A research note on Multinational & Regional Banks by Sterne Agee analysts Todd L. Hagerman and Robert Greene reiterates a Buy rating on Puerto Rico exposed banks Popular Inc (NASDAQ:BPOP), First Bancorp (NYSE:FBP) and OFG Bancorp (NYSE:OFG), albeit with riders.

“While a clear path has been established to improve the Commonwealth’s fiscal woes, patience is beginning to wear thin. To that end, our sense is on-going stabilization in the underlying economy and a return to the long-term capital markets in early ’14 are required to restore investor confidence,” say the analysts.

Markets worried about recent events in Puerto Rico

The action by Moody’s to put the Commonwealth’s debt on watch for a possible downgrade from its current Baaa3 rating, as well as moves to transfer about $2.8B in public deposits out of private banks to the Government Development Bank (GDB) to bolster the latter’s liquidity, are worrisome signals to the markets.

Likewise, the GDB’s placement of $110M in Senior Guaranteed Notes with the Puerto Rico State Insurance Fund Corporation, at 8% interest, smacks of a liquidity crunch.

According to Sterne Agee, these developments are “undoubtedly testing the market’s patience,” and that “headline risk continues to pressure the Commonwealth to more aggressively address its fiscal position.”

Soaring muni spreads and slumping bank stocks

The chart below shows the soaring bond spreads – exemplifying the risk of a weakening economy and the potential rating downgrade.

Puerto Rico

The Commonwealth’s deteriorating financial picture and the desperate actions by the government have taken a toll on Puerto Rico’s banks as shown in this chart.

Puerto Rico

But here are the mitigating factors…

“The GDB’s deposit transfer plan is unlikely to have any meaningful impact on the banks’ liquidity or profitability,” says Sterne Agee, even though Popular Inc (NASDAQ:BPOP), First Bancorp (NYSE:FBP), and OFG Bancorp (NYSE:OFG), hold approximately $1.0B, $584mm, and $491mm in outstanding government/municipal deposits respectively.

Secondly, the analysts say the weakness in both the debt and equity markets in Puerto Rico is overdone at this point considering that Puerto Rico would have no option but to make concerted moves to shore up revenue and take political actions to ensure a return to the capital markets in 2014.

Lastly, recent economic signals emerging from the Commonwealth point to a new-found stability; its Economic Activity Index posted its third consecutive positive month-over-month growth rate—the first since November ’12. Moreover, the unemployment rate has declined from 15.1% in September 2013 to 14.1% in November.

Read more about Puerto Rico’s signs of stabilization here.

Recommendations

Popular Inc(NASDAQ:BPOP) – Buy – (Last traded Jan 8 $27.95)

First Bancorp(NYSE:FBP) – Buy – (Last traded Jan 8  $5.80)

OFG Bancorp(NYSE:OFG) – Buy – (Last traded Jan 8  $15.75)