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Fitch: P.R. bank ratings reflect Commonwealth’s woes

Puerto Rico banks Banco Popular and First BanCorp will likely be spared from a credit cut for now, Fitch Ratings said. (Credit: ©Mauricio Pascual)

Puerto Rico banks Banco Popular and First BanCorp will likely be spared from a credit cut for now, Fitch Ratings said. (Credit: ©Mauricio Pascual)

Following the Commonwealth of Puerto Rico’s default, ratings for the island’s two main banks, Popular (BPOP) and First BanCorp (FBP), will not be immediately affected, according to Fitch Ratings.

The long-term issuer default rating, or IDR, of BPOP of ‘BB-‘ and FBP of ‘B-‘ reflect the persistently weak and difficult operating environment, Fitch said, adding it “believes the banks will be able to weather losses related to Commonwealth exposures.”

Overall, capital positions and expected profitability at both banks remain adequate to support current rating levels in light of the Commonwealth’s recent default on July 1 of some $900 million in debt owed, including constitutionally protected General Obligation bonds.

“With that said, despite the ongoing fiscal challenges and economic malaise in Puerto Rico, BPOP’s and FBP’s ratings remain sensitive to the operating environment, particularly regarding the fiscal situation and its impact to the broader local economy,” Fitch said.

Unemployment rates have remained high (11.7 percent as of May 2016) and have not dropped significantly. However, Fitch stated it has a “cautious view” on long-term economic trends given the structural issues in Puerto Rico that need to be addressed, such as net out migration.

“Should the Commonwealth’s fiscal situation worsen further and lead to a material change in economic trends, BPOP and FBP’s ratings may be pressured,” the agency noted.

Both banks have various exposures to the Commonwealth and its instrumentalities. At March 31, 2016, BPOP’s direct and indirect exposure totaled $982 million, while FBP’s direct and indirect exposure totaled $757 million. Although these exposures are sizable, they have been reduced over time, and the majority is directly tied to municipalities with some exposures collateralized by tax revenues, Fitch noted.

Capital positions support the current rating levels. “Our view is that the banks will be able to manage through a period of stress,” the agency said.

In a scenario assuming a 40 percent write-down to direct and indirect exposures, Fitch estimates a pro forma “Tangible Common Equity to Tangible Assets” ratio of 12.05 percent for BPOP and a pro forma TCE/TA ratio of 12.22 percent for FBP, which would still be relatively high versus similarly sized U.S. mainland banks. Fitch’s mid-tier peer group has a median TCE/TA ratio of about 9 percent, it said.

Fitch pointed out that both BPOP and FBP also showed solid capital positions in their 2015 Dodd-Frank Act Stress Test (DFAST) results, which use specifically prescribed macro conditions unique to Puerto Rico’s circumstances and worse than those prescribed under the Fed’s standard “severely adverse” scenario.

The DFAST results reflect a GDP contraction of 3.2 percent to 3.3 percent (versus a 1.1 percent contraction for the standard test) and an unemployment rate of 18 percent to 19 percent (versus 9.2 percent under the standard test). Both banks passed the tests by comfortable margins over “well-capitalized” minimums.

In Fitch’s view, earnings performance for both banks is sustainable, although loan growth will be a challenge. Both banks have returned to profitability, albeit at modest levels. BPOP and FBP have also worked to stabilize non-performing assets over the past several quarters; nonetheless, nonperformers remain very elevated compared with U.S. banks, Fitch said.

“Given the low rate environment and consolidation in the local banking sector, as well as weak loan demand, BPOP’s and FBP’s liquidity positions have also improved. Funding costs have declined as both banks have reduced their reliance on wholesale borrowings,” it added.

Fitch also stated many of Puerto Rico’s 100+ credit unions in its banking sector, which account for about $8.5 billion in total assets, have outsized exposures to the Commonwealth and the Government Development Bank.

“As a result, some credit union capital positions are likely weak. In December 2015, the Legislature passed Senate Bill 1454, which allowed credit unions to amortize a loss on defaulted Commonwealth bonds over 15 years rather than immediately. Under the final Puerto Rico restructuring bill, credit unions will likely be handled by the independent oversight committee,” Fitch predicted.

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This story was written by our staff based on a press release.

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