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Issued : Tuesday, July 9, 2013 12:00 AM
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Puerto Rico banks play it safe

By : JOSÉ L. CARMONA
Edition: July 11, 2013 | Volume: 41 | No: 26

Despite recapitalization and deleveraging efforts, Puerto Rico banks are only lending to local companies with very little risk or SBA guarantee

Following the three-bank consolidation that reduced the number of commercial banks in Puerto Rico three years ago, the island's banking industry is showing some signs of stabilization.

Banco Popular, Oriental Bank & Trust and Scotiabank acquired on April 30, 2010, the assets of Westernbank, Eurobank and R-G Premier Bank, respectively, from the Federal Deposit Insurance Corp. (FDIC), receiver of the failed banks.

Last December, Oriental also completed the acquisition of the operations of Spanish bank Banco Bilbao Vizcaya Argentaria in Puerto Rico, further reducing the number of players in the local banking industry.

However, the surviving commercial banks operating in Puerto Rico shouldn't expect the industry to return to what was considered the "normal" a few years ago—the approval of under-collaterized loans— which ultimately caused the demise of the three local banks in 2010.

Despite their recapitalization and deleveraging efforts, the remaining players in Puerto Rico's banking industry are dependent on the island's still frail economy to bounce back from the seven-year slump to further increase their lending activity, which has been hampered by lower demand from consumers and businesses affected by the longest economic downturn in Puerto Rico's history.

On top of that, federal regulators have gotten tougher on banks in an effort to avert another financial crisis, such as the one that afflicted the industry in 2009. On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Act, touted as the most sweeping change to financial regulation in the U.S. since the Great Depression.

As a result of the tighter regulations the Dodd-Frank Act has imposed on banks since its inception—estimated to cost U.S. banks $16 billion—a financial institution that a few years ago would approve a loan without much hassle, now requires much more paperwork, such as sales projections and solid financial reports, as well as additional collateral to guarantee such loan.

In a nutshell, local banks nowadays are playing it safe, mainly lending only to those individuals and businesses that have shown to have repayment capacity and cash fl ow.

The island's economic depression has tempered the banks' desire to take risks and their need to expand lending. As property values have declined, businesses and individuals found themselves having less equity to offer as collateral, so it was only natural that lending activity would come down from its 2004-2005 peak.

SIGNS OF STABILIZATION

In the view of José Rafael Fernández, president, CEO & vice chairman of Oriental, Puerto Rico's banking industry is showing signs of stabilization with respect to the banks' credit and fiscal situation.

"The banking industry in Puerto Rico is a direct reflection of the island's economic situation. As long as the economy doesn't show signs of improvement, the banks will participate in a similar fashion, meaning economic contraction and stagnation,"Fernández said. "Nonetheless, the local banking industry has done an excellent job in reducing assets classified by regulators, which has helped stabilize banks' capital. We are also seeing foreign interest in acquiring these assets from Puerto Rico, which also helps in the stabilization process."

Fernández believes there are some financial institutions in Puerto Rico that have a few "innings" to play before these can show signs of complete stabilization, as they might still have unresolved regulatory, credit and capital issues.

"I can say that the local banking industry still has appetite for lending, and that's irrefutable, but banks have to lend to those with good credit. Again, the credit situation of individuals and businesses in Puerto Rico is intertwined with the performance of our economy," the Oriental executive said. "Having said that, there are industries and small businesses that have managed their capital and finances well, maintaining a high level of financial liquidity, and these are truly the engine of Puerto Rico's economy."

For Eli Sepúlveda, executive vice president of Banco Popular commercial- credit group, the environment for Puerto Rico banks is definitely more stable, but it demands constant analysis.

"At this moment, many businessowners and managers are analyzing the impact of the fiscal measures that were recently approved and put in place," Sepúlveda said. He was referring to the nearly $1.5 billion in newly approved taxes that were part of the government's $9.77 billion budget for fiscal year 2014.

Aurelio Alemán, president & CEO of FirstBank, sees 2013 as a year of optimism for the banking industry despite the large losses recently reported by FirstBank and other competitors, as part of the process of cleaning their loan portfolios.

"We see investor interest in acquiring these nonperforming assets, which is a positive thing as we heal the system. Although we are operating in a smaller economy, there are also fewer players, which generates a more competitive, rational environment than what existed previously," Alemán noted.

IT'S THE ECONOMY…

For Arturo Carrión, executive director of the Puerto Rico Bankers Association, the local banks' lending activity has to be evaluated in relation to the state of the local economy.

"There's no other way to analyze this, because if you compare total [lending activity] against previous years, you'll see a decline. I think we need to look at this within the context that banks don't create demand, they finance it. You have to take into account there were some bank consolidations three years ago with some problem assets involved and the FDIC assisted with [this]. All this contributed to a decrease in the number of loans generated and those in the portfolio," Carrión said. "However, when you compare banks' capital levels, you'll notice these are at their historical peak."


In 2000, local banks had $3.5 billion in capital, whereas in 2012and with fewer players, the amount jumped to $7.2 billion.

"In terms of capital and liquidity, local banks have money to lend," Carrión pointed out. "The problem is there's not enough lending demand, although banks are tending to the existing lending demand, whether it's mortgages or commercial loans."

In 2005, 59.5% of all commercial loans issued by local banks were for less than $25,000. In 2012, that percentage jumped to 71.4%.

"When you consider that there are 417 bank branches in Puerto Rico, the loans of less than $25,000 reaching small businesses are spread throughout the island. If you take loans of $25,000 to $100,000, these represent 14.7% of all commercial loans approved in 2012 and 86% of total loans," Carrión stated. "On top of that, there are many small businesses that finance their operations with personal loans."

As the local banking industry goes through its recapitalization and deleveraging process, Carrión said the industry's biggest concerns are the frail economy and the threat of a credit downgrade to noninvestment status, while there are still a large number of delinquent loans, foreclosures and an inventory of residential properties that banks need to dispose.


Nevertheless, he pointed out there were $4 billion in commercial loans issued by local banks in 2012, and more importantly, 98% of the deposits at local banks were loaned.

"That demonstrated local banks are very active in the economy, and although banks have investment portfolios, most of their assets are loans," Carrión added. "While mortgage- loan originations are lower than what they were back in their peak in 2003, some 24,000 mortgage loans were initiated in 2012, including refinancing."

NUMBERS DON'T LIE

Based on the most recent data provided by the Financial Institutions Commissioner's Office (OCIF by its Spanish acronym), net loans by Puerto Rico banks during 2012 amounted to $48 billion, a 0.52% increase from the $47.75 billion originated in 2011. Many of these loans received a Small Business Administration (SBA) guarantee.

The island's commercial banks made $48.43 billion in loans & leases in 2012, representing a 1.46% drop from the $49.15 billion in 2011.

As a group, local banks finished last year with $66.8 billion in assets, $49 billion in deposits and $6.8 billion in capital, versus $70.78 billion in assets, $48.2 billion in deposits and $7.2 billion in capital reported in 2011.

After two-straight years of net losses in 2009 and 2010, local banks as a group reported net income of $195.8 million in 2011 and $234.8 million in 2012.

Financial data from local commercial banks for the first quarter ended March 31, reflect a similar trend.

Puerto Rico banks finished the first quarter with $66.38 billion in assets, $46.4 billion in net loans, $49.2 billion in deposits and $6.8 billion in capital.

However, the local banks as a group reported a combined net loss of $178.2 million for the first quarter of this year, mostly the result of the sale of nonperforming assets, mainly by Popular and FirstBank.

BANKS' DELEVERAGING EFFORTS CONTINUE

As a way to shore up their bottom lines and capital levels, as well as improve asset quality, Puerto Rico banks are continuing their efforts to reduce the number of nonperforming assets in their portfolios.

Over the past few months, Doral Financial Corp., Popular Inc. and First BanCorp—the bank holding companies of Doral Bank, Banco Popular and FirstBank, respectively— have taken action to trim toxic assets from their balance sheets.

The deleveraging effort is nothing new and is part of an ongoing effort by the island's financial institutions that began soon after the 2009 financial crisis and includes the sale of bad loans, recognition of losses and, in some cases, takeover of construction projects.

For the fourth quarter ended Dec. 31, 2012, the amount of nonaccrual loans at local commercial banks was $3.2 billion, according to data from OCIF. That number dropped to $2.9 billion in the first quarter of 2013.

As of Dec. 31, 2012, the nonperforming- loan-to-total-loans ratio stood at 6.69%, while it dropped to 6.27% in the first quarter of this year.

Of the total loans local banks have in their portfolios, around $18.84 billion correspond to residential and mortgage loans, representing 38% of total loans. Mortgage loans amounted to $44 billion in the first quarter.

The combined construction loans portfolio at local banks, which in 2009 reached $2 billion, have been reduced by almost half, to $1.189 billion during the first quarter of this year.

Consumer loans totaled $4.5 billion and have remained stable with no significant delinquency. The same goes for the credit card portfolio, which reached $1.8 billion in the first quarter and hasn't presented major issues.

"The biggest problems are the construction and commercial real-estate [CRE] portfolios. The CRE portfolio is at $10.857 billion and has been going down. It was at $11.173 billion by the end of last year, but it got as high as $13 billion in 2007-2008," commented Puerto Rico Financial Institutions Commissioner Rafael Blanco, the local bank regulator.

The two portfolios with the highest number of nonperforming loans are mortgage loans, of which 32.5% is nonperforming, and the CRE portfolio, with 6.53%, he said.

"However, banks' asset quality has been showing signs of improvement. Nevertheless, nonperforming assets are the banks' biggest threat since the portfolio will respond to Puerto Rico's economic reality. As the economy improves and those unemployed find a job and regain repayment capacity, things will start to improve, and these problems will be solved," said Blanco, warning that if things get worse, the quality of the loan portfolio would worsen.

For Blanco, it is the quality of the loan portfolio what really allows banks to have lending capacity.

"It's not the same to carry 7% of nonperforming loans over your shoulders than 2%, which is the level we had back in 2000," he added. "Back then, the delinquency rate was very low. We have a long way to go if we want to go back to those levels."

Nevertheless, Blanco noted that what has been happening in the past few months, especially in the first quarter of this year, indicates that the island's banking industry is moving in the right direction.

In his view, what local banks need is more activity.

"Banks want to lend. It's not that they don't want to; they do, but in a responsible way," Blanco said. "There are too many banks chasing the same loans, and that's not good for anyone, because banks will resort to their old ways and soften their terms and conditions to win the loans."

To that end, he said local banks have refocused their lending strategies and are concentrating on their core strengths and taking all the necessary steps to compete more efficiently, as these have to reduce operational costs. That means exiting those business areas that aren't as profitable and focus resources on those areas that are, Blanco said.

REPOSSESSIONS, FORECLOSURES CONTINUE UPWARD TREND

Unfortunately, an area that hasn't improved is residential repossessions and foreclosures. In 2009, there were 2,537 residential foreclosures, a 4% increase from 2008 with 2,454. In 2010, foreclosures jumped a whopping 29%, to 3,162.

"If you annualize the foreclosures during the first quarter of this year, the number for 2013 will end up higher than in 2012," the OCIF commissioner said.

There were 1,231 foreclosures in the first quarter and when annualized, this brings the total number for 2013 to 4,924 residential units foreclosed. Despite the high number of foreclosures last year, more than 6,000 residential properties were saved through the banks' loss-mitigation programs.

"While there were 1,231 foreclosed properties in the first quarter, another 1,445 were saved through loss mitigation during the same period," Blanco said. "What this means is this doesn't look good. Foreclosures take from 24 to 36 months, and on July 1, a new program began that forces homeowners to seek judicial mediation to avoid the foreclosure. This means foreclosures will now take longer."

Currently, there are 18,870 residential properties under the foreclosure process, with a total loan value of $1.6 billion, an amount Blanco described as "significant."

"Banks are doing the impossible to avoid a foreclosure, because they have no interest in keeping those properties. When the homeowner can't pay the loan, the bank has no other option but to foreclose," he indicated.

Homeowners can voluntarily hand out the property to the bank, or do a short sale. In a short sale, whatever amount the property is sold for cancels the mortgage, even if the sale price is below its appraised value.

With the delinquency rate in the banks' mortgage portfolio hovering at 17%, Blanco underscored how pressing this issue is for local banks, as mortgage loans represent 38% of total loans in the banks' portfolios.

"It's a sore thumb sticking out," Blanco said. "That means banks have to reserve and provision more for these loan losses, which have a high cost for them."

Puerto Rico banks cater to their own niches when lending

With a tougher regulatory environment and a smaller economy, Puerto Rico banks are catering to their own niches when it comes to lending.

Some institutions target small and midsize businesses (pymes by its Spanish acronym), while others focus on the middle market or women entrepreneurs.

"Given today's regulatory parameters, you must take into account that businesses must be well-capitalized and have a good credit performance history. Puerto Rico's commercial portfolios still have an elevated level of nonperforming loans, and the regulatory expectation is that these are reduced through the generation of high-quality loans," said Aurelio Alemán, president & CEO of First BanCorp, the bank holding company of FirstBank Puerto Rico.

In the case of FirstBank, Alemán noted there was an increase in new loans from 2012 to 2013, although this wasn't reflected in the size of the bank's portfolio due to the significant sale of nonperforming commercial loans.

In April, First BanCorp announced it had entered into three separate agreements to sell $532 million of unpaid principal balance in commercial loans, or $315 million in book value, for a total price of $201 million, or 38% of the unpaid principal balance.

These transactions will result in a pre-tax loss, net of reserves, of about $65 million. At the completion of the transaction, FirstBank will reduce its nonperforming assets by some 23%, or $282 million.

ADVISING PYMES

For Banco Popular, Puerto Rico's largest financial institution and the No. 36 bank in the U.S., its focus right now lies in being a trusted advisor to local businesses, which are analyzing the impact of the fiscal measures put in place by the administration of Gov. Alejandro García Padilla.

"This means a higher number of visits with our clients to further build our relationships," said Eli Sepúlveda, executive vice president of the commercial-credit group at Banco Popular. "Our customers know that we are a full-fl edge service provider, so in the current scenario, we feel the added value comes through advising pymes."

He added that the bank has more than 200 officials dedicated to advising pymes at its 174 bank branches and 45 commercial business centers throughout the island.

"We were honored to receive the U.S. Small Business Administration's [SBA] Platinum award in 2012 for helping local businesses grow, with $18 million in SBA originations. We forecast a 15% increase in SBA originations in 2013," Sepúlveda said.

The Popular Inc. executive vice president indicated that demographics is the main driver right now for growth opportunities, in industries such as food service and healthcare.

"We are also seeing a larger number of mergers & acquisitions transactions, in which businessowners are taking steps to grow through consolidation," Sepúlveda added.

CATERING WOMEN ENTREPRENEURS

Targeting women as drivers of economic development, Doral Bank has so far invested about $2 million in its umbrella program Mujeres d Éxito [Successful Women], a series of initiatives aimed at supporting and driving women's economic development.

"Through Fondo Doral [Doral Fund], Doral aims to strengthen the local nonprofit system that provides alternate financing options for first-time women entrepreneurs who would otherwise not have access to the traditional banking system," explained Glen Wakeman, CEO of Doral Financial Corp., the bank holding company of Doral Bank.

In alliance with Fundación Comunitaria de Puerto Rico, which manages the fund, Doral has provided capital to six organizations, which in turn have provided microloans and mentoring to new women businessowners, he said.

In the past year alone, Doral Fund created 14 new small businesses and more than 25 new jobs, four of these new businesses in Vieques. Doral has provided $200,000 in capital to these organizations.

Doral's Despegue Empresarial (Business Launch) initiative provides capital and mentoring to women who own small businesses that need growth capital. The program was launched in 2012 and has provided five women-owned businesses $50,000 each to grow their companies with promising results, Wakeman said.

Through its Successful Women initiative, Doral provides free seminars by experts in various fields to women interested in starting a business, or improving their skills. Last year, more than 500 women participated in the program.

AFTER THE MIDDLE MARKET

During the past five to six years, Oriental Bank has focused its efforts on the middle market, defined as businesses making $10 million to $50 million in annual sales.

"Now, with the acquisition of Banco Bilbao Vizcaya Argentaria Puerto Rico, we have a very important portfolio of $600 million to $700 million in that specific segment," said José Rafael Fernández, president, CEO & vice chairman of OFG Bancorp, the bank holding company of Oriental Bank.

It is the middle market to which Oriental provides its financing services, as well as transactional and deposit services, in addition to what Fernández calls an added value that no other local bank can offer them—retirement-plan services for company employees.

"With each passing day, and with all the economic issues in Puerto Rico and the mainland U.S., Puerto Ricans need to continue saving for their retirement to help cover their living expenses when they are no longer working," Fernández said. "We have all that infrastructure in place at Oriental, where for many years, we have emphasized retirement plans and where we feel we have a unique position in the marketplace."

In addition to the middle market, Oriental also has a significant portfolio of pymes, which the bank has been growing over the past three to four years and now amounts to nearly $500 million.

"These are our clients of $1 million to $10 million in annual sales, and that is really a segment that needs assistance and one which we have been able to focus on, with our agile culture. That is an area where we have been able to differentiate ourselves, helping us capture a good chunk of that market," Fernández indicated.

For Banco Santander, Latin America pymes have great growth potential

Spanish bank launches strategic project to facilitate access to credit, financial services, new technologies and exports to the sector

During Banco Santander's 12th Annual Encounter with Latin America, held late June at Menéndez Pelayo International University in Santander, Spain, Javier San Félix, the Spanish bank's general director for commercial banking, announced the launch of Santander's strategic project for small and midsize businesses (pymes by its Spanish acronym).

With the plan, Santander expects to reach a level of lending of $20 billion for pymes in Latin America, excluding Brazil, and achieve one million clients in the region by 2016.

The goal would double the current lending activity in the region, to a level of about 100,000 pymes clients a year.

Speaking to the more than 30 Latin American journalists gathered for the Encounter, San Félix highlighted the importance of increasing efficiency through process automation for pymes, including processing payroll and credit card payments electronically.

"Santander is the financial leader in the region and pymes' bank of choice in Latin America for many years now. This year, we will surpass $12 billion in credit and 750,000 clients in the region. In countries such as Mexico, we have increased credit to pymes fourfold and tripled it in Argentina, while in Chile it is growing at a rate of more than 10% a year during the past five years," San Félix said.

The general director of Santander's commercial banking noted, however, that there are still many challenges to overcome to increase access to the financial system for Latin America pymes, and underscored the importance of the bank's new plan, which seeks to reduce the productivity gap and high level of informality among these small businesses.

"Without strong, competitive and well-articulated pymes, a country can't reach its true growth potential," he said, adding that pymes' relationship with banks in the region is much less than that in countries belonging to the Organization for Economic Cooperation & Development (OCDE by its Spanish initials).

The level of deposits by Latin America pymes isn't that great and transactional services aren't that utilized, San Félix said. In terms of jobs, the number of people employed by pymes in Latin America is similar to that of OCDE members, but their contribution to the gross domestic product (GDP) in the region is half that of OCDE members.

"Latin America has great opportunities for economic growth and social well-being, but their contribution to the GDP needs to be increased, because pymes are the main source of jobs in the world," San Félix noted.

In his view, support for pymes can't only come from the financial sector, as he urged other institutions, including universities, business organizations, public corporations, large corporations and technology companies to also step in.

"Santander's support to pymes is serious, profound and complete. We want to provide more financial services, but we also want to help other actors who do business with pymes to do so through the Internet, to help them export and find qualified personnel," San Félix added.

'WE ARE HERE TO LEND'

For Román Blanco, president & CEO of Banco Santander Puerto Rico, the fact the Spanish bank did its "internal work" (i.e. deleveraged its balance sheet) a few years ago, has turned Santander into a very solid, robust and strong commercial bank ready to lend.

"This has allowed us to be closer to our clients, understand their needs and, whenever feasible, finance their viable projects," Blanco told CARIBBEAN BUSINESS. "The U.S. Small Business Administration recently recognized Santander for our growth in loan generation, so obviously, we are increasing our proposals to help the pymes in Puerto Rico."

Santander's strong liquidity and lowest levels of nonperforming loans among all banks on the island allow the Spanish bank to be more at ease when lending, Blanco noted.

"This gives us peace of mind that we have done our homework, and that we can finance their projects, whether it is an expansion, a new endeavor, or they simply want to get out of a business and merge with another one under different conditions…that is what we are looking at," Blanco said. "We are here to lend."

Santander is currently focused on its "100X35" plan, which entails achieving $100 million in earnings through the growth of its five business segments during the next three years—small and midsize businesses, mortgage lending, asset management, consumer banking and insurance services.

"While the Puerto Rico banking industry has gotten smaller, Santander is the only bank that is gaining market share. To grow, you obviously must provide credit," Blanco stated. "Our people have been instructed to be out on the streets because we obviously can do it."

The Spanish bank, he added, is the only large bank on the island that lends to the mass market, with personal loans of up to $6,000 through its Island Finance subsidiary.

Santander rolled out last month its Santander Select private-banking program in Puerto Rico. The bank's new value proposition offers high-net-worth individuals a more personalized experience with preferential access to Banco Santander Puerto Rico's best services.

"We are a very diversified bank, with many business lines,"Blanco said.

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