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Edited Transcript of FBP earnings conference call or presentation 22-Oct-19 2:00pm GMT

Q3 2019 First Bancorp Earnings and Agreement to Acquire Banco Santander Puerto Rico Call

Santurce Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of First Bancorp earnings conference call or presentation Tuesday, October 22, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aurelio Alemán-Bermudez

First BanCorp. - President, CEO & Director

* John B. Pelling

First BanCorp. - IR Officer & Capital Planning Officer

* Orlando Berges-González

First BanCorp. - Executive VP & CFO

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Conference Call Participants

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* Alexander Roberts Huxley Twerdahl

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Glen Philip Manna

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Joseph Gladue

J. Alden Associates, Inc., Research Division - Director of Research

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Presentation

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Operator [1]

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Good morning, and welcome to the First BanCorp Third Quarter 2019 Results and Acquisition of Banco Santander Puerto Rico Discussion. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to John Pelling of Investor Relations. Please go ahead.

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John B. Pelling, First BanCorp. - IR Officer & Capital Planning Officer [2]

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Thank you, Nick. Good morning, everyone, and thank you for joining First BanCorp's conference call and webcast to discuss the company's financial results for the third quarter 2019 as well as the strategic transaction announced after the close yesterday. Joining today from First BanCorp are Aurelio Alemán, President and Chief Executive Officer; and Orlando Berges, Executive Vice President and Chief Financial Officer.

Before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from the forward-looking statements made due to the important factors described in the company's latest SEC filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the webcast presentation, transaction presentation or press release, you can access them at our website at 1firstbank.com.

At this time, I'd like to turn the call over to our CEO, Aurelio Alemán. Aurelio?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [3]

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Thank you, John, and good morning, everyone. And thank you for joining us today. It's an important call. We will be discussing the third quarter results, and we will be discussing the exciting transaction we announced yesterday, so it would be a different call. We're definitely very excited about the strategic transaction we reported last night, but we will be discussing that one in the second part of this call. Then we will have a joint Q&A session for both results.

So please, let's move to the third quarter highlights, Page 5 of the deck. We reported this morning what we consider an awesome quarter of bottom line results with net income of $46.3 million, representing $0.21 per share. I think it's important to highlight that the core franchise metrics continue positive and moving in the right direction. Pretax, preprovision income at the $70 million level. Net interest income increased quarter to quarter by $1.9 million and $12 million when we compare to the same quarter in the prior year.

Our loan portfolio declined this quarter approximately $137 million. I have to say that we view -- in this case, we view this reduction as a positive one because it was driven by a large payoff of 2 loans that were actually criticized and the repayment of another large nonperforming loan. So it really improved our risk profile on the portfolio.

In spite of this, year-over-year, the loan portfolio has grown almost 3%, composed of 19% increase in the consumer, 3% increase in the commercial and construction, while we strategically continued to reduce the mortgage -- the residential mortgage portfolio, which year-over-year have been reduced 6.5%.

Originations and renewals were strong for the quarter. The third quarter is not usually a stronger one, but this one was a really good one with $1.1 billion in originations and renewals.

On the NPA side, we're very pleased to say that the path of organic improvement and reduction continued this quarter with a $52 million reduction or 14%. Now NPA assets represent only 2.65% of the book, which is the lowest that we had in many, many years.

On the funding side, core deposits slightly decreased driven by government and brokered certificates, which is our intent to continue. And then capital obviously continues to grow now with $2.2 million (sic) [$2.2 billion] and tangible book at $9.79 million (sic) [$ 9.79]. And obviously, we're giving you, I think, excellent capital news, which has been a question in all the prior calls.

So with that summary, I'm going to turn the call over to Orlando, and we'll be back to cover the deal presentation later.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [4]

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Good morning, everyone. So Aurelio mentioned this third quarter was a very good quarter, to some extent driven by improvement in some asset quality-related components that led to provision reductions and improvements in net interest income. Net income, as he said, was $46.3 million or $0.21 a share. This compares to $41.3 million or $0.19 a share last quarter. And the offset, on a non-GAAP basis, net income was $44.7 million, which is $0.20 a share compared to $40.8 million last quarter. And you can see the detail of the breakdown on the earnings release that was sent out this morning.

Pretax, preprovision remained strong at $70.2 million, slightly lower than the $71 million achieved in the second quarter. The provision for the quarter was much better. Provision was down $5.1 million to $7.4 million in the quarter. It was mostly driven by $6.5 million reserve releases in commercial loans, combination of historical -- lower historical loss rates in the portfolios, the early payoff of $120 million in 2 large criticized loans, as Aurelio mentioned, and some credit upgrades we had in the quarter.

In terms of net interest income, the net interest income grew $1.9 million. However, I'd like to point out that we are starting to see the impact of the declining interest rates in our -- on the variable-rate loans. On one hand, we saw interest income grew -- growing $2.9 million due to an increase of $96 million in the average balance of consumer loans. And we saw an additional $3 million growth from the accelerated discount accretion of an acquired loan that was paid off in the quarter. On the other hand, we saw a reduction of $900,000 from downward repricing of the variable-rate commercial loans, and $700,000 was related to the reduction in the commercial portfolio associated with some of these large pay-downs.

Net interest margin for the quarter was 4.89%, very close to 4.90% from last quarter. But the accelerated discount accretion I just mentioned improved the margin by about 10 basis points in the quarter.

The one thing important with LIBOR and prime, projected to decrease further. We believe margin will see some pressure if it happens as the variable-rate loans reprice. That could be partially compensated by the trends in growth that we've had in the consumer portfolios. But assuming no changes in deposits, we do expect a little bit of pressure on the margin and might be close to the adjusted number for the quarter after excluding the discount accretion or slightly lower than that amount in the next few quarters.

On noninterest income, it was fairly comparable to last quarter. We did see -- remember the last quarter, we had a $600,000 gain from recovery on insurance proceeds related to insurance claims. And we did have this quarter $500,000 of PPI charges on the private-label MBS we have on the books. Other than that, we saw some increases in service charges and fee-based income related to transactions.

The expenses for the quarter were $92.8 million, just under the $92.9 million we had last quarter. The main items is we did have a $2.5 million decrease in OREO expenses, mostly lower write-downs to the value of OREO properties. And we had a $700,000 decrease in occupancy costs. You recall last quarter, we had a write-down of some capitalized costs on a project that was changed -- technology project that was changed, and we eliminated some of the components.

We did see increases in professional service fees in the quarter. $600,000 were legal fees related to strategic projects, mostly associated with the transaction we disclosed last night, and $400,000 on assessment of some technology-related projects we had in the quarter. Also, employee compensation was higher as we had salary increases that took effect -- merit increases took effect in July, and we had one extra day in the quarter.

Regarding asset quality, I think it was -- Aurelio made reference to -- we had a very good quarter. We were able to sell $31.5 million nonaccrual commercial mortgage loan in the Florida region -- or not sell, but it was repaid, which was the largest nonaccrual in the portfolio. We had collections of $3.5 million in nonperforming in the quarter, which was pretty good. And also, we sold the $10.8 million OREO property we had for some time. As a result, nonperforming came down $52 million to $332 million compared to $384 million last quarter. The decrease we had in the quarter was partially offset by a $1.2 million increase in nonaccrual loans, primarily auto and finance leases. And it's important to mention that, obviously, as the portfolios have continued to go down, the latency trends have continued to be good and charge-off trends have continued to be very good. But it's a much higher portfolio, so we're going to see a little bit of that happening, which -- and then with some additional inflows to non-accruals for the quarter. But overall, pretty good results in terms of movement in nonperforming assets.

Charge-offs were -- net charge-offs were down in the quarter, were $13.8 million, which is 61 basis points, which compares to $24 million last quarter. We did have a $12 million -- $11.5 million charge-off was taken in the second quarter on the loan -- nonperforming loan that was paid off this quarter.

The ratio of the allowance coverage is at 1.85% to loans held for investment, slightly down from the 1.89% last quarter. But also, you can see on the slides that commercial NPL portfolios have come down significantly. They're now at $76 million, and they are carried at $0.41 to the dollar basically on the books.

Before we have calls, as Aurelio mentioned, we're going to go to our presentation on the strategic transaction, and then we'll address all the questions.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [5]

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Thank you, Orlando. Yes, please move to Slide #3 on the second presentation titled Acquisition of Banco Santander Puerto Rico. Definitely, as I say, we're really excited about this strategic announcement. It is transformational for the company. It will give us scale, which is important to continue competing and expanding in this market. And I think very clear, we want to get bigger. We want to -- we see an opportunity to grow in the market with this acquisition. We'd like to see 1 plus 1 become 3, no 1 plus 1 become 1.5. So we're going to work towards achieving that.

Some of the assumptions on the presentation, which you could view as conservative, are driven by the fact that we would like to have more presence, retain more clients, grow more clients and expand our branch network to serve the communities and the clients better.

As you can see in the announcement, the affinity agreement, we signed the agreement yesterday. It's going to go through a process of approval, which is customary to this type of transactions. So the announcement is the signing of the agreement. We're going to go through the process of approval, the filing of the application, and we should move on, and we estimate somewhere mid-2020. Considering how things operate in this market and regulatory views of the market, that is -- this is a process that we would work hand to hand with the regulators over the next months in -- is filing the application and submitting the required information.

We -- as the agreement state, we pay $62 million -- $63 million premium for -- to core tangible equity. And again, I'm going to try to walk you through the highlights, and Orlando will cover the details of the terms and the structure of the deal.

We're very excited that -- we feel it's a very efficient capital deployment, and we're acquiring a strong and stable earnings stream. We are also very pleased to see how we expand the talent bench across retail, commercial, business banking and risk management functions. So definitely, the Santander team that comes over and joins our team is an expanded talent bench for us to continue our combined strategy.

Also, the transaction will give us additional revenues as a larger company to continue expanding our investment in technology, which is a critical component in parallel that is running with the strategy. Definitely, when you add all this together, we're going to be a stronger competitor to further support the growth in Puerto Rico and economic recovery and redevelopment of Puerto Rico.

Yes. Let's move to Slide 4 for a moment. This is just an overview, what are the assets, what is the composition of Santander today as of June 30, 2019, $6.2 billion in assets, $3.1 billion in loans and $5 billion in deposits and approximately 1,000 employees. The 27 branch locations are complementary to our footprint and definitely will allow us to provide expanded and better services.

Moving to Page 5. On a pro forma basis, the -- using again June 30, 2019, the combined entity will have $17.6 billion in deposits (sic) [total assets] and $12 billion in loans and $14.2 billion in deposits, becoming the #2 rank in Puerto Rico as we are today in all areas. The pro forma loan-to-deposit ratio will be 84% as we achieve an improved mix of deposit. As you could note in the agreement, we will not be acquiring any nonperforming assets. So by -- if we pro forma again as of June 30, the NPA and NPL loan ratios will both be reduced, NPA to 2.2%.

I also want to highlight that, as we said, it's an all-cash transaction. Our projected pro forma capital ratios are still well in excess of the well-capitalized regulatory guidelines, with the pro forma leverage ratio over 11%, CET1 at 15.3% and total risk-based capital ratio at close approximately of 18%.

Let's move to Slide 7, so you can see more granularity on the pro forma combined institution. We will be growing market share in every segment that we participate today, and the pro forma loan portfolio brings a larger participation in the commercial activity in Puerto Rico, specifically in some of the segments that we are small, like the small business and business banking, an opportunity to grow in those segments. And then when you look at the pro forma deposit mix, it's definitely healthy in the 4 core products that we have in the core deposits. So it's a similar loan profile to ours in terms of pro composition. Obviously, within consumer, we have the auto lending, which is still one of the offers that they had at Santander, but we -- I mean, we have scale in the credit card business and in the personal loan business. Definitely, the transaction, when you look at the deposit mix, will definitely enhance our funding profile, our cost of funds and our customer base.

Moving to Slide 8. When we look at the pro forma branch network, definitely, on deposits, you can see we reached 20% of deposits in the island, which has been our goal for some time, and 21% -- almost 22% of total asset. As you can see, the branch footprint is complementary to ours, giving some additional presence in the island, in the west side and south part of the island, which we definitely need. So we definitely -- the transaction, it's both complementary, and it helps grow the franchise.

So with that summary, I'm going to hand the call to Orlando, so he can expand on the structure. We definitely look forward to welcoming the Santander team and the customers to the FirstBank family, and we're very optimistic with the future growth that this potential transaction brings.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [6]

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Thanks. As Aurelio mentioned, I -- we're extremely excited about announcing this deal and having been able to reach this. But I'm going to walk you through some of the key components of the transaction and address, later on, any questions.

The transaction, as Aurelio also mentioned, is an all-cash transaction. There is a significant built-in liquidity in both our balance sheet and in terms of cash and securities as well as in Santander's balance sheet, which helps in achieving the structure.

The premium, it's $63 million, he made reference to, which is about 17.5% over the $362 million of Santander's core tangible common equity as of June, for a total base price of $425 million. In addition, Santander has $638 million in excess capital that will be paid at par. He also made reference to -- and it's important to highlight that we will not be acquiring any nonperforming asset in this transaction.

The purchase price represents approximately 7.2x the last 12 months adjusted earnings, giving effect to the option of the excess capital. And obviously, it's subject to adjustments based on Santander's balance sheet at closing date, which, as we said, we expect to be sometime mid-2020, pending the receivable necessary and regulatory approvals.

Assuming a full year of earnings and cost savings for 2020, we use 2020 because of the availability of consensus information, this transaction will be about 35% accretive to a consensus estimate of $0.81 a share. That would assume the transaction would have been completed beginning of 2020 and obviously includes earnings throughout the full 12 months of both institutions.

The tangible book value per share dilution on the transaction at closing is estimated to be approximately 7%, with an earn-back of 2.6 years using the crossover method.

Some of the assumptions that we have done in the transaction -- in modeling this transaction, we have estimated that we could achieve -- we can achieve approximately $48 million in cost savings, which is about 35% of the last 12 months noninterest expenses, excluding OREO as no OREO is coming on with the transaction. This is -- after an extensive diligence process, we have gone through different components and trying to achieve some of the objectives that Aurelio just made reference to. Assuming a mid-2020 closing, we anticipate that those savings will be about -- 25% will be achieved in 2020, and obviously, 100% of the savings will be by 2021.

Also, we've modeled a reduction of approximately $4 million in pretax noninterest income due to the limitations of the Durbin Amendment, which are applicable to us as an institution with more than $10 billion in assets, which was not applicable to Santander in Puerto Rico. We did conduct an analysis of the commercial, consumer and residential portfolios to estimate some fair value loan mark. We estimate those marks are approximately 5.9%.

And looking at the other components, we've estimated that preliminarily, the core deposit intangible, it's about 1.5% value. And the same thing on the credit card, the positive relationship, which is about 3% of value, it's being assigned in the model. These intangibles are being amortized over 7 years using the sum of the years' digits.

I'd like to point out that the transaction also -- Santander has now a portfolio which is tied to a co-branded card with JetBlue. That portfolio is being transferred to another institution, so it's not part of the transaction and is being excluded from the analysis.

Lastly, we have estimated that transaction costs -- restructuring charges will be approximately $76 million, with 50% of that being incurred at closer -- or closely thereafter, and the other 50% in 2021, once we achieve all conversions and integrations.

I would also like to touch a bit on CECL. As you all know, the adoption of CECL is effective at the beginning of 2020 for institutions with calendar years like us. And CECL changes the way the accounting is done for acquired loans. On one part, we still have to follow the rules for accounting for business combination, where all assets are mark-to-market, which includes, obviously, marking loans at fair value. However, in addition, CECL requires that, for loans that are not considered what we call PCD loans or purchase credit deteriorated loans, an additional allowance will have to be established in accordance with the new standard, in essence, duplicating some of the impact. The impact will be recovered or compensated in the future as the net fair value marks are accreted back through income over the estimated life of the loan portfolios, of the specific loan portfolios.

So to estimate CECL, what we've done is using the fair value assessment of the portfolios that we did. Given the expected closing of mid-'20, so we anticipate the need to establish a CECL allowance for non-PCD loans at closing in the range of $45 million to $55 million pretax. It would be approximately $28 million to $34 million after tax. This will increase the dilution at closing in tangible book value per share by an additional 1.6% to 1.9% over the 7% dilution that I just mentioned, so that's been part of the analysis. Clearly, as I mentioned, there will be some accretion of some of the other impact coming back in the future year.

With that, I would like to open the call for questions on both the presentations, the earnings and on the transactions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ebrahim Poonawala, Bank of America Merrill Lynch.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [2]

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So I guess just first question. I think, Aurelio, you mentioned that you made some conservative assumptions around how you've laid out either the expense savings or the earnings accretion tied to the deal. I think some of the feedback from investors overnight has also been on similar lines, where there's expectation that we could see better than 35% earnings accretion. One, I would appreciate if you could address in terms of the potential for that happening. And also tied to that, if you can talk about any loans, deposits that you will be running off following the deal which may have made sense as part of Santander global but don't as part of FBP.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [3]

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Okay. Let me -- yes, let me cover it, yes. First, I think first of all, obviously, we're still operating on the Puerto Rico economy. So we know that predicting the economy, it's not an easy task. So we took a conservative approach of economic growth, but obviously, we're assuming the estimates are going to be certain growth and is going to give us opportunity. So this works 2 ways. Our goal is to -- after we combine the 2 institutions, we can start, actually, some additional growth. So for that, you need definitely to retain as much clients and as much front-end personnel to continue the task of increasing the franchise. You also need to retain significant part of the branch network to continue servicing and delivering to a larger client base.

So as we go through the approval process, integration planning and all the things that will take us over the next 6 months, we will learn more. We will continue to view how the economy is moving. We have sectors of our strategy that, as you know, for example, strategically, we're increasing mortgage origination in the conforming, but we're decreasing the portfolio side. So we'll be adjusting all those estimates. So we think it's a balancing -- it's a balanced approach. It's been a balancing act. And I -- the way we present the transaction is a balanced approach.

Yes, there could be an opportunity to go to a higher number, as you guys -- your estimates have put around. But we're -- first, before we get into that, we'd like to see how we make sure that we maximize the resources and maximize the growth opportunities as we're going to be a stronger competitor. There are certain segments that we are a small competitor today, like small business and business banking. This gives us the opportunity to be a larger competitor in this sector. Some of the cash management service, the number of clients, there's an expansion there, too. Credit cards, there's going to be scale, better scale in credit card and personal loans by having larger portfolios in both segments.

So we think our approach is the right one. Yes, numbers could evolve, and as we continue progressing quarter by quarter, we'll update you guys with that. But that's the main strategic goal in the transaction.

I'm sorry, the deposits and -- and then the deposits, yes. We are assuming a conservative 20% in the model, accretion on deposits. There's some intercompany deposits. Some of them will stay, some of them would not stay, but -- and there's a government -- accumulation of government deposits that is happening in Puerto Rico over time. So we believe that all institutions in Puerto Rico, not only us, would see, once this -- the debt of Puerto Rico is restructured and the agreement is approved, that some of the government liquidity will be utilized. So we're also taking that into consideration. So our 84% pro forma include -- considers that already on the core deposit base, which is really a very strong ratio from where we are today in terms of loan-to-deposit. So that is the -- I hope that answered your question.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [4]

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Got it. And just in terms of -- Orlando, if you could remind us in terms of the funding. There's about $900 million of cash on the balance sheet at the end of the quarter. If you could just talk to in terms how much of the deal gets funded through this cash, where that cash balance should be coming out of the deal, that would be helpful.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [5]

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Well, the modeling we did does assume that when you add up the $425 million and the $638 million, it's $1 billion of cash that is coming out. And definitely, the model assumes that reduction in interest income associated with that cash that goes out. It's -- the way we see it, it's a combination of the liquidity we have in cash and the available securities that we have. Obviously, we have the flexibility of drawing lines or using repos -- FHLB lines or using repos if needed. But as I mentioned also, there's significant built-in liquidity in Santander's balance sheet. So a bunch of that liquidity, it's going to be complemented on both institutions once combined. So that's why the deal was structured this way. We feel it's a very doable transaction. But clearly, as you will mention, about $1 billion comes out and does affect some of the investment income. At this point, a large chunk that you saw was sitting in the Fed account at 1.80%, so it's that kind of impact on the income statement. But it's been incorporated into the numbers that we're assuming for the earnings accretions.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [6]

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Got it. And just one last question on the deal in terms of the 6% credit marks, a little high given what Puerto Rico's gone through over the last few years and obviously not taking on the NPAs. Is there anything specific in the portfolio where you assume the higher credit mark? Or are you just being conservative there?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [7]

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It's -- remember, new fair value marks assume lifetime losses in there. The portfolio, there's nothing -- they have a good portfolio. As you made reference to, we're not getting the nonperforming. But you still have the credit card portfolio in there. You have a mortgage portfolio, which is longer term, about $1 billion in mortgages. So it's that combination of the components with lifetime loss kind of scenarios that led to those marks. We will obviously update that, and we -- the marks, it has been a combination of external parties we use for the assessment of the mark as well as using the internal models that we use for DFAST and for CECL and all those components. So we've done a lot of work. That has to be updated. I think we have as of transaction date, but it was most reasonable estimate based on all the information we have at this point.

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Operator [8]

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Our next question comes from Alex Twerdahl, Sandler O'Neill.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [9]

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Congrats on getting this thing finally announced.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [10]

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Thank you.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [11]

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A couple of clarification questions. In the cost saves number, the 35%, are there branch consolidations contemplated in that number?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [12]

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There is, there is. Primarily, you're going to see overhead, technology components, legal, marketing, a lot of administrative expenses. There's a small assumption on that part, yes, but the final number hasn't been determined.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [13]

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Okay. So it seems like there's a little bit of potential that 35%, as things get assessed, could potentially move a little bit higher as the deal gets closer to close and thereafter.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [14]

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I think it goes together with growth opportunity that could obviously -- or the best part of the deal is if you want to grow, then you have to do less reduction on expenses.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [15]

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Remember, the key -- our key view, as Aurelio mentioned, is around this is a very strategic transaction. We think it's going to position us extremely well for the future. So it's not a financial -- immediate financial transaction but a long-term financial transaction, the way we see it. So we want to be able to maximize the capacities of the combined entities.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [16]

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Got it. And then just to clarify, the 25% realized in 2020, that assumes $12 million of the $48 million assumed is realized in 2020, right, not 25% or 35%?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [17]

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No, no it's $12 million.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [18]

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Correct.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [19]

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Yes.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [20]

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Okay. And then I think there was a comment in the press release. I've read that there's potential adjustment to pricing based on Santander's balance sheet at the time of closing. What would trigger an adjustment to the pricing of the transaction?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [21]

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The way the transaction is structured, it's -- you'll see the deal -- the documents of the deal published, but it's basically a calculation of the base tangible common equity, which is based on the size of the institution. So obviously, we do expect that the institution will continue to execute business. And the base capital we're using is 8%, so the institution will continue to do business and grow. So if that happens, the price might go up a bit. If it comes down in size by any reason, it might come down a bit. So we're just trying to point out that the premium, it's based on a base capital which could change on size of the balance sheet as of transaction date.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [22]

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And then the excess capital that remains at closing will be paid at par.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [23]

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Right. And then just a quick question on -- I think this is something that you guys have obviously been preparing your balance sheet for, for quite some time. Can you maybe just shed a little light in terms of where you are in terms of preliminary conversations that you've had and the confidence in being able to get this thing close in sort of -- I know you said mid-2020, which gives obviously a lot of wiggle room, but just in terms of capital levels, in terms of balance sheet capacity, things you need to do. I mean do you feel like, from a regulatory standpoint, that you're in a pretty good spot to get this thing closed without too much delay?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [24]

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I think the capital -- the committed capital, it's strong when you look at deals in the market, and if you compare to the asset quality profile that is the pro forma and if you consider how much excess compared to normal, even for Puerto Rico, 11% leverage, I think -- we think, is a strong number.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [25]

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And obviously, the estimated pro forma at closing...

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [26]

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Leverage, yes.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [27]

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Leverage.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [28]

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So as a matter of practice, the formal application process is the only forum to do with the regulators will provide a definitive view on the transaction proposal. However, the formal disclosure are an important aspect of any bank's supervisory relationship with our regulators. And the content of those discussions, I definitely consider -- they are considered comprehensive supervisory confidential information for banks that we're not allowed to share. But I can say that our discussion today have been very helpful in preparing us to address the key points that most likely arise in the formal application process. So we think the structure that we have put together is strong because all the metrics that make an institution more healthy are actually covered in the way the transaction was structured.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [29]

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And as with Santander keeping the nonperforming and with us having achieved reductions we have achieved in nonperforming and classified assets, I think that positions the institution in a much better way for any transaction.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [30]

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Plus an improved funding profile, yes.

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Operator [31]

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Our next question comes from Brett Rabatin, Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [32]

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Congrats on the deal.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [33]

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Thank you, Brett.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [34]

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I wanted to, I guess, first just go back to just thinking about the deal and that you're having Durbin be lower. Can you give us -- and I missed it, the numbers you gave on the card portfolio, how big it was or how much the income that you're going to not be pulling over from that institution.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [35]

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Well, we did some estimates based on the composition of the fee-based, that approximately $4 million pretax, give or take $3 million after tax, of fee income, if there is a possibility we won't be able to charge. So that -- for our modeling purposes, we are excluding that amount of income from the other fee-based income that Santander has as an institution. Obviously, we need to go through very much detail at the end, but based on the information, we feel it's a reasonable estimate of what could be the impact based on similar -- remember, when this was adopted, we went through similar analysis for ourselves to see what was the impact. So we used the same kind of approach to estimate what could be the impact on their numbers.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [36]

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And the $4 million, that's on the card portfolio? Or is that Durbin? Or is that some -- I'm confused.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [37]

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It's Durbin, everything related to Durbin, limitation and -- right.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [38]

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He asked about the card also.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [39]

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The card, you mean the JetBlue card, the portfolio they're -- is that being kept or...

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [40]

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Right, right, the card portfolio.

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John B. Pelling, First BanCorp. - IR Officer & Capital Planning Officer [41]

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It's a $75 million portfolio, but it's not coming over. Interest income of that is about 14%.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [42]

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Yes, that's also been taken out. But the fee-based -- the $4 million is mostly Durbin.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [43]

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Okay. And then how are you -- your margin would have been down 10 basis points if you exclude the discount accretion benefit in the quarter. Can you talk about both your margin going forward? I know you said a little bit of pressure, the Fed cuts. Maybe give us some color on how much your margin comes down from here with Fed cuts and then how you're thinking about their balance sheet with lower rates.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [44]

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I mean our margins, remember that there were few components of rates coming down. We built in with some more liquidity on some of the repayments. We had large repayments on the commercial portfolio, and we did have some repayments on the investment portfolio also. So looking at the way the market moves, we continue to accumulate a bit of cash more than we would like to see, so that affected margin. And as I mentioned, with rates coming down, there was a $900,000 impact. It's a bit difficult to estimate exactly. We think it's going to put a bit of pressure on margin to come down a little bit more.

Obviously, remember, there is a combination of -- the consumer portfolios are still moving well, so those are higher yielding. On the other hand, we have continued to reduce the size of our mortgage portfolio with originations of more conforming paper to be sold in the market rather than keep it on the books. So those combined will put a little bit of pressure, so I am assuming that we're going to come down a bit from the $479 million. Normal pay-downs and normal deposit behavior will help keep that reduction at not a large amount, but it's a bit difficult to say with the way rates have been moving.

In their -- their balance sheet, I would say, would have similar behavior. They have a good amount of liquidity. And obviously, with the transaction, $1 billion that's going to go out, so there is some impact on interest income, not necessarily on margin because obviously, those -- that $1 billion would be low-yielding kind of investment. So we're looking at it mostly from the interest income perspective rather than the margin perspective in that sense. But I don't think it's different from what you are seeing in other places, that there was a little bit of pressure on margin.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [45]

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Yes, look, the target portfolio has a lower amount of proportion of variable-rate loans than ours, having a fixed-rate mortgage, having fixed-rate personal loans and a credit card portfolio, which actually are mostly fixed. So that really -- and then the loans tied to LIBOR and variable are low income, yes.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [46]

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Okay. And then on CECL, the $45 million to $55 million, that's for the acquired portfolio if I understand correctly. Do you have an estimate for your portfolio?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [47]

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Well, we -- I do. I don't have it -- I'm not disclosing it yet because we're going to include that on the Q, Brett. We have gone through a full exercise. We have gone through different iterations of the CECL. So those numbers, we're going to share what's the estimated impact we're seeing on CECL for our portfolio. That number -- the number we're estimating on their portfolio are on non-PCD loans. Obviously, we felt it was important to give some idea of where we see the rates coming in on their portfolio for the impact on dilution on the book value per share. That was important that you all understand. But within a couple of weeks, once we publish the Q, you'll see a little bit of the disclosures on the estimated impact we'll have on our institution. At the end, it's -- we're going to have that no matter what. So the important thing would be the new impact, what would be on the acquired transaction.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [48]

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Okay. And then I want to get, just if I can, one more on credit. Your net charge-offs are lower, NDAs are lower, but you had higher migration in the NDAs this quarter. Given what we're seeing with credit trends, it would seem like you're provisioning level that declined in the third quarter could be sustainable. Can you just talk about provisioning from here? And absent that increase in inflow in 3Q, are you expecting credit to continue to improve?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [49]

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I think -- yes, I think we have to see how the balance sheet is also changing, the loan portfolio changing. The mix of core mortgage portfolio is reducing, even though originations are increasing, and conforming is the one that we're increasing. But the portfolio, it's going a little down. Consumer will continue to grow. That is our expectation, both auto, personal loans, credit cards or the peripheral products. And commercial will also grow. But when you look at the proportion, provision component of the consumer is higher than commercial. So from that perspective, predicting that provision is going to be driven by how this portfolio mix has moved. Definitely, we see very stable migration on credit trends. We see very early -- good early indications on the delinquencies, which is really our leading -- primary leading indicator. So from that perspective, there's a lot of moving parts inside those formulas that you are very aware, but we continue to see a positive trend when you add all the components within.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [50]

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Keep in mind that obviously, this quarter, we did have some reserve releases on the large repayments. The $120 million repayments were criticized loans, so they had some reserve releases in there. You don't have that every quarter. And you have to balance the fact that as we grow the consumer portfolio, you're going to have some more charge-offs. You're going to have some provision associated with it but a much higher-yielding asset at the same time on the income statement. So if you ask me, I mean we had talked about not being more than $15 million. That stands. I think $7 million, it's on the low side of the quarter. We will never get to the $15 million, I would say, in this current scenario based on the behavior of the portfolio.

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Operator [51]

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Our next question comes from Joe Gladue, Alden Securities.

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Joseph Gladue, J. Alden Associates, Inc., Research Division - Director of Research [52]

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Congratulations. Just let me follow up a little bit on one of Brett's questions on the margin. I just see that Santander's net interest margin is about, if I'm looking at this correctly, about 100 basis points lower than FirstBank's. And just wondering if there's any changes in mix or any structural changes that you'll be able to accomplish shortly after the acquisition that might sort of narrow that difference between the margin and what you're acquiring.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [53]

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Keep in mind, you have to think a little bit about their composition. Number one, proportionately, they have a large amount of investments and cash on the balance sheet. Number two, their portfolios are -- higher components are commercial and mortgages. So those items would, by themselves, yield lower kind of interest rates. On the other hand, we should get a glitch by not having the nonperforming that is on their balance sheet, and that would help improve. If you look at their consumer portfolio, it's mostly credit cards. So we do have other components of our consumer portfolios that improve the margins. So as we can develop more some of those businesses through their branch network, we'll improve the margin, but you have to keep in mind what's the composition of their current asset mix.

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Operator [54]

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Our next question comes from Glen Manna, KBW.

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Glen Philip Manna, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [55]

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Congratulations on the deal. Just from a bigger picture perspective, we've seen a lot of consolidation on the island over the last 1.5 years, whether it's portfolios or whole bank. And really, I'd be interested to get from your perspective -- you've all been long-time bankers on the island. How do you see the environment of banking changing on the island and banks' roles in the future of Puerto Rico?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [56]

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Well, I think the -- one thing is definitely, the local capital is being invested in growing in Puerto Rico for the last years. And we've seen how Popular does it. We see how Oriental is doing it and how we're going to be doing it. Those other players like Citi and Banesco, which have also been growing in recent years. Puerto Rico's also -- through the digital channels, we have other competitors that are very active in the credit card market. They're very active in the personal loan market. They're very active in the deposits. So the landscape is not just the branch networks. We have to -- as we're all doing, we're also investing in digital channels and technology component.

And then you have the credit unions, which -- we divide the credit unions in 2 sectors: the co-ops, which are the local credit unions; and then the federal credit unions. Both of them have continued to grow. The largest -- if you add all the co-ops, they are the largest lender of personal loans. They have the largest market share altogether. They also have 40% of the branches in Puerto Rico when you add all the branches or the credit unions that are physically in the island. And then you see some of the other federal credit unions continue expanding. They definitely -- they have a competitive advantage on the tax side, and there's no barriers of entry for a federal credit union to continue growing in Puerto Rico. Some of them continue to open branches, and they have -- they've been very active in the offering of deposits.

So we think it's -- it continues to be competitive. We think the scale that we're going to have will help us to be -- to improve competition in certain sectors that we haven't been able successfully to do it, like some of the small business and commercial banking sectors. And by having expanded branch network, we'll also compete to the larger banking network.

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Glen Philip Manna, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [57]

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Okay. And when you look at loans on the island and normalize for the pay-downs and maybe the runoff in the resi book, the planned runoff in the resi book, it looks like it's about 3% quarter-over-quarter annualized growth. Is that kind of where you see the island growing at? And also, with respect to bringing on Santander's mortgage book, are your plans to continue to kind of run mortgages down? Or does this kind of alter some of those plans?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [58]

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Yes. I think the mortgage book will reach next year the point of stabilization. When you calculate our 3% year-over-year, remember that we have taken down significant NPLs. So derisking has been part of our history for the last 10 years, and we don't see -- we see we're finishing that in the coming quarters. So from that perspective, we probably can achieve more than the 3% once you consider all the aspects. And there's a component that we would not participate over this period, which is the construction sector, which we are starting to see some new projects coming into the pipeline. And even though the funds -- as we all are aware, the recovery funds of Puerto Rico have been delayed and are moving slowly. They're coming but at a pace that obviously will last more than we all want it to last, which, at the end, is going to bring more loan volume on the construction sector as we see it.

So it's been certain moving parts in how our $9 billion loan portfolio has moved over the last 10 years with NPL sales, migration of OREOs, the originations and sale participations, which we also -- part of our derisking was also to reduce concentrations on borrowers. And some of that was achieved also over the last year. Actually, this quarter, we achieved some of that also. So it is -- I think the paper said it's the low end of the number. We should be capable of doing better than that.

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Glen Philip Manna, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [59]

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Okay. And I was just looking at the CECL tip. Did you disclose the percentage of non-PCD loans that you're acquiring in the breakout versus the whole number or not?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [60]

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We did not. Remember that PCD definitions are pretty ample under CECL, and it requires a lot more analysis. We did estimate how much were the non-PCD. Obviously, it's a higher percentage of non-PCD from PCD loans because they are keeping the nonperforming. But the rules for CECL are a bit more gray area kind of thing or more ample than the old PCI kind of definitions. So we did some estimates to get those numbers that I showed on the $45 million to $55 million, which obviously will, as we go through the integration process, will iron out to come up with specific amounts. But there is some space that you can think of a typical institution, any kind of delinquency, could offer a definition of PCD and things like that. So that's why it's a little bit difficult to say a specific number.

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Operator [61]

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Up next is a follow-up question from Ebrahim Poonawala from Bank of America Merrill Lynch.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [62]

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Just a quick question just on capital. I'm assuming, if the TCE shakes out something between 10% and 11% pro forma for the deal, sorry if I missed that, but wondering in terms of additional capital action. Should we anticipate that the dividend that you initiated last year, we still see some movement on that? And I think you initiated in the fourth quarter of last year. And just in terms of the outlook of where the pro forma TCE would be and kind of your expectations beyond that. I know the deal is probably the big priority right now, but if you can just talk to how you think about capital levels pro forma for the deal and your plans to use that.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [63]

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Yes, you're right. The deal is the priority. But also, there could be some room for moving on the dividend as you see where the earnings are and how much payout we have. Definitely, all our larger actions will have to wait until we have the final number and we are ready to close the deal and we close the deal. But when you look at it on a pro forma basis, assuming the Puerto Rico economy continue on the pace it is moving and the asset quality trends continue in the pace we've been achieving, there should be opportunities for additional actions after we close the deal.

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Operator [64]

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Up next is a follow-up question from Brett Rabatin, Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [65]

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Just wanted to go back to talking about the assumptions on the deal. And I guess, first, everyone's super focused on the 35% expense saves. Can you just go back to the branch assumption, and you said some are small, I think, how much of the 27 locations you might look at and just talk about what percentage of facilities might be of the expense saving assumption that you have?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [66]

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We're not giving a specific number of branches, but Brett, there's also a little back-office facilities that are embedded in this as both institutions have very large facilities and computer centers and technology components that are occupying the facilities, which definitely would be put together. So that is a number that we're not disclosing because we want to make sure we go through a more detailed view or link with the growth strategies and make sure that at the end, we can disclose that. When you look at 35%, we feel very comfortable with that number.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [67]

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Okay. And then I wanted to make sure I understood. I mean you've got a few things that are kind of will net drag down and a higher fee income pro forma. But obviously, there's going to be things that you'll do with the balance sheet that will be synergistic. Can you maybe just talk about, once you've gotten the deal closed, what opportunities you see with the balance sheet in terms of your comment earlier about some things could be conservative?

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [68]

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Well, the opportunities that we see is, number one, Aurelio made reference to the small business and middle-market business. We think that, that would help the combined institution develop -- further develop that business.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [69]

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Yes, but in the period, in the time frame of projection that we have for you that we shared, I think it's important to highlight, and I'm glad you asked the question, we're assuming no growth of loan portfolio for the target period -- in that period of time, okay? So it is a no-growth scenario in the assumptions. As Orlando say, we have areas that we will leave. But again, we want to put that into our new projections once we go to a more detailed process and link that to the trends that we continue to see in the economy. But in the projected period that we're sharing with you in the presentations, that is the assumption. There's no growth in the loan portfolio.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [70]

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Okay. And does the increased size of the platform, does it change your ability to compete better in terms of larger credits on the island?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [71]

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It changes the ability to reach out to clients. I think it also -- if you have a larger corporate banking team, you can get to more clients, too. So it changes the ability at our levels. We originate personal loans and credit cards to the branches in addition to the digital channels, so that is expanded. In most of the products, more or less the same. In auto, we're doing direct, but the rest of the products, they use the branch network or the sales teams, which are going to be an expanded group.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [72]

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Okay. And then one other last one for me just on the mortgage portfolio. I'm just curious how much more you want to deemphasize that piece of the book given the CECL treatment.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [73]

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Well, we don't -- we basically want to see -- the mix of conforming is really our focus. On the noninterest income that comes with that, we see -- probably you should expect next year similar decrease to the end of the year on the mortgage portfolio, which -- and then that should start leveling to the level that we see by the end of next year because the originations and repayment are going to be probably close one to the other.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [74]

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Okay. I said last one, but actually, I have one more, if I could. Just thinking about the portfolio before the close of the deal, given that you're going to deploy all this capital with it, would it be fair to assume that the loan portfolio might be flattish in the next few quarters?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [75]

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You mean ours?

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [76]

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Correct.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [77]

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I can tell you that we expect to grow in the consumer, and we expect to continue reducing the mortgage, and the commercial is very deal-driven. Small and middle, it's growing. Corporate, it depends on deals that get close in the quarter and prepayments that we receive to offset. Obviously, this quarter, it was a strong originations quarter, but it's also -- there were $150 million in good prepayments, which we call good prepayments. So our goal is to grow the portfolio. Obviously, how the opportunities -- and the pipelines are positive. It's how fast we can close now these deals that would make the difference in having an appreciable net growth. Yes.

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Orlando Berges-González, First BanCorp. - Executive VP & CFO [78]

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We'll continue our normal business. We don't intend to hold back. Remember, after all, we continue to generate revenues and net income, and that builds up capital. So it allows for the growth component on the balance sheet.

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Operator [79]

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Next is a follow-up question from Alex Twerdahl, Sandler O'Neill.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [80]

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Just a couple of follow-ups for me. First off, do you have the cost of deposits on Santander's deposit book?

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John B. Pelling, First BanCorp. - IR Officer & Capital Planning Officer [81]

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It's slightly lower than our cost of interest-bearing deposits.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [82]

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Okay. And that -- is that for your total interest-bearing deposits or just...

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John B. Pelling, First BanCorp. - IR Officer & Capital Planning Officer [83]

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Total interest-bearing, including brokered.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [84]

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Okay. And then the $120 million of large criticized commercial mortgages that paid down during the quarter, were those in Puerto Rico? And if so, did they refi with another bank? Or would they pay it off? Or was there outside money that came in to buy? Or can you just maybe elaborate a little bit on what happened to them?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [85]

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Actually, both of them refi-ed with other banks, non-Puerto Rico type of funding sources.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [86]

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Okay.

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [87]

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Transactions related to acquisitions of those assets.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [88]

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Okay. And is it fair to assume that since you didn't take the JetBlue credit card portfolio, I'm not sure if that was an option or not, but is it fair to assume that the loans that you took are all loans that you want and that there will not be any divestitures of concentrations or anything like that following the close of this transaction?

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Aurelio Alemán-Bermudez, First BanCorp. - President, CEO & Director [89]

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It is fair, yes.

I just want to mention -- I know that the Q&A session is over. I just want to mention that we're definitely very pleased. Santander has been an extremely good banking franchise in Puerto Rico. And we're really excited about the combination, so we look forward to continue updating you as this process progress over the next months. And thank you all for your attention today.

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John B. Pelling, First BanCorp. - IR Officer & Capital Planning Officer [90]

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Just real quick on the investor front. We have a number of conferences upcoming: Bank of America conference in New York, November 5 and 6; Sandler conference in Naples on November 14. We also have Bank of America investor tour on December 12.

So with that, we greatly appreciate your ongoing support, and we look forward to seeing many of you at these upcoming conferences.

And with that, we will conclude the call. Thank you.

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Operator [91]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.