OFG Bancorp — Q3 2019 Form 10-Q
Business and period: Puerto Rico-based financial holding company offering banking, lending, wealth management, insurance and trust services. This unaudited report covers the quarter and nine months ended September 30, 2019; balance-sheet comparisons are to December 31, 2018. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2019 | Q3 2018 | Change / context |
|---|---|---|---|
| Net interest income | $80.7 million | $82.3 million | Down 1.9%; net interest margin was 5.35% versus 5.39%. |
| Provision for loan losses | $43.8 million | $14.6 million | Up $29.2 million, mainly reflecting planned sales of nonperforming loans. |
| Noninterest income | $22.2 million | $18.6 million | Up 19.1%, including a $3.5 million gain on securities sales. |
| Noninterest expense | $50.7 million | $50.9 million | Down 0.4%; included $1.6 million of merger and restructuring charges. |
| Net income | $7.4 million | $23.1 million | Down 68.0%. |
| Income available to common shareholders | $5.8 million | $19.6 million | Diluted GAAP EPS was $0.11 versus $0.42. |
Management’s non-GAAP reconciliation reports Q3 adjusted net income of $26.5 million, adjusted income available to common shareholders of $24.9 million, and adjusted diluted EPS of $0.48. Adjustments include the loan-sale provision, securities and charged-off-loan sales, acquisition costs, and credits; these measures are not GAAP results.
- Nine-month results: net interest income was $243.6 million (up 4.2% year over year); provision was $73.7 million (up 64.5%); noninterest income was $62.8 million (up 12.4%); noninterest expense was $154.3 million (down 0.7%); net income was $54.8 million (down 8.1%). Diluted EPS was $0.97 versus $1.07.
- Cash flow: nine-month operating cash flow was $41.0 million, investing cash flow was positive $745.5 million, and financing cash flow was negative $273.7 million. Cash, cash equivalents and restricted cash ended at $962.9 million, up $512.8 million from year-end.
- Balance sheet: total assets were $6.33 billion, down 3.8% from year-end. Net loans were $4.41 billion, down 0.6%; deposits were $4.88 billion, down 0.6%. Total borrowings were $305.9 million, down 46.4%, principally after securities sales reduced repurchase-agreement funding.
- Capital and liquidity: stockholders’ equity was $1.05 billion, up 4.9%. OFG’s CET1 ratio was 17.98%, total risk-based capital ratio 21.71%, and leverage ratio 15.41%; the Bank was classified as well capitalized. Available liquidity included $961.8 million of unrestricted cash, $140.9 million of unpledged investment securities and $744.2 million of additional FHLB borrowing capacity.
Material changes and credit trends
- OFG sold $672.2 million of available-for-sale mortgage-backed securities in the first nine months, recognizing an $8.3 million gain. Proceeds supported liquidity and reduced brokered deposits and repurchase borrowings. The company also reclassified $424.7 million of held-to-maturity securities to available-for-sale upon adopting hedge-accounting guidance.
- Management decided to sell mostly nonperforming commercial and mortgage loans; the filing cites approximately $95 million unpaid principal balance targeted for sale in Q4 and a $39.0 million related provision increase. Other disclosure says $168.8 million of nonperforming loans had been identified for sale during the nine-month period; some were sold by quarter-end and the remainder were expected to be sold later.
- Nonperforming assets declined 33.5% to $107.3 million from year-end, and nonperforming loans were 2.01% of loans excluding certain acquired credit-impaired loans, versus 3.30%. These improvements partly reflect loan sales and should not be read as solely organic credit improvement. Nine-month originated-loan net charge-offs were $59.5 million, versus $38.7 million a year earlier.
- Quarter-end originated loans were $3.79 billion: auto and leasing increased 12.1% from year-end, while mortgage declined 11.9% and commercial declined 1.5%. Total allowance for loan and lease losses was $154.3 million versus $164.2 million at year-end.
Outlook, transaction, and risks
- OFG expected the Scotiabank transaction to close before year-end 2019, subject to regulatory approvals and customary conditions. The agreements cover Scotiabank de Puerto Rico, selected Puerto Rico branch assets and liabilities, and U.S. Virgin Islands banking operations. The stated stock purchase consideration is $550 million in cash, subject to specified dividend adjustments; the filing also describes pre-closing dividends of $200 million and up to $125 million. Management characterized the transaction as an approximately $560 million acquisition and said liquidity had been strengthened to support it.
- Management said the strategy is to grow lending and core deposits, improve credit quality and operating efficiency, and expand the franchise. The filing provides no formal quantified earnings or margin guidance. Management anticipated further growth following the Scotiabank transaction, while warning that regulatory approval, integration, asset quality, costs and customer retention could affect outcomes.
- CECL adoption was planned for January 1, 2020. Preliminary simulations indicated a possible 16%–23% net increase in reserves for the originated loan book compared with the incurred-loss model; management expected to remain well capitalized and planned to phase in regulatory-capital effects over three years. The ultimate effect remained dependent on portfolio mix, credit quality and economic conditions.
- Key risks include Puerto Rico economic and fiscal conditions, municipal and government-related credit exposure, natural disasters, interest-rate and funding-market changes, and regulatory and integration risks. Management noted legal proceedings but said reasonably possible losses were not significant; an adverse outcome could nevertheless materially affect results or cash flows in a particular period.
Important facts for investors to verify
- Progress and final terms of the Scotiabank transaction, including approvals, closing timing, cash consideration, dividends, integration costs and acquired asset quality.
- Whether targeted nonperforming-loan sales were completed, and how sale prices and provisions affect subsequent credit metrics and earnings.
- Underlying credit performance apart from loan-sale effects, including charge-offs, delinquencies, allowance adequacy and Puerto Rico municipal exposure.
- CECL’s final reserve and capital impact compared with the preliminary 16%–23% estimate.
- Sustainability of near-$1 billion cash balances, remaining brokered funding, and reported earnings excluding securities-sale gains and other adjustments.