NEW YORK--(BUSINESS WIRE)--Weak economic fundamentals in Puerto Rico and ongoing budgetary challenges for the island's government are likely to weigh on the operating performance and credit profiles of local banks, according to Fitch Ratings.
Economic conditions in Puerto Rico have kept the non-performing assets (NPAs) of banks on the island very high relative to U.S. midtier and community bank peer groups. Combined, the NPA rate of Fitch-rated Puerto Rican banks was 11.9% at the end of 4Q13, compared with 2.5% for mainland peers.
Unemployment in Puerto Rico remains high, running at over 14%. Labor market conditions are restraining recovery potential in the local housing market and worsening the recoveries on defaulted loans. The government's high debt levels, pension funding requirements and still-sluggish growth have exacerbated the banks' challenges.
The core deposit base of the Puerto Rican banks is not sufficient to support local banks' funding requirements. Heavy reliance on non-core funding, particularly brokered CDs and other wholesale sources, could constrain liquidity if economic conditions worsen.
Doral Financial (DRL), which had $1.4 billion in brokered deposits at year end 2013, or 28% of total deposits and 18% of total funding, saw its use of brokered deposits frozen by the FDIC on May 1. The bank must resubmit a revised capital plan to resume access to the brokered deposit market. DRL's IDR was downgraded to 'C' from 'CCC' on May 5.
Maintaining a good measure of stability in the Puerto Rican banks' capital positions is critical to supporting current ratings in light of the poor economic environment. Favorably, most banks' capital positions have improved somewhat over the past two years as a result of equity issuances that have helped to shore up credit quality.
While all of Puerto Rico's banks have suffered from market weakness, DRL entered 2014 as already the weakest of the island's rated banks. The FDIC advised the bank and the Office of Financial Commissions, Puerto Rico's local bank regulator, that it could no longer include some or all of certain tax receivables due from the government of Puerto Rico as part of its Tier 1 capital calculation. The tax receivables, totaling $289 million, account for roughly 43% of DRL's current Tier 1 capital. With the exclusion of these assets, DRL is no longer compliant with its minimum regulatory capital requirement.
For most of Puerto Rico's banks, better profitability will be key in determining whether capital ratios and other financial measures can continue improving in the face of macro headwinds.
For a full analysis of Puerto Rican bank credit profiles, as well as a discussion of the impact that weak economic fundamentals are having on banks' operating environment, see the Fitch special report "Puerto Rican Banks: Difficult Operating Environment Constrains Ratings," dated May 20, 2014, at www.fitchratings.com.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research: Puerto Rican Banks: Difficult Operating Environment Constrains Ratings