But most loans are either to big, solid companies or are SBA-guaranteed
Loose lending standards a thing of the past Make no mistake about it: The days when you could just walk into a bank and ask the branch manager for a loan based on a decent credit rating, a solid business plan and good intentions are long gone.
The loose loan underwriting standards practiced by banks both in the mainland U.S. and Puerto Rico, which helped cause the Great Recession—and the failure and subsequent consolidation of three large local banks in 2010—are history.
On April 30, 2010, Banco Popular, Oriental Bank & Trust and Scotiabank acquired the assets of Westernbank, Eurobank and R-G Premier Bank, respectively, from the Federal Deposit Insurance Corp. (FDIC) as receiver of the failed banks.
On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Act, touted as the most sweeping change to financial regulation in the U.S. since the Great Depression.
As a result of the tighter regulations the Dodd-Frank Act has imposed on financial institutions—estimated to cost U.S. banks $16 billion—a financial institution that a few years ago would approve a loan without much hassle now requires much more paperwork, such as sales projections, cash fl ow analysis and financial reports, plus additional collateral and probably personal guarantees, to secure such a loan.
In a nutshell, banks are mostly lending only to those individuals and institutions that have shown themselves to have repayment capacity with cash fl ow based on solid, credible projections.
“It should come as no surprise that when banks stopped making these unwise loans, loan volumes dropped,” Joe Gladue, senior analyst for the financial institutions group B. Riley & Co., told CARIBBEAN BUSINESS. “Nobody should expect loan volumes to return to the levels seen in 2004, 2005. This could only happen if banks once again take excessive risks by ignoring sound underwriting principles.”
NUMBERS DON’T LIE
Based on the most recent data provided by the Financial Institutions Commissioner’s Office (OCIF by its Spanish acronym), net loans by Puerto Rico banks during 2011 amounted to $47.75 billion, a 6.46% decline from the $51.05 billion originated in 2010.
The island’s commercial banks made $49.17 billion in loans & leases in 2011, representing a 3.68% drop from the $51.05 billion produced in 2010.
In contrast, Puerto Rico banks as a group reported $101.47 billion in assets, $57.83 billion in net loans, $55.49 billion in deposits, $6.71 billion in capital, and 579 branches as of Dec. 31, 2005.
Local banks made significant strides in reducing the number of nonaccrual loans and loans 30 to 89 days past due in their portfolios last year. Loans 30 to 89 days past due dropped from $2.07 billion in 2010 to $1.61 billion last year, while nonaccrual loans declined from $4.28 billion in 2010 to $3.75 billion in 2011.
Loans labeled 90 days past due or more increased, from $2.5 billion in 2010, to $2.72 billion at the end of 2011.
As a group, local banks finished last year with $70.78 billion in assets and $7.2 billion in capital versus assets of $75.51 billion and capital of $6.79 billion in 2010.
The two banking sectors bucking the trend in terms of assets and capital were mortgage banks and credit unions or co-ops.
As of Sept. 30, 2011, the island’s credit unions reported a combined $7.84 billion in assets and $2.42 billion in capital, in contrast with assets of $7.52 billion and capital of $2.31 billion as of Dec. 31, 2010.
After five years of net losses, Puerto Rico’s mortgage institutions reported net income of $12.8 billion at the end of 2011, mainly fueled by an increase in refinancing.
Vicente Feliciano, president of local research & consultancy firm Advantage Business Consulting, firmly believes the financial condition of Puerto Rico banks is on the mend. However, he added, they will be hard-pressed to lend for three main reasons.
“Number one, the economic depression has tempered the desire to take risks and the need to expand; second, as property prices have declined, businesses have less equity to offer as collateral; and third, once burned, twice shy,” Feliciano said. “Banks misjudged credit risk badly, lost millions, and now are being extra careful.”
DIFFERING LENDING TARGETS
In Gladue’s view, each of the banks in Puerto Rico has the financial capacity and willingness to lend, but there are striking differences between the institutions’ lending targets.
Doral Financial Corp. is focusing on mortgage lending, where it has a strong platform and economies of scale, but lacks the scale in other lending areas, Gladue pointed out.
Banco Popular is also lending in mortgage, commercial & industrial (C&I) and commercial real estate (CRE) to some extent, while First- Bank is lending in mortgage and C&I, Gladue said.
“Oriental Financial Group is also doing C&I and mortgage lending. In fact, Oriental expanded its C&I loan originations significantly in the fourth quarter of 2011, increasing originations by 58% compared with the previous quarter in this segment,” the B. Riley & Co. analyst noted.
Construction loans are declining at all local banks, Gladue indicated, as there is little appetite for new projects, and bad loans in this segment are still causing pain for Puerto Rico banks.
Many types of real-estate loans (other than mortgage loans, which get federal government backing through the Federal Housing Administration [FHA], Fannie Mae or Freddie Mac) are difficult to issue in the current environment, Gladue noted.
“Banks won’t make a loan using real estate as collateral when the value of that real estate is declining or uncertain, because it makes no sense,” Gladue noted. “Loans that rely on the cash fl ow of an ongoing enterprise, rather than on real-estate collateral values, are much easier for a bank to make in this environment.”
Ultimately, Gladue believes the stricter capital standards imposed by bank regulators will probably have an impact on the volume of loans issued by Puerto Rico banks, but local financial institutions aren’t at that point yet, he stressed.
“The capital issue will only come into play when banks are closer to the limits of their capital and leverage ratios,” Gladue pointed out. “Right now, most local banks are sitting on lots of excess liquidity that could be used to extend loans. This could be done without breaching their capital ratios.”
LOWER LOAN DEMAND, TIGHTER SUPERVISION
For Arturo Carrión, executive director of the Puerto Rico Bankers Association, the longstanding perception that banks are not lending is both true and false.
“Banks don’t create lending demand; they finance the demand. Therefore, we can’t pretend that, in an economic environment such as ours, there would be high demand for loans,” Carrión said. “Secondly, one of the reasons why the three local banks that failed in 2010 got into trouble in the first place was because of a pickup in construction lending just a few years before the local economy tanked in 2006.”
At the moment, these loans were made in the early 2000s, the economy was good, there was demand for the projects and construction loans were granted. When the 10-year phaseout of Section 936 came to an end in 2005, the island’s manufacturing sector took a hit.
Between 2007 and 2008, Carrión estimated some 125,000 jobs were lost on the island. All those people who had originally committed to buy those properties either lost their jobs or left the island, he said.
“With the loss of so much purchasing power, those banks with large portfolios containing construction loans ultimately ended up having problems. And that’s when the regulator takes over and invests in these portfolios that are now in the hands of the consolidating banks,” Carrión explained. “These portfolios require strong due diligence and are under extraordinary, and much tighter, supervision by the regulator.”
The bank regulator, for example, now requires banks in Puerto Rico as well as those in the mainland U.S. to reappraise all properties in their portfolios, he said.
“The bank regulator is stricter, and banks have to be much more careful, that in a weak economy like ours, they don’t continue lending and end up having the same problems as before,” Carrión added.
Nevertheless, Carrión insisted Puerto Rico banks are lending, especially to small businesses, throughout the island.
“I think it’s important to point out that 80% of the commercial loans granted last year were for amounts less than $100,000,” Carrión said. “Sure, the number of loans made last year was smaller than in 2010, as would be expected with a nonfinanced demand. If you add to that the 430 bank branches in Puerto Rico, it demonstrates that those loans of less than $100,000 are reaching all the communities.”
NUMBER OF SBA-GUARANTEED LOANS GREW 57% IN 2011
Carrión noted the total number of U.S. Small Business Administration (SBA)-guaranteed loans issued by local financial institutions was up 40%, while loan volume surged 25% during the first quarter of the federal fiscal 2012 (Oct. 1 through Dec. 31, 2011).
On loans of $150,000 or more, the SBA guarantees up to 75%, whereas the federal agency only guarantees at a 50% rate on SBA Express loans. The SBA guarantee allows the issuing bank to reduce its risk in case of a default, or if the business goes under.
Throughout the SBA’s fiscal 2011 (Oct. 1, 2010 to Sept. 30, 2011), loan volume increased 18% to $84.8 million, while the number of SBA-guaranteed loans grew by 57%, to 656.
The SBA’s combined loan volume by local lending partners Banco Popular, Banco Santander, Banco Bilbao Vizcaya Argentaria (BBVA), Scotiabank, FirstBank and the Economic Development Bank during December 2011 amounted to $11.74 million.
“Banks are lending to those who have repayment capacity, and if it is a good loan, you can be sure banks will make that loan,” Carrión added.
A CARIBBEAN BUSINESS analysis of the SBA-guaranteed loans given out by local banks to island businesses during the first quarter of federal fiscal 2012 revealed that, out of the $22.2 million in gross loans approved by the federal agency during the period, $10.3 million, or 46.4%, was requested by medical and healthcare-related businesses.
This industry sector—which includes professional offices of doctors, dentists and optometrists; drugstores; and providers of healthcare and social assistance—has been dominating the demand for SBA-guaranteed loans for some time now, SBA data suggests.
Loans ranged from $5,000 to $1.2 million, with an average gross loan amount of $136,195.
Other industry sectors that requested SBA-guaranteed loans during the first fiscal quarter of 2012 through local lending partners include: lawyers’ offices, certified public accountants and engineering services firms; motor vehicle-related services (dealerships, auto parts and accessories stores, gasoline stations); supermarkets and grocery stores; construction- related service companies; and beauty and barber shops.
BBVA LOANS UP 68%
“When people say banks aren’t lending, I tell them they aren’t referring to BBVA, because the proof is out there that our loans portfolio is indeed growing,” said Rafael Varela, president of BBVA Puerto Rico. “Certainly there is a smaller demand for loans, because there are fewer investment projects.”
Given the state of the island’s economy, Varela said, there are now far fewer clients with the capacity to take on more debt. In similar fashion, the lower property values resulting from appraisals are affecting clients’ capacity to obtain additional financing.
Despite Puerto Rico’s struggling economy, BBVA Puerto Rico experienced significant loan and deposit growth, and a drastic decline in delinquent loans, to achieve net income of $32 million in 2011, Varela announced last week.
At the end of 2011, loan production amounted to $1.168 billion, a 68% increase over the $396 million in loans generated in 2010. The bank’s total loan portfolio grew to $3.6 billion, and total assets reached $5 billion, the BBVA Puerto Rico president noted.
“All business areas contributed in a positive way to the results,” Varela said. “However, the increase experienced in the origination of commercial loans, with an additional $369 million for a total of $599 million, or a 160% increase over 2010, must be underscored.”
Auto loans inched up from $323 million in 2010 to $358 million in 2011, representing a 10.7% increase. At the end of 2011, BBVA Autos became the island’s market leader, with a 35.19% share of the market, he said.
As a result of a restructuring and reinforcement of the bank’s customer service staff in its mortgage division, and a greater presence at the bank’s 36 branches, BBVA Puerto Rico generated $144 million in new loans in 2011, surpassing the loan volume in 2010 by 57.8%.
Client deposits at BBVA Puerto Rico during 2011 (excluding brokered CDs) reached $2.497 billion, a 15.6%, or $336 million, increase over 2010, Varela said.
BBVA’s provisioning for loan losses amounted to $31 million, which represents a $49 million, or 61.4%, reduction over the provisioning made during 2010. The bank’s delinquency rate closed at 6.725, a 245-basis-points decline over 2010, and substantially lower than the delinquency rate average among Puerto Rico banks, the BBVA Puerto Rico president said.
SCOTIABANK HAS RECORD YEAR
Peter Bessey, president & chief executive of Scotiabank de Puerto Rico, said the bank had a record year in 2011, reporting $1.3 billion in corporate and commercial lending.
Scotiabank originated $5.01 billion in net loans for the year.
“Last year was a very big year for Scotiabank,” said Bessey, who took the helm of the Canadian bank’s local subsidiary last year. “We are well-capitalized, we have lots of liquidity, and we are the 18th most solid bank in the world. That helps us with our cost of funds. We do lend, and we are lending.”
On the retail side, the bank provided $600 million in mortgages last year, attaining a 16% share of the island’s mortgage-lending market. Bessey said the bank will try to maintain the same level this year as Scotiabank takes an aggressive approach as the island’s second-largest mortgage lender.
“Our dealer finance business, which is our auto lending business, had a very strong year in 2011, experiencing growth,” Bessey added. “And this year, we are tracking ahead of last year, so we’re lending aggressively.”
With lingering memories of 2008 and the challenges it brought to world financial markets, everybody in the banking business is being cautious in terms of where they spend their money and what they do, he said.
“Good credit is key,” the Scotiabank executive said. “But we will always lend to people with good credit and cash fl ow. You have to have the means to repay, but there are lots of good business opportunities in retail, corporate and commercial, with clients with good credit and good cash fl ow.”
Scotiabank, which Bessey noted has been in business for 180 years in Canada and 101 years in Puerto Rico, has always had strong credit policies in place. They don’t change year to year, he said.
“We are consistent in what we do,” he added. “And from our perspective, our numbers reflect it. We are lending as much as or more than we ever have.”
Puerto Rico has many good business opportunities, Bessey pointed out. The challenges with the island, from a business perspective, are primarily in high-end real-estate development, where there is an oversupply, he said.
“That’s a segment no one will want to lend to, but it’s a specific segment,” he said. “There are many other growth segments such as healthcare, food distribution and educational services. There are niches within this economy that are very strong.”
The Scotiabank executive added there are a number of opportunities to look at in the midmarket segment as well.
FOR POPULAR, CORPORATE LENDING HAS REAWAKENED
During 2011, Popular, the largest bank on the island by assets and deposits, originated $17.67 billion in net loans, according to OCIF.
In the opinion of Eli Sepúlveda, chief credit official & executive vice president of Banco Popular’s Commercial Credit Group, lending to large corporations reawakened during 2011, as the bank was involved in large financial transactions, with some exceeding $100 million.
“These transactions demonstrate the corporate market is active, looking for opportunities, either to diversify or expand operations,” Sepúlveda said.
He noted certain acquisitions have been taking place in that market segment, where large corporations with capital and financial support are looking for, and taking advantage of, market opportunities. He expects that trend to continue this year as the island’s economy improves.
In the midmarket segment, Sepúlveda said, the bank is already noticing the same type of activity, where some clients are once again investing in their facilities.
“This isn’t a boom, but a trend of companies reviewing their business models and possibly looking to remodel, replenish inventories, expand certain business lines, etc. in that type of market segment,” he said. “This demonstrates that they too have more trust and optimism in the future.”
Smaller businesses on the lower end of the market, which have struggled the most during the economic downturn, don’t yet exhibit the same optimism and confidence as their larger counterparts—that they will be able to survive the storm, Sepúlveda indicated.
“There is still a lot of mistrust in the small-business segment, prompting them to do one of two things: remain on the sidelines, waiting to see what happens; or start looking at alternatives to see how they can overcome their situation and move on, assuming an improving economy will help them in the process,” the Popular chief credit official said.
FIRSTBANK LOOKING TO INCREASE ORIGINATIONS
FirstBank, which originated $8.29 billion in net loans during 2011 as reported by OCIF, is looking for ways to increase its loan originations this year, especially in the small and mid-markets, said Aurelio Alemán, the bank’s president & chief executive.
“People can say all they want about banks not lending, but in the end, the numbers speak for themselves,” he said. “Borrowers lacking repayment capacity didn’t get a loan in the past, and won’t get one now. That hasn’t changed, as it is part of the legal and regulatory process.”
During 2011, FirstBank fortified its capital base, in particular their common equity level, and ended the year with strong regulatory capital and very strong common-equity capital ratios.
The quality of their deposit base improved in 2011 with a $365.8 million, or 7%, growth in core deposits and a $2.5 billion, or 40%, decrease in brokered CDs.
“Deposit customers grew 19.8% during 2011, and our client base now exceeds 650,000 retail and commercial customers,” Alemán said. “Our strong second position in the loans market in Puerto Rico, and our brand recognition provide opportunities for additional deposit growth and crossselling.”
The looming crisis in Puerto Rico real estate
While mainland U.S. banks were busy issuing subprime mortgages over the past decade, commercial and mortgage banks in Puerto Rico largely resisted the temptation to indulge in such high-risk lending activity.
Puerto Rico didn’t experience the devaluation of properties seen stateside that followed the frenzy of adjustable-rate mortgage lending from 2004 to 2006, a free-for-all that triggered a domino effect in which the proliferation of so-called “underwater mortgages” (on properties that had come to owe more than they were worth) gave way to mass delinquencies, which in turn gave way to mass foreclosures.
Puerto Rico’s housing crisis, while no less severe than that of the mainland U.S., evolved in its own way.
Puerto Rico experienced a huge residential construction boom in the 2000s, which led to a massive surplus of inventory that has proven difficult to sell despite the numerous government incentives directed to that purpose. According to a variety of industry metrics, there are still anywhere between 8,000 and 14,000 completed residential units still on the market.
Many of these units are in condominiums, dozens of which have been built in the last decade, with many of those mostly vacant. Understandably, this situation places pressure on the developers and the banks that financed their construction.
Local banks have financed most, if not all, of the construction loans of these condominiums. Early in 2011, the governing bodies of federally guaranteed loan institutions such as Fannie Mae and Freddie Mac imposed strong restrictions on the issuance of federally guaranteed loans on condos.
The popular Federal Housing Administration (FHA) loan, which provides low interest rates and, more importantly, low downpayments, will now only finance 50% of the units in certified condos. This means that the remaining 50% of units will require either nonconforming financing (loans that don’t meet government-sponsored enterprise [GSE] guidelines and therefore must be kept on the bank’s books) or that the buyer come up with a 20% downpayment and closing costs.
Some of the banks holding the construction loans on these properties are becoming creative with the mortgage-lending process and are offering 40-year nonconforming mortgages with terms similar to those that led to the U.S. subprime mortgage crisis. These include the developer offering funds at the closing to lower the mortgage payment at the beginning of the term of the mortgage loan, which will then increase after the first five years.
Once the payments increase, unless the economy improves, buyers will be unable to make their payments, foreclosure proceedings will ensue, and property values will decline.
Should such conditions develop, Puerto Rico’s housing market in, say, 2015 could look a lot like the mainland U.S. market circa 2006- 2010.
A quick look at the just-released 2011 numbers for mortgage banking activity on the island suggest that the local market could be headed for such a scenario (see box below).
There are currently 3,000 properties under foreclosure in Puerto Rico and an additional 16,000 properties in the process of foreclosure. Although not all 16,000 are destined for foreclosure, there remains a huge inventory of available property, which can only lead to depressed property values.
Suffice it to say that in the coming years, unless the economy substantially improves, many of the creative loans offered by banks that have offered these “boricua-style” nonconforming loans to condos for which they have outstanding construction loans will come back to haunt them—and the Puerto Rico economy in general.
By the same token, this also presents a fantastic buying opportunity. CARIBBEAN BUSINESS has learned that several high-end condos in the Hato Rey area of San Juan that have been completed but have remained unsold will be drastically reducing their original asking prices in the $400,000 range to the much more affordable $200,000 range.
Although the sale price may be at or below construction cost, as one government official put it, “Somebody’s got to take a hit, and it’s not the consumer.”