OREANDA-NEWS. The protection of US regulatory oversight over Puerto Rico's banks, including US federal deposit insurance and the intervention authority of the Federal Reserve and the FDIC, is critical to considering the range of possible outcomes facing local banks on the island, says Fitch Ratings. The US umbrella materially differentiates the situation in Puerto Rico versus other regions where the local government is battling a fiscal crisis. Such distinctions are relevant given the comparisons commonly being drawn between Puerto Rico and Greece.

Puerto Rico's banks operate within the legal jurisdiction of the United States of America (Long-Term IDR AAA, Outlook Stable), thus the risk of transfer to and convertibility by the Commonwealth of Puerto Rico (IDR CC, Rating Watch Negative) is irrelevant to the island's banks in credit rating terms. Neither of Puerto Rico's two Fitch-rated banks, Popular, Inc. (Issuer Default Rating BB-, Rating Outlook Stable) and First BanCorp (IDR B-, Rating Outlook Stable), face any possibility of becoming nationalized by the commonwealth. The highest possible viability ratings (VRs) of Puerto Rico's banks are constrained by the country ceiling rating of the United States, rather than Puerto Rico.

Puerto Rico's local economy will be the primary determinant of how well Puerto Rico's banks uphold their credit strength. We see Popular's and First BanCorp's ratings remaining highly sensitive to deterioration in economic trends, but modestly cushioned by their capitalization levels.

At March 31, 2015, Popular's Common Equity Tier 1 ratio and tangible common equity (TCE)/tangible assets (TA) totaled 15.74% and 10.72%, respectively. In a scenario assuming a 40% write-down to direct (obligations of Puerto Rico and its municipalities) and indirect exposures (obligations payable by non-government entities while having a government guarantee), Fitch estimates a pro forma TCE/TA of 9.37%. Popular also has over $2.3 billion of liquid investments, $4.5 billion of available-for-sale securities, and valuable stake in Evertec, a payment processing company spun off by the bank in 2010. We expect Popular's good liquidity to be maintained, even with the Government Development Bank of Puerto Rico's plan to take over local municipalities' deposits.

First BanCorp's common equity Tier 1 and TCE/TA ratios were 16.15% and 12.71%, respectively, at March 31, 2015. First BanCorp's non-performing loan performance has held relatively steady at slightly under 6% for the last two years. Non-performing assets typically run at much higher levels than all US mainland banks. However, charge-offs have not occurred at the same high levels, as many delinquencies end up being cured by borrowers.

Popular's and First BanCorp's recently reported Dodd-Frank Act Stress Test (DFAST) results specifically prescribed macro conditions unique to the Puerto Rico's circumstances, and worse than those prescribed under the Fed's standard "severely adverse" scenario. The test results reflected a GDP contraction of 3.3% (versus a 1.1% contraction for the standard test) and an unemployment rate of nearly 19% (versus 10% under the standard test). Puerto Rico's unemployment rate was 12.4% as of May 2015. Both banks passed the tests by comfortable margins to the "well capitalized" threshold minimums.

Puerto Rico's banks will continue to operate with elevated and likely weakening NPAs. While the sluggish economic conditions in Puerto Rico are unlikely to resolve quickly, Popular and First BanCorp do not have outsized loan concentrations (such as in commercial real estate loans), and their moderate loan growth rates suggest they have adapted to the weak environment. Overall, the capital positions and overall expected profitability of both banks remain adequate to support current rating levels, even in light of the commonwealth's admitted need for debt relief.

If the commonwealth defaults and the fiscal situation of the local government clearly degrades, leading to worsening losses for the banks, Fitch would review the Puerto Rican banks ratings for negative action.