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The Trip To Bountiful
The Local Banking Industry Looks Stronger Than Ever, With Total Assets And Net Income Up 65% And 62%, Respectively, In Four Years
By LUIS A. RAMOS
November 27, 2003
These have been the best of times for some. While most sectors of Puerto Ricos economy have gone into a holding pattern during the economic slowdownat times recession of the past four years, commercial banks, mortgage lenders, and credit unions have grown by leaps and bounds.
Loans, in particular, have shown spectacular growth amid a recession, playing a key role in keeping the local economy afloat. In less than four years, since January 2000, domestic commercial banks and mortgage lenders in Puerto Rico have pumped a whopping $54 billion into the islands economy through consumer, mortgage, and commercial/industrial loans.
Local commercial banks have originated $15 billion in new loans to the commercial & industrial sector (including agriculture), plus $5 billion in loans to consumers (including personal and auto loans). Mortgage lending by the commercial banks has contributed another $16 billion through 100,000 loans. Nondepositary mortgage lenders have originated some 178,000 loans, for a lending amount of $18 billion.
Local credit unions have also experienced growth during the past four years. As of Sept. 30, their loan portfolio stood at $3.5 billion, partly reflecting 25% in mortgage loans and 54% in consumer loans.
The economic strength and liquidity of local financial institutions have allowed them to extend credit, without which the islands economy couldnt be sustained. The growing combination of loans, deposits, and assets has been the key to the economic progress of the past four years.
Local financial institutions have managed to outdo the general economys growth, to beat economic forecasts, and to become the pillars of Puerto Ricos economy. The financial industrys contribution to the local economy is evidenced by the growth rate of its loan output compared with the growth rate of the overall economy. In 1999, when the islands gross national product (GNP) grew at 8.8%, the loan growth rate was 17.9%. In 2002, while GNP growth shrank to 2.3%, loan growth was some three times higher at 7.4%. (See chart on page 19.)
Puerto Ricos domestic commercial banksthose organized under Puerto Ricos Banking and Cooperative Bank acts, which excludes Citibankincreased their net income from $494 million in 2000 to an estimated $800 million in 2003, a growth of 62% in four years. Commercial banks total assets increased 65% in four years, from $44.6 billion in 2000 to $66 billion in 2002, and reached $73.6 billion in the third quarter of 2003, the latest figure available.
A total of 11 banks compose the commercial banking sector in Puerto Rico. Seven of them, the largest financial institutions based on assets, are the principal market players on the island: Banco Popular, First BanCorp, W Holding Co., Doral Financial Corp., Banco Santander, R&G Financial Corp., and Oriental Financial Group.
Of these, four have pursued expansion to the U.S. mainland as a means to increase revenue. In a push that started in 1995, Popular Inc. has consolidated through Banco Popular North America its stateside expansion efforts and generated total assets of $6.1 billion. The latest to head north, R&G Financial, doubled its assets to $1.2 billion within a year of entering the Central Florida market. Even the smaller U.S. Virgin Islands/British Virgin Islands market has generated $765 million in assets for First BanCorp.
Nondepositary mortgage lenders have continued a growth pattern that took them from $3.4 billion in loan originations in 2000 to nearly $5 billion as of Sept. 30, 2003. Low interest rates during the period stimulated new home loans and home refinancing. The low rates favored mortgage lenders and commercial banks mortgage divisions alike.
The credit unions, meanwhile, kept pace with their bigger siblings, with assets increasing from $4.4 billion in 2000 to $5.7 billion as of Sept. 30, 2003. This success was accompanied by an increase in loans, deposits, and membership, even though the number of credit unions contracted to 142 units from a high of 161 in 1999.
Expanding to other markets or locally is not the only way local financial institutions have grown. Through brokered certificates of deposit (CDs), international banking entities (IBEs), and other means, local commercial banks have sought to expand their deposits base to fuel their lending-to-growth opportunities. In the past four years, for example, the amount of brokered CDs in local banks has grown by $7.4 billion, going from $2.9 billion in 1999 to $10.2 billion as of Sept. 30, 2003. (See chart on page 20.)
Originating within U.S. mainland jurisdictions, these flexible funds have provided new liquidity to the islands banking institutions. One of their uses has been to make up for the dwindling deposits of the past few years, in part due to the flight of so-called 936 deposits.
Local financial institutions have also benefited from accessibility to funds provided by IBEs. This pass-through mechanism, also seen by the government as an instrument of job creation, is intended to allow tax-free repatriation of offshore profits to Puerto Rico.
First BanCorp helped its growing plans by acquiring the portfolios of J.P. Morgan Chase & Co. in the U.S. Virgin Islands, British Virgin Islands and the Royal Bank of Canada. This instantly increased First BanCorps deposits, loan portfolio, and market share. The deal also made available for hire a group of experienced professionals who added immediate value to the institutions operations.
In an expansion mood
The recent economic downturn has required that local financial institutions implement aggressive growth strategies. A few of Puerto Ricos largest banks have expanded not only to the U.S. mainland but also to Latin America and the Caribbean.
For Popular Inc., First BanCorp, Doral Financial, and R&G
Financial, for example, expanding abroad has provided an opportunity to increase deposits and loan portfolios, improve market share, and develop nonbanking businesses (such as insurance, investments, and securities). This cross-selling of financial services under one roof has added to the banks growth. Popular, First BanCorp, Doral Financial, and R&G Financial already have an important presence outside of the island and are receptive to developing other markets.
Despite 9/11 and the recessionary environment of the past three-and-a-half years, Puerto Ricos financial entities have managed not merely to compete but to press ahead for real gains. Statistics on commercial banks from the Office of the Commissioner of Financial Institutions demonstrate consistent increases in most categories. From September 2000 to June 2003, for example, average capital went from $3 billion to $5 billion; average total loans went from $26 billion to $36 billion; and equity capital went from $3 billion to $5 billon.
Consumer loans, notwithstanding the large cancellation of consumer financing debt through home refinancing, stood at $5 billion as of the third quarter of 2003. The sale of securities for the first nine months of 2003 reached $30.7 billion, compared with $21 billion for 2000. Investment companies and mutual funds energized the financial system by helping to preserve and increase the local capital.
"Bank loan portfolios have continued to grow, particularly in the real-estate sector, which has served as a buffer, helping to avoid a deeper recession for Puerto Rico," said Commissioner of Financial Institutions Alfredo Padilla. Credit unions have quietly complemented the rest of the financial industry and provided stability. Although their numbers have been reduced, their contributions have increased in many categories. As of Sept. 30, 2003, credit unions had a loan output of $3.4 billion, compared with $2.9 billion for 1999. "The credit unions are booming and are expected to continue to grow steadily through 2004," said Ana Ortiz, president of the Puerto Rico Cooperative Supervisory & Insurance Corp.
The need to keep growing and stay ahead of competitors has led commercial bankers to focus on improving their financial performance. One vehicle is the IBE, which is designed to attract major international financial companies to the island through offshore activities. Income earned by an IBE is exempt from Puerto Rico income taxes, branch profit taxes, and municipal license taxes.
As of Sept. 30, 2003, the assets of locally organized IBEs constituted about $58.4 billion, or 36%, of the total assets in Puerto Ricos financial system.
Although some say IBEs should be eliminated because they generate few jobs relative to their own benefit, others think the right move would be to reconfigure them so they suit Puerto Ricos economic needs. Those in favor of the IBE regime recognize its growth capability, not because it brings immediate liquidity but because it helps the capital markets.
Income generated by an IBEs primary business outside of Puerto Rico cant be directly funneled back to the island. The profit spreads made on the use of that money are what can be sent back to the island through the IBEs unit or branch structure. These, in turn, support local lending and job development efforts.
"The IBE structure has allowed Citibank to carry out international funding and brokerage activities in a way that no other jurisdiction can," said Alvaro Jaramillo, Citigroups country officer. Padilla fully supports IBEs and hopes their numbers in Puerto Rico will significantly increase from the current six.
Many industry observers say brokered CDs have also become critical to island banks. The existence of brokered CDs has alleviated the liquidity problem caused by the loss of 936 funds, the low savings rate, and the flight of deposits to alternate investment sources. Brokered CDs are issued through securities firms in the U.S. and insured by the Federal Deposit Insurance Corp. (FDIC).
"This funding vehicle has become a key element in the banking equation by providing continuity to the lending process in the face of limited deposits," said Freddy Maldonado, chief financial officer of W Holding Co. According to the Office of the Commissioner of Financial Institutions, there was $10.2 billion in brokered CDs in Puerto Ricos banking institutions as of Sept. 30, 2003.
Brokered CDs have allowed financial institutions to boost their lending power in the face of eroding deposits. Deposits have actually increased on the island in recent years, but people have resorted to more interest-competitive institutions such as brokerage firms. Bank customers savings have also dashed off to mutual funds, preferred stock offerings, and instruments such as the Government National Mortgage Association.
The low interest rates of the past three-and-a half years have played a significant role in enticing investors away from banks. "The banking industry has suffered from people shifting to a $7 billion mutual funds industry," said Padilla.
The flight of deposits has caused financial institutions to make adjustments at the operational and treasury levels. Nevertheless, brokered CDs are expected to continue fueling the growth of local financial institutions.
Most buyers of brokered CDs purchase denominations of less than $100,000 and are attracted by the higher interest rate (by U.S. standards) and the FDIC guarantee. Brokered CDs have diverse maturity terms and may carry a callable feature, predetermining a date by which the financial institution could buy the brokered CD back from the investor. Banks have actively been using brokered CDs for over five years.
Most local banks have welcomed the access to brokered CDs, though a few have opted to emphasize alternate money sources. Banco Santander Puerto Rico and Oriental Financial have the lowest balances of brokered CDs among the islands major banks, with $229 million and $63 million, respectively. First BanCorps FirstBank and W Holding Co.s Westernbank have the highest balances, with $2.7 billion and $3.1 billion, respectively.
P.R. Banks getting outside attention
The memory of a more-crowded local banking industry is still fresh. As recently as 1982 there were 21 banks on the island. Through mergers, acquisitions, and consolidations, the seven dominant commercial players that remained have managed to become stronger and more competitive.
Other banking organizations such as Eurobank, The Bank & Trust, and Scotiabank have worked to strengthen their positions. Empresas Fonalledas continues to operate UniBank in Florida.
"The financial institutions reserves and capital structure are fundamentally strong. Management has improved and matured since the 70s with the influx of professionals into the industry. No doubt about it, banking leaders are visionary," said Padilla.
The astonishing growth and financial performance of Puerto Ricos big seven havent gone unnoticed.
Brean Murray & Co., a New York investment firm following Puerto Ricos seven largest banking institutions grouped as the Puerto Rico Stock Index (PRSI), has demonstrated that the institutions have outperformed the S&P 500 Bank Index and the S&P 500 for the past decade.
The companies making up the PRSI are publicly traded on the New York Stock Exchange except for Popular Inc., which is listed on the Chicago Stock Exchange. Eurobank and The Bank & Trust may have equally impressive growth and performance numbers given their size, but they are excluded from the PRSI because they havent gone public. As of June 30, 2003, Eurobank had $1.2 billion in total assets and $72.5 million in capital, while The Bank & Trust had $670 million and $41 million, respectively.
The world is weathering harsh economic times, yet Puerto Ricos financial institutions have demonstrated their ability to move forward. In the process, they have contributed to Puerto Ricos economic stability and provided a safety net while other economic sectors recovered.
"In reaching the key economic sectors, the lending activity has fostered economic growth while allowing capital to circulate and grow," said Padilla. "Growth, which is fundamental to the islands development, has been possible by maintaining quality loan portfolios with adequate reserves set aside for potential losses."
Even if all the components of the islands financial system arent fully reconciled, Puerto Ricos financial institutions have been a source of pride and prestige in and outside the island. While moving themselves forward, they have managed to breathe life into this island.
Converting the unbanked population
The unbanked, or those lacking access to financial services, number more than one million people. The sheer size of this segment has attracted the interest of government and banking institutions alike.
Puerto Ricos unbanked segment is estimated at 36% of the islands population. Officially, these are individuals who dont have a deposit account with a bank, credit union, or brokerage firm. Statistics also show that 41% of the unbanked households in Puerto Rico are employed; in fact, many government employees belong to this segment.
Both Puerto Rico and the U.S. mainland have experienced relative prosperity in the past several years, as evidenced by general economic growth, productivity, and advances in technology. Yet the unbanked segment has remained financially anonymous.
To them, cashing a check or paying a bill means an additional expense. Emergencies usually require borrowing money at usurious interest rates, which will only worsen their situation. Buying a home will probably remain a dream in the absence of an acceptable credit history.
"Providing these families with important financial servicesand thus with entry into the financial mainstreamcan alleviate their situation enormously," said Miguel Soto, executive director of the Center for the New Economy, an organization dedicated to developing economic strategies.
There are many reasons people are unbanked in Puerto Rico. They may not make enough money, may not perceive a need or benefit, or may believe the account-balance requirements are too high. Additional reasons are the complexity of managing checking accounts, the desire to keep financial information private, and the lack of savings habits.
"The key to connecting the unbanked segment to financial services is direct deposit," said Jose R. Gonzalez, president of both Banco Santander and the Puerto Rico Bankers Association. The Center for the New Economy has identified two principal methods for attracting the unbanked situation: expanding banking services and providing the opportunity to build assets.
Expanding banking Services
Banco Popular, for example, has designed Acceso Popular, which allows the separation of daily transactions from savings. Since 2001, the bank has opened more than 200,000 Acceso accounts, with average deposits of $311. Of the account holders, 50% have activated the savings component.
"The principle of savings promotes self-improvement; savings is a means to achieving self-empowerment," said Mariangeli Berlingeri, vice president & retail bank manager at Banco Popular.
Electronic banking is another tool for banking institutions to connect with the unbanked population. Individuals that dont have a banking relationship can be introduced to this simple, lowcost, accessible banking approach. Electronic transfer used for direct deposits alone could save the government and businesses up to 90% on the cost of check processing.
"Owning a bank account can be the catalyst in a chain of events leading to long-term financial stability," said Soto. "Banked families usually have better credit ratings, which grants them greater access to lower-interest loans and thus to improved social mobility."
Some maintain that poverty is the absence of income, while others say poverty is the lack of capabilitythe capability needed to grow economically through the development of personal assets. Economic advancement for the unbanked, whether in the form of a home, a business, or something else, is linked to asset accumulation, which will validate credit, collateral, or guarantee requirements.
Trends show banking institutions are working with unbanked families by developing custom-tailored products and services that will promote asset accumulation. The government says its revenue would increase as a result of unbanked individuals leaving the poverty ranks and filing income tax returns.
"There are over a quarter-million government employees who can make a difference for themselves and for the government by taking up the offer for direct deposit and the savings plan," said Arturo Carrion, executive vice president of the Puerto Rico Bankers Association.
The federal Community Reinvestment Act, which requires that banking institutions in low-income communities invest in those neighborhoods, also promotes access to capital and other financial services.
In the final analysis, it is expected that as more unbanked individuals join the financial mainstream, there will be a higher level of savings and asset building which will lead to personal stability and the improvement of the entire society.
Local banks in an expansion mode
Expansion to the U.S. mainland has become a key growth strategy for Puerto Rico banks. Banks already there have resorted to branch construction, production offices, and acquisitions to stake a claim in the stateside financial market. Those who arent in the States may be making the jump yet.
Popular Inc., with total assets of $35.8 billion, operates 96 branches in six states and has a presence elsewhere in the Caribbean and Latin America. Its stateside operations represent $6.1 billion in assets, or approximately 17% of the total; stateside revenue accounts for 28% of the companys total. Equity One, the largest subprime-mortgage banking operation on the U.S. mainland, is a Popular subsidiary and has assets of $3 billion.
First BanCorp, known for its commercial and consumer banking businesses, operates 12 branches in the U.S. Virgin Islands and British Virgin Islands (acquired in October 2002), which offer commercial banking and insurance. Assets abroad represent $765 million, or 6% of the $12.1 billion total. Success in the residential mortgage business moved the company to launch a FirstMortgage subsidiary recently.
Doral Financial, the largest mortgage banking institution in Puerto Rico, has four Doral Bank branches in New York and a fifth due to open in early 2004. As of Sept. 30, 2003, it had assets abroad of $495.5 million and deposits of $327.9 million. New York-based assets represent approximately 5% of Dorals $10.8 billion total assets. Doral Financial has shown eagerness to continue expanding its stateside interests.
By purchasing the Crown Bank of Florida in summer 2002, R&G Financial acquired 15 branches in Central Florida and four production offices in various southern states. With total assets of $7.8 billion as of Sept. 30, 2003, the Florida operations represent $1.2 billion, or 15% of total assets. As Puerto Ricos second-largest mortgage lender, it is expected to benefit from the boom in housing construction here and abroad. Like other financial institutions, it is diversifying its portfolio through banking and nonbanking businesses.
The four financial institutions that have made the leap to the U.S. mainland market have claimed satisfaction with their move and are showing interest in seeking new venues. "We saw an instant opportunity to grow as we carefully studied the demographics, the lower costs of deposits, and the incredible real-estate and construction development movement in Central Florida," said Victor Galan, chairman & CEO of R&G Financial.
Others, like Oriental Financial, have acquired a pension fund management business in Florida but havent made expanding on the U.S. mainland a top priority. "We are concentrating on diversifying and strengthening the company and will evaluate offshore expansion options at the right time," said Jose F. Fernandez, senior executive vice president & chief operating officer of Oriental Financial.
Banco Santander and Banco Bilbao Vizcaya Argentaria, with their powerful global financial networks, havent ruled out entering the stateside market. "Our intention is to continue developing in Puerto Rico and positioning the bank so it will be ready in the event that we proceed with an expansion to the U.S. mainland," said Emilio Botin, president of Grupo Santander Central Hispano, during a visit to the island earlier this year.
Expanding, growing or escalating, just call it b-r-a-n-c-h-i-n-g
Electronic gurus were quick to forecast the demise of the branchs role in the banking system, stating that their substantial reduction, almost to the point of disappearance, was inevitable. Federal Deposit Insurance Corp. statistics logging 87,000 operational branches across the country in 2003, with construction of many more under way, have put the lie to that prediction.
There is general interest throughout the banking community in the development of branch locations as it relates to building up a physical network. This could be due to the excess of deposits available in a historic moment of swinging capital markets. Aggressive financial institutions have increased their drive to attract and retain high-net-worth customers by creating inviting, sophisticated retail environments that provide all services under one roof.
"In the beginning, expansion trends had more to do with mergers and acquisitions of financial institutions," said Pedro Pecunia, vice president & metro district manager of Doral Bank. "Then it was realized that expanding through a branch network could be more efficient, thus allowing for specific-area targeting and consistency in branch construction."
However, no banking institution would be enticed to build a large number of branches simply to pursue the unstable cash flows of particular groups. There appears to be a well-synchronized marketing effort among financial institutions to appeal to their customers concerns about time and personal finance. It is a well-known fact that Puerto Rico and U.S. mainland consumers thrive on convenience and, indeed, demand it.
"Peoples everyday-living constraints make access to banking services a strategic consideration. This need promoted the lets go to the bank store mentality, which brought with it crossover servicing at full strength," said Pecunia. Marketing plays a key role in promoting new banking outlets. Because customers are Increasingly voicing their approval or disapproval of service delivery, brand reinforcement and market share now have a direct relationship to a branchs physical appearance. Research by Bostons Celent Communications supports the importance of face-to-face contact in handling applications or providing product advice.
Citibanks strategy for the establishment of branches in the Puerto Rico market has been focused on new construction, although the institution has lately shown interest in branch acquisition. "In decisions related to branches, two elements are key: population numbers versus number of branches and income per capita," said Carlos J. Davila, Citibanks retail bank business manager. "From an economic point of view, when acquiring a branch you are going to pay a premium, and if constructing one you are making an investment."
Friendly neighborhood branches carry an additional responsibility: preserving and increasing brand loyalty among new customers and those that have moved from other neighborhoods or communities. As time and distance continue to impact islanders lives, a strategically located, friendly, all-service branch will continue to be an attractive offering.
Pecunia recounted a recent experience when he suggested that an elderly customer expedite her transaction by using the new electronic equipment at a branch: "She said, Thank you, my son, but I have all the time in the world to waste, so I will just a grab seat and wait."
The branching trend will continue its pace for now, as it accommodates the generation gap.
P.R. Commercial Banks Brokered Certificates of Deposit
P.R. Financial Systems Total Assets (In billions of dollars)
A total $160.7 billion as of Sept. 30, 2003
Credit unions (estimate)$6.0
Source: Office of the Commissioner of Financial Institutions
P.R. Commercial Banks Brokered Certificates of Deposit
Brokered CDs in billions
2003 Detail (January-September)
90 days or less14%
91 through 18016%
181 through 36518%
2 years or less9%
3 years or less7%
4 years or less5%
5 years or more31%
Source: Office of the Commissioner of Financial Institutions
This Caribbean Business article appears courtesy of Casiano Communications.