accreted up to the value that the acquirer expected to receive at acquisition of the loan. |
Based on the above, the Corporation elected Option 2 the ASC 310-30 approach to the outstanding balance for all the acquired loans in the Westernbank FDIC-assisted transaction with the exception of revolving lines of credit with active privileges as of the acquisition date, which are explicitly scoped out by the ASC 310-30 accounting guidance. New advances / draws after the acquisition date under existing credit lines that did not have revolving privileges as of the acquisition date, particularly for construction loans, will effectively be treated as a new loan for accounting purposes and accounted for under the provisions of ASC 310-20, resulting in a hybrid accounting for the overall construction loan balance.
Management used judgment in evaluating factors impacting expected cash flows and probable loss assumptions, including the quality of the loan portfolio, portfolio concentrations, distressed economic conditions in Puerto Rico, quality of underwriting standards of the acquired institution, reductions in collateral real estate values, and material weaknesses disclosed by the acquired institution, including matters related to credit quality review and appraisal report review.
At April 30, 2010, the acquired loans accounted for pursuant to ASC 310-30 by the Corporation totaled $4.9 billion which represented undiscounted unpaid contractually-required principal and interest balances of $9.9 billion reduced by a discount of $5.0 billion resulting from acquisition date fair value adjustments. The non-accretable discount on loans accounted for under ASC 310-30 amounted to $3.4 billion or approximately 68% of the total discount, thus indicating a significant amount of expected credit losses on the acquired portfolios.
Pursuant to ASC 310-20-15-5, the Corporation aggregated loans acquired in the FDIC-assisted transaction into pools with common risk characteristics for purposes of applying the recognition, measurement and disclosure provisions of this subtopic. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Characteristics considered in pooling loans in the Westernbank FDIC-assisted transaction included loan type, interest rate type, accruing status, amortization type, rate index and source type. Once the pools are defined, the Corporation maintains the integrity of the pool of multiple loans accounted for as a single asset.
Under ASC Subtopic 310-30, the difference between the undiscounted cash flows expected at acquisition and the fair value of the loans, or the accretable yield, is recognized as interest income using the effective yield method over the estimated life of the loan if the timing and amount of the future cash flows of the pool is reasonably estimable. The non-accretable difference represents the difference between contractually required principal and interest and the cash flows expected to be collected. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively as an adjustment to accretable yield over the loans or pools remaining life. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses.
The fair value discount of lines of credit with revolving privileges that are accounted for pursuant to the guidance of ASC Subtopic 310-20, represented the difference between the contractually required loan payment receivable in excess of the initial investment in the loan. Any cash flows collected in excess of the carrying amount of the loan are recognized in earnings at the time of collection. The carrying amount of lines of credit with revolving privileges, which are accounted pursuant to the guidance of ASC Subtopic 310-20, are subject to periodic review to determine the need for recognizing an allowance for loan losses.
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The FDIC loss share indemnification asset for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the assets be sold.
The FDIC loss share indemnification asset is recognized on the same basis as the assets subject to loss share protection, except that the amortization / accretion terms differ for each asset. For covered loans accounted for pursuant to ASC Subtopic 310-30, decreases in expected reimbursements from the FDIC due to improvements in expected cash flows to be received from borrowers are recognized in non-interest income prospectively over the life of the FDIC loss sharing agreements. For covered loans accounted for under ASC Subtopic 310-20, as the loan discount recorded as of the acquisition date was accreted into income, a reduction of the related indemnification asset was recorded as a reduction in non-interest income. Increases in expected reimbursements from the FDIC are recognized in non-interest income in the same period that the allowance for credit losses for the related loans is recognized.
Over the life of the acquired loans that are accounted under ASC Subtopic 310-30, the Corporation continues to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics. The Corporation evaluates at each balance sheet date whether the present value of its loans determined using the effective interest rates has decreased based on revised estimated cash flows and if so, recognizes a provision for loan loss in its consolidated statement of operations and an allowance for loan losses in its consolidated statement of financial condition. For any increases in cash flows expected to be collected from borrowers, the Corporation adjusts the amount of accretable yield recognized on the loans on a prospective basis over the loans or pools remaining life.
The evaluation of estimated cash flows expected to be collected subsequent to acquisition on loans accounted pursuant to ASC Subtopic 310-30 and inherent losses on loans accounted pursuant to ASC Subtopic 310-20 require the continued usage of key assumptions and estimates. Given the current economic environment, the Corporation must apply judgment to develop its estimates of cash flows considering the impact of home price and property value changes, changing loss severities and prepayment speeds. Decreases in the expected cash flows for ASC Subtopic 310-30 loans and decreases in the net realizable value of ASC Subtopic 310-20 loans will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. These estimates are particularly sensitive to changes in loan credit quality.
The amount that the Corporation realizes on the covered loans and related indemnification assets could differ materially from the carrying value reflected in these financial statements, based upon the timing and amount of collections on the acquired loans in future periods. The Corporations losses on these assets may be mitigated to the extent covered under the specific terms and provisions of the loss share agreements.
Refer to Notes 4 and 12 to the consolidated financial statements for further discussions on the Westernbank FDIC-assisted transaction and loans acquired.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, and attributable to operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted.
The calculation of periodic income taxes is complex and requires the use of estimates and judgments. The Corporation has recorded two accruals for income taxes: (i) the net estimated amount currently due or to be received from taxing jurisdictions, including any reserve for potential examination issues, and (ii) a deferred income tax that represents the estimated impact of temporary differences between how the Corporation recognizes assets and liabilities under accounting principles generally accepted in the United States (GAAP), and how such assets and liabilities are recognized under the tax code. Differences in the actual outcome of these future tax consequences could impact the Corporations financial position or its results of operations. In estimating taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into consideration statutory, judicial and regulatory guidance.
A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation
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allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The realization of deferred tax assets requires the consideration of all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in carryback years and tax-planning strategies.
The Corporations U.S. mainland operations are in a cumulative loss position for the three-year period ended December 31, 2012, taking into account taxable income adjusted by temporary differences. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland operations, this cumulative taxable loss position is considered significant negative evidence, which evaluated along with all sources of taxable income available to realize the deferred tax asset, has caused management to conclude that it is more-likely-than-not that the Corporation will not be able to fully realize the deferred tax assets in the future, considering solely the criteria of ASC Topic 740. Management will reassess the realization of the deferred tax assets based on the criteria of the applicable accounting pronouncement each reporting period. At December 31, 2012, the Corporation recorded a full valuation allowance of approximately $1.3 billion on the deferred tax assets of the Corporations U.S. operations. To the extent that the financial results of the U.S. operations improve and the deferred tax asset becomes realizable, the Corporation will be able to reduce the valuation allowance through earnings.
At December 31, 2012, the Corporation had net deferred tax assets related to its Puerto Rico operations amounting to $558 million. The Corporations Puerto Rico banking operation is no longer in a cumulative loss position. This operation shows a cumulative income position for the three-year period ended December 31, 2012 taking into account taxable income exclusive of reversing temporary differences (adjusted taxable income). The sustained profitability during years 2011 and 2012 is considered a strong piece of objectively verifiable positive evidence for the evaluation of the deferred tax asset valuation allowance. Based on this evidence and its estimated adjusted taxable income for future years, the Corporation has concluded that it is more likely than not that the net deferred tax asset of the Puerto Rico operations will be realized.
Changes in the Corporations estimates can occur due to changes in tax rates, new business strategies, newly enacted guidance, and resolution of issues with taxing authorities regarding previously taken tax positions. Such changes could affect the amount of accrued taxes. The current income tax payable for 2012 has been paid during the year in accordance with estimated tax payments rules. Any remaining payment will not have any significant impact on liquidity and capital resources.
The valuation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in the financial statements or tax returns and future profitability. The accounting for deferred tax consequences represents managements best estimate of those future events. Changes in managements current estimates, due to unanticipated events, could have a material impact on the Corporations financial condition and results of operations.
The Corporation establishes tax liabilities or reduces tax assets for uncertain tax positions when, despite its assessment that its tax return positions are appropriate and supportable under local tax law, the Corporation believes it may not succeed in realizing the tax benefit of certain positions if challenged. In evaluating a tax position, the Corporation determines whether it is more-likely-than-not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The Corporations estimate of the ultimate tax liability contains assumptions based on past experiences, and judgments about potential actions by taxing jurisdictions as well as judgments about the likely outcome of issues that have been raised by taxing jurisdictions. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Corporation evaluates these uncertain tax positions each quarter and adjusts the related tax liabilities or assets in light of changing facts and circumstances, such as the progress of a tax audit or the expiration of a statute of limitations. The Corporation believes the estimates and assumptions used to support its evaluation of uncertain tax positions are reasonable.
The amount of unrecognized tax benefits, including accrued interest, at December 31, 2012 amounted to $16.9 million. Refer to Note 39 to the consolidated financial statements for further information on this subject matter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $10 million.
The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in managements judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of
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uncertain tax positions. Although the outcome of tax audits is uncertain, the Corporation believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result from open years. From time to time, the Corporation is audited by various federal, state and local authorities regarding income tax matters. Although management believes its approach in determining the appropriate tax treatment is supportable and in accordance with the accounting standards, it is possible that the final tax authority will take a tax position that is different than the tax position reflected in the Corporations income tax provision and other tax reserves. As each audit is conducted, adjustments, if any, are appropriately recorded in the consolidated financial statement in the period determined. Such differences could have an adverse effect on the Corporations income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on the Corporations results of operations, financial position and / or cash flows for such period.
Goodwill
The Corporations goodwill and other identifiable intangible assets having an indefinite useful life are tested for impairment. Intangibles with indefinite lives are evaluated for impairment at least annually, and on a more frequent basis, if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit.
Under applicable accounting standards, goodwill impairment analysis is a two-step test. The first step of the goodwill impairment test involves comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed. The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangibles (including any unrecognized intangible assets, such as unrecognized core deposits and trademark) as if the reporting unit was being acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The Corporation estimates the fair values of the assets and liabilities of a reporting unit, consistent with the requirements of the fair value measurements accounting standard, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of the assets and liabilities reflects market conditions, thus volatility in prices could have a material impact on the determination of the implied fair value of the reporting unit goodwill at the impairment test date. The adjustments to measure the assets, liabilities and intangibles at fair value are for the purpose of measuring the implied fair value of goodwill and such adjustments are not reflected in the consolidated statement of condition. If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment. If the goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted under applicable accounting standards.
At December 31, 2012, goodwill amounted to $648 million. Note 17 to the consolidated financial statements provides the assignment of goodwill by reportable segment and the Corporate group.
The Corporation performed the annual goodwill impairment evaluation for the entire organization during the third quarter of 2012 using July 31, 2012 as the annual evaluation date. The reporting units utilized for this evaluation were those that are one level below the business segments, which are the legal entities within the reportable segment. The Corporation follows push-down accounting, as such all goodwill is assigned to the reporting units when carrying out a business combination.
In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, including market price multiples of comparable companies and transactions, as well as discounted cash flow analysis. Management evaluates the particular circumstances of each reporting unit in order to determine the most appropriate valuation methodology. The Corporation evaluates the results obtained under each valuation methodology to identify and understand the key value drivers in order to ascertain that the results obtained are reasonable and appropriate under the circumstances. Elements considered include current market and economic conditions, developments in specific lines of business, and any particular features in the individual reporting units.
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The computations require management to make estimates and assumptions. Critical assumptions that are used as part of these evaluations include:
| a selection of comparable publicly traded companies, based on nature of business, location and size; |
| a selection of comparable acquisition and capital raising transactions; |
| the discount rate applied to future earnings, based on an estimate of the cost of equity; |
| the potential future earnings of the reporting unit; and |
| the market growth and new business assumptions. |
For purposes of the market comparable approach, valuations were determined by calculating average price multiples of relevant value drivers from a group of companies that are comparable to the reporting unit being analyzed and applying those price multiples to the value drivers of the reporting unit. Multiples used are minority based multiples and thus, no control premium adjustment is made to the comparable companies market multiples. While the market price multiple is not an assumption, a presumption that it provides an indicator of the value of the reporting unit is inherent in the valuation. The determination of the market comparables also involves a degree of judgment.
For purposes of the discounted cash flows (DCF) approach, the valuation is based on estimated future cash flows. The financial projections used in the DCF valuation analysis for each reporting unit are based on the most recent (as of the valuation date) financial projections presented to the Corporations Asset / Liability Management Committee (ALCO). The growth assumptions included in these projections are based on managements expectations for each reporting units financial prospects considering economic and industry conditions as well as particular plans of each entity (i.e. restructuring plans, de-leveraging, etc.). The cost of equity used to discount the cash flows was calculated using the Ibbotson Build-Up Method and ranged from 11.93% to 18.38% for the 2012 analysis. The Ibbotson Build-Up Method builds up a cost of equity starting with the rate of return of a risk-free asset (20-year U.S. Treasury note) and adds to it additional risk elements such as equity risk premium, size premium and industry risk premium. The resulting discount rates were analyzed in terms of reasonability given the current market conditions and adjustments were made when necessary.
For BPNA, the only reporting unit that failed Step 1, the Corporation determined the fair value of Step 1 utilizing a DCF approach and a market value approach. The market value approach is based on a combination of price multiples from comparable companies and multiples from capital raising transactions of comparable companies. The market multiples used included price to book and price to tangible book. The Step 1 fair value for BPNA under both valuation approaches (market and DCF) was below the carrying amount of its equity book value as of the valuation date (July 31, 2011), requiring the completion of Step 2. In accordance with accounting standards, the Corporation performed a valuation of all assets and liabilities of BPNA, including any recognized and unrecognized intangible assets, to determine the fair value of BPNAs net assets. To complete Step 2, the Corporation subtracted from BPNAs Step 1 fair value, the determined fair value of the net assets to arrive at the implied fair value of goodwill. The results of the Step 2 indicated that the implied fair value of goodwill exceeded the goodwill carrying value of $402 million at July 31, 2012 resulting in no goodwill impairment. The reduction in BPNAs Step 1 fair value was offset by a reduction in the fair value of its net assets, resulting in an implied fair value of goodwill that exceeds the recorded book value of goodwill.
The analysis of the results for Step 2 indicates that the reduction in the fair value of the reporting unit was mainly attributed to the deteriorated fair value of the loan portfolios and not to the fair value of the reporting unit as a going concern. The current negative performance of the reporting unit is principally related to deteriorated credit quality in its loan portfolio, which is consistent with the results of the Step 2 analysis. The fair value determined for BPNAs loan portfolio in the July 31, 2012 annual test represented a discount of 18.2%, compared with 28.0% at July 31, 2011. The discount is mainly attributed to market participants expected rate of returns, which affected the market discount on the commercial and construction loan portfolios of BPNA.
If the Step 1 fair value of BPNA declines further in the future without a corresponding decrease in the fair value of its net assets or if loan discounts improve without a corresponding increase in the Step 1 fair value, the Corporation may be required to record a goodwill impairment charge. The Corporation engaged a third-party valuator to assist management in the annual evaluation of BPNAs goodwill (including Step 1 and Step 2) as well as BPNAs loan portfolios as of the July 31, 2012 valuation date. Management discussed the methodologies, assumptions and results supporting the relevant values for conclusions and determined they were reasonable.
For the BPPR reporting unit, the average reporting unit estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPPRs equity value by approximately $222 million or 9% in the July 31, 2012 annual test as compared with
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approximately $472 million or 20% at July 31, 2011. This result indicates there would be no indication of impairment on the goodwill recorded in BPPR at July 31, 2012. For the BPNA reporting unit, the estimated implied fair value of goodwill calculated in Step 2 exceeded BPNAs goodwill carrying value by approximately $338 million or 46% as compared to approximately $701 million or 64% at July 31, 2011. The reduction in the excess of the implied fair value of goodwill over its carrying amount for BPNA is due to the improvement credit quality of its loan portfolio.
Furthermore, as part of the analyses, management performed a reconciliation of the aggregate fair values determined for the reporting units to the market capitalization of Popular, Inc. concluding that the fair value results determined for the reporting units in the July 31, 2012 annual assessment were reasonable.
The goodwill impairment evaluation process requires the Corporation to make estimates and assumptions with regard to the fair value of the reporting units. Actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Corporations results of operations and the reporting units where the goodwill is recorded. Declines in the Corporations market capitalization could increase the risk of goodwill impairment in the future.
Management monitors events or changes in circumstances between annual tests to determine if these events or changes in circumstances are indicative of possible impairment.
Pension and Postretirement Benefit Obligations
The Corporation provides pension and restoration benefit plans for certain employees of various subsidiaries. The Corporation also provides certain health care benefits for retired employees of BPPR. The non-contributory defined pension and benefit restoration plans (the Plans) are frozen with regards to all future benefit accruals.
The estimated benefit costs and obligations of the pension and postretirement benefit plans are impacted by the use of subjective assumptions, which can materially affect recorded amounts, including expected returns on plan assets, discount rates, termination rates, retirement rates and health care trend rates. Management applies judgment in the determination of these factors, which normally undergo evaluation against current industry practice and the actual experience of the Corporation. The Corporation uses an independent actuarial firm for assistance in the determination of the pension and postretirement benefit costs and obligations. Detailed information on the Plans and related valuation assumptions are included in Note 33 to the consolidated financial statements.
The Corporation periodically reviews its assumption for the long-term expected return on pension plan assets. The Plans assets fair value at December 31, 2012 was $656.1 million. The expected return on plan assets is determined by considering various factors, including a total fund return estimate based on a weighted-average of estimated returns for each asset class in the plan. Asset class returns are estimated using current and projected economic and market factors such as real rates of return, inflation, credit spreads, equity risk premiums and excess return expectations.
As part of the review, the Corporations independent consulting actuaries performed an analysis of expected returns based on the plans asset allocation at January 1, 2013. This analysis is reviewed by the Corporation and used as a tool to develop expected rates of return, together with other data. This forecast reflects the actuarial firms view of expected long-term rates of return for each significant asset class or economic indicator; for example, 8.8% for large cap stocks, 3.5% for fixed-income securities, 9.0% for small cap stocks and 2.2% inflation at January 1, 2013. A range of expected investment returns is developed, and this range relies both on forecasts and on broad-market historical benchmarks for expected returns, correlations, and volatilities for each asset class.
As a consequence of recent reviews, the Corporation reduced its expected return on plan assets for year 2013 from 7.60% to 7.25%. The 7.60% and 8.00% had been used as the expected rate of return in 2012 and 2011, respectively. Since the expected return assumption is on a long-term basis, it is not materially impacted by the yearly fluctuations (either positive or negative) in the actual return on assets. However, if the actual return on assets performs below managements expectations for a continued period of time, this could eventually result in the reduction of the expected return on assets percentage assumption.
During the fourth quarter of 2011, the Corporation offered a Voluntary Retirement Program (VRP) to all participants eligible for retirement under the Plans, excluding senior management. The VRP provided for an additional benefit of one-year of base pay, payable either as a lump-sum payment from the Plans on February 1, 2012, or as an increase in monthly pension payments on their elected pension benefit commencement date.
Pension expense for the Plans amounted to $13.2 million in 2012. The total pension expense included a credit of $41.3 million for the expected return on assets.
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Pension expense is sensitive to changes in the expected return on assets. For example, decreasing the expected rate of return for 2013 from 7.25% to 7.00% would increase the projected 2013 expense for the Banco Popular de Puerto Rico Retirement Plan, the Corporations largest plan, by approximately $1.5 million.
The Corporation accounts for the underfunded status of its pension and postretirement benefit plans as a liability, with an offset, net of tax, in accumulated other comprehensive income or loss. The determination of the fair value of pension plan obligations involves judgment, and any changes in those estimates could impact the Corporations consolidated statement of financial condition. The valuation of pension plan obligations is discussed above. Management believes that the fair value estimates of the pension plan assets are reasonable given that the plan assets are managed, in the most part, by the fiduciary division of BPPR, which is subject to periodic audit verifications. Also, the composition of the plan assets, as disclosed in Note 33 of the consolidated financial statements, is primarily in equity and debt securities, which have readily determinable quoted market prices.
The Corporation uses the Towers Watson RATE: Link (10/90) Model to discount the expected program cash flows of the plans as a guide in the selection of the discount rate. The Corporation used a discount rate of 3.80% to determine the benefit obligation at December 31, 2012, compared with 4.40% at December 31, 2011.
A 50 basis point decrease in the assumed discount rate of 3.80% as of the beginning of 2013 would increase the projected 2013 expense for the Banco Popular de Puerto Rico Retirement Plan by approximately $2.8 million. The change would not affect the minimum required contribution to the Plan.
The Corporation also provides a postretirement health care benefit plan for certain employees of BPPR. This plan was unfunded (no assets were held by the plan) at December 31, 2012. The Corporation had an accrual for postretirement benefit costs of $183.6 million at December 31, 2012. Assumed health care trend rates may have significant effects on the amounts reported for the health care plan. Note 33 to the consolidated financial statements provides information on the assumed rates considered by the Corporation and on the sensitivity that a one-percentage point change in the assumed rate may have on specified cost components and the postretirement benefit obligation of the Corporation.
STATEMENT OF OPERATIONS ANALYSIS
Net Interest Income
Net interest income is the Corporations primary source of earnings with 75% of total revenues (defined as net interest income plus non-interest income) for 2012 compared to 72% in 2011. The Corporations main source of income is subject to volatility derived from several risk factors which include market driven events, changes in volumes and repricing characteristics of assets and liabilities, as well as strategic decisions made by the Corporations management. Net interest income on a taxable equivalent basis for the year ended December 31, 2012 resulted in a decrease of $64 million when compared with the same period in 2011.
The average key index rates for the years 2010 through 2012 were as follows:
2012
|
2011
|
2010
|
||||||||||||||
| ||||||||||||||||
Prime rate |
3.25% | 3.25% | 3.25% | |||||||||||||
Fed funds rate |
0.14 | 0.11 | 0.18 | |||||||||||||
3-month LIBOR |
0.42 | 0.34 | 0.34 | |||||||||||||
3-month Treasury Bill |
0.08 | 0.05 | 0.13 | |||||||||||||
10-year Treasury |
1.74 | 2.76 | 3.19 | |||||||||||||
FNMA 30-year |
3.07 | 4.11 | 3.95 | |||||||||||||
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Interest earning assets include the investment securities and loans that are exempt from income tax, principally in Puerto Rico. The main sources of tax-exempt interest income are certain investments in obligations of the U.S. Government, its agencies and sponsored entities, and certain obligations of the Commonwealth of Puerto Rico and its agencies. Assets held by the Corporations international banking entities had a temporary 5% tax rate that ended in December, 2011. To facilitate the comparison of all interest related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates at each period, in the subsidiaries that have the benefit. The taxable equivalent computation considers the interest
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expense disallowance required by the Puerto Rico tax law. Under this law, the exempt interest can be deducted up to the amount of taxable income. The decrease in taxable equivalent adjustment for 2012 is mainly related to lower exempt income due to renewal of cash flows in lower yielding securities, higher premium amortization and a lower volume of investment securities.
Average outstanding securities balances are based upon amortized cost excluding any unrealized gains or losses on securities available-for-sale. Non-accrual loans have been included in the respective average loans and leases categories. Loan fees collected and costs incurred in the origination of loans are deferred and amortized over the term of the loan as an adjustment to interest yield. Prepayment penalties, late fees collected and the amortization of premiums / discounts on purchased loans are also included as part of the loan yield. Interest income for the period ended December 31, 2012 included a favorable impact, excluding the discount accretion on covered loans accounted for under ASC 310-30, of $19.2 million, related to those items, compared to a favorable impact of $21.4 million for the same period in 2011 and $19.1 million in 2010. The $2.2 million reduction from 2011 to 2012 resulted in part from higher amortization of premiums related to mortgage loans purchased. The discount accretion on covered loans accounted for under ASC 310-20 (revolving lines) was fully accreted in the third quarter of 2011 and totaled $37.1 million.
Tables 5 and 6 present the different components of the Corporations net interest income, on a taxable equivalent basis, for the year ended December 31, 2012, as compared with the same period in 2011, segregated by major categories of interest earning assets and interest bearing liabilities.
Net interest margin, on a taxable equivalent basis, remained flat at 4.47% for the years ended December 31, 2012 and 2011. Although the net interest margin did not change from year to year, there were several factors that affected its composition as detailed below:
| a decrease in the yield of investments in part due to higher premium amortization related to mortgage backed securities as a result of higher prepayment activity and renewal of cash inflows in lower yielding collateralized mortgage obligations; |
| a lower proportion and lower yield of covered loans. This portfolio, due to its nature, will continue to decline as scheduled payments are received and workout arrangements are made. The yield variance was impacted by the fact that the interest income for 2011 includes $37.1 million of discount accretion related to covered loans accounted for under ASC 310-20. As previously mentioned, this discount was fully accreted into earnings during 2011. Also, during 2011, resolutions of certain large commercial loan relationships caused the unamortized discount to be recognized into income for one pool and increased the accretable yield to be recognized over a short period of time for another pool. The accretion generated by the amortization of the discount for covered loans accounted for under ASC 310-20 as well as the transactions occurring within these two ASC 310-30 pools contributed to the high yield exhibited by the covered loan portfolio during 2011; and |
| a decrease in the yield of mortgage loans due to acquisitions made, mainly in the US, of high quality loans, which generally carry a lower rate, originations in a lower rate environment, reversal of interest for delinquent loans, and non-performing loans repurchased under credit recourse agreements. |
The above variances were partially offset by the following factors which affected positively the Corporations net interest margin:
| higher yield in the non-covered construction portfolio as a result of a lower proportion of non-performing loans; |
| decrease of 35 basis points in the cost of interest bearing deposits, driven by management actions to reduce deposit costs; and |
| lower cost of short-term borrowings resulting from the cancellation, during the quarter ended June 30, 2012, of $350 million in repurchase agreements with an average cost of 4.36% and replacing them with lower cost Federal Home Loan Bank advances. |
Average earning assets decreased $1.4 billion when compared with 2011. This reduction was distributed between both investments and loans categories. The average loans volume decreased by approximately $772 million, principally in the categories of non-covered and covered commercial loans. This reduction occurred in both Puerto Rico and U.S markets. Lower origination activity, resolution of non-performing loans and charge-offs continue to impact the portfolio balance. In addition, the covered loan portfolio continues its normal amortization which contributes to the reduction in loan balances. For a detailed movement of covered loans refer to Note 10 of this Annual Report. The increase in the mortgage loans category resulted from strong originations within the Puerto Rico market as well as acquisitions made during the year by BPNA. The Corporation is pursuing its strategy of acquiring high
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quality assets to mitigate the reduction in the loan portfolio. The consumer loans category also benefitted from this strategy as $225 million of portfolio purchases at the end of June 2012 contributed to the increase in the average balance of this category. In addition, the reduction in the average balance of investment securities reflects maturities and prepayment activity within the mortgage related investments. The average balance of borrowings decreased by $1.4 billion mostly due to the repayment, at the end of 2011, of the note issued to the FDIC.
The increase in the net interest margin, on a taxable equivalent basis, from 3.82% in 2010 to 4.47% in 2011 was driven mostly by:
| a higher proportion of covered loans when compared to 2010. This was mainly due to the covered loan portfolio being outstanding for the full year in 2011 vs. eight months during 2010. This portfolio, due to its nature, carries a higher yield than the other loan portfolios. This impact is included in the line item Covered loans in Table 6; |
| a decrease of 40 basis points in the cost of interest bearing deposits, driven by management actions to reduce deposit costs as well as renewing brokered certificates of deposits at a lower cost due to the low rate environment; and |
| a higher yield in the investments category by 26 basis points. This increase was the result of the combination of maturities of lower yielding investments as well as a higher taxable equivalent benefit for 2011. |
The above variances were partially offset by the following factors which affected negatively the Corporations net interest margin:
| excess liquidity invested in money market investments with the Federal Reserve earning a low interest rate, which reduced the yield on earning assets; |
| a lower yield in both the commercial and construction portfolios. This reduction can be attributed to the level of non-performing loans within the portfolio; and |
| the FDIC loss share indemnification asset of $1.9 billion at December 31, 2011, which is a non-interest earning asset being funded throughout the year with interest bearing liabilities, mainly a combination of the FDIC note at a 2.50% annual fixed interest rate and brokered certificates of deposits. The FDIC note was repaid as of December 31, 2011. The accretion of the FDIC loss share indemnification asset is recorded in non-interest income. |
The increase in the taxable equivalent adjustment for 2011 was mainly the result of a change in BPPRs tax position when compared to 2010. During 2011, BPPR was able to deduct tax exempt income, net of the related interest expense. BPPRs net interest income for 2010 did not include a tax benefit related to exempt income due to its tax position at that time.
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Table 5 - Net Interest Income - Taxable Equivalent Basis
Year ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
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Average volume | Average yields / costs | Interest | Variance attributable to |
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2012 | 2011 | Variance | 2012 | 2011 | Variance | 2012 | 2011 | Variance | Rate | Volume | ||||||||||||||||||||||||||||||||||
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|
|
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($ in millions) | (In thousands) | |||||||||||||||||||||||||||||||||||||||||||
$ | 1,051 | $ | 1,152 | $ | (101) | 0.35 % | 0.31 % | 0.04 % | Money market investments |
$ | 3,704 | $ | 3,597 | $ | 107 | $ | 206 | $ | (99) | |||||||||||||||||||||||||
5,227 | 5,494 | (267) | 3.45 | 4.05 | (0.60) | Investment securities |
180,243 | 222,465 | (42,222) | (28,147) | (14,075) | |||||||||||||||||||||||||||||||||
446 | 667 | (221) | 5.81 | 5.82 | (0.01) | Trading securities |
25,909 | 38,850 | (12,941) | (76) | (12,865) | |||||||||||||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||||||||||||||||||||||
6,724 | 7,313 | (589) | 3.12 | 3.62 | (0.50) | Total money market, investment and trading securities |
209,856 | 264,912 | (55,056) | (28,017) | (27,039) | |||||||||||||||||||||||||||||||||
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Loans: |
||||||||||||||||||||||||||||||||||||||||||||
10,226 | 10,889 | (663) | 4.95 | 5.06 | (0.11) | Commercial |
506,127 | 551,252 | (45,125) | (12,105) | (33,020) | |||||||||||||||||||||||||||||||||
459 | 731 | (272) | 3.61 | 1.48 | 2.13 | Construction |
16,597 | 10,801 | 5,796 | 11,001 | (5,205) | |||||||||||||||||||||||||||||||||
545 | 577 | (32) | 8.62 | 8.81 | (0.19) | Leasing |
46,960 | 50,867 | (3,907) | (1,121) | (2,786) | |||||||||||||||||||||||||||||||||
5,817 | 5,154 | 663 | 5.58 | 6.06 | (0.48) | Mortgage |
324,574 | 312,348 | 12,226 | (25,994) | 38,220 | |||||||||||||||||||||||||||||||||
3,749 | 3,654 | 95 | 10.22 | 10.30 | (0.08) | Consumer |
383,003 | 376,158 | 6,845 | (3,484) | 10,329 | |||||||||||||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||||||||||||||||||||||
20,796 | 21,005 | (209) | 6.14 | 6.2 |