Regulators struggle to solve Puerto Rican bank crisis

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Bank regulators’ spring break in Puerto Rico may not prove to be much of a holiday.

There are rumblings FDIC officials are moving in to figure out a solution for the banking system on the US controlled Caribbean island that is in tatters after years of recession, a source familiar with the matter and two industry bankers told dealReporter.

Puerto Rico banks’ fragile condition do not pose a systemic risk to the mainland, but at the same time their isolation from the rest of the US banking system means the government will be challenged to find a market-based solution to their problems, these sources said.

Popular (NASDAQ:BPOP), the largest Puerto Rico-based financial institution, may be one of the few banks that can attract private capital, said the source familiar and first industry banker. The bank has already spoken to private equity firms, but the first industry banker said he has heard PE appears to be only interested in investing in the bank at a significant discount. A spokesperson did not return a call seeking comment.

At the end of 2009, Popular reported 11.4% of its Puerto Rico bank subsidiary’s loans were noncurrent. The second largest bank on the island by assets, Firstbank, reported 12%. The third and fourth largest, Westernbank and Doral Bank, reported 16.6% and 16.8%, respectively.

Two smaller Puerto Rico banks are in even worse shape. R-G Premier Bank reported 22% of its loans were noncurrent. Eurobank disclosed it is no longer well capitalized as measured by its Tier 1 leverage ratio. About 16% of the bank’s loans were noncurrent at the end of the year.

The US industry average for noncurrent loans is 5.4%, according to the FDIC. The Puerto Rican banks reported much higher levels in part because the economy on the island has faired much worse than the rest of the US. Since at least 2006, GDP on the island has declined each year and the unemployment rate stood at 15% at the end of 2009.

Bank regulators led by the FDIC usually resolve failing banks by quickly auctioning them off to stronger competitors. But given Puerto Rico’s poor macroeconomic prospects and geography, there are almost no strategic bidders or investors willing to step up to the plate, the sources said.

”Obviously, there is not a cross town solution or cross state. Cross state is the ocean,” the source familiar said.

US banks that used to operate in Puerto Rico sold most of their operations before the financial crisis started in America in 2008. Citigroup (NYSE:C) is the only bank that continues to have a branches, according to FDIC data. Two Spanish banks, Santander and BBVA, and a Canadian institution, Bank of Nova Scotia, maintain a presence on the island through US chartered bank subsidiaries.

Regulators might be able to coax Santander to acquire one of the failing Puerto Rican banks, the first industry banker said, but the source familiar said the government would likely have to provide a large financial incentive. Santander has so far focused its Americas expansion on Brazil and the contiguous US.

Another option for regulators would be to try to convince Scotia to rescue Firstbank, the first banker said. Scotia exited in 2009 its 10% stake in Firstbank’s holding company, First Bancorp (NYSE:FBP). The Canadian bank has made acquisitions in the Caribbean in recent years.

Regulators could also try to merge some of the problem banks into a larger institution that may be more attractive to a buyer, the sources said. However, the source familiar noted that investors would be reluctant to buy a bigger bank for the same macro-reasons as a smaller institution.

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