Puerto Rico's banks are experiencing their sunniest outlook in a decade as the island's economy stands to benefit from a $10 billion federal aid package and restructured debt.

Puerto Rico's three major banks — First BanCorp., POPULAR Inc. and OFG Bancorp — pose an attractive comparison to mainland U.S. banks, where double digit yearly loan growth is hard to find, Brett Rabatin, head of research and managing partner with Hovde Group, said. The three banks have outlasted competitors and posted profitable gains amid the island's bankruptcy, economic recession and a string of natural disasters.

Pandemic-related fiscal stimulus, coupled with private insurance payments disbursements and federal aid following natural disasters including Hurricane Maria, are likely to provide a "meaningful boost" to the Puerto Rican economy and banks' balance sheets, S&P Global Ratings agency said in a 2021 report. The island's GDP growth might rise to as much as 2% in 2022 if the federal funds were spent this year, Mario Marazzi, an economist, and former head of Puerto Rico's national statistical agency, said in an interview. That would be "extraordinary" for an economy struggling with multiple years of economic contraction, Marazzi said.

"They've got a big opportunity in front of them to be really profitable relative to mainland banks that have much more significant competition in the U.S.," Rabatin said.

The banks will eventually have to contend with Puerto Rico's shrinking population, a trend that is undermining the incentives for businesses to invest in the market.

Turning the page

"Puerto Rico is at the beginning of an economic growth cycle," OFG Bancorp. CEO & Vice Chairman José Rafael Fernández said in the latest earnings call. "The macro situation continues to improve and we're seeing continued incremental business sector optimism."

Puerto Rico's recent sovereign debt restructuring could clear out short-term uncertainty and raise hopes that investments could flow into the economy. In 2017, Puerto Rico had entered bankruptcy with more than $72 billion in debt, with an additional $55 billion owed in pension obligations.

"The approval of this agreement lifts a cloud of uncertainty that was hanging over the economy," Marazzi said. "It shows that there is light at the end of the tunnel."

The U.S. government has released billions in relief for the island. The Federal Emergency Management Agency approved in October 2021 over $10 billion in funds to repair infrastructure damage, on top of pandemic-related funds.

Long-term aid funds could be even larger, according to Rabatin. "People have cried wolf a dozen times before and it did not happen, but it now actually looks like it's finally going to improve. There's still about $50 billion of aid that's going to be coming to the island over the next decade."

A consolidated banking environment

From over a dozen banks in the early 2000s, the financial system in Puerto Rico has shrunk significantly leading to a highly concentrated sector of just three major banks.

Domestic banks have benefitted from a retreat from Canadian and Spanish banks in the Caribbean. In 2019, OFG acquired Scotiabank's business in Puerto Rico for $500 million, whereas FirstBank bought Banco Santander's unit in 2020 on a $1.1 billion deal.

"Consolidation over the past several years has reduced competitive pressures and allowed both OFG and FirstBank to achieve greater scale and market presence," S&P Global Ratings said in a ratings action report on all three major lenders in the island.

Savers have been left with fewer choices on the island, leaving the few standing banks in pole position to benefit from growing deposits and loan demand. As for the pandemic, delinquencies should be diluted by economic growth ahead.

For analysts, banks in Puerto Rico offer an investment opportunity, with the three major banks under "buy" recommendation, according to data collected by S&P Global Market Intelligence.

"They are still trading at a discount to the U.S.-based banks in terms of price to tangible book as well as earnings," Rabatin said. "They are not trading for as deep a discount as they used to (…) but these banks are really profitable and have good prospects. Plus, there is no one else to buy in Puerto Rico and it looks like they're going to have a pretty good tailwind."

Price to book ratios suggest that Popular is the least expensive of the three, with a ratio of 117.0% that compares to 125.6% in the case of OFG and 131.6% in the case of FirstBank. To be sure, stocks made a swift recovery after a plunge in early 2020. The three banks produced a return close to 60% in 2021, already surpassing pre-pandemic price levels.

FirstBank and Popular did not immediately respond to requests for comment on this story, while OFG declined to comment.

Declining population, a huge headwind

One of the main reasons that international banks have exited the Puerto Rican market has been a steady decline in the island's population that reduced the addressable market.

A population exodus from the island, which had been ongoing for over a decade, was exacerbated by both the economic plight and recent natural disasters.

Puerto Rico's population has shrunk from a 3.8 million peak in 2004, by as much as 19%, down to 3.2 million as of 2020. More than half a million people left the island throughout that period, undermining the incentive for businesses to invest in a dwindling market.

"It has been the largest exodus in Puerto Rico history," Marazzi, who is Puerto Rican, said. "The population continues to decline and there are more deaths than births. That is a huge headwind that has been going on for the past 15 years."

Experts argue that although short term growth is discounted, there is no assurance that the economy will transition into a virtuous cycle in the years that follow. A reversal in the population decline is not guaranteed.

"The conditions that led to bankruptcy and fiscal crisis have not changed at all. They remain intact," he added. "Everyone knows that those funds will be received, perhaps used for good things. But after a certain time, they will run out. What will the Puerto Rican economy base itself on when that happens?"