The banking industry's YTD 2013 pre-tax ROE adjusted for the sale of NPLs portfolios by Popular and FirstBank was 3.9%. The industry delinquency levels continue to improve and solvency ratios remain very solid. In this banking report we are taking a closer look at the mortgage business which represents 37% of the industry's total loan portfolio. As we will see, mortgage margins may reduce in the short/medium term driven by low originations in the context of rate increases, the implementation of new federal regulations and the recent and future repurchases of recourse portfolios. Both in the mortgage business and at the total bank level, workout efforts will need to be combined with cost reductions in order to boost profitability.

The local banking industry reached a pre-tax ROE of 7% in Q1 2013 once we eliminate the negative impact from the sale of non performing loan (NPL) portfolios by Popular and FirstBank. The current environment of low leverage and still high provision expenses, is preventing the industry from reaching profitability levels in line with the pre-crisis period. The recent sales of NPL portfolios have helped decrease the delinquency levels but may also impact the local property prices given the discounts involved in the purchase prices which have ranged between 32% and 53% of the unpaid principal balance (UPB).

The profitability of the Puerto Rico banking industry in 2012 was positive for the second consecutive year (3.4% ROE in 2012 and 6.3% in 2011) thanks to the reduction in the provision expense. However, higher profitability levels are not likely to materialize in an environment of still high charge-offs and slow credit activity. The debt burden that Puerto Ricans face in the coming years is likely to push credit activity further down and maintain delinquency at higher levels compared to pre crisis years. In this context, there will be pressure to increase pricing and fees and leverage economies of scale with additional consolidation.

As we have commented in previous reports, the Puerto Rico banking industry maintains its slow but solid recovery with its pre-tax ROE in 2012 (Jan.-Sep.) at 4%, approximately 14 percentage points above the 2009 and 2010 levels. Furthermore, the Q3 2012 pre-tax ROE reached 6.7%, the highest profitability level since Q2 2011.

The banking sector showed a positive Pre-Tax ROE in the first half of 2012 but the profitability level was still far from the levels achieved before the local banking crisis. All banks except Doral showed positive net income, with Scotia presenting the highest profitability despite being one of the smallest banks in terms of total assets.

The first quarter of 2012 started with positive profitability for the Puerto Rico banking sector despite showing a decrease in the Pre-Tax ROE from 6.3% in 2011 to 3.4% in Q1 2012. The fact that the total pre-tax income for the industry remained positive is another sign that the banking crisis is over and that the banking industry in general is in a much better position compared to previous years.

"There is light at the end of the tunnel" The year 2011 marked a turning point for the local banking industry. After two years of losses and a 7 year trend of steady reduction in profitability, the banking sector returned to the path of positive returns in 2011.