Popular, Inc. (NASDAQ:BPOP) Q4 2022 Earnings Conference Call January 25, 2023 10:00 AM ET
Company Participants
Paul Cardillo – Investor Relations Officer
Ignacio Alvarez – Chief Executive Officer
Javier Ferrer – Chief Operating Officer
Carlos Vazquez – Chief Financial Officer
Lidio Soriano – Chief Risk Officer
Conference Call Participants
Timur Braziler – Wells Fargo Securities
Alex Twerdahl – Piper Sandler
Kelly Motta – KBW
Gerard Cassidy – RBC
Operator
Hello and welcome to today’s Popular Fourth Quarter 2022 Earnings Call. My name is Bailey, and I will be the moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to our host, Paul Cardillo, Investor Relations Officer at Popular. Please go ahead.
Paul Cardillo
Good morning, and thank you for joining us. With us on the call today is our CEO, Ignacio Alvarez; our COO, Javier Ferrer; our CFO, Carlos Vazquez; and our CRO, Lidio Soriano. They will review our results for the full year and fourth quarter and then answer your questions. Other members of our management team will also be available during the Q&A session.
Before we begin, I would like to remind you that on today’s call, we may make forward-looking statements that are based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s earnings press release and are detailed in our SEC filings. You may find today’s press release and our SEC filings on our web page at popular.com.
I will now turn the call over to our CEO, Ignacio Alvarez.
Ignacio Alvarez
Good morning, and thank you for joining the call. Our results for the quarter in the full year were solid and reflect the strength of our franchise. Our record annual net income of $1.1 billion reflects an increase of $168 million above our 2021 annual net income of $935 million. The increase was largely driven by the benefit of the Evertec Transactions, and the partial reversal of the DTA valuation allowance. The results also reflect higher net interest income, partially offset by higher provision expense and higher operating expenses. The 2021 results included a provision benefit of $193 million.
During the summer, we’ve completed the acquisition of key customer facing channels from Evertec, and also made important changes to our contractual relationship with them. Leveraging these transactions, we have embarked on a broad based multiyear technological and business process transformation. The needs and expectations of our clients as well as the competitive landscape has evolved, requiring us to make important investments in our technological infrastructure and adopt more agile practices.
Our technology and business transformation will be a significant priority for the company over the next 3 years and beyond. We believe that there continues to be opportunity for growth in our primary market as well as within our existing customer base, and these efforts will help capitalize upon that opportunity. We are confident that these investments will make us a stronger, more efficient and profitable company.
Throughout 2022, we continue to return capital to our shareholders. During the year, we repurchased 8.25 million shares of common stock for $631 million, which surpassed our original expectation of $500 million. We also increased our quarterly common stock dividend to $0.55 per share, representing nearly $164 million in dividends paid in 2022.
Credit quality remains strong throughout 2022. We are pleased with how our portfolios have continued to perform, particularly with net charge-offs well below historical levels and a lower level of nonperforming loans. Our capital levels are strong with year-end common equity Tier 1 ratio of 16.4%. Our tangible book value ended 2022 at $44.97, a 31% decrease year-over-year, primarily due to unrealized losses on investment securities. However, during the fourth quarter, tangible value increased by 16%.
Please turn to Slide 4. Our quarterly net income excluding the partial reversal of the DTA valuation allowance was $189 million, or $7 million lower in the adjusted third quarter net income of $196 million. Fourth quarter results were impacted by lower net interest income, which reflected higher loan income that was more than offset by the higher cost of public deposits, as well as a higher provision for credit losses.
Loan growth was strong and broad based during the quarter, both geographically and across most loan segments. Total loan balances held in portfolio grew by $560 million. Commercial loan growth, particularly it was healthy at most banks in the fourth quarter. Our net interest margin decreased by 4 basis points to 3.28% in the quarter.
Higher deposit costs, particularly in our Puerto Rico public deposit portfolio and at Popular Bank impacted the margin. This was offset in part by an improvement in asset mix to loan growth and a reduction in the investment portfolio. Credit quality trends remain favorable during the period. Nonperforming loans decreased in the quarter and net charge-offs have remained well below pre-pandemic levels.
Please turn to Slide 5. Our customer base in Puerto Rico grew by approximately 28,000 during the year, reaching 1.98 million unique customers. Adoption of digital channels among our retail customers continues to be strong. Active users on our Mi Banco platform exceeded 1.1 million or 56% of our customer base. Additionally, we continue to capture 1 in 60% of our deposits through digital channels. This trend remains significantly higher than pre-pandemic levels, and well above our Island peers.
Commercial loan growth was strong. Commercial loan balances at BPPR and Popular Bank increased by $118 million and $255 million, respectively. Credit card and auto loan and lease balances at BPPR increased by $53 million and $31 million, respectively. In the fourth quarter, the dollar value of credit and debit card sales of our customers increased by 11% sequentially and were 6% above the fourth quarter of 2021.
As on the Mainland, mortgage originations in Puerto Rico have been impacted by rising rates and limited inventory of available properties. The dollar value of mortgage originations at BPPR decreased by 29% compared to the fourth quarter of last year, driven by lower repayment activity due to the interest rate environment. However, loans to finance the purchase of homes decreased only 11% during the same period.
The local economy continues to perform well during the fourth quarter, and business activity has remained strong. We remain encouraged by solid employment levels. In December, total non-farm employment in Puerto Rico increased slightly from its level in September and was 4% higher than in December of 2021.
New auto sales increased by 3% in the fourth quarter, compared to the same period in 2021. While auto sales declined by 4% in the year, 2022 was the second highest year of sales since 2006, easily surpassing pre-pandemic levels, evidencing continued robust demand for cars [technical difficulty]. The industry is forecasting new car sales of 118,000 with 2023 well above pre-pandemic levels.
The tourism and hospitality sector continues to be a source of strength for the local economy, as Puerto Rico is a popular destination for Mainland residents. Airport traffic has remained robust. Year-to-date through December, total passenger traffic increased by 7% compared to 2021.
Hotel demand has also remained strong. Occupancy rates were up more than 500 basis points in 2022 and the average daily room rate continues to compare favorably to historical results. In short, we are pleased with the results for the year, particularly our robust loan growth and continued strength in credit quality.
We are mindful of the global economic uncertainty and market volatility, but remain optimistic about the future of Puerto Rico, our primary market and our ability to manage any potential challenges that may lie ahead.
I now turn the call over to Carlos for more detail on our financial results.
Carlos Vazquez
Thank you, Ignacio. Good morning. Before we turn to fourth quarter results, let me expand on Popular’s 2022 full year performance, which is included in the appendix to this presentation and today’s press release. In 2022, we report a record annual net income of $1.1 billion, $168 million above our 2021 annual net income. The increase was largely driven by the benefit of the Evertec Transactions and the partial reversal of the DTA valuation allowance, somewhat offset by provision expense.
Our net interest income increased by 11% year-over-year to $2.17 billion due to higher rates, loan growth and the change in the mix of earning assets. For the year, we reported an $83 million provision for credit losses, which compares to a provision benefit of $193 million in 2021. Non-interest income increased by $254 million year-over-year, primarily driven by the impact of the Evertec Transactions. Operating expenses increased 13% in 2022 to $1.75 billion with higher personnel, technology, professional fees and regulatory cost.
Please turn to Slide 6. Net income for the fourth quarter was $257 million. This compares to $422 million in Q3. Excluding the impact of the Evertec Transactions in Q3 and the DTA reversal in Q4, net income decreased $7 million to $189 million in Q4. Net interest income for the fourth quarter was $560 million, a decrease of $20 million from Q3.
Interest income grew by $62 million from loan growth of both banks as well as higher yields on loans and investment securities. This was more than offset by higher interest expense on deposits, resulting from increased deposit rates, mainly from Puerto Rico public deposits and to a lesser extent Popular Bank.
Non-interest income was $158 million, a decrease of $268 million from Q3. The results of the third quarter included a $258 million pre-tax gain on the Evertec Transactions and a favorable fair value purchase price adjustment of $92 million related to the U.S equipment finance business we acquired in 2021. Excluding these items, remaining various non-interest income resulted mainly from lower deposit service fees.
The fourth quarter non-interest income results fully embed the changes in our [indiscernible] policies and the reduction in equity pickup for the sale of our Evertec shares. The results also include an $8.2 million gain on the sale of a previously written-off investments. Excluding this gain, the non-interest income for the quarter would have been approximately $150 million.
For 2023, we expect non-interest income to continue around this $150 million per quarter run rate or approximately $600 million for the year. The provision for credit losses in the fourth quarter was $50 million compared to $40 million in the third quarter.
Total operating expenses were $462 million in the quarter, a decrease of $14 million from the prior quarter. Q3 included $17 million expenses related to the Evertec Transactions and a $9 million goodwill impairment on our U.S equipment finance business.
Excluding these items, expenses increased by $12 million, mostly resulting from a $10 million increase in technology expenses, seasonally higher business promotional expenses by $4 million, higher other processing and transactional services by $4 million, mainly due to higher network incentives received during the prior quarter and higher professional fees.
For 2023, we expect annual expenses of approximately $1.87 billion, compared to our expenses $1.75 billion during 2022. The drivers of the $120 million increase will be: first, continued increase in personnel expenses, driven primarily by the previously announced increase in our minimum hourly wage from $13 to $15, which took effect on January 1. This will add approximately $15 million to expenses in 2023.
Additionally, the market salary adjustments that were made effective on July 1 of last year will be in effect for the full year 2023. There will also be a 2023 merit increase that traditionally is granted in the summer. These two items will add approximately $24 million to expenses in 2023. These actions are necessary to keep our compensation competitive.
Second, we expect that the FDA sees 2 basis points increase in assessment rate to all depository institutions will add $14 million to expenses. Pension and retirement health care expenses will also increase by $19 million. Finally, as Ignacio described in his opening remarks, we’ve undertaken a significant multiyear corporate transformation initiative. As part of this transformation, we need to expand our digital capabilities, modernize our technology platform and to implement agile and efficient business processes across the entire company.
Since completing the Evertec Transactions on July 1, through the end of last year, we invested $24 million towards this effort primarily in professional fees and technology expenses. In 2023, we anticipate transformation-related expenses of $50 million. These technological ways of working and operational investments will result in an enhanced data experience from our clients as well as better technology and more efficient processes for our employees.
We expect these efforts to contribute to higher earnings and a better efficiency, resulting in a sustainable 14% ROTCE target by the end of 2025. To facilitate the transparency of our progress in some of these efforts we have now separated technology, professional fees and transaction activities as standalone items in our income statement.
Our effective tax rate for the quarter was a benefit of 24% compared to an expense of 14% in the third quarter. The income tax benefit in Q4 was mainly due to the $68 million partial reversal of the DTA valuation allowance of the U.S. operation.
Excluding this impact, the effective tax rate for the fourth quarter was 12% compared to 14% in the third quarter. This partial reversal was based on our evaluation of the sustained profitability of the U.S. operation over the last 2 years as well as evidence of stable credit metrics while considering the remaining life of the net operating losses.
As of December 31, 2022, the DTA related to the U.S. operations was $278 million, net of our valuation allowance of $423 million. For the full year 2023, we expect the effective tax rate to be in a range of 18% to 22%.
Please turn to Slide 7. Net interest income was $160 million. On a taxable equivalent basis, it was $622 million, $25 million lower than in the third quarter. Net interest margin decreased by 4 basis points to 3.28% in Q4. On a taxable equivalent basis, NIM was 3.64%, a decrease of 7 basis points. The decrease is driven by higher interest expense on deposits due to a significant, though anticipated, 159 basis point increase in the cost of public deposits. This was partially offset by higher loan balances and yields, plus an improved mix of earning assets.
At the end of the fourth quarter, public deposits were roughly $15.2 billion, a decrease of $2.2 billion from Q3. We expect public deposits to be in a range of $13 billion to $15 billion during 2023. Over the next couple of quarters, the balance of our deposits should increase during the cyclical nature of tax collections. However, the balances should decrease during the second half of 2023.
Excluding Puerto Rico public deposits, deposit balances declined by $1.4 billion in the quarter, mainly from excess cash balances of corporate clients. These declines are reflective of clients pursuing better yields on excess liquidity. Popular continues to have a strong relationship with these clients.
Our Puerto Rico commercial deposit balances remain $5 billion higher than they were in December of 2019. We will continue to actively manage the cost of commercial deposits, taking into consideration the overall client relationship and our liquidity position. Retail deposit balances remain stable.
Our ending loan balances increased by $560 million or almost 2% compared to Q3 and are up by $2.8 billion or just under 10% year-to-date. Commercial loan growth was particularly strong, and all other loan segments were higher in the quarter, except for construction.
We are encouraged by credit demand at BPPR and PB. We will continue to take advantage of opportunities to extend credit, thereby improving the use and yield of our existing liquidity. While we expect to see continued strong loan growth in 2023, we do not anticipate it will replicate 2022’s exceptional growth rate.
Please turn to Slide 8. Year-to-date, our retail deposit franchise, particularly Puerto Rico, has continued to track below these historical beta. Commercial deposit betas have remained low, but are now tracking slightly above the prior cycle. Combined, retail and commercial, deposits represent a lower proportion of total deposits compared to the last rate cycle due to the increase in public deposits.
As we discussed last quarter, during the rapid shift to higher interest — short-term interest rates, we expect a significant increase in the cost of public deposits. In the fourth quarter, the cost increased by 159 basis points. We expect the magnitude of the increase in cost of public deposits to moderate in Q1 to approximately 120 basis points. As we have described in the past, the deposit pricing agreement with Puerto Rico public sector clients is market linked with the like [ph]. This source of funding resulted in an attractive spread under market rates.
Please turn to Slide 9. In 2022, we reported a decrease in fair value of the investment portfolio that we expect to be temporary. Our investment portfolio is almost entirely comprised of treasury and agency mortgage-backed securities which carry minimal credit risk. The bond portfolio has an average duration of approximately 2.8 years. As the positions roll down the yield curve, their fair value will convert to par and the mark will go down to zero.
As discussed in our last webcast, given the rapid increase in interest rates in 2022 as well as the uncertain outlook for interest rates, in October, we transferred to held to maturity $6.5 billion of U.S. treasuries in the 4 to 6-year term, thereby reducing the future impact of rates on tangible book value. At the time, this action reduced AOCI exposure to interest rates by about a third. When transferred to HTM, these positions had a pre-tax unrealized loss of $873 million, which will be amortized back into capital throughout the life of the transferred positions.
As of the end of the fourth quarter, the balance of the unrealized loss stood at $832 million, a reduction of $42million. We expect a similar quarterly amortization through 2026. The yield on transfer securities remains the same and no losses were recognized as a result of this move. This transfer doesn’t have a material effect on our liquidity as we continue to maintain a large available-for-sale portfolio in short-term treasuries and cash at the Fed.
The changes in realized gains and losses in AOCI have an impact on the corporation’s tangible capital ratios as well as those of our wholly owned banking subsidiaries, but they do not impact regulatory capital ratios.
Please turn to Slide 10. Our return on tangible equity was 19.2% in the quarter. Regulatory capital levels remain strong. Our common equity Tier 1 ratio increased by 35 basis points in Q4 to 16.4%. In December, we completed our previously announced $231 million ASR, repurchasing approximately 3.2 million shares at an average purchase price of $72.66.
To summarize our capital actions last year, we repurchased $631 million common stock or 8.25 million shares via two separate ASRs and increased our quarterly dividend by $0.10 per share to $0.55 per share. Annual book value at quarter end was $44.97 per share, an increase of $6.28 per share from Q3, driven mostly by quarterly net income of $257 million and a favorable variance of $183 million in unrealized losses on securities available for sale. This is partially offset by dividends of $40 million declared in the quarter.
Our outlook on capital return has not changed, anchored in our strong regulatory capital ratios. Over time, we expect our regulatory capital ratios to gravitate towards the levels of our Mainland peers plus a spread. Given the continued economic uncertainty, we still plan to revisit our future capital actions in the second half of 2023, once we have more clarity around the outlook for interest rate and the economy.
With that, I’ll turn the call over to Lidio.
Lidio Soriano
Thank you, Carlos, and good morning. Overall, Popular continues to reflect stable credit quality trends with low levels of net charge-offs and decreasing nonperforming loans. We remain encouraged by the performance of our loan book post-pandemic, specifically, early delinquency, net charge-offs and nonperforming loan formation continue to trend significantly below pre-pandemic levels.
We also believe that the improvement in the risk profile of the corporation’s loan portfolio positions Popular to operate successfully on the more difficult economic conditions. We remain vigilant and continue to closely monitor changes in borrower performance and the macroeconomic environment, given potential economic headwinds rising interest rates and geopolitical uncertainties.
Turning to Slide #11. Nonperforming assets decreased by $18 million to $520 million this quarter, driven by an NPL decrease of $40 million, coupled with an order decrease of $4 million. In Puerto Rico, NPLs decreased by$8 million driven by lower mortgage NPLs of $10 million and lower commercial NPLs by $5 million, in part offset by higher order NPLs by $7 million.
In the U.S., NPLs decreased by $6 million, mainly due to a $9 million charge-off on a previously reserved commercial borrower in the health care industry. Compared to the third quarter, NPL inflows, excluding consumer loans, decreased by $3 million, driven by the U.S. health care relationship mentioned previously that was placed in nonaccrual in the prior quarter, offset in part by higher mortgage inflows in Puerto Rico. At the end of the quarter, the ratio of NPLs to total loans held in portfolio remained flat at 1.4% compared to the previous quarter.
Turning to Slide #12. Net charge-offs amounted to $31 million or an annualized 39 basis points of average loans held in portfolio compared to $18 million or 24 basis points in the prior quarter. The results for the quarter were impacted by the $9 million charge-off on the previously reserved health care relationship in the U.S. Excluding this item, net charge-off ratio was comparable to last quarter at 28 basis points.
In Puerto Rico, net charge-offs remained stable, increasing by 1.5% quarter-over-quarter mainly driven by higher consumer charge-offs by $5.5 million, mostly due to the order portfolio, in part offset by lower mortgage net charge-offs by $4 million. The corporation allowance for credit losses increased by $17 million or 2.5% to $720 million, driven by changes in macroeconomic scenarios, higher loan volumes and changes in credit quality.
The ratio of allowance for credit losses to loans held in portfolio remained stable at 2.25% compared to 2.23% in the previous quarter. The allowance for credit losses to NPLs held in portfolio was 164% compared to 155% in the prior quarter. The provision for credit losses was an expense of $48 million compared to $40 million in the previous quarter, reflecting the changes in allowance for credit losses and the net charge-off activity. In Puerto Rico, the provision for credit losses was $44 million compared to $29 million in the prior quarter. And in the U.S., the provision was $44 million compared to $11 million in the prior quarter.
Please turn to Slide #13. As discussed in prior webcast, we leverage Moody’s analytics for the U.S. and Puerto Rico economic forecast. Notwithstanding general economic uncertainty, Moody’s baseline outlook remains for the U.S. economy to continue recession free.
Moody’s fourth quarter forecast, however, reflects a slowdown in the economy with lower 2023 GDP growth for both Puerto Rico and the U.S. The baseline scenarios assume a 2023 annualized GDP growth for Puerto Rico and the U.S. of 1.3% and 0.7%,respectively, compared to 2.2% and 1.5% in the previous quarter. The reduction is due to the expected slowdown in the economy as a result of tight monetary policy.
The 2023 average unemployment rate remained consistent quarter-over-quarter. Our framework for the allowance incorporates multiple economic scenarios. In the fourth quarter, we assigned the highest probability to the baseline scenario, followed closely by the more pessimistic recession scenario, S3. The quarter-over-quarter difference in the allowance for credit losses was driven by the macroeconomic scenarios and portfolio changes, which includes loan growth and changes in credit quality.
To summarize, our loan portfolio continues to exhibit strong credit quality metrics in the fourth quarter with low net charge-offs and decreasing nonperforming loans. We remain attentive to the evolving environment, but remain encouraged by the post-pandemic performance of our loan book.
With that, I would like to turn the call over to Ignacio for his concluding remarks. Thank you.
Ignacio Alvarez
Thank you, Lidio and Carlos, for your updates. 2022 was an outstanding year for Popular. In addition to record earnings, we achieved strong credit quality, continued customer growth, closed the Evertec Transactions, launched our transformation and successfully executed on our capital actions. Our franchise provides a powerful platform to go beyond serving our customers. It also affords us the opportunity to possibly impact the lives of our colleagues and communities and create value for our shareholders.
In 2022,we reached key milestones including participating in the Bloomberg Gender Equality Index issuing our ninth Corporate Sustainability Report, also following Hurricane Fiona, we provided immediate relief to the — to affected communities and clients and assisted impacted employees. Looking ahead, I am optimistic about the economic outlook in Puerto Rico, our primary market.
While we are aware of the macroeconomic headwinds related to inflation and geopolitical risk, we are confident that given the amount of stimulus support from federal funds, Puerto Rico will continue its growth path, albeit perhaps at a slower pace.
2023 marked Popular’s 130th anniversary. Since 1893, we have successfully adopted and led through changing conditions, and we are proud of our history and the legacy that made Popular what it is today, a strong vibrant organization with [indiscernible] values. Leveraging these strengths, we will continue to transform our organization to ensure success for many years to come. This entails meeting the rapidly changing needs of our customers providing our colleagues at work place [indiscernible], promoting progress in the communities we serve and generate sustainable value for our shareholders. The team is energizing — is energized and looking forward to another strong year.
We are now ready to answer your questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question today comes from the line of Timur Braziler from Wells Fargo. Please go ahead. Your line is now open.
Timur Braziler
Hi, good morning. Thanks for the questions.
Ignacio Alvarez
Good morning.
Timur Braziler
Maybe starting on expenses and the technology and business process transformation that has been laid out, I guess on the back end of that, how should we think about Popular? Is this investment in kind of standing up Evertec and getting that investment kind of up to where you expect it to be? Or is this getting Popular more broadly on pace with the broader group? Or do you expect the back end of ’25 for Popular to be an industry leader when it comes to tech and innovation?
Ignacio Alvarez
Yes. I think — this is Ignacio. I think — thank you for the question. I think Evertec was the initial phase. It’s more than just Evertec. Obviously, Evertec has positioned ourselves to be able to begin to transform our technological foundation. So it’s more than just taking over the services Evertec was providing for us. That was an essential step. But obviously, our goal is to be able to compete with the different entities that are coming to the market, especially in terms of giving digital options to our clients. So yes, we aspire to be not best-in-class, top quartile in terms of the services and the products we can offer our clients. And Popular has traditionally been a leader in technology in Puerto Rico, and given what’s happening now, I think it’s more important than ever that we take this initiative on.
Timur Braziler
Okay. And then in terms of investing into this initiative, is the expectation kind of $50 million per year through ’25? Or does that ramp higher as you get closer to completion?
Carlos Vazquez
Yes. I’m not sure we being able to nail that down at this point in time, Timur. I think the — what we expect will happen over time is that the expense will shift from the present expense, which is more weighted towards professional services and consultants and people that are trying to help us stand up and set up what we want to do and where we want to go, it will shift to execution. So again, we haven’t nailed down the number looking forward in the composition of the expense will change into execution and putting in place the systems and the technology that we are designing and selecting right now.
Timur Braziler
Okay, great. And then maybe moving to NII and NIM. It looks like the inflection point happened here in the fourth quarter, just maybe an outlook for the magnitude of the remaining inflection as those public funds continue to lag already happened in interest rate hikes. And then more importantly, kind of once that lag is complete, what’s the outlook for NII and NIM growth from there?
Carlos Vazquez
Yes. The components that led to our margin coming down this quarter, those pressures still exist for the first quarter. Moving forward, you described them properly that the most important one being the increase in cost of public deposits. We — as we said last quarter, we expect NIM to retake an upward trend in 2023. Exactly in ’23, it happens — will depend on the interaction of the drivers. And you know what the drivers are, the rate of loan growth, the rate of change in interest rates and deposit balances are the biggest three drivers. And the interaction between those three will — this take exactly what happens in the year, but we do expect NIM to retake an upward trend in the year ’23.
Timur Braziler
Okay. Then maybe one last one for me, if I can. Just circling back on fee income, the guide for around 150 a quarter, I’m just wondering when does that inflect? And when do we start seeing some of the positive attributes from the combination with Evertec and getting those assets back in-house?
Carlos Vazquez
Well, the biggest driver of the move down from our prior guidance to this ’23 guidance is the change in the fact that we don’t own the shares Evertec anymore, number one; and number two, the change in overdraft policies and number three, the change on our practice of setting mortgages that we are not setting anymore. So those are the biggest drivers of the shift down to 150 per quarter roughly.
Obviously, remember, there’s always some seasonality in that number. So it goes up and down for different things during the year, but that is the right range. We continue initiatives on our business initiatives to try to continue to move rates up in different fronts. So hopefully, as those initiatives succeed, we can start moving rates up from the 150. And some of those are already being designed and implemented if everything works well, we may start seeing some of that in ’23, but our best guess right now is 150 per quarter.
Timur Braziler
Got it. Thank you.
Operator
Thank you. Our next question today comes from the line of Alex Twerdahl from Pipe Sander. Please go ahead. Your line is now open.
Alex Twerdahl
Hey, good morning, guys.
Ignacio Alvarez
Good morning.
Carlos Vazquez
Good morning.
Alex Twerdahl
I just want to ask some of the questions the team I just asked a little bit differently. I’m just — I’m curious, when you put out a target for 2025, why 2025? Does that represent sort of an inflection point or an end point in some of these initiatives? Or how can you pick that date for that year?
Ignacio Alvarez
This is Ignacio. Basically, we think that year. The transformation initiative is going to be an ongoing effort. It’s the way — it’s going to change the way we work. But obviously, to sort of measure our success, we wanted to take an initial 3-year period, where we see where we are going to be at the 3-year period. And basically, that’s how we reached ’25. It was kind of arbitrary, but we felt 3 years gave us enough time to implement the measures that we’re doing to give them time to bear fruit. So — and that’s how you picked it. But obviously, this is all going — and obviously, we expect all these efforts to be sustainable, not only sustainable, so it’s not like we are going to reach that and stop, but keep growing incrementally over time.
Alex Twerdahl
Right. And then is Popular a leaner institution at that point? Or like what’s going to be different? I mean, obviously, every bank is investing in technology meaningfully, but does it allow you to operate with a reduced branch count or sort of what — like what would we see that would be different at that point?
Ignacio Alvarez
I’m not sure branch count is the thing you expect to see the most. I mean that will depend on traffic. We can talk about branches separately. But I think, obviously, we are aiming to do a lot more things digitally, and we are also aiming to do a lot more things self-service. So for example, making our underwriting more automatic, so you don’t have to have as much manual intervention, this is across, especially our businesses, but it will apply to everything. But hopefully, we will do — it will help us with our compliance. We’re investing also in technology, which is very manual today, very people-oriented, so really, I can’t give you a specific date, but definitely over time, we should see a lot less manual intervention in many of our processes, be the underwriting, be the compliance, be the everything. So I think that’s the goal. The goal is to be more digital, more — have more self-servers for our clients. And hopefully, over time, that’s going to impact us favorably.
Alex Twerdahl
Okay. Are there any sort of chunks of the initiative that might hit at any certain point in time? You mentioned that a lot of the fees right now are being conducted towards the planning phase, and then there’s going to be implementation phase, which maybe is more of a 2024 thing. But are there segments that you kind of — we can sort of look at over the next couple of — maybe even more in the near-term to sort of get a good sense for how to track the progress.
Ignacio Alvarez
Well, I’m not sure within the near-term, but one of the things that we obviously are going to want to be able to report to you is what percentage of our loan applications will be digitally enhanced — and obviously, that we will be able to give you numbers on that. We will be tracking that. And obviously, that will reflect in efficiencies. We’ve already implemented some things that are less technology oriented because again, this is more than just technology, it’s also process improvement.
In terms of how do we make sure that our pricing strategy for products and services, including cash management are coherent across the organization. We expect that to bear fruit pretty much immediately. [Indiscernible] should be a game changer, but that will bear fruit immediately [ph]. So we will be watching very carefully that in terms of revenues that we are getting from cash management, we are going to make important investments in that area.
Now the technological area on cash management will take us a few years. I mean when you change your system for cash management, that will be a couple of year process. But we are very hopeful that will drive benefits for us. But again, we will be following and closely tracking that and think about digitally enhanced applications, self-service applications. So those are things that we will be tracking.
Carlos Vazquez
Yes. I mean, Alex, one of the things that we have a very strong belief that there is still a lot — a big opportunity for growth in Puerto Rico — with — by deepening the relationships we have with our existing clients. So a lot of the effort that’s going into transformation is for us to execute on that belief meaning that we will be in a position to provide clients quicker, better service to offer them products that fit their needs in a more efficient way. And with that, we increased the satisfaction of our clients, and that means we have more happy clients, we have more employees that can actually execute with excellence, what we are trying to do as far as client service and all those things add up to positive outcomes as far as the contribution of all those clients to the bank.
As Ignacio said, these are incremental efforts. Some small things will start happening in a few months. Other things will start happening next year. So the bigger things are technology dependent, will probably be sort of a bit back-ended, because we have to maintain investment and implement the systems to achieve what we want to achieve, but we expect that there will be some quick wins starting soon.
Ignacio Alvarez
Yes. Add to what Carlos was saying, I mean one of the big initiatives is designed at what we call personalization and segmentation. And therefore — and that involves a lot of investment in our data abilities also. But the idea is that we will be able to offer our clients products that they need faster. As you know, we have, by far, the largest client base in Puerto Rico, both retail and commercial. And if we can just penetrate that market, the cost of — our cost of acquisition will be much below any possible competitors. So we are going to put a lot of effort to the personalization and segmentation.
Carlos Vazquez
And the last comment for you to get a sense of what we are talking about, — we believe, we think we have to build the best digital banking offering in Puerto Rico already. But what we are seeking is to be able to provide more products and services to our clients through that offering and to allow us to roll out new offerings a lot faster than we can do it now. So we are changing the architecture of what is a market-leading digital offering so that we can be a lot more effective in providing more and new services quicker to our clients than we are today. So the client will never see the change in impact and architecture, but they will see the more efficient and bigger offering once we’ve done that.
Alex Twerdahl
Okay. And then with the 14% ROTCE, obviously, there’s a lot of pieces to that, and it could mean a lot of different things. So can you give us some of the assumptions on capital levels, or like anything else to kind of help us really figure out what it actually means for profitability?
Carlos Vazquez
No. At this point in time, we’ve chosen that one because it’s our encompasses the result of everything, Alex. And you are correct, there’s a lot of pieces that compose that. We are not in a position to talk about the pieces specifically yet. or right now. But again, we think this is the most comprehensive nature of everything that we do. So we’ve chosen to hang our head on that one for the moment. But at this point in time, we haven’t disclosed the components that we will get us there. There’s a lot of things that probably can change and underweight as well.
Alex Twerdahl
Okay. And then just one final one for me before I get back in the queue. You gave us the increase in the government deposits in the first quarter of 120, assuming we get two more hikes, where do those peak out? I mean can you just spell it out for us?
Carlos Vazquez
I’m afraid, where they peak out, you’ll have to ask the Fed. If it’s true that they go down to two more 25 — and that’s it. And then they sit tight, then a quarter after that, you’ll see [indiscernible] of 50 basis points more expenses. But it really is market linked, so depend on the Fed. Again, our best guess of the Fed increases will give us 120.Again, roughly, if it’s still more 25, that will end up being about 50 basis points higher in the quarter after that. And once if the rates start moving in the other direction, then we’ll see that we start seeing the benefit of the quarter after that. So I would love to be able to answer your question, but I can’t read the mind of the Fed very well.
Alex Twerdahl
But they do peak out below, I mean, last time they peaked at 125 basis points, but below where the Fed peaked out. Is that a reasonable assumption for this tightening cycle?
Ignacio Alvarez
It is timing. I mean we — ultimately, the question you’re asking is what’s the spread that we make on the deposit. We have never answered that question purposely, and we’re not going to start today. But obviously, we do make a positive spread on these deposits.
Alex Twerdahl
Okay. Thanks for taking my questions.
Operator
Thank you. [Operator Instructions] The next question today comes from the line of Kelly Motta from KBW. Please go ahead. Your line is now open.
Kelly Motta
Hi, good morning. Thanks for the question. I — may be asking the government deposits question a little bit differently. I appreciate the color around margin and how you expect that to, I believe, it start to inflect at some point this year. Does that commentary there require a certain amount of roll-off of the government deposits? Or is that irrespective of levels? Just trying to get a sense of how much that may be a driver of that inflecting NIM you speak of?
Carlos Vazquez
No. That commentary incorporates the outlook we expressed on the balance of the current deposits that they will remain between $13 million and $15 million for the year. Again, it’s not a constant 13 to 15. They’re probably going to be slightly higher than that in the first half of the year and then maybe slightly lower than that in the second half of the year. But that is what is incorporated in the components of that commentary.
Kelly Motta
Thank you. Appreciate it. And just a point of clarification on your expense guidance that $1.87 billion that you gave, I just want to confirm that includes the innovation stuff that you’re doing and that $50 million is on top of that 1.87.
Carlos Vazquez
That number includes the $50 million.
Ignacio Alvarez
Yes, definitely incorporated within it.
Kelly Motta
Okay. Excellent. Thank you so much. Maybe last one for me. I appreciate the time it is on capital. I know you reiterated that you plan to revisit your capital plans in the second half of this year. Wondering if that kind of your decision to do that is there’s a certain level of TCE where you would feel comfortable stepping back in. Is there any sort of parameters around that you’d be willing to share? And — that’s part one. And then part two of the question is, by second half of the year? Do you think maybe by sometime in July, given the accretion back on AOCI, is that kind of the timing we’re looking at here?
Carlos Vazquez
Yes. So I answer both questions. There is no TCE target that would trigger us to do something or not do something. What — I think, if anything, what will be more important on how we think about this is, again, getting a more clear consensus of what’s happening with the economy and what’s going to happen with interest rates moving forward. So I think those two components are probably more important. There’s — again, there’s no magic number of TCE that will get us there. As Ignacio said last quarter, our best guess is that we will get that clarity we are looking for in the summer, and that’s where our comment comes from the second half of the year.
But if that clarity comes in May, then we’re a couple of months ahead. If that clarity comes in September, we may be a couple of months behind. But no specific target, the outlook and there being consensus outlook on the economy and interest rates are probably the two most important inputs into the timing of our revisiting of the capital plan. Again, these overall view of capital is unchanged. We are only slightly adjusting the timing here and when we execute, not our intent of what we like to do.
Kelly Motta
Great. I appreciate. That’s all the color [indiscernible].
Carlos Vazquez
Thank you.
Operator
Thank you. The next question today comes from the line of Gerard Cassidy from RBC. Please go ahead. Your line is now open.
Gerard Cassidy
Hey Ignacio, hey Carlos.
Carlos Vazquez
Good morning.
Ignacio Alvarez
Good morning. Happy New Year.
Gerard Cassidy
Happy New Year to you, too. Carlos, on the OCI or AOCI, I should say, when you look at it, you had in the available-for-sale portfolio, about $1.8 billion of unrealized losses. Can you share with us what kind of interest rate environment would we need to see for that number to fall materially from here.
Carlos Vazquez
Lower. I agree with that. No, I mean the portfolio has about a 2.8-year duration. So that can give you some sensitivity on the entire piece, right? So you could probably run some calculations based on the duration and the size of the portfolio should give you an idea of, roughly speaking, were unrealized good move.
Yes. The — obviously, the as [indiscernible] said, the portfolio is [indiscernible] on the short end. So we are the biggest bang for the buck. You’ll probably get short-end rates — an intermediate rates moved lower. I think AOCI only happy, if the 30 year comes down, but the 30 year does not have big effect on our AOCI as the shorter and into medium terms. The other thing is there’s a significant amount of bonds that mature every quarter. So the portfolio is laddered out all the way up to 6 years. In fact, we probably have about $1 billion or so that mature every given quarter. So that also shows the duration as time passes.
Gerard Cassidy
Got it. And even though — yes, I’m sorry go ahead. Right, right. The reason I asked is that I noticed that the agency portion of the portfolio, which has the largest unrealized loss because the majority of 7.5 years and even though I know the total AFFS is under three. I didn’t know that Men port of the portfolio, the longer into the curve, is something we are going to watch.
Ignacio Alvarez
Yes. That piece — that portion of the portfolio is mostly agency pass-throughs. So we put the weighted average life of the instruments. It’s a mix of 15-year and 30-year mortgage-backed securities. That has a slightly different basis than treasury. So that will be a function of where intermediate rates move as well as where the mortgage back to treasury basis moves as well. So we had some relief for that in the fourth quarter. If those trends continue, that would be a positive news for that. But again, it will all be subject to where the market sees the risks.
Gerard Cassidy
Very good. And then following up on the technology commentary that you guys gave us, Ignacio, I think you said in your prepared remarks or actually in response to a question that Popular has traditionally been a leader in technology in Puerto Rico. So it’s somewhat surprising that this overhaul is coming, but me as it is, were you guys seeing — or are you seeing evidence that other entrants are making headway against your core customers and you’re starting to lose some of these customers? Or what was the real — or is that part of the reason for the big spend that’s coming?
Ignacio Alvarez
No, I think that when I say we are a traditional [indiscernible] leader in the technology, that’s true, but we feel the world is changing much faster. And we may have been a little bit behind where we normally would be on this kind of a curve. We haven’t lost customers yet, but we are not going to wait to lose customers. We are seeing — there are certain areas where you see more U.S. entrants, for example, credit cards, where you see more of the U.S. issuers coming in with features and different things that we may be a little bit behind, but really, we want to get ahead of this. We don’t want to leave ourselves open to future digital entrants taking away our clients. So basically, we think — we really think that if we offer a top-notch digital experience and you combine that with our branch network, and you combine that with the diverse services we offer a client that we have an unbeatable solution. If we fall in any of those areas, then we could become [indiscernible], and we are not about to let that happen. So yes, we know that technology is a tough game, and we may not be able to match the investments of some of the bigger huge banks. But we have to stay at least given our clients what they expect in today’s world. And our clients in Puerto Rico are just like anywhere else. They expect a better digital experience, and they expect a more personalized digital experience. And we’re going to work hard to give them that.
Lidio Soriano
To give some more color on Ignacio’s comment, Gerard, when I talked about our data offered to our clients, I said it was market-leading, which it is. And I spoke about the back end, the architecture of it, we find ourselves wanting to roll out more things at a faster speed than our present architecture allows us to do. So again, what we’re doing is doing a lot of work in the back end. The client will never even new. This was happening, but it will — the client will feel it because the speed at which we’ll be able to offer new things and more things will go up. So that is the kind of thing we’re talking about. It is improving the core of our technology. And again, the client may not see that in their phone app but they’ll see it in our capacity to offer them more personalized offerings for personalized services and new services faster than we can do today.
Gerard Cassidy
Very good. And then, Lidio, you mentioned you gave us some insights into credit and credit obviously, has been strong for you folks and your peers. Two questions. One, you gave us some of the assumptions, I think, in the Moody’s outlook on real GDP growth what kind of unemployment rates are you factoring in? I think you said they’re constant, but what are those numbers? And two, are there any sectors within the portfolio that you’re currently spending more time really focusing on just to make sure nothing gets tripped up if we go into some sort of shallow recession.
Carlos Vazquez
We have on a yearly basis, you have on Page 13 of the deck, the assumptions for unemployment rates, also Puerto Rico and the U.S. under the baseline, stronger growth and recession scenarios. So I will leave you to look at those as to what’s the second part of the question? I’m sorry, Gerard?
Gerard Cassidy
That’s okay. And — and just what parts of the portfolio are you guys really focused on to make sure that if we do go into a shallow recession, you’re prepared to handle it.
Lidio Soriano
I would say small business lending is an area of focus. I mean we continue to be pleased how the Popular has continued to behave post-pandemic or is an area where increasing interest rate inflationary pressures, increases in energy prices could have a potential higher impact than other sectors. I think it’s important to highlight that one area where we see a lot of press in the U.S. in terms of office space, we don’t have any significant exposure to the office space in Puerto Rico to the U.S.
Gerard Cassidy
Very good. Thank you.
Operator
Thank you. The next question today is a follow-up from Alex Twerdahl from Piper Sandler. Please go ahead. Your line is now open.
Alex Twerdahl
I just wanted to ask for the loan growth that you guys are seeing, what kind of yields new production is coming on in the various categories?
Carlos Vazquez
Yes. I don’t have that number right now, Alex. We can try to dig it out, but I don’t have that off the top of my head or in my notes, my apologies. You can see that the overall yield of loans, the overall loan yield of our book did go up 31 basis points on [indiscernible] in the quarter. So obviously, we are originating our new [indiscernible] at higher rate, but I don’t have the answer to your question. We will get back.
Alex Twerdahl
Okay. Are you able to give us a little bit more color, like if you look at the commercial growth sort of the percentage or just a rough breakdown of what might be the larger corporate customer that’s based off of [indiscernible] and we saw some press releases this quarter on sort of pricing that maybe we could apply to that in Puerto Rico versus what might be more tied to prime?
Carlos Vazquez
Yes, the — and Lidio, maybe correct me, the take-up of sulfur in Puerto Rico has been pretty limited — pretty slow. So I think big picture assumptions for the moment, Alex, is that whatever part of our book is floating is still linked to the old floating rates. Again, the pickup of sulfur has been slow so far.
Alex Twerdahl
Okay. And then I just wanted to clarify your comments on the timing for capital return. It sounded like you guys go through this process every year where you engage the Fed and then a quarter later or 4 months later, you windup actually telling us what you guys have all decided for the capital return. Is it the second half of this year that you gave the Fed? Or do you intend to have an announcement in the second half of the year.
Ignacio Alvarez
Yes. I think our plan would be to do both, we would engage the Fed at some point, but the announcement, I think when we talk about second half of the year would be an announcement.
Alex Twerdahl
Okay. So you engage the Fed at some point in the next couple of months. And realistically, July, we could still, a expect a capital update.
Carlos Vazquez
What we — we will make the decision of what we want to do once we have clarity on the outlook for interest rates and the economy, Alex. So that is the starting point. So again, our guess is that, that point in time will come in the summer and that we ended up talking about the second half of the year. So that’s the starting point. And from there, we would do our modeling and discuss the opportunities on the alternatives with our regulator, we would have to decide how we want to execute anything we want to execute.
We want to revisit what has been our practice in the past of having very structured every January, we have an announcement, we may choose to change that moving forward. So we’re going to — again, the underlying thing we want to do that has not changed, which is to move in the direction of our Mainland peers as a buffer, but exactly how we execute that will be revalued and we may decide to execute in a different path than we did in the past, okay? So don’t assume we will be back to January announcement and that’s it for the year. Again, we may choose to manage our capital return to slightly different moving forward. If and when we choose to make a change, obviously, we will discuss over the market.
Alex Twerdahl
Okay. But it is the same process that you’ve gone through. There’s nothing changing about how often are the regularity that you would engage the Fed to include in this. And I guess the question that I got from a lot of investors after last quarter is why not go through the process as normal last year and then get approval but just say we are not going to implement it as quickly. Maybe we will wait and not do an ASR. But we have it and the Fed is comfortable with our capital levels and all these things that seem exceedingly healthy from the surface.
Carlos Vazquez
You are describing some of the alternatives that we are considering as we revisit how we want to do this. I always caution everybody, when we speak about this, the Fed does not give conditional approvals to anything. They will only approve things when you request an approval and they will not approve things as long as things work out in the future this way. So again, we try to manage the Fed, the best way we can. I think over the last 4 or 5 years, we’ve been pretty effective in our dealing with the Fed, and we will try to continue that.
But some banks manage it differently. Some banks have quarterly capital plans. I discussed with the Fed instead of a yearly capital plan, which has been our practice in the past. Again, we want to go and revisit all those alternatives, Alex, to be frank with you. So we will be doing that when we reengage. Again, we think what we did in the past has been pretty successful for us as far as dealing with the Fed. We will analyze if there is a path that is even better for us and for our shareholders moving forward.
Alex Twerdahl
Okay. Thank you for taking my follow-ups.
Carlos Vazquez
You’re welcome.
Operator
Thank you. The final question today is a follow-up question from Gerard Cassidy from RBC. Please go ahead. Your line is now open./
Gerard Cassidy
Thank you, Actually, I didn’t pull myself out of the queue. I didn’t understand the instructions. I’m also, thank you Carlos.
Carlos Vazquez
Thank you, Gerard.
Operator
That concludes today’s question-and-answer session. So I’d like to pass the conference over to Ignacio Alvarez for any closing remarks. Please go ahead.
Ignacio Alvarez
Okay. Thank you for joining us today and for your questions. We look forward to updating you on our progress in April. Thank you.
Operator
This concludes today’s conference call. Thank you all for your participation. You may now disconnect your lines.
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