Banks in P.R. Should Continue Optimizing Costs
SAN JUAN — The banking industry in Puerto Rico maintained a positive trajectory in the first quarter (1Q) of 2017, registering a pretax return on equity (ROE) of 8.6% on an annualized basis, but a report advises them to continue optimizing operational costs amid the uncertain economic outlook.
The information is contained in the latest banking industry report prepared by Vision to Action (V2A), a company that analyzes data from the Federal Deposit Insurance Corp., Securities & Exchange Commission and the local Financial Institutions Commissioner’s Office to shed light on the state of Puerto Rico’s banking sector. The report covers the period from January to March 2017.
“Banks are advised to continue cost optimizing their operations, exploiting opportunities to enhance customer and shareholder value by leveraging emerging technologies, and strengthening their digital competencies to achieve greater productivity. Banks’ strong capital levels, with the Tier 1 Risk-Based Capital Ratio reaching 20.5% in YTD [year-to-date] 2017, provide a robust capital cushion in the event that adverse risks materialize. The delinquency ratios have continued to decrease, with the 90+ days past due non-accruing ratio reaching 6.3% in YTD 2017,” the report said.
Banco Popular and Oriental Bank registered double-digit pretax ROEs in YTD 2017, at 12.3% and 10.3%, respectively. The sector as a whole registered a pretax ROE of 8.6% on an annualized basis, the highest level of profitability since the beginning of the island’s economic downturn in 2006. Popular’s profitability fared better than the industry’s, due to its strengthening financial leverage, with an assets-to-equity ratio of 8.4:1 compared with the industry’s 7.0:1.
In the case of Oriental, its higher-interest income vis-à-vis the industry, partially offset by higher provision expenses, drove its profitability. The third-highest pretax ROE was registered by Scotia (6.4%) after experiencing a deeply negative pretax ROE in 2016 (-12.1%) due to high goodwill impairment losses. When comparing Scotia’s profitability with the industry’s, higher operating expenses and weaker financial leverage (industry’s lowest assets-to-equity ratio 4.6:1) adversely impacted its returns.
Santander and FirstBank registered the lowest pretax ROEs, at 4.8% and 3.6%, respectively. Santander’s higher provision expenses with respect to the industry, which has seen a gradual uptick in its delinquent loans, negatively impacted its profitability.
The V2A report advises banks to engage in cost optimization, exploit emerging technologies and the digitization of platforms. Local banks, on a consolidated level, registered a cost-to-income ratio of 61.4% in 1Q 2017, relatively low vis-à-vis previous quarters and the highest level of efficiency since 2011.
“However, this apparent higher level of efficiency in the 1Q is likely a reflection of seasonal factors, the first quarter of the year typically not reflecting certain costs that are incurred as the year progresses. The industry’s high cost-to-income ratio in 2016 was driven by Scotia’s unusually high costs in 4Q 2016, which reflected $145 million in goodwill impairment losses as well as Popular’s relatively high efficiency ratio. Previously, V2A has highlighted that low financial leverage and high credit provision levels, rather than productivity, have been largely to blame for subpar profitability,” the report said.
Low financial leverage
While low financial leverage continues to pressure profitability down, reaching an assets-to-equity ratio of 7.0 [sic] in 1Q 2017, credit-loan provisions’ impact on profitability has lessened due to a gradual decrease, reaching a credit-provision expenses-to-assets ratio of 0.6% in 1Q 2017 compared to 0.7% in 2016 and 1.2% in 2015. “Furthermore, the operational-expenses-to-assets ratio decreased to 3.1% in 1Q 2017, lower than the 3.4% reached in 1Q 2016 but still well above pre-economic downturn levels, which were below 2%,” according to the report.
In the area of capital adequacy, V2A found the industry’s Tier 1 Risk-Based Capital Ratio exceeds 20%. The Tier 1 Risk-Based Capital Ratio reached 20.5% in 1Q 2017, a hike with respect to 2012 when it reached 14.2%.
“When analyzing capital adequacy by bank, Scotia and Santander, which operate locally as affiliates of large multinational financial entities and are therefore less dependent on the Puerto Rico market, boast the highest capital ratios, with Tier 1 Risk-Based Capital Ratios of 34.4 and 27.2, respectively.
“The somewhat lower capital ratios of Popular, FirstBank and Oriental, vis-à-vis Scotia and Santander, reflect the more aggressive strategies of these banks to further consolidate their presence in the island through the deployment of excess capital while still maintaining very robust capital levels. It should be noted that there is pressure being put by the federal regulators to lessen the stringency of annual stress test rules,” the report said.
In the area of asset quality, the 90-plus past due non-accruing ratio continues to decrease and is at 6.3%.
“The 90+ days past due nonaccruing ratio, which excludes loans and other real estate owned that remain covered under the terms of the FDIC-sponsored single-family loss-share agreement, has continued a downward trend, reaching 6.3% in YTD 2017, reflecting the local banking sector’s aggressive and steady derisking strategy,” the report said.
When analyzing asset quality by bank, the 90+ days past due nonaccruing ratio of all banks, except Scotia, fluctuated between 4.5% and 6.3% so far in the past year. Scotia has continued to struggle with its delinquent loans reaching a 90+ days past due nonaccruing ratio of 23.9%, a clear outlier among its peers. “Further aggravating this issue is the fact that Scotia has a relatively low reserve-to-nonperforming loan (NPL) ratio. If further economic and fiscal deterioration materializes in the short and medium term, as has been forecasted by local private economists, negatively impacting the jobs market, delinquent loans may begin to creep up,” the report said.
Total Loan Originations
On the other hand, when comparing 2016 against 2005, the report found that total loan originations have dropped by 71% and loan portfolios by 39%. Loan originations have experienced a significant drop since the beginning of the economic downturn in 2006. Total loan originations in 2016 reached $7.2 billion, a decrease of 71%, or $17.3 billion, with respect to 2005. When compared to 2012, the most recent peak, loan originations decreased by 42%, or $5.2 billion. However, the total loans and leases portfolio of the banking sector has decreased at a lower rate: 39% since 2005 and 27% since 2012.
“If the total loan portfolio of the market is brought in line with the current level of loan originations, the profitability of banks would be seriously adversely affected, given its fixed-cost structure and the high margins of loan portfolios compared to investments or cash management. Given the current economic outlook with no clear engines of growth and the tightening of monetary policy through the raising of the Federal Funds Rate, among other factors, it is completely sensible to expect that loan originations will remain subdued going forward.
“Moreover, knowing that another mortgage boom is unlikely to occur in the short and medium term, the loan origination mix will move toward shorter-lived portfolio segments (i.e. consumer and commercial loans), which would ultimately lead to a downsized total loan portfolio,” the report said.