Banking Industry Reports
Our Quarterly Banking Industry Reports are designed as a tool for top executives to get a quick, yet deep understanding of the banking industry in Puerto Rico and Dominican Republic.
Our Banking Industry Reports are designed to provide top banking executives with a brief three page report with enough depth in order to augment their decision making. It is strictly based on publicly available information and only distributed to a selected set of clients or potential clients in the banking industry. The report is divided in five sections:
- Our Perspective. Concise and synthesized overview of the industry and our perspective about it.
- Profitability. Understanding of the level and source of profitability (ROE and ROA) of the players.
- Asset Quality and Risk. Review of capitalization levels vs. minimum levels required, asset portfolio composition and NPLs analysis.
- Productivity. Identify sources of productivity performance and compare vs. competitors.
- Liquidity. Describe the dynamics on funding sources, market share of deposits, and brokered deposits levels.
Although local banks are operating against a backdrop of a deep economic malaise, an unre-lenting fiscal and debt crisis, and a persistent population decline, they have been able to maintain, on a consolidated basis, positive levels of profitability for three consecutive years. The local banking industry posted a Pre-Tax ROE of 4.3% in 2016, 5.7% in 2015, and 3.3% in 2014. Revised forecasts of economic growth point to a prolonged economic contraction which will keep local banks profitability levels subdued. In this issue we will highlight the difference in performance and financial condition of banks that are highly geographically diversified and the banks that are Puerto Rico-centric. Broadly speaking, Popular, FirstBank and Oriental have experienced increases in their market share in assets, deposits and loans & leases from the end of 2011 to the end of 2016. On the other hand, Santander and Scotia, which operate locally as affiliates of large multinational financial entities, have either maintained their market share or lost market share. With few possibilities of local growth, banks might be eyeing the market share of savings and credit cooperatives and nondepository entities.
The banking industry has largely become acclimated to a challenging local operating market, sustaining positive and increasing levels of profitability on a consolidated basis for 3 consecutive years, reaching a Pre-Tax ROE of 7.1% in YTD 2016. Although the economic and fiscal landscape might very well continue to deteriorate in coming quarters before there is a turnaround, as per the Planning Boards downward revised economic growth forecasts (-2.3% for FY 2017) and the daunting liquidity issues and debt obligations being faced by the government, Dodd-Frank Act Stress Tests (DFAST) results indicate that local banks can withstand additional pressures given strong capital positions. In this issue we will present trends in ATM-related indicators, check processing and POS transactions. ATM terminals, ATM debit transactions and check processing have all decreased significantly in the past 5 years, while POS transactions have materially increased, pointing to increased use of online/mobile banking and non-cash methods of payment. Lastly, we analyze the implications of interest rate hikes by the U.S. Federal Reserve Board on the local economy and banking sector.
The local banking industry as a whole has been able to sustain positive returns during the first half of 2016, despite operating in a challenging and uncertainty-laden environment, posting a Pre-Tax ROE of 7.1%. Given the current bleak economic forecasts, banks will likely continue to embrace a de-risking, deleveraging and cost rationalization strategy in the local market. In this issue, a review of macro consumption trends will be presented, highlighting the relative stability of personal consumption vis-à-vis investments and government spending. Subsequent sections will also examine the amount of loan originations and balances of consumer loans and leases (i.e. credit cards, other revolving credit plans, auto loans, and other consumer loans and leases). Consumer loan originations have been gaining a greater share of total loan originations, increasing from 26% in 2012 to 35% in YTD 2016 (13% in 2005), while consumer loan balances as a per cent of total balances increased to 19% from 15% in 2012. Given the generally higher net interest margin of consumer loans and stable net charge-off rates, this segment has become materially important for banks profitability.
The banking industry kicked off the year on a positive note, posting a solid industry-level Pre-Tax ROE of 8.4%, despite the continuous reduction in economic activity. This reduction is clearly reflected in the drop in loan originations, impacting the revenue generating capacity of the banking system. In this issue, we will provide a 10-year review of mortgage originations by depository and non-depository institutions as well as a 5-year analysis of market share fluctuations. The number of institutions originating mortgages in 2015 reached 35, down from a peak of 53 in 2006 (-18 or -34%). In terms of mortgage origination count, the Island experienced a steep drop from 95.5K in 2005 to 21.6K in 2015 (-73.9K or -77%) while the dollar volume decreased from $12.7B to $3.5B (-$9.2B or -73%). Among depository institutions, Popular leads the way commanding 34% market share (dollar volume), followed by Santander and FirstBank both with 18%. Among non-depository lenders, Moneyhouse (17%), SunWest (9%), and Preferred (9%) are the leaders. Given bleak prospects for renewed growth in the near future, loan originations and banks earnings potential will remain subdued.
In this final issue of 2015, we will be highlighting the main local banking trends of the past 10 years and offer our outlook for 2016. In the last decade, total employment has decreased by 20%, real GNP by 14% and the GDBs EAI by 19%. Looking at macro banking trends specifically, the number of retail banks has decreased from 10 to 5, the number of branches has been cut by 34%, and total assets have experienced a reduction of 42%. Delinquency levels have remained at very high levels, with noncurrent loans and leases ratio averaging 10% in the 2006-2015 period compared to 2% between 2002 and 2005. Credit losses have translated into a deterioration of the pre-tax return on equity (ROE) of the local banking system which averaged 1.4% during the 2006-2015 period, compared to 17% between 2002 and 2005. Notwithstanding tough local market conditions, during the past years banks have done an extraordinary job at reducing the amount of troubled assets and have dramatically increased capital levels (risk-based capital ratio of 18.6% in 2015 vs. 10.6% in 2006). As a result, the banking sector currently boasts a much healthier balance sheet and a more robust capital position which will allow it to face the additional economic and financial stress expected for 2016 and beyond.
The local banking industry continues to weather the storm of economic and fiscal malaise that is gripping the Island. It has maintained positive, albeit modest, levels of profitability during YTD 2015, reaching a Pre-Tax ROE of 6.2% on a consolidated level. Profitability by individual bank exhibited notable variability. Popular, Scotia and Santander posted relatively strong levels of profitability, with Pre-Tax ROEs of 9.7%, 8.9%, and 7.2% respectively, while First Bank and Oriental produced ROEs below 1% (0.9% and 0.3%, respectively). Higher provision expenses due to heightened credit risk stemming from uncertainties regarding PR government assets and current shaky economic grounds, have adversely impacted local banks 2015 performance. Nevertheless, a strong capital base provides banks with an adequate cushion to assimilate potential future losses. Given the importance of the auto industry for the local economy and specifically for local banks and other financial institutions, this issue will provide an overview of key auto trends. New auto sales in Puerto Rico peaked in 2005 with 140,400 cars sold, dropping to 88,175 in 2014 (-52K units or -37%), continuing a downward trend in YTD 2015. This trend has important implications for local banks as well as for already strained public coffers.
The local banking industry on a consolidated basis has been able to maintain positive returns in the first half of 2015, reaching a Pre-Tax ROE of 5.9%, highlighting the resilience of this sector despite steep challenges in Puerto Ricos operating market. The Island is undoubtedly traversing one of the most challenging economic and fiscal periods of its post-World War II history, as has been consistently chronicled in past issues. Real economic output has decreased by close to 15% since FY 2006, the liquidity drought that ails the government could ultimately lead to a partial government shutdown and population decline continues unabated reaching historic proportions in 2014 with a net migration of -64,000. Furthermore, on Aug. 1 the government made an incomplete payment to cover the Public Finance Corporations (PFC) debt which has been seen by Wall Street and the investor community as the Commonwealths first-ever default. Given current elevated capital ratios, the industry will be able to withstand additional economic deterioration in the short-term. However, a worsening of economic and fiscal conditions may lead to higher non-performing loans, higher credit provisions and a depletion of capital levels. This issue will briefly examine local credit unions exposure to $1.1 billion in PR government debt, sector which might be dealt a hard blow if public sector defaults continue.
The local banking industry underwent a reconfiguration during the first quarter of 2015 after federal and local regulators shutdown Doral following years of struggling with profitability and inadequate capital levels. Popular and FirstBank aptly seized the opportunity of acquiring a large part of Dorals assets and deposits, further strengthening their leading position in the local market. The reshaped banking industry registered a pre-tax ROE of 8.0% in Q1 2015, showing a strong improvement vis-à-vis 2014 despite operating in a challenging environment. The most recent macroeconomic and fiscal indicators point to continued economic contraction in fiscal years 2015 and 2016 and severe governmental liquidity problems which will continue to pose challenges for local banks. However, extremely strong capital levels will help banks cope with potential future difficulties. Delinquency ratios continued to increase in Q1 2015, trend that must be closely observed. In this issue, given the profound economic and fiscal issues Puerto Rico is facing, an analysis of the exposure of local banks to government-related assets and deposits is presented. Lastly, given the growth in assets of International Banking Entities, a brief analysis of this important sector of the Islands financial system is also put forth.
The local banking industry posted modest earnings in 2014, reaching a Pre-Tax ROE of 3.4% on a consolidated basis. When excluding Doral, which was ultimately closed by the OCFI and the FDIC after years of financial and legal troubles and was the only bank to report negative returns in 2014, the pre-tax ROE of the industry reached 6.8%. While productivity levels improved in 2014 vis-à-vis 2013, as did capital levels, the delinquency ratio for the industry, after four consecutive years of decline, experienced some deterioration. The 90+ days past duenon accruing ratio increased from 6.0% in 2013 to 7.3% in 2014. In anticipation of potential future losses due to nonperforming assets and a macro-economic environment riddled with uncertainties, local banks have increased their loan loss reserves. Doral, after struggling to survive for several years, was ultimately closed by the FDIC and partially bought by Popular and FirstBank, who will further solidify their positions in the local banking market. In this issue we analyze some of the potential impacts of the 2015 tax reform, whose major component is the introduction of a value added tax (VAT), on the overall economy and specifically the banking sector. There are both downsides and upsides to the proposed transformation of the Islands tax code.
The local banking sector reached positive returns in 2014 YTD, registering a pre-tax ROE of 3.1% (8.3% excluding Doral), despite the ongoing acute fiscal and economic challenges. Economic activity continues to contract according to the GDBs Economic Activity Index and job numbers remain at historically low levels. Falling oil prices should provide a much needed, although limited, positive impact on the Islands economy, increasing consumers disposable income. Still high credit provision levels and decreasing leverage continue to adversely affect profitability of banks. Capitalization levels continue to be strengthened for all banks except Doral, which is now considered significantly undercapitalized by the FDIC. Delinquent loans have been creeping up in recent quarters, trend that should be closely monitored.