Fitch Affirms Popular's Long- & Short-Term IDRs; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) at 'BB-' and Short-term IDRs at 'B' for Popular Inc. (BPOP) and its subsidiaries following Fitch's peer review of Puerto Rican banks. The Rating Outlook is Stable. A full list of rating actions follows at the end of this rating action commentary.

KEY RATING DRIVERS

IDRs, VRs, AND SENIOR DEBT

Fitch-rated Puerto Rican bank VRs and IDRs incorporate limiting rating factors, and current rating levels are indicative of the significant challenges facing Puerto Rican banks. The Puerto Rican bank VRs and IDRs are significantly more sensitive to economic conditions within their main operating market, the Commonwealth of Puerto Rico (PR), and current rating levels incorporate the weak state of the local economy. Although Fitch recognizes that BPOP has been operating under these conditions for a number of years, while continuing to improve performance and strengthen its balance sheet, the prolonged recessionary environment and fiscal challenges of the Commonwealth together could intensify pressure on retail and commercial customers.

In addition, while direct exposure to the Commonwealth and its instrumentalities appears manageable in Fitch's estimation, Fitch remains concerned with the Commonwealth's fiscal situation and potential spill-over effects to the local economy over the medium-to-longer term, especially in light of the Governor of the Commonwealth of Puerto Rico's statements in June regarding the possibility of restructuring numerous debt instruments, including government general obligation (GO) bonds.

Presently, BPOP's VR is higher than Puerto Rico's 'CC' general obligation rating. This reflects Fitch's view that the Commonwealth of Puerto Rico operates broadly within the legal system of the United States and transfer and convertibility risk is not foreseeable, as Puerto Rican banks are regulated by the U.S. Federal Reserve and Federal Deposit Insurance Corporation.

The affirmation of BPOP's ratings and the Stable Outlook reflects Fitch's view that the bank's current operating performance is sustainable and will likely continue during this difficult operating environment. Fitch recognizes improvements to BPOPs core fundamentals such as stabilization of credit, earnings, capital, and deposit funding.

In addition, Fitch recognizes BPOP's solid Dodd Frank Act Stress Testing (DFAST) results, which incorporated severe economic conditions, as well approval to reinstate quarterly dividends in Q3 2015. However, current and expected challenges in Puerto Rico's operating environment limit positive rating momentum at this time.

On a comparative basis, asset quality remains in line with the current rating as the adjusted NPA ratio (which includes 90+ days, accruing restructured loans and excludes FHA covered loans) still remains elevated at 8.88%, and NCOs at 0.81% at 3Q'15 are still much higher than U.S. Mid-Tier peers. Fitch notes that BPOP has taken significant steps to reduce its problem assets including the successful execution of loan sales, which has helped reduce NPAs by approximately $1.7 billion since the peak in 2010. Additionally, BPOP's loan portfolio includes $665 million of covered loans, where risk of loss is largely born by the FDIC.

BPOP has direct exposure of about $635 million to the local government through investment securities, credit facilities to some of the public corporations, and loans to entities related to the government as well as municipalities. Recent market events in Puerto Rico may put pressure on credit performance, but Fitch does not believe that negative pressure on the ratings would likely develop solely related to its direct exposure to the Commonwealth as these appear to be well structured and mostly secured by collateral and/or with specific sources of payment. Further, Fitch has stressed BPOP's Puerto Rico exposure (a 40% writedown for securities and 20% writedown to other direct and indirect exposures) and has concluded the company's ratings could be sensitive to losses approaching this level.

Despite the weak local economy, BPOP has been able to deliver improving results. Core earnings continue on a positive trend with an expectation that ROA, NIM and PPNR-to-average assets will remain in line with current levels, which supports the rating. In particular, Fitch views positively the company's buoyant PPNR-to-average assets ratio has been averaging 1.66% over the past four quarters, which helps to cushion provisioning and its impact to total income. This measure compares favorably to U.S. Mid-Tier peers. Although slow-to-negative economic growth in Puerto Rico may be the norm for some time to come, the company's growth strategy in the U.S., its expectation for rising interest rates in 2016 as well as an improving deposit cost profile could provide a partial offset.

Similar to most peers, BPOP has improved its capital position following the peak of the financial crisis. At 3Q'15, BPOP's TCE stood at 12.65% and Common Equity Tier 1 stood at 16.21%. The company also remains in compliance, by a sizeable margin, with its regulatory order minimum capital ratios. Fitch believes that as the company's core earnings improve, its capital position will continue to be maintained at current levels and support the current risk on the balance sheet.

BPOP's funding profile has historically been weaker when compared to U.S. bank peers given stronger reliance on non-core funding sources. BPOP faces competition for deposits from locally based commercial banks, several U.S. and foreign banks as well as over one-hundred cooperative banks and the Government Development Bank for municipal deposits. However, BPOP has been reducing its reliance on non-core funding sources, particularly higher cost brokered deposits, over the past several quarters, which has both improved the overall stability of its deposit base as well contributed to earnings growth.

Nonetheless, BPOP is not immune to the challenging environment should the recession in Puerto Rico become more pronounced. Also, the company has expanded its consumer assets. Although the Puerto Rico consumer has been resilient considering the current economic environment, further deterioration in economic conditions on the back of a potential fiscal dislocation may put pressure on asset quality and earnings.

SUPPORT RATING AND SUPPORT RATING FLOOR

The Support Rating of '5' and Support Ratings Floor of 'NF' reflect Fitch's view that BPOP is not considered systemically important and therefore, the probability of support is unlikely. The IDRs and VRs do not incorporate any support.

LONG- AND SHORT-TERM DEPOSIT RATINGS

BPOP's uninsured deposit ratings at its subsidiary banks are rated one notch higher than BPOP's IDR and senior unsecured debt rating because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

Hybrid capital instruments issued by BPOP are notched down from the company's VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which may vary considerably.

BPOP's preferred stock and trust preferred stock rating at 'B-' is three notches below its Viability Rating (VR) of 'BB-', in accordance with Fitch's assessment of the instruments' non-performance and loss severity risk profiles for issuers that have VRs rated below 'BB+'.

HOLDING COMPANY

BPOP has 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 the BHC. IDRs and VRs are equalized with those of the 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 the BPOP parent company.

SUBSIDIARY AND AFFILIATED COMPANIES

All of the BPOP entities factor in a high probability of support from the parent. 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.

RATING SENSITIVITIES

IDRs, VRs, AND SENIOR DEBT

Given uncertainty regarding the Puerto Rico's fiscal situation and potential impacts from current exposure, upside is limited in the near term. Positive rating momentum would be predicated on sustained improvement in the Puerto Rico operating environment coupled with modestly improved operating performance.

BPOP's current ratings incorporate the potential for write-downs on its securities holdings and credit exposures to the Commonwealth and its instrumentalities. Fitch has applied loss factors of 40% to securities exposure and 20% for both other direct and indirect exposures in its sensitivity analysis of capital. We believe that capital as measured by tangible common equity-to-tangible assets remains sufficient to absorb these stress losses. However, should market events in the Commonwealth of Puerto Rico actually result in losses approaching this level, or the company's exposure to the Puerto Rican government materially increases, negative pressure on the ratings could develop.

SUPPORT RATING AND SUPPORT RATING FLOOR

The Support Rating and Support Rating Floor are sensitive to Fitch's assumption around capacity to procure extraordinary support in case of need.

LONG- AND SHORT-TERM DEPOSIT RATINGS

The ratings of long- and short-term deposits issued by BPOP subsidiaries are primarily sensitive to any change in the company's IDRs. This means that should a Long-term IDR be downgraded, deposit ratings could be similarly affected.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The ratings of hybrid securities are sensitive to any change in BPOP's VR or to changes in BPOP's propensity to make coupon payments that are permitted but not compulsory under the instruments' documentation.

HOLDING COMPANY

If BPOP became undercapitalized or increased double leverage significantly, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.

SUBSIDIARY AND AFFILIATED COMPANIES

As the IDRs and VRs of the subsidiaries are equalized with those of BPOP to reflect support from their ultimate parent, they are sensitive to changes in the parent's propensity to provide support, which Fitch currently does not expect, or from changes in BPOP's IDRs.

Fitch has affirmed the following ratings:

Popular, Inc.

--Long-term IDR at 'BB-';

--Senior unsecured at 'BB-';

--Short-term IDR at 'B';

--Short-term Debt at 'B'.

--Viability at 'bb-';

--Preferred stock at 'B-';

--Support at '5'

--Support floor at 'NF'.

Popular North America, Inc.

--Long-term IDR at 'BB-';

--Senior unsecured at 'BB-';

--Short-term IDR at 'B';

--Short-term Debt at B

--Viability rating at 'bb-';

--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'.

BanPonce Trust I

--Trust preferred at 'B-'.

Popular Capital Trust I

--Trust preferred at 'B-'.

Popular Capital Trust II

--Trust preferred at 'B-'.

Popular North America Capital Trust I

--Trust preferred at 'B-'.

Popular Capital Trust III

--Trust preferred at 'B-'

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 20 Mar 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863501

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=995312

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995312

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Doriana Gamboa
Director
+1-212-908-0865
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Stefan Kahandaliyanage
Associate Director
+1-646-582-4918
or
Committee Chairperson
Joo-Yung Lee
Managing Director
+1-212-908-1560
or
Media Relations
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Doriana Gamboa
Director
+1-212-908-0865
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Stefan Kahandaliyanage
Associate Director
+1-646-582-4918
or
Committee Chairperson
Joo-Yung Lee
Managing Director
+1-212-908-1560
or
Media Relations
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com