OFG Bancorp — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are to December 31, 2012. Amounts are in U.S. dollars. The company changed its name from Oriental Financial Group, Inc. to OFG Bancorp on April 25, 2013.
Business context and reporting period
OFG is a Puerto Rico-based financial holding company operating in banking, financial services and treasury. Results reflect the December 2012 acquisition of BBVAPR, including its approximately $3.6 billion of non-covered loans and expanded deposits, branches and financial-services operations. Management was evaluating how to integrate the acquired operations into its reporting segments during 2013, so year-over-year comparisons are significantly affected by the acquisition.
Financial performance and condition
- Earnings and revenue: Net income was $21.2 million, up 98.9% from $10.7 million in Q1 2012. Income available to common shareholders was $17.7 million; diluted EPS was $0.37 versus $0.23. Operating revenue (net interest income plus non-interest income) was $101.8 million, up 96.8%.
- Interest and margins: Net interest income rose 137.5% to $92.6 million. Reported net interest margin was 4.65%, versus 2.60% a year earlier; management attributed the expansion principally to the acquired loan portfolio and lower funding costs. Total interest income increased 62.5% to $113.6 million, while interest expense declined 32.0% to $21.0 million.
- Credit costs: Total loan-loss provision was $8.6 million, down from $10.2 million. Non-covered provision rose to $7.9 million from $3.0 million; covered provision fell to $0.7 million from $7.2 million. Non-covered net charge-offs were $3.4 million, up from $2.6 million. Non-accrual loans were $132.2 million, down from $146.6 million; non-performing assets were $221.3 million, or 3.84% of the specified asset base.
- Expenses and profitability ratios: Non-interest expense increased 123.9% to $64.9 million, reflecting the enlarged company and integration costs. The efficiency ratio improved to 56.08% from 57.48%. Return on average assets was 0.95% versus 0.65%, and return on average common equity was 10.14% versus 6.00%.
- Balance sheet and liquidity: Total assets were $8.70 billion, down 5.3% from year-end. Net loans were $5.21 billion, up 0.6%; investments were $2.05 billion, down 8.3%. Deposits were $5.56 billion, down 2.2%, while total borrowings declined 15.0% to $2.11 billion. Cash and cash equivalents fell to $561.4 million from $868.7 million.
- Cash flows: Operating activities provided $21.4 million and investing activities provided $183.4 million; financing activities used $512.0 million. Cash and cash equivalents decreased $307.2 million during the quarter.
- Capital and dividends: Stockholders’ equity was $870.2 million, up 0.8%. OFG’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 8.07%, 13.24% and 15.26%, respectively; the Bank was categorized as well capitalized. The common dividend was $0.06 per share.
Material changes versus comparable periods
- Acquisition-related loan balances drove higher loan interest income and materially changed the scale and mix of operations; 2012 did not include the acquired BBVAPR operations.
- Banking and financial-services revenue increased to $23.2 million from $11.5 million, including higher deposit-related fees. Investment income declined as the securities portfolio was reduced.
- Net non-interest income fell to $9.3 million from $12.8 million. Q1 2013 included $12.9 million of net amortization of the FDIC shared-loss indemnification asset, versus $4.8 million; Q1 2012 included a $7.4 million securities-sale gain, while Q1 2013 had no such gain.
- Deposit costs declined, with the reported weighted-average deposit rate at 0.75% versus 1.33% at year-end 2012; management also cited lower borrowing costs and repricing of core deposits. The quarter included repayment of a $200 million repurchase agreement at maturity and cancellation of a $50 million acquired subordinated note.
- Non-performing loans declined, although foreclosed real estate increased to $81.3 million from $75.4 million. Credit losses and provision trends varied between acquired, originated and FDIC-covered portfolios.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no quantified earnings or margin guidance. Management’s stated longer-term aims include expanding lending, growing fee revenue, integrating services and improving operating efficiency. It expects BBVAPR integration to continue during 2013 and anticipates benefits from greater scale and a larger, higher-yielding loan base.
- Unusual and integration items: Q1 included $5.534 million of merger and restructuring charges: $3.836 million for a contract cancellation, $948,000 for systems integration and $750,000 for severance and employee-related costs. The company also recorded a $1.061 million gain on early extinguishment of subordinated notes. Management described merger charges as non-recurring integration costs.
- Credit and FDIC exposure: The allowance for non-covered loans was $42.7 million; the covered-loan allowance was $53.0 million. The FDIC indemnification asset was $267.0 million, down from $286.8 million at year-end. Management’s estimates depend on covered-asset performance, expected cash flows and compliance with FDIC requirements. The filing reports an estimated FDIC true-up liability of $16.2 million.
- Liquidity and market risks: Management cited approximately $561.4 million in cash, $205 million in investment securities, $600 million of FHLB borrowing capacity and $397 million of Federal Reserve discount-window capacity as available liquidity sources. The company remains significantly dependent on wholesale funding, including repurchase agreements; funding availability and cost could worsen. Interest-rate simulations estimated a one-year net-interest-income increase of 2.57% to 2.64% for a 200-basis-point rise and a decrease of 0.98% to 1.09% for a 50-basis-point decline, depending on balance-sheet assumptions.
- Other risks and contingencies: Management highlighted Puerto Rico’s weak economic and employment conditions, real-estate and credit risks, interest-rate and market risks, regulation, and acquisition integration. Legal matters were not expected to materially affect financial condition, though an adverse outcome could affect results or cash flows in a particular period. No material changes to previously disclosed risk factors were reported.
- Controls: Management concluded disclosure controls provided reasonable assurance of effectiveness and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of the earnings and margin improvement is sustainable after separating BBVAPR acquisition effects, purchase-accounting accretion and lower funding costs.
- Whether integration delivers expected efficiencies and whether further merger, restructuring or contract-exit costs arise.
- Trends in non-covered loan delinquencies, mortgage charge-offs, foreclosed real estate and allowance adequacy, including the performance of acquired loans.
- The collectability and timing of the FDIC indemnification asset and the final shared-loss true-up liability.
- Deposit stability, wholesale-funding dependence, repurchase-agreement maturities and puts, and actual availability of stated contingent liquidity.
- Exposure to Puerto Rico government and economic conditions, and sensitivity to interest rates, securities valuations and funding markets.