Hurricanes Impact

9 Months Ended

Sep. 30, 2017

Note 2 – Hurricanes impact

During September 2017, Hurricanes Irma and Maria (the “hurricanes”), impacted Puerto Rico, the U.S. and British Virgin Islands, causing extensive damage and disrupting the markets in which Banco Popular de Puerto Rico (“BPPR”) does business.

On September 6, 2017, Hurricane Irma made landfall in the USVI and the BVI as a Category 5 hurricane on the Saffir-Simpson scale, causing catastrophic wind and water damage to the islands’ infrastructure, homes and businesses. Hurricane Irma’s winds and resulting flooding also impacted certain municipalities of Puerto Rico, causing the failure of electricity infrastructure in a significant portion of the island. While hurricane Irma also struck Popular’s operations in Florida, neither our operations nor those of our clients in the region were materially impacted.

Two weeks later, on September 20, 2017, Hurricane Maria, made landfall in Puerto Rico as a Category 4 hurricane, causing extensive destruction and flooding throughout Puerto Rico. Following the passage of Hurricane Maria, all Puerto Rico was left without electrical power, other basic utility and infrastructure services (such as water, communications, ports and other transportation networks) were severely curtailed and the government imposed a mandatory curfew. The hurricanes caused a significant disruption to the island’s economic activity. Most business establishments, including retailers and wholesalers, financial institutions, manufacturing facilities and hotels, were closed for several days.

Puerto Rico and the USVI were declared disaster zones by President Trump due to the impact of the hurricanes, thus making them eligible for Federal assistance. Notwithstanding the significant recovery operation that is underway by the Federal, state and local governments, as of the date of this report, most businesses and homes in Puerto Rico and the USVI remain without power, other basic utility and infrastructure remains significantly impacted, and many businesses are partially operating or remain closed. Electronic transactions, a significant source of revenue for the bank, have also declined significantly as a result of the lack of power and telecommunication services. Several reports indicate that the hurricanes have also accelerated the outmigration trends that Puerto Rico was experiencing, with many residents moving to the mainland United States, either on a temporary or permanent basis.

While it is too early to assess and quantify the full extent of the damage caused by the hurricanes, as well as their long-term impact on economic activity, the damages are substantial and have, at least in the short-term, had a material adverse impact on economic activity, as reflected by, among other things, the slowdown in production and sales activity and the reduction in the government’s tax revenues. Employment levels are also expected to decrease at least in the short-term. The speed at which the government is able to restore power and other basic services throughout Puerto Rico, which we are not able to predict, will be a critical variable in determining the extent of the impact on economic activity. Furthermore, the hurricanes severely damaged or destroyed buildings, homes and other structures, impacting the value of such properties, some of which may serve as collateral to our loans. While our collateral is generally insured, the value of such insured structures, as well as other structures unaffected by the hurricanes, may be significantly impacted. Although some of the impact of the hurricanes, including its short-term impact on economic activity, may be offset by recovery and reconstruction activity and the influx of Federal emergency funds and private insurance proceeds, it is too early to know the amount of Federal and private insurance money to be received and whether such transfers will significantly offset the negative economic, fiscal and demographic impact of the hurricanes.

Prior to the hurricanes, the Corporation had implemented its business continuity action program. Although the Corporation’s business critical systems experienced minimal outages as a result of the storms, the Corporation’s physical operations in Puerto Rico, the USVI and the BVI, including its branch and ATM networks, were materially disrupted by the storms mostly due to lack of electricity and communication as well as limited accessibility. Reconstruction of the island’s electric infrastructure and restoration of the telecommunications network remain the most critical challenges for Puerto Rico’s recovery from the hurricanes.

The following summarizes the estimated impact on the Corporation’s earnings for the quarter ended September 30, 2017 as a result of the impact caused by Hurricanes Irma and Maria, net of estimated insurance receivables of $7.5 million. We expect the hurricanes to continue to impact the Corporation’s earnings for the quarter ending December 31, 2017 and future periods.

(In thousands)				Quarter ended September 30, 2017
Provision for loan losses^[1]			$	69,887
Operating expenses:
		Personnel costs		58
		Net occupancy expenses		468
		Business promotion
		Donations		1,123
		Other sponsorship and promotions expenses		203
		Total business promotion		1,326
		OREO expenses		2,685
		Other expenses
		Write-down of premises and equipment		3,932
		Other operating expense		1,033
		Total other expenses		4,965
	Total operating expenses			9,502
Total pre-tax hurricane expenses			$	79,389
[1] Includes $3.5 million in provision for covered loans.

Provision for Loan Losses

Damages associated with Hurricanes Irma and Maria impacted certain of the Corporation’s asset quality measures, including higher delinquencies and non-performing loans. Payment channels, collection efforts and loss mitigation operations were interrupted during the last month of the quarter as a result of the hurricanes. An incremental provision expense of $69.9 million was made to the allowance for loan losses based on management’s best estimate of the impact of the hurricanes as of September 30, 2017 on the Corporation’s loan portfolios and the ability of borrowers to repay their loans, taking into consideration currently available information and the already challenging economic environment in Puerto Rico prior to the hurricanes.

Management has initially estimated that the effects of the hurricanes could result in loan losses in the range of $70 to $160 million. However, since the Corporation’s base allowance for loan losses already incorporated reserves for environmental factors such as unemployment and deterioration in economic activity of approximately $57.9 million, management increased the environmental factors reserve by $64.3 million to $122.2 million using the near mid-range as the best estimate. The $69.9 million provision also includes $5.6 million for the portfolio of purchased credit impaired loans, accounted for under ASC 310-30, for which the estimated cash flows were adjusted to reflect a three-month payment moratorium offered to certain eligible borrowers. Since there is significant uncertainty with respect to the full extent of the impact due to the unprecedented nature of Hurricane María, the estimate is judgmental and subject to change as conditions evolve. Management will continue to carefully assess and review the exposure of the portfolios to hurricane-related factors, economic trends and their effect on credit quality and that assessment and review could result in further loan loss provisions in future periods.

Operating Expenses

The results for the quarter include $6.6 million in expenses, net of $7.5 million in insurance receivables, from structural damages caused by the hurricanes to branches, buildings and repossessed properties as a result of the hurricanes. An additional $2.9 million in other operating expenses are reflected for costs such as donations, debris removal, fuel for backup generators and other ancillary costs associated with hurricane recovery efforts.

The Corporation has over 200 branches and office buildings and over 2,000 repossessed properties in the areas affected by the hurricanes. While the Corporation has completed a preliminary estimate of the physical damages to these properties, it has been unable to individually examine each of these properties. As the Corporation continues to evaluate the extent of the damage, additional adjustments may be necessary. However, the Corporation believes that given its level of insurance coverage, the estimated impact of damages to these properties should not vary materially.

Revenue Reduction

In addition to the previously mentioned incremental provision and direct operating expenses, results for the three months ended September 30, 2017 were impacted by the hurricanes in the form of a reduction in revenue resulting from reduced merchant transaction activity, the waiver of certain late fees and service charges, including ATM transaction fees, to businesses and consumers in hurricane-affected areas, as well as the economic and operational disruption in the Corporation’s mortgage origination, servicing and loss mitigation activities due to the hurricanes’ operational and economic impact. The impact on transactional and collection based revenues has continued into the fourth quarter and the amount will depend on the speed at which electricity, telecommunications and general merchant services can be restored across the region