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.

The Puerto Rico banking industry achieved a Pre-Tax ROE of 7.9% in the first nine months of 2011 after two years of negative bottom line. The improvement in the banking system profitability coincides with a period of weak economic activity and decreasing total assets. As a result, banks are facing the need to rationalize their expense structure locally to cope with increasing fixed costs relative to productive assets. Additionally, they are finding themselves with excess capital after a period when they had to strengthen their capital levels to face large credit losses. With limited opportunities to invest in the local market, banks are looking at alternatives to use their spare capital, like investing in existing outside operations, repaying debt or returning capital to their shareholders.

The Q2 2011 results confirm the success of the measures taken in the past years to reduce nonperforming assets and maintain appropriate capital levels. With banks ready to grow their core businesses in a challenging economic scenario with limited organic growth opportunities, a new competitive landscape has emerged. In this new landscape, stealing share through superior service and innovative marketing ideas while protecting margins will be the name of the game. So far, some banks have fared better than others under this new landscape, particularly in the commercial credit business where competition is most fierce. While we are optimistic that the banking sector credit performance will continue to improve and the market will slowly recover, it is still possible that the economy deteriorates further and that banks will need to refocus on loss mitigation.