SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10 – Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934
POPULAR, INC.
Popular Center Building209 Muñoz Rivera Avenue, Hato ReySan Juan, Puerto Rico 00918
Registrant’s telephone number, including area code (787) 765-9800
Not Applicable
(Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
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TABLE OF CONTENTS
INDEX
Forward-Looking Information. This Quarterly Report on Form 10-Q contains certain forward-looking statements with respect to the adequacy of the allowance for loan losses, the Corporation’s market and liquidity risks and the effect of legal proceedings on Popular, Inc.’s financial condition and results of operations, among others. These forward-looking statements involve certain risks, uncertainties, estimates and assumptions by management. Various factors could cause actual results to differ from those contemplated by such forward-looking statements.
With respect to the adequacy of the allowance for loan losses and market risk, these factors include, among others, the rate of growth in the economy, the relative strength and weakness in the consumer and commercial credit sectors and in the real estate markets, the performance of the stock and bond market and the magnitude of interest rate changes. Moreover, the outcome of litigation, as discussed in “Part II, Item I. Legal Proceedings,” is inherently uncertain and depends on judicial interpretations of law and the findings of judges and juries.
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The accompanying notes are an integral part of these unaudited consolidated financial statements.
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Disclosure of accumulated other comprehensive income:
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Notes to Unaudited Consolidated Financial Statements
Note 1 – Nature of operations and basis of presentation
Popular, Inc. (the Corporation) is a financial holding company offering a full range of financial products and services to consumer and corporate customers through its offices in Puerto Rico, the United States, the Caribbean, including the U.S. and British Virgin Islands, and Central America. The Corporation’s subsidiaries are engaged in the following businesses: commercial banking, auto loans and lease financing, mortgage and consumer lending, broker/dealer activities, retail financial services, insurance agency services and information technology, ATM and data processing services through its subsidiaries in Puerto Rico, the United States, the Caribbean and Central America. Note 14 to the consolidated financial statements presents further information about the Corporation’s business segments.
The consolidated financial statements include the accounts of Popular, Inc. and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. These statements are, in the opinion of management, a fair statement of the results for the periods presented. These results are unaudited, but include all necessary adjustments, of a normal recurring nature, for a fair statement of such results. Certain minor reclassifications have been made to the prior year consolidated financial statements to conform with the 2002 presentation.
Note 2 – Accounting Changes
Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141 “ Business Combinations,” and SFAS No. 142 “Goodwill and Other Intangible Assets.” SFAS No. 141, adopted by the Corporation in 2001, supersedes Accounting Principles Board Opinion (APB) No. 16, “Business Combinations.” The provisions of SFAS No. 141 require that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill, and require that unamortized negative goodwill be written off immediately as an extraordinary gain instead of being deferred and amortized. SFAS No. 141 also requires that upon adoption of SFAS No. 142 the Corporation reclassify the carrying amounts of certain intangible assets into or out of goodwill, based on certain criteria. SFAS No. 142 supersedes APB No. 17, “Intangible Assets,” and is effective for fiscal years beginning after December 31, 2001. SFAS No. 142 primarily addresses the accounting for goodwill and other intangible assets subsequent to their initial recognition. The provisions of SFAS No. 142 repeal the amortization of goodwill and indefinite-lived intangible assets, require that goodwill and indefinite-lived intangible assets be tested at least annually for impairment, require that reporting units be identified for the purpose of assessing potential impairments of goodwill, and remove the forty-year limitation on the amortization period of intangible assets that have definite lives.
The Corporation adopted the provisions of SFAS No. 142 in the first quarter of 2002. Based on the provisions of SFAS No. 142, the Corporation will no longer record amortization relating to existing goodwill. In 2001, the quarterly amortization of goodwill amounted to approximately $4,300.
SFAS No. 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to identify if a potential impairment exists. The second step of the goodwill impairment test measures the amount of the impairment loss (measured as of the beginning of the year of adoption), if any, and must be completed by the end of the entity’s fiscal year. Other intangible assets deemed to have an indefinite life will be tested for impairment using a one-step process which compares the fair value with the carrying amount of the asset as of the beginning of the fiscal year. Any impairment loss resulting from the transitional impairment tests should be reflected as a cumulative effect of a change in accounting principle.
The Corporation completed all transitional impairment tests during the first quarter of 2002, and determined that there are no impairment losses to be recognized in the period as a cumulative effect of accounting change.
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The following table present the reconciliation of reported net income and earnings per share (EPS) (basic and diluted) adjusted to exclude the amortization expense recognized in the period prior to the adoption of SFAS No. 142.
With the adoption of SFAS No. 142, there were no changes to amortization expense on acquired other intangible assets with definite lives.
For further disclosures required by SFAS No. 142, refer to Note 7 to the consolidated financial statements.
Accounting for Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143 “Accounting for Asset Retirement Obligations.” This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. Management understands that the adoption of this statement will not have a material effect on the consolidated financial statements of the Corporation.
Accounting for the Impairment or Disposal of Long-Lived Assets
In January 2002, the Corporation adopted SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” issued by the Financial Accounting Standards Board. This Statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the requirements of Statement 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset. This Statement removes goodwill from its scope and, therefore, eliminates the requirement of Statement 121 to allocate goodwill to long-lived assets to be tested for impairment. Also, the Statement requires that a long-lived asset to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spin-off be considered held and used until it is disposed of. The changes in this Statement improve financial reporting by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. The adoption of this statement did not have a material effect on the consolidated financial statements of the Corporation.
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Rescission of SFAS Statements No. 4, 44, and 64, Amendment of SFAS Statement No. 13, and Technical Corrections
In April 2002, the Financial Accounting Standards Board issued SFAS No. 145 “Rescission of SFAS Statements No. 4, 44, and 64, Amendment of SFAS Statement No. 13, and Technical Corrections.” This Statement rescinds SFAS Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, SFAS Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” This Statement also rescinds SFAS Statement No. 44, “Accounting for Intangible Assets of Motor Carriers.” This Statement amends SFAS Statement No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS No. 145 is effective for transactions occurring after May 15, 2002. The adoption of SFAS No. 145 did not have a material effect on the consolidated financial statements of the Corporation.
Note 3 — Investment Securities Available-For-Sale
The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investments securities where no market quotations are available), and contractual maturities of investment securities available-for-sale as of June 30, 2002, December 31, 2001 and June 30, 2001 were as follows:
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The expected maturities of collateralized mortgage obligations, mortgage-backed securities and certain other securities may differ from their contractual maturities because they may be subject to prepayments.
Stock that is owned by the Corporation to comply with regulatory requirements, such as Federal Reserve Bank and Federal Home Loan Bank stock, is included as equity securities available-for-sale.
Note 4 – Investment securities held-to-maturity
The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investment securities where no market quotations are available), and contractual maturities of investment securities held-to-maturity as of June 30, 2002, December 31, 2001 and June 30, 2001 were as follows:
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Note 5 – Pledged assets
Securities and loans were pledged to secure public and trust deposits, securities sold under agreements to repurchase and other borrowings. The classification and carrying amount of the Corporation’s pledged assets, which the secured parties are not permitted to sell or repledge the collateral were as follows:
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Securities and loans that the creditor has the right by custom or contract to repledge are presented separately in the consolidated statements of condition.
Note 6 – Derivative Instruments and Hedging Activities
In managing its market risk the Corporation enters, to a limited extent, into certain derivatives primarily interest rate swaps, interest rate forwards and future contracts, interest rate caps, swaptions, foreign exchange contracts and interest-rate caps, floors and options embedded in financial contracts.
Futures and forwards are contracts for the delayed delivery of securities in which the seller agrees to deliver on a specified future date, a specified instrument, at a specified price or yield. These contracts qualify for cash flow hedge accounting in accordance with SFAS 133 and therefore changes in the fair value of the derivative are recorded in other comprehensive income. As of June 30, 2002 the total amount (net of tax) included in accumulated other comprehensive income pertaining to forward contracts was an unrealized loss of $466. These contracts have a maximum maturity of 50 days.
To satisfy the needs of its customers, from time to time, the Corporation enters into foreign exchange contracts in the spot or futures market and at the same time into foreign exchange contracts with third parties under the same terms and conditions. As of June 30, 2002, the Corporation included $10 and $10 in other assets and other liabilities, respectively, pertaining to the fair value of these contracts.
The Corporation purchased interest rate caps as part of securitization transactions in order to limit the interest rate payable to the security holders. These contracts qualify for cash flow hedge accounting in accordance with SFAS No. 133, as amended. As of June 30, 2002, the fair market value of these interest rate caps was $4,473 included in other assets and the amount included in accumulated other comprehensive income was a loss of $1,127. These contracts have a maximum maturity of 7.5 years. As part of these contracts, during the second quarter of 2002 the Corporation reclassified a gain of $217 from other comprehensive income into earnings related to the ineffective portion of its hedging instruments.
The Corporation enters into options on swaps (“swaption”) derivative securities, which combine the characteristics of interest rate swaps and options. These swaptions are related to certificates of deposit with returns linked to the Standard and Poor’s 500 index through an embedded option, which has been bifurcated from the host contract, and in accordance with the pronouncement does not qualify for hedge accounting. As of June 30, 2002, the Corporation had a derivative liability of $13,401 representing the fair value of the swaptions, which is included in other liabilities. Also, a derivative liability of $8,493 which is the fair value of the embedded option and a discount on the certificates of deposits of $19,011 are included in deposits.
The Corporation uses interest rate swaps to convert floating rate debt to fixed rate debt in order to fix the future cost of the portfolio of short-term borrowings. The specific term and notional amounts of the swaps are determined based on management’s assessment of future interest rates, as well as other factors. These swaps do not qualify as hedges in accordance with SFAS No. 133, as amended, and therefore changes in fair value of the derivatives are recorded in the statement of income. For the quarter ended June 30, 2002, the Corporation recognized a loss of $855 as a result of the changes in fair value of the non-hedging derivatives.
The interest-rate caps and floors embedded in the interest bearing contracts are clearly and closely related to the economic characteristics of the contract and therefore, as stated in SFAS No. 133, are not bifurcated from the host contract.
Note 7 – Goodwill and Other Intangible Assets
SFAS No. 142 requires that goodwill and other indefinite live intangible assets be tested for impairment at least annually using a two-step process at each reporting unit level. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not
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considered impaired, thus the second step of the impairment test is unnecessary. If needed, the second step consists in comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The Corporation uses the expected present value of future cash flows and market price multiples of comparable companies to determine the fair value of each reporting unit. The cost of equity used to discount the cash flows was calculated using the Capital Asset Pricing Model.
The Corporation’s management has defined the reporting units based on legal entity, which is the way that operating decisions are made and performance is measured. For presentation purposes, these reporting units have been aggregated by reportable segments based on the provisions of SFAS No. 131 “Segment Reporting.” These segments have been defined as follows: Commercial Banking, Mortgage and Consumer Lending, Auto and Lease Financing and Other. All the operating segments and components that constitute reporting units were determined evaluating the nature of the products and services offered, types of customers, methods used to distribute their products and provide their services, and the nature of their regulatory environment, as well as other similar economic characteristics. Goodwill is assigned to each reporting unit at the time of acquisition, since the Corporation records the intangibles originated in the acquisition on the books of the entity acquired by using the practice of push down accounting.
The changes in the carrying amount of goodwill for the six-months ended June 30, 2002, are as follows:
As of June 30, 2002, December 31, 2001 and June 30, 2001, goodwill totaled $178,739, $177,842 and $185,108, respectively. The Corporation has no other intangible assets not subject to amortization. Goodwill written-off during the quarter ended June 30, 2002 is related to various branches of Popular Finance sold during this quarter.
The following table reflects the components of other intangible assets subject to amortization as of June 30, 2002, December 31, 2001 and June 30, 2001:
During the quarter ended June 30, 2002, the Corporation recognized $2,556 in amortization expense related to other intangible assets with definite lives. This expense totaled $2,527 for the quarter ended June 30, 2001, excluding the effect of goodwill amortization. For the six months ended June 30, 2002 and 2001, the Corporation recognized $5,099 and $5,049, respectively, in amortization expense related to other intangible assets with definite lives.
The credit-based customer relationships were fully amortized during the quarters ended June 30, 2002.
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The following table presents the estimated aggregate amortization expense of the intangible assets with definite lives that the Corporation has as of June 30, 2002, for each of the following fiscal years:
No significant events or circumstances have occurred that would reduce the fair value of any reporting unit below its carrying amount.
Note 8 – Commitments and Contingencies
In the normal course of business there are letters of credit outstanding and stand-by letters of credit which, at June 30, 2002, amounted to $11,972 and $87,356, respectively (June 30, 2001 — $9,182 and $112,959; December 31, 2001 — $16,846 and $87,810). There are also other commitments outstanding and contingent liabilities, such as guarantees and commitments to extend credit, which are not reflected in the accompanying financial statements.
As of June 30, 2002, the Corporation has an outstanding commitment, entered into during 2001, to purchase $100,000 of mortgage loans from another institution with the option of purchasing $75,000 in additional loans. The commitment expires on June 30, 2003. As of June 30, 2002, $75,000 in loans have been purchased under this agreement.
The Corporation is a defendant in a number of legal proceedings arising in the normal course of business. Management believes, based on the opinion of legal counsel, that the final disposition of these matters will not have a material adverse effect on the Corporation’s financial position or results of operations. Refer to Item 1 — Legal Proceedings on Part II — Other Information on Form 10-Q for further information.
Note 9 – Stock Option Plan
The Corporation has a Stock Option Plan (the Plan) since 2001, which permits the granting of incentive awards in the form of qualified stock options, incentive stock options, or non-statutory stock options of the Corporation. Any employee or director of the Corporation or of any of its subsidiaries is eligible to participate in the Plan. The selection of individuals eligible to participate is within the discretion of the Board of Directors, or an appointed committee. The Plan provides for the issuance of Popular, Inc.’s common stock at a price equal to its fair market value at the date of grant, subject to certain Plan provisions. The aggregate number of shares of common stock, which may be issued under the Plan, is limited to 5,000,000 shares, subject to adjustment for stock splits, recapitalizations and similar events. The shares are to be made available from authorized but unissued shares of common stock or treasury stock. The maximum option term is generally ten years from the date of grant. Unless an option agreement provides otherwise, all options granted are 20% exercisable after the first year and an additional 20% is exercisable after each subsequent year. The exercise price of each option is equal to the market price of the Corporation’s stock on the date of grant.
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The following table summarizes information about stock options outstanding at June 30, 2002:
There were no stock options exercisable during 2001.
The following table summarizes the stock option activity and related information:
No compensation cost was recognized during the period ended June 30, 2002 and 2001 since the exercise price of the stock options equals the market price of the stock on the date of grant. Had the Corporation elected to recognize compensation cost for options granted in 2002 and 2001, consistent with the fair value method of accounting of SFAS No. 123, “Accounting for Stock-Based Compensation”, the pro forma net income and pro forma earnings per share would have been as follows:
The fair value of these options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The weighted-average assumptions used for the grants issued during 2002 were the following: an expected dividend yield of 2.14%, an average expected life of options of 10 years, an expected volatility of 26.54% and a risk-free interest rate of 4.96%. The weighted-average fair value of options granted during 2002 was $9.81 per option.
Subordinated notes of $125,000 consist of notes issued by the Corporation on December 12, 1995, maturing on December 15, 2005, with interest payable semi-annually at 6.75%.
On February 5, 1997, BanPonce Trust I, a statutory business trust created under the laws of the State of Delaware that is wholly-owned by Popular North America, Inc. (PNA) and indirectly wholly-owned by the Corporation, sold to institutional investors $150,000 of its 8.327% Capital Securities Series A (liquidation amount $1,000 per Capital Security) through certain underwriters. The proceeds of the issuance, together with the proceeds of the purchase
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by PNA of $4,640 of its 8.327% common securities (liquidation amount $1,000 per common security) were used to purchase $154,640 aggregate principal amount of PNA 8.327% Junior Subordinated Deferrable Interest Debentures, Series A (the “Junior Subordinated Debentures”). As of June 30, 2002, the Corporation had reacquired $6,000 of the capital securities. The capital securities qualify as Tier 1 capital, are fully and unconditionally guaranteed by the Corporation, and are presented in the Consolidated Statements of Condition as “Preferred Beneficial Interests in Popular North America’s Junior Subordinated Deferrable Interest Debentures Guaranteed by the Corporation.” The obligations of PNA under the Junior Subordinated Debentures and its guarantees of the obligations of BanPonce Trust I are fully and unconditionally guaranteed by the Corporation. The assets of BanPonce Trust I consisted of $152,817 of Junior Subordinated Debentures at June 30, 2002 (June 30, 2001 — $154,640; December 31, 2001 — $154,640) and a related accrued interest receivable of $4,177 (June 30, 2001 — $4,292; December 31, 2001 — $4,292). The Junior Subordinated Debentures mature on February 1, 2027; however, under certain circumstances, the maturity of the Junior Subordinated Debentures (which shortening would result in a mandatory redemption of the Capital Securities) may be shortened.
Note 11- Stockholders’ Equity
Authorized common stock is 180,000,000 shares with a par value of $6 per share. At June 30, 2002, there were 138,945,303 (June 30, 2001 — 138,567,996; December 31, 2001 — 138,749,647) shares issued and 132,251,194 (June 30, 2001 — 136,180,713; December 31, 2001 — 136,362,364) shares outstanding. As of June 30, 2002, a total of 6,694,109 (June 30, 2001 — 2,387,283; December 31, 2001 — 2,387,283) common shares with a total cost of $205,210 (June 30, 2001 — $66,136; December 31, 2001 — $66,136) were maintained as treasury stock. In May 2002, the Corporation repurchased 4,300,000 shares of its common stock from Banco Popular de Puerto Rico Retirement Plan, at a cost of $139 million.
As of December 31, 2001, the Corporation had 4,000,000 shares issued and outstanding of its 8.35% noncumulative monthly income Series A preferred stock. Effective January 22, 2002, the Corporation redeemed the 4,000,000 shares outstanding of preferred stock at a redemption price of $25.6276 per share, which consisted of the redemption price of $25.50 plus an amount representing accrued and unpaid dividends for the current monthly dividend period up to, but excluding, the redemption date. The redemption price paid by the Corporation, excluding dividends, exceeded the liquidation preference value by $2,000 or $0.50 per share.
Note 12 — Earnings per Common Share
A computation of earnings per common share follows:
Potential common shares consist of common stock issuable under the assumed exercise of stock options granted under the Corporation’s stock option plan, using the treasury stock method.
Options with an exercise price greater than the average market price of the Corporation’s common stock are antidilutive and, therefore, are not included in the computation of diluted earnings per common share. During the second quarter and six-months ended June 30, 2002 there were 7,520 antidilutive stock options outstanding with an exercise price of $34.87.
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For the quarter and six months ended June 30, 2001 all stock options outstanding were included in the computation of diluted earnings per common shares.
Note 13 — Supplemental Disclosure on the Consolidated Statements of Cash Flows
During the six-month period ended June 30, 2002, the Corporation paid interest and income taxes amounting to $423,980 and $72,245, respectively (2001 — $580,503 and $46,976). In addition, the loans receivable transferred to other real estate and other property for the six-month period ended June 30, 2002 amounted to $20,192 and $16,184, respectively (2001 — $18,404 and $15,028).
Note 14 — Segment Reporting
Popular, Inc. operates three major reportable segments: commercial banking, mortgage and consumer lending, and auto and lease financing. Management has determined its reportable segments based on legal entity, which is the way that operating decisions and performance is measured. These entities have then been aggregated by products, services and markets with similar characteristics.
The Corporation’s commercial banking segment includes all banking subsidiaries, which provide individuals, corporations and institutions with commercial and retail banking services, including loans and deposits, trust, mortgage banking and servicing, asset management, credit cards and other financial services. These services are offered through a delivery system of branches throughout Puerto Rico, the U.S. and British Virgin Islands and the United States.
The Corporation’s mortgage and consumer lending segment includes those non-banking subsidiaries whose principal activity is originating mortgage and consumer loans such as Popular Mortgage, Popular Finance, Equity One and Levitt Mortgage.
The Corporation’s auto and lease financing segment provides financing for vehicles and equipment through Popular Auto, Inc. in Puerto Rico and Popular Leasing, USA in the U.S. mainland. The “Other” category includes all holding companies and non-banking subsidiaries which provide insurance agency services, retail financial services, broker/dealer activities, as well as those providing ATM processing services, electronic data processing and consulting services, sale and rental of electronic data processing equipment and selling and maintenance of computer software.
The accounting policies of the segments are the same as those followed by the Corporation in the ordinary course of business and conform with generally accepted accounting principles and with general practices within the financial industry. Following are the results of operations and selected financial information by operating segments for the quarters and six-months ended June 30, 2002 and 2001.
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The following condensed consolidating financial information presents the financial position of Popular, Inc. Holding Company (PIHC), Popular International Bank, Inc. (PIBI), Popular North America, Inc. (PNA) and all other subsidiaries of the Corporation as of June 30, 2002, December 31, 2001 and June 30, 2001, and the results of their operations and cash flows for periods ended June 30, 2002 and 2001. PIBI, PNA, and their wholly-owned subsidiaries, except Banco Popular North America (BPNA) and Banco Popular, National Association (BP, N.A.), have a fiscal year that ends on November 30. Accordingly, the consolidated financial information of PIBI and PNA as of May 31, 2002, November 30, 2001 and May 31, 2001, corresponds to their financial information included in the consolidated financial statements of Popular, Inc. as of June 30, 2002, December 31, 2001 and June 30, 2001, respectively.
PIHC, PIBI and PNA are authorized issuers of debt securities and preferred stock under various shelf registrations filed with the SEC.
PIBI is an operating subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries, ATH Costa Rica, CreST, S.A., Popular Insurance, V.I., Inc. and PNA.
PNA is an operating subsidiary of PIBI and is the holding company of its wholly-owned subsidiaries, Popular Cash Express, Inc., Equity One, Inc., BPNA, including its wholly-owned subsidiary Popular Leasing, U.S.A., and Popular Insurance, U.S.A.; and BP, N.A., including its wholly-owned subsidiary Popular Insurance, Inc. PIHC fully and unconditionally guarantees all registered debt securities and preferred stock issued by PIBI and PNA. The principal source of cash flows for PIHC consists of dividends from BPPR.
As a member subject to the regulations of the Federal Reserve Board, BPPR must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared by it in any calendar year would exceed the total of its net profits for that year, as defined by the Federal Reserve Board, combined with its retained net profits for the preceding two years. The payment of dividends may also be affected by other regulatory requirements and policies, such as the maintenance of certain minimum capital levels. At June 30, 2002, BPPR could have declared a dividend of approximately $96,493 without the approval of the Federal Reserve Board.
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONAS OF JUNE 30, 2002(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONDECEMBER 31, 2001(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CONDITIONJUNE 30, 2001(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE QUARTER ENDED JUNE 30, 2002(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE QUARTER ENDED JUNE 30, 2001(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE SIX MONTHS ENDED JUNE 30, 2002(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF INCOMEFOR THE SIX MONTHS ENDED JUNE 30, 2001(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFOR THE PERIOD ENDED JUNE 30, 2002(UNAUDITED)
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POPULAR, INC.CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFOR THE PERIOD ENDED JUNE 30, 2001(UNAUDITED)
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TABLE AItem 2. Management’s Discussion and Analysis of Financial Condition and Results of OperationsFinancial Highlights
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This financial review contains an analysis of the consolidated financial position and financial performance of Popular, Inc. and its subsidiaries (the Corporation). All accompanying tables, financial statements and notes included elsewhere in this report should be considered an integral part of this analysis. The Corporation is a financial holding company which offers a wide range of products and services to consumer and corporate customers in Puerto Rico, the United States, the Caribbean and Central America. The Corporation’s subsidiaries are engaged in the following businesses:
NET INCOME
The Corporation reported net income of $96.3 million for the second quarter of 2002, compared with $77.5 million for the same quarter in 2001. Basic and diluted earnings per common share (EPS) for the quarter were $0.72, compared with $0.55 in the second quarter of 2001. Refer to Note 12 to the consolidated financial statements for a detail of the average shares used in the computation of basic and diluted EPS. Net earnings for the first quarter of 2002 were $89.0 million or $0.63 per common share, basic and diluted. Return on assets (ROA) and return on common equity (ROE) for the quarter ended June 30, 2002 were 1.23% and 18.14%, respectively, compared with 1.14% and 15.36% for the same period in 2001. For the first quarter of 2002 these ratios were 1.19% and 16.83%.
The Corporation’s results of operations for the quarter ended June 30, 2002 reflected an increase of $29.2 million in net interest income and $14.8 million in other income, excluding derivatives, compared with the same quarter in 2001. These improvements were partially offset by rises of $16.7 million in operating expenses and $5.3 million in income taxes. Derivative losses for the quarter amounted to $0.9 million compared with gains of $1.7 million for the same quarter in 2001. The results for this quarter benefited from the reduction of $4.3 million in the amortization of goodwill when compared with the quarter ended June 30, 2001, associated with the adoption in year 2002 of SFAS No. 142 “Goodwill and Other Intangible Assets.”
For the six months ended June 30, 2002, the Corporation’s net income rose to $185.3 million, compared with $151.8 million for the same period in 2001. Basic and diluted EPS for the first six months of 2002 and 2001 were $1.35 and $1.08, respectively. ROA and ROE for the six-month period ended June 30, 2002 were 1.21% and 17.43%, respectively. For the same period in 2001, these ratios were 1.12% and 15.31%.
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CRITICAL ACCOUNTING POLICIES
For a summary of the Corporation’s Critical Accounting Policies, refer to that particular section in the Management Discussion and Analysis included in Popular, Inc.’s 2001 Financial Review and Supplementary Information to Stockholders, incorporated by reference in Popular, Inc.’s Annual Report on Form 10-K. Also, refer to Note 1 to the consolidated financial statements included in said report for a summary of the Corporation’s significant accounting policies. There were no new critical accounting policies or any changes to existing ones during 2002.
NET INTEREST INCOME
Net interest income for the quarter ended June 30, 2002 rose $29.2 million to $294.7 million, an increase of 11% over the second quarter of 2001. On a taxable equivalent basis, net interest income increased to $319.2 million from $285.1 million in the same quarter of 2001.
The improvement of $34.1 million in net interest income, on a taxable equivalent basis, from the second quarter of 2001 resulted from a $23.1 million increase due to a higher volume of earning assets and an $11.0 million increase due to higher spreads.
Table B presents the different components of the Corporation’s net interest income for the second quarter of 2002, as compared with the same quarter in 2001 segregated by major categories of earning assets and interest bearing liabilities. Some of the assets, mostly investments in obligations of the U.S. Government and the Puerto Rico Commonwealth and its agencies, generate interest, which is exempt for income tax purposes, principally in Puerto Rico. Therefore, to facilitate the comparison of all interest data related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates.
Earning assets increased in average by $4.1 billion due to higher average loan volume of $1.7 billion, mainly mortgage loans, and a $2.4 billion increase in the average volume of money market, trading and investment securities.
The increase in mortgage loans was principally achieved through our consumer and mortgage-banking subsidiary, Equity One, as well as from higher mortgage loan activity in Puerto Rico. The commercial loan portfolio increased in average by $212 million compared with the second quarter of 2001. On the other hand, consumer loans decreased by $156 million, mostly related to the lower demand for personal loans and to the shifting of consumer credit to mortgage credit.
The average yield on earning assets, on a taxable equivalent basis, declined 134 basis points from 8.47% for the second quarter of 2001 to 7.13% for the second quarter of 2002. The reduction is attributed to the lower interest rate scenario, resulting from the Federal Reserve easing cycle, that prevailed during the year 2001. Commercial loans experienced the largest impact due to the floating rate characteristics of a portion of the portfolio and the origination of new loans in the lower rate environment. As of June 30, 2002, approximately 50% of the Corporation’s commercial and construction loans portfolio had floating or adjustable rates. The decrease in yield in this category for the quarter ended June 30, 2002 amounted to 171 basis points, compared with the same quarter in 2001. Furthermore, the average yield on the investment portfolio decreased by 151 basis points, due to the increase in volume of the portfolio, and to the maturities of securities with higher yields that were replaced, during a lower interest rate scenario.
The increase of $3.9 billion in the average balance of interest-bearing liabilities for the second quarter of 2002, as compared with the same quarter in 2001, was partly due to higher average levels of interest-bearing deposits. NOW and money market accounts and savings deposits increased in average by $588 million and $571 million, respectively, while time deposits increased by $393 million. Within the latter category, brokered deposits increased by $64 million.
Average short-term borrowings, comprised mostly of Fed funds, repurchase agreements and commercial paper, increased by $598 million or 9% in the second quarter of 2002, compared with the same quarter last year, while
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longer-term borrowings increased by $1.8 billion or 70%. The increase in long-term debt, which is debt with an original maturity of more than one year, was principally due to the issuance of medium term notes and secured borrowings arising in securitization transactions. The shift in the composition of debt primarily results from the extension of the duration of the Corporation’s borrowings to reduce future interest rate risk, as the Corporation is positioning itself against the event of a rising rate scenario.
TABLE BANALYSIS OF LEVELS & YIELDS ON A TAXABLE EQUIVALENT BASISQuarter ended June 30,
Note: The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of the change in each category.
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The Corporation’s net interest margin, on a taxable equivalent basis, for the second quarter of 2002 was 4.28%, resulting in a 16 basis points reduction from 4.44% in the same quarter of 2001. The net interest margin for the first quarter of 2002 was 4.29%. The decrease resulted mostly from the higher level of arbitrage activities on which the Corporation earns a lower margin, and the impact of the declining interest rate scenario during the second half of 2001, on commercial loans with floating rates and on the investment portfolio. In addition, the redemption and repurchase of capital stock since December 31, 2001, also had an impact on the net interest margin, since these funds do not carry an interest cost. Notwithstanding the above, the Corporation’s spread, which is the difference between the yield on earning assets and the cost of interest-bearing liabilities, improved by 12 basis points.
For the six-month period ended June 30, 2002, net interest income, on a taxable equivalent basis, rose $68.6 million, or 12%, compared with the same period of 2001. The improvement resulted from a $42.1 million increase due to a higher average volume of earning assets and a $26.5 million increase due to a higher net interest spread.
TABLE CANALYSIS OF LEVELS & YIELDS ON A TAXABLE EQUIVALENT BASISPeriod ended June 30
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As shown in Table C, average earning assets increased by $3.4 billion for the six-month period ended June 30, 2002, compared with an average of $25.9 billion in the same period of 2001. This increase was derived mainly from a higher mortgage loan portfolio and investment activities, which were funded mainly through interest-bearing deposits and long-term borrowings. Interest-bearing liabilities for the six months ended June 30, 2002 increased in average by $3.2 billion compared with the same period of 2001.
The net interest margin, on a taxable equivalent basis, for the six-month period ended June 30, 2002 was 4.29% compared with 4.33% for the same period in 2001.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
For the second quarter of 2002 the provision for loan losses amounted to $50.1 million, compared with $49.5 million for the same period in 2001, an increase of $0.6 million. The provision for loan losses represented 109% of net charge-offs for the quarter ended June 30, 2002 and 119% for the same quarter in 2001. For the six-month period ended June 30, 2002, the provision for loan losses amounted to $104.5 million, an increase of $5.0 million or 5% compared with $99.5 million for the same period in prior year.
The provision for loan losses reflects management’s assessment of the adequacy of the allowance for loan losses to cover probable losses in the loan portfolio after taking into account loan impairment and net charge-offs for the current period. Management’s review of quantitative factors and qualitative factors affecting the performance of the credit portfolio results in the final determination of the provision for loan losses intended to maintain an adequate level of allowance for loan losses. In determining the allowance, management considers the portfolio risk characteristics, the results of periodic credit reviews of individual loans, the value of the collateral, prior loss experience, current economic conditions and loan impairment measurements, among other factors. The adequacy of the allowance for loan losses is evaluated on a monthly basis.
The methodology used to establish the allowance for loan losses is based on SFAS No. 114 “Accounting by Creditors for Impairment of a Loan,” and SFAS No. 5 “Accounting for Contingencies.” Under SFAS No. 114, certain commercial loans are identified for evaluation on an individual basis, and specific reserves are calculated based on impairment. SFAS No. 5 provides for the recognition of a loss allowance for a group of homogeneous loans when it is probable that a loss has been incurred and the amount can be reasonably estimated.
The allowance for loan losses amounted to $347 million as of June 30, 2002, or 1.84% of loans, compared with $313 million or 1.82% at the same date in 2001. At December 31, 2001, the allowance for loan losses totaled $337 million or 1.85% of loans. The Corporation’s management considers the allowance for loan losses to be at a level sufficient to provide for estimated losses based on current economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses. For more information regarding the allowance for loan losses and asset quality refer to the Credit Quality section.
The Corporation has defined impaired loans as loans with interest and/or principal past due 90 days or more and other specific loans for which, based on current information and events, it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. Loan impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective rate, on the observable market price of the loan, or on the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment based on past experience adjusted for current conditions. Larger balance commercial loans are evaluated on a loan-by-loan basis. Once a specific measurement methodology is chosen for evaluating a loan, it is consistently applied unless there is a significant change in the financial position of the borrower. An impaired loan for which the discounted cash flows, collateral value or market price is less than its carrying value requires an allowance. The allowance for impaired loans is part of the Corporation’s overall allowance for loan losses.
The following table shows the Corporation’s recorded investment in impaired loans and the related valuation allowance calculated under SFAS No. 114 (as amended by SFAS No. 118) at June 30, 2002, December 31, 2001 and June 31, 2001.
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Average impaired loans during the second quarter of 2002 and 2001 were $144 million and $175 million, respectively. The Corporation recognized interest income on impaired loans of $0.7 million and $1.0 million for the quarters ended June 30, 2002 and 2001, respectively.
Table D summarizes the movement in the allowance for loan losses and presents several loan loss statistics for the quarters and six months ended June 30, 2002 and 2001. Net charge-offs for the quarter ended June 30, 2002 were $45.8 million or 0.99% of average loans, compared with $41.7 million or 0.99% for the second quarter of 2001. Net charge-offs for the six months ended June 30, 2002 were $95.5 million or 1.05% of average loans, compared with $77.8 million or 0.94% for the same period in 2001.
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TABLE DAllowance for Loan Losses and Selected Loan Losses Statistics
Mortgage loans net charge-offs amounted to $3.5 million for the quarter ended June 30, 2002, compared with $2.0 million for the same quarter in prior year, an increase of $1.5 million or 73%, mainly as a result of the growth in the portfolio. These net charge-offs represented 0.20% of the average mortgage loan portfolio for the quarter ended June 30, 2002, compared with 0.15% in the second quarter of 2001. Mortgage loans net charge-offs reached $5.8 million for the six months ended June 30, 2002, compared with $3.4 million for the same period in 2001. Mortgage loans net charge-offs represented 0.17% of the average mortgage loan portfolio for the six months ended June 30, 2002, compared with 0.14% in the first half of 2001.
Lease financing net charge-offs increased $2.4 million for the quarter ended June 30, 2002, compared with the same period in prior year. These net charge-offs totaled $4.5 million or 2.08% of the average lease financing portfolio for the quarter ended June 30, 2002, compared with $2.2 million or 1.03% for the same period in 2001.
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This increase is mostly related to higher delinquencies. Lease financing net charge-offs totaled $9.7 million for the six-month period ended June 30, 2002, representing 2.23% of the average lease financing portfolio, compared with $7.1 million or 1.71% for the same period in 2001.
Commercial and construction loans net charge-offs amounted to $17.5 million or 0.92% of the average balance of those loans for the quarter ended June 30, 2002, compared with $17.3 million or 0.93% for the same quarter last year. For the six months ended June 30, 2002 these net charge-offs reached $40.1 million, compared with $28.8 million for the same period in 2001. As a percentage of average commercial and construction loans, these net credit losses rose from 0.78% in the six-month period ended June 30, 2001 to 1.05% for the same period in the current year. This latter rise in commercial loans net charge-offs was mostly related to the growth in the commercial loan portfolio, as well as the charge-off of commercial loans, including a $3.7 million charge-off on a particular loan pertaining to Kmart, sold at a discount during the first quarter of 2002, and a $7 million charge-off in the second quarter of a commercial loan in our Puerto Rico operations pertaining to a client who filed for bankruptcy.
Consumer loans net charge-offs for the quarters ended June 30, 2002 and 2001 totaled $20.2 million, and represented 2.62% and 2.49% of the average consumer loan portfolio at each respective date. Consumer loans net charge-offs amounted to $40.0 million for the six months ended June 30, 2002, an increase of $1.6 million from $38.4 million in the same period of 2001. They represented 2.58% and 2.35% of the average consumer loan portfolio for the six-month periods ended June 30, 2002 and 2001, respectively. The increase in consumer net charge-offs from 2001 was mostly related to higher delinquencies in the credit card portfolio.
CREDIT QUALITY
Non-performing assets consist of past-due loans that are no longer accruing interest, renegotiated loans and real estate property acquired through foreclosure. A summary of non-performing assets by loan categories and related ratios is presented in Table E.
TABLE ENon-Performing Assets
The Corporation places commercial loans on non-accrual status if payments of principal or interest are delinquent 60 days or more rather than the standard industry practice of 90 days. Financing leases, conventional mortgages and close-end consumer loans are placed on non-accrual status if payments are delinquent 90 days. Closed-end consumer loans are charged-off when payments are delinquent 120 days, while open-end (revolving credit) consumer loans are charged-off when payments are delinquent 180 days. Under the standard industry practice, close-end consumer loans are charged-off when delinquent 120 days, but are not customarily placed on non-accrual status prior to being charged-off. Certain loans, which would be treated as non-accrual loans pursuant to the foregoing policy, are treated as accruing loans if they are considered well-secured and in the process of collection. Loans past due 90 days or more and still accruing are not considered as non-performing loans.
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Unsecured retail loans to borrowers who file for bankruptcy are charged-off within 60 days of receipt of notification of filing from the bankruptcy court.
At June 30, 2002, non-performing assets were $502 million or 2.66% of ending loans, compared with $383 million or 2.23% at the same date last year and $458 million or 2.52% at December 31, 2001. The increase in non-performing assets since June 30, 2001 and December 31, 2001 was mostly reflected in mortgage loans, which rose by $102 million and $44 million, from each respective date, principally as a result of the growth in the loan portfolio and higher delinquency rates. Non-performing mortgage loans were $221 million or 44% of non-performing assets and 3.10% of total mortgage loans as of June 30, 2002, compared with $119 million or 31% of non-performing assets and 2.12% of total mortgage loans as of June 30, 2001. At the end of 2001, non-performing mortgage loans were $177 million or 39% of non-performing assets and 2.72% of total mortgage loans. Historically, the Corporation has experienced a low level of losses in its mortgage portfolio, both in the U.S. mainland and Puerto Rico.
At June 30, 2002, commercial non-performing loans, including construction, reflected increases of $13 million and $1 million when compared with June 30, 2001 and December 31, 2001, respectively. Non-performing commercial and construction loans represented 2.58% of the total commercial and construction loan portfolio as of June 30, 2002, compared with 2.50% and 2.59% at June 30, 2001 and December 31, 2001, respectively. The increase since June 30, 2001 was principally due to the economic slowdown that has prevailed since mid 2001 and the growth of $242 million in the portfolio since June 30, 2001.
Non-performing consumer loans amounted to $37 million or 1.16% of consumer loans as of June 30, 2002, compared with $36 million or 1.12% as of June 30, 2001, and $41 million or 1.31% as of December 31, 2001.
Non-performing financing leases amounted to $10 million or 1.11% of the lease financing portfolio as of June 30, 2002, compared with $11 million or 1.34% as of June 30, 2001 and $10 million or 1.20% as of December 31, 2001.
Other real estate amounted to $35 million as of June 30, 2002, an increase of $6 million and $4 million compared with June 30, 2001 and December 31, 2001, respectively. The increase was related to the growth in the mortgage loan portfolio and higher delinquencies in the housing sector.
At June 30, 2002, the allowance for loan losses as a percentage of non-performing loans was 74.31% compared with 88.56% at June 30, 2001 and 78.88% at December 31, 2001. The lower allowance to non-performing loans ratio reflects the changing composition of the loan portfolio, as most of its growth was realized in mortgage loans, which historically has represented a low-risk portfolio with minimal losses. Mortgage loans comprised 88% of total loan growth since June 30, 2001. The Corporation, based on historical experience and current economic conditions, does not foresee significant losses in the mortgage portfolio. Excluding non-performing mortgage loans, the total allowance for loan losses to non-performing loans was 140.94% as of June 30, 2002, compared with 133.34% and 134.76% as of June 31, 2001 and December 31, 2001, respectively.
Assuming the standard industry practice of placing commercial loans on non-accrual status when payments of principal and interest are past due 90 days or more and excluding the closed-end consumer loans from non-accruing, the Corporation’s non-performing assets as of June 30, 2002 would have been $434 million or 2.30% of loans, and the allowance for loan losses would have been 86.99% of non-performing loans. At June 30, 2001 and December 31, 2001, adjusted non-performing assets would have been $313 million or 1.82% of loans and $389 million or 2.14% of loans, respectively, and the allowance to non-performing loans would have been 110.22% and 94.21%, respectively.
OPERATING INCOME
Operating income, excluding derivatives, securities and trading transactions, reached $136.1 million for the second quarter of 2002, increasing $12.1 million or 10%, compared with $124.0 million for the same quarter in 2001. Refer to Table F for a detail of operating income by its major categories.
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TABLE F
Service charges on deposit accounts rose to $39.5 million for the quarter ended June 30, 2002, contributing with a rise of $3.2 million or 9% compared with $36.3 million for the same quarter in 2001. This increase was primarily the result of higher commercial account charges, and new charges implemented during mid-2001.
Other service fees rose $5.7 million or 9%, compared with $60.3 million in the second quarter of 2001. This increase was mainly due to higher insurance agency commissions and debit card, credit card and check cashing fees, which resulted from higher activity and business growth. The growth in insurance agency commissions was partly attained through the launching of new products and programs, and by capitalizing on the Corporation’s broad delivery channels and client base. The Corporation established Popular Insurance Agency, U.S.A. at the beginning of 2002, incorporated Popular Insurance V.I., Inc., and acquired an insurance agency in Puerto Rico during this quarter. The increase in debit card fees is mainly due to higher volume of transactions. Average debit card transactions processed by the Corporation’s subsidiaries in Puerto Rico increased to 9,032,000 as of June 30, 2002, from 6,570,000 a year earlier. The rise in credit card fees was due to higher charges of merchant discounts and late payment fees. Furthermore, the increase in check-cashing fees was driven by the continuous expansion of Popular Cash Express (PCE), which as of June 30, 2002, operated 110 offices, including 54 mobile units, compared with 89 offices, including 52 mobile units, at same date a year earlier.
Other operating income, including gain on sales of loans, amounted to $30.6 million for the quarter ended 2002, an increase of $3.2 million or 12% compared with the second quarter of 2001. The rise in other operating income resulted from a non-recurring gain of $3.1 million on the sale of Banco Popular North America’s (BPNA) trust operations in Chicago, Illinois and a $0.6 million gain on the sale of 15 branches of Popular Finance during this quarter. These transactions were held as part of strategic initiatives at these subsidiaries. The trust operations of BPNA had contributed approximately $1.0 million in revenues during the six-month period ended June 30, 2002.
For the six-month period ended June 30, 2002, operating income, excluding derivatives, securities and trading transactions, amounted to $271.1 million, compared with $239.7 million for the same period of 2001, an increase of $31.4 million or 13%. Service charges on deposit accounts and other service fees increased $7.5 million, or 11%, and $8.7 million, or 7%, respectively, compared with the six months ended June 30, 2001, mostly attributed to the same reasons explained above. Other operating income, including gain on sales of loans, increased by $15
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million or 30% compared with the same period in 2001 due to the non-recurring gains explained above and to higher gains on the sales of mortgage loans and loans guaranteed by the Small Business Administration (SBA). Also, higher underwriting profits derived by the Corporation’s broker/dealer subsidiary and higher income recorded on the investments carried on the equity method contributed to the increase in other operating income for the period.
SECURITIES, TRADING AND DERIVATIVES GAINS/LOSSES
Gain on sales of securities during the quarter ended June 30, 2002, resulted in moderate gains of $85 thousand compared with losses of $2.2 million in the same period of 2001. Trading losses amounted to $0.4 million for the second quarter of 2002 as compared with losses of $0.8 million for the same period a year earlier. For the six-month period ended in June 30, 2002, there were losses on sale of securities of $3.9 million and trading losses of $1.4 million as compared with losses of $1.9 million and $0.6 million, respectively, for the first six months of 2001. The loss on sales of securities experienced in the first half of 2002, resulted mainly from the sale of $710 million in U.S. Agency Securities, as part of the positioning strategies followed by the Corporation in the current interest rate environment. Proceeds from these sales were reinvested at higher yields.
Derivative losses for the quarter ended June 30, 2002, amounted to $0.9 million compared with gains of $1.7 million for the same quarter in 2001. For the first six months of 2002, derivative losses amounted to $0.3 million compared with gains of $1.0 million for the same period in 2001. These losses on derivatives resulted from adjustments to the market value of the interest rate swaps and swaptions entered into by the Corporation.
OPERATING EXPENSES/INCOME TAX
For the quarter ended June 30, 2002, operating expenses totaled $250.7 million, an increase of $16.7 million or 7%, compared with $233.9 for the same quarter in 2001. For the six-month period ended June 30, 2002, operating expenses amounted to $492.8 million compared with $454.4 million for the same period of 2001, an increase of $38.4 million or 8%.
Personnel costs, the largest category of operating expenses, rose $15.8 million or 15%, from $106.7 million for the quarter ended June 30, 2001, to $122.6 million for the same period of 2002. This increase is partly due to higher salaries, resulting from merit increases and headcount, higher pension plan costs, incentives, and other costs associated with the previously mentioned strategic initiatives. As of the end of this quarter, full time equivalent employees (FTE’s) totaled 11,207, compared with 11,041 as of the end of the same period in 2001.
Excluding personnel costs, other operating expenses amounted to $128.1 million, a moderate increase of $0.9 million or 1%, compared with the same period in 2001. Contributing to this increase were higher business promotion, net occupancy, professional fees and communication expenses. The increase in business promotion was partly due to higher advertising and public relation expenses mostly associated with the launching of PREMIA, an innovative rewards program for our customers in Puerto Rico, and to programs related with the Corporation’s involvement and contributions to the community. Net occupancy expenses increased due to higher rental expenses resulting from continued business expansion, and to higher depreciation expenses and demolition costs of various buildings, in preparation for the construction of new office buildings for the relocation of various of the Corporation’s head offices and subsidiaries. Professional fees rose mainly due to higher expenses incurred for consulting services in the strategic initiatives of BPNA’s operations. Communications costs increased mainly due to higher costs related to our electronic and data network. Partially offsetting these rises was the decrease in the amortization of goodwill associated with the adoption of SFAS No. 142 “Goodwill and Other Intangible Assets.” Goodwill amortization for the quarter ended June 30, 2001 was $4.3 million. Refer to Note 7 to the consolidated financial statements for further information about the impact of the adoption of SFAS No. 142. The Corporation did not have any impairment of goodwill or a cumulative effect of accounting change in connection with the adoption provisions of SFAS NO. 142. Also, offsetting the rise in operating expenses were lower sundry losses, which are included as part of other operating expenses in the statement of income.
For the six-month period ended June 30, 2002, operating expenses, excluding personnel costs, amounted to $249.9 million, compared with $242.8 million for the same period in 2001, an increase of $7.1 million or 3%. Personnel costs amounted to $242.9 million, an increase of $31.2 million or 15%, when compared with the $211.6 million
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reported for the same period of 2001.The same expense categories and factors mentioned above were the principal contributors to the net increase in other operating expenses.
Income tax expense increased $5.3 million or 19%, from $27.3 million in the quarter ended June 30, 2001, to $32.6 million in the same quarter this year. The effective tax rates for these quarters were 26.07% and 25.28%, respectively. Income tax expense for the six-month period ended June 30, 2002 amounted to $62.7 million, an increase of $8.3 million or 15%, over the $54.5 million reported for the same period in 2001. The effective tax rate for the first six months of 2002 was 25.28%, compared with 26.51% a year ago.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Upon the adoption of SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” on January 1st, 2001, the Corporation recognized $0.7 million (net of tax) in income as a cumulative effect of accounting change.
During the first quarter of 2002, the Corporation adopted the provisions of SFAS No. 142 “Goodwill and Other Intangibles Assets.” As further discussed in Notes 1 and 7 to the consolidated financial statements, the Corporation did not record any cumulative effect of accounting change in connection with the adoption provisions of this statement.
BALANCE SHEET COMMENTS
The Corporation’s total assets as of June 30, 2002 reached $32.7 billion, representing an increase of $4.8 billion or 18% when compared with $27.9 billion a year earlier. At December 31, 2001, total assets were $30.7 billion. Earning assets totaled $30.6 billion at June 30, 2002, compared with $26.2 billion and $29.1 billion at June 30, 2001 and December 31, 2001, respectively.
The investment portfolio reached $10.3 billion, an increase of $2.6 billion or 34%, compared with $7.7 billion at June 30, 2001. Investment securities at December 31, 2001 were $9.9 billion. The growth was mostly related to higher arbitrage activities undertaken by the Corporation during the end of 2001 and first part of 2002. For a breakdown of the Corporation’s investment portfolio refer to Notes 3 and 4 to the consolidated financial statements.
Table G presents the Corporation’s loan portfolio broken down by major categories. Total loans amounted to $18.9 billion at June 30, 2002, an increase of $732 million or 4% from December 31, 2001. Mortgage loans accounted for the largest increase in the portfolio, rising $630 million since the end of 2001. The growth in the mortgage loan portfolio was principally achieved through strong sales efforts and to the impact of the low interest rate scenario, which has stimulated higher demand for these loans. Total loans rose $1.7 billion or 10% since June 30, 2001, when the portfolio reached $17.2 billion. Mortgage and commercial, including construction, loans were the principal contributors to this rise, with $1.5 billion and $242 million, respectively. The leasing portfolio also increased $45 million compared with June 30, 2001. On the other hand, consumer loans decreased by $87 million since June 30, 2001, partly due to a lower demand for personal loans, which decreased by $166 million, as a result of the declining interest rate scenario, which tends to favor the refinancing of mortgage loans and the personal debt consolidation. Also, it is due to the sale of approximately $20 million in small consumer loans, as part of the sale of 15 branches of Popular Finance, Inc. during this quarter. Subsequent to the sale, this subsidiary still operated a network of 36 branches, including mortgage centers. The decline in personal loans was compensated by higher volume of auto loans by $86 million when compared with June 30, 2001.
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TABLE G
Cash and due from banks amounted to $1.1 billion at June 30, 2002, compared with $506 million at the end of 2001. The increase of $497 million is associated to funds received at the end of June 2002 from deposits in trust from governmental sources.
At June 30, 2002, total deposits amounted to $17.8 billion compared with $16.4 billion at December 31, 2001, an increase of $1.4 billion or 9%. Demand, savings and time deposits increased $732 million, $577 million and $151 million, respectively. The increase in demand deposits is partly due to deposits in trust from governmental sources used to repay government bond redemptions on July 1st 2002. The increase in savings and time deposits is associated with both, retail and commercial accounts. Brokered CDs which are included as part of time deposits, decreased by $45 million since the end of 2001. Deposits totaled $15.6 billion at June 30, 2001. The growth in the deposit base from June 30, 2001 to 2002 was reflected in all deposit categories. Savings, demand and time deposits increased $1.1 billion, $873 million and $319 million, respectively, from June 30, 2001. Brokered certificates of deposits, also included as part of time deposits, decreased $34 million since June 30, 2001.
Borrowed funds, including subordinated notes and capital securities, increased $2.6 billion, from $9.6 billion on June 30, 2001 to $12.2 billion at the end of the second quarter of 2002. Borrowed funds at December 31, 2001 were $11.6 billion. The increase in borrowed funds was used primarily to fund the Corporation’s loan and investment portfolio growth. Refer to the Liquidity section for further information as to the composition of the Corporation’s funding sources.
The Corporation’s stockholders’ equity at June 30, 2002 and 2001 was $2.2 billion, compared with $2.3 billion at the end of 2001. The decrease from the end of 2001 is related to the $100 million redemption of the Corporation’s preferred stock in January 2002 and the repurchase of 4,300,000 shares of the Corporation’s common stock from Banco Popular de Puerto Rico Retirement Plan in May 2002, at a cost of $139 million. These declines from December 31, 2001 were offset by earnings retention and by an increase of $41 million in unrealized gains on securities available-for-sale, net of taxes.
Dividends declared per common share for the second quarter of 2002 and 2001 were $0.20. Year-to-date dividends declared per common share amounted to $0.40 at June 30, 2002 and $0.36 at the same date in 2001. The dividend payout ratio to common stockholders for the quarter ended June 30, 2002 was 28.34%, compared with 28.86% in June 30, 2001.
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The Corporation continues to exceed the well-capitalized guidelines under the federal banking regulations. Ratios and amounts of total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage as of June 30, 2002 and 2001, and December 31, 2001 are presented on Table H.
TABLE H
Book value per common share was $16.69 at June 30, 2002, compared with $15.93 at December 31, 2001 and $15.18 at the end of the second quarter of 2001. The Corporation’s market capitalization was $4.5 billion at June 30, 2002 and 2001, and $4.0 billion at December 31, 2001.
Popular, Inc.’s common stock had a market price at June 30, 2002 and 2001 of $33.68 and $32.94 per share, respectively. At December 31, 2001, the market price was $29.08 per share. The Corporation’s stock is traded on the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System under the symbol BPOP.
MARKET RISK
Market risk refers to the impact of changes in interest rates on the Corporation’s net interest income, market value of equity and trading operations. It also arises from fluctuations in the value of some foreign currencies against the U.S. dollar. Despite the varied nature of market risks, the primary source of this risk at the Corporation is the impact of changes in interest rates. Depending on the duration and repricing characteristics of the Corporation’s assets, liabilities and derivatives instruments, changes in interest rates could either increase or decrease the level of net interest income. The Corporation maintains a formal asset and liability management process to quantify, monitor and control interest rate risk (IRR) and to assist management in maintaining stability in the net interest margin under varying interest rate environments.
The Corporation uses various techniques to assess the degree of interest rate risk, including simulation analysis and static gap estimates for measuring short-term IRR, and duration analysis to quantify the level of long-term IRR. These techniques focus on different aspects of the interest rate risk that is assumed at any point in time, and are therefore used jointly to make informed judgments about the risk levels and the appropriateness of strategies under consideration.
An interest rate sensitivity analysis performed at the Corporation level is the primary tool used in expressing the potential loss in future earnings resulting from selected hypothetical changes in interest rates. Sensitivity analysis
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is calculated on a monthly basis using a simulation model which incorporates actual balance sheet figures detailed by maturity and interest yields or costs, the expected balance sheet dynamics, reinvestments, and other non-interest related data. Simulations are processed using various interest rate scenarios to determine potential changes to the future earnings of the Corporation.
Computations of the prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, loan prepayments and deposit decay. They should not be relied upon as indicative of actual results. Further, the computations do not contemplate actions that management could take to respond to changes in interest rates. By their nature, these forward-looking choices are only estimates and may be different from what actually may occur in the future.
Based on the results of the sensitivity analysis as of June 30, 2002, the change in net interest income, on a hypothetical rising rate scenario, for the next twelve months was a $1.9 million decrease and the change for the same period, utilizing a hypothetical declining rate scenario, was a decrease of $0.6 million. Both hypothetical rate scenarios consider a gradual change of 150 basis points during the twelve-month period. These estimated changes are within the policy guidelines established by the Board of Directors.
The Corporation maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Corporation’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. Derivative instruments that are used, to a limited extent, include interest rate swaps, interest rate forwards and future contracts, interest rate swaptions, foreign exchange contracts, and interest rate caps, floors and put options embedded in interest rate contracts.
As a matter of policy, the Corporation does not use highly leveraged derivative instruments for interest rate risk management. Hedging strategies are developed through analysis of data derived from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into Popular Inc.’s overall interest rate risk management and trading strategies. These hedging strategies are managed by the Market Risk Committee, composed of members from management, and monitored by the Board’s Risk Management Committee. Refer to Note 6 to the consolidated financial statements for further information on the Corporation’s involvement in derivative instruments and hedging activities.
The Corporation’s trading activities are another source of market risk and are subject to strict guidelines approved by the Board of Directors. Most of the Corporation’s trading activities are limited to the purchase of debt securities for the purpose of selling them in the near term and positioning securities for resale to retail customers. As the trading instruments are recognized at market value, the changes resulting from fluctuations in market prices, interest rates or exchange rates directly affect reported income. In the opinion of management, the size and composition of the trading portfolio as of June 30, 2002 does not represent a potentially significant source of market risk for the Corporation. The Corporation does not participate in any trading activities involving commodity contracts.
The Corporation conducts business in certain Latin American markets through several of its processing and information technology services and products subsidiaries. Also, it holds an interest in Consorcio de Tarjetas Dominicanas, S.A. and Centro Financiero BHD, S.A. in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s particular foreign currency. However, management does not expect future exchange volatility between the U.S. dollar and the particular foreign currency to affect significantly the value of the Corporation’s investment in these companies.
LIQUIDITY
Liquidity refers to the ability to fund current operations, including the cash flow requirements of depositors and borrowers as well as future growth. This can be accomplished by generating profits, attracting new depositors, converting assets to cash through sales or securitizations and increasing borrowings. The Corporation utilizes various sources of funding to help ensure that adequate levels of liquidity are always available.
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The Corporation raises its funding from a combination of retail and wholesale markets. Historically, core deposits have been the Corporation’s primary source of funding, although wholesale borrowings have become an increasingly important source. Retail sources of funds include individual and corporate depositors in the markets where the Corporation competes, which over the past several years has become more geographically diverse as a result of acquisitions and expansion of the Corporation’s business. Deposits tend to be less volatile than institutional borrowings and their cost is less sensitive to changes in market rates.
The Corporation has established borrowing relationships with the FHLB and other correspondent banks, which further support and enhance liquidity. Wholesale or institutional sources of funds comprise primarily of other financial intermediaries such as commercial banks, securities dealers, investment companies, insurance companies, as well as non-financial corporations.
Another important liquidity source to the Corporation is its assets, particularly the investment portfolio. Refer to Notes 3 and 4 to the consolidated financial statements for further information as to the composition of the available-for-sale and held-to-maturity investment portfolios. Liquid U.S. Treasury and Agency securities can be used to raise funds in the repo markets. The loan portfolio can also be used to obtain funding in the capital markets. In particular, mortgage loans and some types of consumer loans and to a lesser extend commercial loans, have highly developed secondary markets. In addition, other sources of liquidity include maturities of money market investments, repayments of loans and investment securities, and cash generated from operations, such as fees collected for services.
Risks to Liquidity
The Corporation’s ability to compete successfully in the marketplace for deposits depends on various factors, including service, convenience and financial stability as reflected by operating results and credit ratings (by one of the nationally recognized credit rating agencies). Although a downgrade in the credit rating of the Corporation may impact its ability to raise deposits, management does not believe that the impact should be material. Deposits at all of the Corporation’s banking subsidiaries are federally insured and this is expected to mitigate the effect of a downgrade in credit ratings.
Although the Corporation raises the majority of its financing from retail deposits, it still borrows a material amount of funds from institutional sources. Institutional lenders tend to be sensitive to the perceived credit risk of the entities to which they lend and this exposes the Corporation to the possibility of having its access to funding affected by how the market perceives its credit quality; this in part, may be due to factors beyond its control.
Changes in the credit rating of the Corporation or any of its subsidiaries to a level below “investment grade” may affect the Corporation’s access to the capital markets. The Corporation’s counterparties are sensitive to the risk of a rating downgrade. In the event of a downgrade, it may be expected that the cost of borrowing funds in the institutional market would increase. In addition, the ability of the Corporation to raise new funds or renew maturing debt may be more difficult. Management does not anticipate changes in the credit ratings of the Corporation based on its expected outlook for the P.R. / U.S. economy, interest rates and expected financial results of the Corporation.
In the course of borrowing from institutional lenders, the Corporation has entered into contractual agreements to maintain certain levels of debt, capital and non-performing loans, among other financial covenants. If the Corporation were to fail to comply with those agreements, it may incur in an event of default. Such failure may accelerate the repayment of the related borrowings. It could also affect the ability of the Corporation to raise new funds or renew maturing borrowings. The Corporation is currently in full compliance with all financial covenants in effect and expects to remain so in the future.
The Corporation’s non-banking subsidiaries may be subject to a higher degree of liquidity risk than the banking subsidiaries, due to the latter’s access to federally-insured deposits. A higher proportion of the funding of the non-banking subsidiaries is from institutional sources, as compared to the banking subsidiaries, and these are more sensitive to the perceived credit risk of the Corporation than providers of deposits. In the event of a downgrade in the credit ratings of the Corporation, the non-banking subsidiaries may experience an increase in their cost of
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funds and reduced availability of financing. Management does not anticipate such a scenario developing in the foreseeable future.
The importance of the Puerto Rico market for the Corporation is an additional risk factor that could affect its financing activities. In the case of an extended economic slowdown in Puerto Rico, the credit quality of the Corporation could be affected as a result of higher credit costs and possible decreases in profitability. The substantial integration of Puerto Rico with the U.S. economy should limit the probability of a prolonged recession in Puerto Rico and the resulting risks to the Corporation.
OFF-BALANCE SHEET ACTIVITIES
In past years, the ordinary course of business, the Corporation conducted asset securitizations involving the transfer of mortgage loans to a qualifying special purpose entity (QSPE), which in turn has transferred the assets to different trusts, thus isolating those loans from the Corporation’s assets. The transactions qualified for sale accounting based on the provisions of SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” as such these trusts are not consolidated in the Corporation’s financial statements. As of June 30, 2002, these trusts held approximately $295 million in assets in the form of mortgage loans. Liabilities in the form of debt principal due to investors approximated $292 million at the end of the second quarter of 2002. In these securitizations, the Corporation retained servicing responsibilities and certain subordinated interest in the form of interest-only securities. The investors and the securitization trusts have no recourse to the Corporation’s assets. The servicing rights and the interest-only securities retained by the Corporation are recorded in the statement of condition at the lower of amortized cost or market, and fair value, respectively.
Part II — Other Information
Item 1. Legal Proceedings
The Corporation and its subsidiaries are defendants in various lawsuits arising in the ordinary course of business. Management believes, based on the opinion of legal counsel, that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the financial position and results of operations of the Corporation.
BPPR has been cooperating fully with an investigation by federal law enforcement authorities. The investigation relates principally to the circumstances surrounding the activities of a former customer of BPPR, including BPPR reporting and compliance efforts. The former customer has been indicted for money laundering, including in connection with transactions through an account at BPPR. BPPR believes based on the information available to it that there was no knowing participation by BPPR or any BPPR employee in the former customer’s activities. The law enforcement investigation could result in adverse consequences to the Corporation and BPPR including the possibility of civil and criminal claims being brought against BPPR. The Corporation cannot predict when or on what basis the investigation will conclude or its effects, if any, on the Corporation or BPPR.
Item 4. Submission of Matters to a Vote of Security Holders
The Corporation held its Annual Stockholder’s Meeting on April 30, 2002, at which common stockholders elected the following three directors: David H. Chafey Jr., Antonio Luis Ferré and Félix J. Serrallés Jr.
All three directors were elected for a three-year term with favorable votes ranging from 83.03% to 83.53% of the voting shares issued and outstanding which amounted to 136,475,530 as of the record date, March 11, 2002. Also, PricewaterhouseCoopers LLP was ratified as the independent public accountants of the Corporation for the year 2002. A 86.23% of the common shares issued an outstanding as of the mentioned record date, were represented at the meeting, which complied with the quorum required by law.
Item 5. Other Information
Election to become a Financial Holding Company
Under the Gramm-Leach-Bliley Act, bank holding companies, whose depository institution subsidiaries are “well
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capitalized” as defined under the Federal Deposit Insurance Act and “well managed” as defined under Regulation Y under the Bank Holding Company Act and which obtain at least a “satisfactory” rating under the Community Reinvestment Act, have the ability to declare themselves to be financial holding companies and engage in a broader range of activities than those traditionally permissible for U.S. bank holding companies. Popular, Inc.’s declaration to become a financial holding company became effective on April 30, 2002.
As a financial holding company, Popular, Inc. may engage in activities that are “financial in nature,” as well as additional activities that the Federal Reserve Board, in coordination with the Secretary of the Treasury, determines are incidental or complementary to financial activities, generally without Federal Reserve Board approval. Under the Gramm-Leach-Bliley Act, activities that are financial in nature include insurance, securities underwriting and dealing, merchant banking, and lending activities.
General
On March 9, 2000, Banco Popular entered into a written agreement with the Federal Reserve Bank of New York, which imposed a number of compliance, reporting and control requirements. All of these compliance, reporting and control requirements are now in place.
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be filed on its behalf by the undersigned thereunto duly authorized.
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