TEXT-Fitch on Puerto Rico banks following peer review
Jan 17 (Reuters) - Fitch Ratings has completed a peer review of four rated Puerto Rican banks. Fitch has affirmed the Long-term Issuer Default Ratings (IDR) of Doral Financial Corp. (DRL) and First BanCorp (FBP) at 'B-'. Fitch has upgraded the Long-term IDR of Popular Inc. (BPOP) to 'BB-' from 'B+', which is now equalized with its bank subsidiaries ratings. The Outlook for BPOP and FBP is Stable.
For Santander Bancorp (SBP), Fitch has affirmed its Viability Rating at 'bb+'. Fitch notes that SBP's IDRs and Rating Outlook are linked with that of its ultimate parent, Banco Santander (based in Spain), and changes in the parent company's ratings result in changes to SBP's. Currently, SBP's Long-term IDRs is 'BBB' with a Negative Outlook. (For additional details, please see 'Fitch Downgrades Santander & BBVA to 'BBB+'/Negative Outlook on Sovereign Action', dated Feb. 13, 2012, and available at www.fitchratings.com.
A full list of rating actions follows at the end of this press release.
RATING ACTION RATIONALE AND RATING DRIVERS AND SENSITIVITIES - VRs and IDRs (applicable to all banks in the peer group)
Fitch-rated Puerto Rican bank Viability Ratings (VRs) and IDRs incorporate limiting rating factors. These VRs and IDRs are significantly more sensitive to the economic conditions within their respective footprints. Given the peer group's concentration in Puerto Rico and the pressures on the local economy, Fitch believes prospects for earnings growth is difficult in the near term. Additionally, this group's funding profiles have generally been weaker compared to its U.S. bank peers. It includes a reliance on non-core deposits, such as brokered certificates of deposit (CDs) time deposits, and wholesale borrowings with a higher cost of funds. Further, non-performing loans (NPLs) are stubbornly high and are reflected in current ratings levels. In Fitch's view, the banks will likely continue to operate with elevated levels of non-performing assets (NPAs), absent loan sales, given pressures in the real estate sector, which has a glut of housing inventory that will likely take a few years to balance out.
Fitch believes current rating levels are indicative of the significant challenges facing Puerto Rican banks. For 3Q'12, Fitch-rated Puerto Rico banks' NPA ratio (which includes TDRs) was 13.19% compared to an average of 3.5% for Fitch-rated Mid-Tier and Community bank peer groups combined. For the group, average net charge-offs (NCOs) totaled 1.90% for 3Q'12, despite the elevated levels of non-performers. Fitch believes NCOs may begin to increase from residential mortgages given the rising delinquency rates in this loan catergory and the increase in foreclosures. In Fitch's view, credit trends reflect the continued stress from the real estate market, particularly commercial real estate (CRE), construction and residential mortgage loans. Fitch notes that Puerto Rican banks' (including those not rated by Fitch) loan mix is heavily weighted towards real estate lending, mainly CRE & construction and residential mortgages, with an average of 32% and 38%, respectively.
Puerto Rican bank funding profiles are considered weaker when compared to those on the U.S. mainland given the higher reliance on noncore funding sources. This characteristic, considered a rating constraint, has been a historical trend as the local market does not have sufficient core deposits to support funding needs. Of note, the peer group's average net interest margin (NIM) was 4.23% for 3Q'12, which is higher than most U.S. banks. This is mainly due to the liability sensitive nature of the balance sheet for most Puerto Rican banks. In a rising rate environment, the NIM would likely be pressured.
Current rating levels incorporate the weak state of the economy in Puerto Rico, which is expected to pressure credit and financial performance over the longer term. The island has been in a recession for seven years with unemployment at 13.6% for 3Q'12 and GNP for 2011 of negative 3.8%. Recent economic trends reflect modest improvements year-over-year. However, much uncertainty remains as to future strategies to address the fiscal and structural issues hurting the local economy. The Stable Outlook reflects the view that any impact from future negative economic weakness would be manageable given the increased capital position across most of the banks, deleveraging of the balance sheet, and modest improvements to liquidity profiles.
Given the challenges noted above, in Fitch's opinion, future consolidation in Puerto Rico may take place as management teams may have more of an incentive to consider M&A as a way to strengthen franchises, improve product diversity, and enhance funding profile to help offset the challenging operating environment.
RATING DRIVERS AND SENSITIVITIES FOR THE IDRS AND VRS OF EACH BANK ARE SUMMARIZED BELOW:
DRL (Long-term IDR/VR 'CCC/ccc')
DRL's ratings affirmation reflects the company's ongoing challenges such as longer-term strategic plans, geographic and product concentration with a limited franchise, and high levels of non-performers. Additionally, DRL's funding profile is much more reliant on wholesale borrowings versus its peers at 35% of total liabilities versus an average of 17% for the peer group. Further, the company's capital position is considered weak and not sufficient to support future losses should NCOs begin to rise from current levels. For 3Q'12, DRL's Fitch Core Capital ratio was 2.17% and Tangible Common Equity (TCE) was 5.43%. During 2012, DRL's capital position trended down.
During 3Q'12, the company reported a net loss as it doubled loan loss provisions compared to the full-year of 2011. Further, Fitch expects credit and capital pressures to persist throughout 2013 that may result in the company needing additional capital as it works through its problem assets. DRL has managed to maintain regulatory capital ratios at well-capitalized as balance sheet shrinkage continues to support capital ratios. However, DRL's Texas ratio defined as NPAs/(TCE + Reserves) is on the high end of most Fitch-rated institutions at above 200% as of Sept. 30, 2012.
The company has the worst rank in terms of NPA at 20.7% for 3Q12 (which includes Troubled Debt Restructurings or TDRs), although reporting a relatively modest NCO ratio of 2.5%. Non-performers are split about 58% related to residential mortgages) and 42% related to CRE & construction loans. On a positive note, on an absolute basis, non-performers are down for 3Q12 to $1.31 billion compared to $1.86 billion the same quarter a year ago. Fitch believes NCOs will likely increase as the real estate sector in Puerto Rico continues to face pressures with high levels of unsold housing inventories and weak economic conditions. NCOs remain manageable up to this point, but well above normalized levels.
Should credit losses and provision expenses trend to levels similar to 2011, Fitch believes DRL could fall below 'well capitalized' status in 2014. DRL's ratings could move lower if regulatory capital ratios are expected to fall into to 'undercapitalized' status. Additionally, deteriorating liquidity or inability to access to funding markets could also place negative rating pressure on the institution.
FBP (Long-term IDR/VR 'B-/b-', Outlook Stable)
FBP's ratings affirmation incorporates the company's geographic concentration in Puerto Rico. Despite some improvements in credit trends compared to 2011, the company is operating with a high level of NPLs and some volatility is expected in NCOS given that 61% of its loan book is tied to real estate in the local market. Further, the loss content in the CRE and construction loan portfolios tends to be higher, which still accounts for about 42% of NPLs. Nonetheless, Fitch does not expect credit losses to return to the peak level experienced in 2010.
Fitch expects profitability to be sustainable at current modest levels, as FBP returned to profitability 2Q'12. The company is focused on improving its franchise by growing its consumer book as it tries to diversify its loan book and customer base. FBP currently ranks 2 in terms of loans with 18.4% in September 2012. During 2012, FBP has seen a steady increase to its pre-provision net revenue, although it is still relatively low. The NIM also improved by 116bps to 3.98% in 3Q12 versus same period a year ago, as the company has benefited from reduced funding costs.
Following a recapitalization in 4Q11, FBP capital is considered solid, as it provides a buffer for potential losses in its loan portfolio and improves its financial flexibility. The company's (TCE) and Tier 1 Common equity ratios improved to 10.39% and 13.33% during 3Q12, respectively, compared to 3.80% and 5.01% for 3Q'11.
Ratings could be positively affected should the improvement in earnings and capital position remain sustainable and/or if nonperforming assets were to materially decline. However, if credit problems continue trending toward peak levels while eroding capital, FBP's ratings would face downward pressure.
Popular Inc. (Long-term IDR/VR upgraded to 'BB-/bb-' from 'B+/b+', Outlook Revised to Stable from Positive)
Popular Inc and Popular North America's (the holding companies) VRs and IDRs have been upgraded and equalized with the bank subsidiary ratings given the improved liquidity position and manageable near-term obligations. Incorporated in the equalization is also the view that the bank subsidiaries will not require capital injections from the parent company.
Prudent liquidity management is important for BPOP given the sizeable amount of total debt outstanding - roughly $1.2 billion of which $935 million is trust preferred securities, including securities issued under the U.S. Treasury's Troubled Assets Relief Program (TARP). The company is currently operating with 2x coverage of its total debt interest expense, which Fitch considers sufficient given manageable near-term debt obligations (about $42 million total maturing in 4Q'12).
Fitch believes the bank's recent operating performance is sustainable despite the difficult operating environment. The company's strong franchise in Puerto Rico is also viewed positively as it holds the number one market share position for loans and deposits by a wide margin at 38% and 40%, respectively. However, current and expected challenges in Puerto Rico's operating environment could limit improvements in the company's financial performance over the near term. BPOP has been profitable since 2011 and capital continues to build. Fitch views BPOP's capital position as adequate (given a still high level of risks) with a TCE of 9.26% and Tier 1 Common of 12.72%. The solid capital base provides a cushion should net losses start to increase.
The company continues to operate with elevated levels of NPAs and NCOs, which totaled 11.6% and 1.80% for 3Q'12, respectively. Fitch notes credit metrics reflect an improvement year-over-year. NPL inflows have slowed compared to the previous year, excluding purchased impaired loans. Nonetheless, BPOP's loan book remains exposed to the pressured real estate conditions as CRE and construction and residential lending account for 55% of total loans.
Positive rating action could ensue should BPOP experience a reduction in level of problem loans while maintaining good earnings trend and build its capital position. Further, the possible removal of regulatory orders with regulators at the holding company and continued liquidity management that is appropriate relative to its debt service could lead to an equalization of the holding company and bank ratings. Offsetting that, the Outlook could be revised to Negative if BPOP's capital position reflected a declining trend and/or a decrease in reserve coverage absent improvement in the level of NPAs.
Santander Bancorp (Long-term IDR/VR 'BBB/bb+', Outlook Negative)
Fitch affirmed SBP's standalone rating, the VR, at 'bb+'. The affirmation is supported by the company's sound operating performance and solid capital position while operating in the challenging Puerto Rican market. Similar to local peers, asset quality remains a challenge.
Although Fitch is concerned with SBP's elevated levels of NPAs at 7.41%, it compares well to local peers with an average NPA of 13.19% at 3Q'12. SBP's loan portfolio exhibits better credit performance due to more conservative underwriting and overall risk management practices (including a relatively low concentration in construction lending). Additionally, given good profitability the company's capital position has remained solid with a TCE ratio at 8.88% for 3Q'12.
Fitch believes there is limited upside to SBP's VR given the concentration in its loan book by product and geography and relatively small franchise. The VR could be negatively affected if loan portfolio quality deteriorates, particularly if significant operating losses emerge and the company's capital position is eroded.
RATING DRIVERS AND SENSITIVITIES - SUPPORT RATING AND SUPPORT FLOOR RATING
DRL, FBP and BPOP have Support Ratings of '5' and Support Floor Ratings of 'NF'. In Fitch's view, the Puerto Rico banks are not systemically important and therefore, Fitch believes the probability of support is unlikely. IDRs and VRs do not incorporate any support.
SBP's Support Rating is '2' reflecting Fitch's view that there is a high probability of support from its parent, Banco Santander. Since this support is based on institutional support, as opposed to sovereign support, there is no Support Floor Rating assigned.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and hybrid capital instruments issued by the banks are notched down from the issuers' VRs in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. The ratings of subordinated debt and hybrid securities are sensitive to any change in the banks' VRs or to changes in the banks' propensity to make coupon payments that are permitted but not compulsory under the instruments' documentation.
HOLDING COMPANY RATING DRIVERS AND SENSITIVITIES
All of the entities reviewed in the Puerto Rican Banks Peer Review Group have a bank holding company (BHC) structure with the bank as the main subsidiary. All subsidiaries are considered core to the parent holding company, supporting equalized ratings between bank subsidiaries and bank holding companies. IDRs and VRs are equalized with those of its operating companies and banks, reflecting its role as the bank holding company which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. Double leverage is below 120% for all the parent companies reviewed in this peer group.
SUBSIDIARY AND AFFILIATED COMPANY RATING DRIVERS AND SENSITIVITIES
All of the entities reviewed in the Puerto Rican Banks Peer Review factor in a high probability of support from parent institutions to its subsidiaries. This reflects the fact that performing parent banks have very rarely allowed subsidiaries to default. It also considers the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults.
Fitch has affirmed the following ratings. Doral Financial Corporation --Long-term Issuer Default Rating (IDR) at 'CCC'; --Viability rating at 'ccc'; --Senior debt at 'CCC/RR6'; --Preferred stock at 'C/RR6'; --Short-term Issuer Default Rating (IDR) at 'C'; --Support '5'; --Support Floor 'NF'; Doral Bank --Long-term IDR at 'CCC'; --Viability rating at 'ccc'; --Long-term deposits at 'CCC/RR4'; --Short-term IDR at 'C'; --Short-term deposit at 'C'. --Support at '5'; --Support Floor at 'NF'; Fitch has affirmed the following ratings. The Outlook is Stable: First BanCorp --Long-term IDR at 'B-'; --Viability rating at 'b-' --Short-term IDR at 'B'; --Support at '5'. --Support floor at 'NF'. FirstBank Puerto Rico --Long-term IDR at 'B-'; --Long-term deposit at 'B-/RR3'; --Viability rating at 'b-'. --Short-term IDR at 'B'; --Short-term Deposits at 'B'. --Market Linked deposit securities at 'B-emr/RR3'; --Support at '5'. --Support floor at 'NF'. Banco Popular North America --Long-term IDR at 'BB-'; --Long-term deposits at 'BB'; --Short-term IDR at 'B'; --Short-term deposits at 'B'. --Viability rating at 'bb-' --Support at '5' --Support floor at 'NF'. Banco Popular de Puerto Rico --Long-term IDR at 'BB-'; --Long-term deposits at 'BB'; --Short-term IDR at 'B'; --Short-term deposits at 'B'; --Viability rating at 'bb-'; --Support at '5' --Support floor at 'NF'. Popular,Inc. --Short-term IDR at 'B'; --Short-term Debt at 'B'. --Support at '5' --Support floor at 'NF'. Popular North America, Inc --Short-term IDR at 'B'; --Short-term Debt at B --Support at '5' --Support floor at 'NF'. Fitch has upgraded the following ratings. The Outlook is revised to Stable from Positive. Popular,Inc. --Long-term IDR to 'BB-' from 'B+'; --Senior unsecured to 'BB-' from 'B+/RR4''; --Viability rating to 'bb-' from 'b+' --Preferred stock to 'B-' from 'CCC/RR6'. Popular North America, Inc. --Long-term IDR to 'BB-' from 'B+'; --Viability rating to 'bb-' from 'b+' BanPonce Trust I --Trust preferred to 'B-' from 'CCC/RR6'. Popular Capital Trust I --Trust preferred to 'B-' from 'CCC/RR6'. Popular Capital Trust II --Trust preferred to 'B-' from 'CCC/RR6'. Popular North America Capital Trust I --Trust preferred to 'B-' from 'CCC/RR6'. Popular Capital Trust III --Trust preferred to 'B-' from 'CCC/RR6' Fitch has affirmed the following ratings: Santander Bancorp --Viability Rating affirmed at 'bb+'; --Support rating at '2'. Banco Santander Puerto Rico --Viability rating at 'bb+'. Santander PR Capital Trust I ----Trust preferred at 'BB'.