Puerto Rico Banking Industry Shows Resilience Despite Pandemic
Stability Index Indicates Strong Liquidity, Solvency
SAN JUAN – The Financial Stability Index (FSI) for Puerto Rico’s banking industry, released locally for the first time by Estudios Técnicos Inc. (ETI) on Thursday, shows that the liquidity and solvency of the island’s financial institutions remain strong despite the headwinds of Covid-19-induced economic upheaval.
The FSI recovered during the fourth quarter of 2020 after declining between the fourth quarter of 2019 and the first quarter of 2020. The index stood at 0.57 for the fourth quarter of 2020, compared to 0.54 in the first quarter of 2020 and 0.64 in the fourth quarter of 2019.
“The index…has been improving in recent quarters, reflecting the strengthening of local banks’ liquidity, largely attributable to the inflow of federal stimulus funds related to the COVID-19 pandemic. The inflow of these funds implies a significant injection of liquidity for local banks,” Leslie Adames, director of the Economic Policy and Analysis Division at ETI, said in a press release.
Graham Castillo, ETI president and chief operating officer, explained that the FSI, developed to measure the financial health of the island’s banking industry, is based on four indicators: liquidity (total loans/deposits), solvency (equity to total assets), asset quality (nonperforming loans/total loans) and profitability (return on assets or ROA).
Castillo highlighted local financial institutions’ strong liquidity, noting that total deposits increased 25% year-over-year to $73.2 billion in the fourth quarter of 2020, while loan balances rose 3.7% from the year before to $39.9 billion. He said this shored up the loan-to-deposit ratio from 65.88% in the fourth quarter of 2019 to 54.58% in the fourth quarter of 2020.
“To receive the pandemic aid, people needed to have a deposit account in a depository institution, something that contributed to the recent upward trend in deposit balances,” the economist said.
Adames concurred with Castillo, affirming that compared to the 2009-2010 period that was part of the Great Recession, and despite the reduction in the number of banks operating on the island from 11 to three, the industry is currently in “a more solid position in terms of capital and liquidity.”
A challenge for the sector is the “compression in net interest margin,” the economist said.
“This compression in margin responds to the low interest rate environment, which is affecting interest spreads and, consequently, the interest income generated from banks’ loan portfolios,” said Adames, who has 24 years’ experience as an economist. He joined ETI in March after having worked for 13 years as an economist for Banco Santander Puerto Rico, where he served as capital planning manager.
“Banks have been deleveraging their balance sheet, that is, their loan portfolio balance has been declining over time, affecting the yield on loan portfolios…. You have a smaller balance and lower interest rates, generating compression in interest margin,” the economist explained, stressing that due to the current economic environment, banks had to implement stricter loan origination policies.
Consequently, banks are taking measures to offset this situation by improving efficiency through a reduction in operating costs and improving processes, Adames said, explaining that the banking index demonstrates that “although the capital to total assets ratio has fallen sequentially since the second quarter of 2019, regulatory capital ratios remained above the minimum required by the Federal Deposit Insurance Corporation (FDIC) to be well-capitalized.”
The industry’s Common Equity Tier 1 was 15.81% and the leverage ratio 8.61% for the fourth quarter of 2020—metrics that are well above the 6.5% and the 5% minimum regulatory threshold, respectively, required by the FDIC—the economist said, noting that “local banks have sufficient capital to absorb potential losses and continue operating as a going concern.”
Castillo added that ETI’s interdisciplinary team of consultants, together with its Data Analytics division, will continue to develop indexes for different sectors of the economy. He said these indicators will be available free of charge. Both the Financial Stability Index of Puerto Rico’s banking industry and the Puerto Rico Economic Indicators Visualizer, which includes the most relevant data for each sector of the economy, can be found at www.estudiostecnicos.com.