OFG Bancorp — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014; comparisons are primarily with Q1 2013 for operating results and December 31, 2013 for balance-sheet changes. OFG Bancorp is a Puerto Rico-focused financial holding company providing banking, lending, mortgage, wealth-management and related services.
Financial performance and position
- Earnings: Net income was $23.7 million, up 12.1% year over year. Income available to common shareholders was $20.3 million; diluted EPS was $0.42, versus $0.37. Basic EPS was $0.45.
- Revenue and margin: Net interest income increased 10.4% to $103.4 million. Total operating revenue, as defined by the company, rose 4.8% to $108.7 million. Net interest margin was 5.90%, compared with 4.90%.
- Credit costs and expenses: Total loan-loss provision rose 36.1% to $11.7 million. Non-interest income fell 47.7% to $5.3 million, including $18.5 million of FDIC shared-loss expense, partly offset by a $4.4 million securities-sale gain. Non-interest expense declined 8.0% to $61.5 million; the prior-year quarter included $5.5 million of merger and restructuring charges. Efficiency ratio improved to 50.03% from 57.46%.
- Cash flow: Operating activities provided $40.6 million and investing activities provided $291.2 million; financing activities used $328.5 million. Cash and cash equivalents ended the quarter at $624.6 million.
- Balance sheet and funding: Total assets were $7.856 billion, down 3.7% from year-end 2013. Net loans were $5.003 billion, down 0.3%; investments were $1.482 billion, down 8.2%. Deposits were $5.301 billion, down 1.5%, while total borrowings were $1.476 billion, down 13.6%. Repurchase-agreement borrowings fell $255 million as maturities were repaid.
- Liquidity and capital: The filing reports $624.6 million of unrestricted cash, $235.7 million of unpledged investment securities, $614 million of FHLB borrowing capacity and $861 million available at the Federal Reserve discount window. Company capital ratios were 9.51% Tier 1 leverage, 14.76% Tier 1 risk-based and 16.56% total risk-based; the Bank was described as well capitalized.
- Credit quality: Non-performing assets were $162.5 million, or 2.84% of relevant total assets, up from $155.3 million and 2.61% at year-end. Non-performing loans were $88.2 million, up 2.3%. Total loan-loss allowance was $110.6 million, including $56.2 million on non-covered loans and $54.4 million on covered loans.
Material changes and notable items
- Higher loan yields and lower deposit costs lifted net interest income, despite lower average interest-earning assets. Covered-loan yield rose to 26.68% from 20.98%; non-covered-loan yield rose to 7.43% from 6.98%.
- Core banking and financial-services revenue declined 14.3% to $19.4 million. Banking-service revenue was affected in part by reclassification of loan late charges to interest income; mortgage banking revenue fell amid lower sales and higher repurchase-related losses and valuation adjustments.
- Management attributed the increase in FDIC shared-loss expense to updated expectations of lower covered-asset losses and higher accretable yield, which reduced the expected FDIC reimbursement asset. The indemnification asset fell to $166.2 million from $189.2 million.
- Puerto Rico government-related loans and securities totaled $761.2 million at quarter-end under the filing’s exposure table; separate disclosures report $718.8 million of credit outstanding and $42.4 million of government-related securities. The issuer repaid a $98.7 million Puerto Rico government bond on March 1, 2014.
- The company repurchased 707,400 shares for $10.4 million in Q1 and declared a common dividend of $0.08 per share. The Puerto Rico corporate tax rate increase from 30% to 39% contributed to income-tax expense rising to $11.8 million from $7.1 million.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management describes a long-term aim to expand lending, grow non-interest revenue, improve operating efficiency and maintain effective asset-liability management. Loan production fell 22.8% year over year, with commercial and mortgage production particularly weaker; management cited generally lower loan demand.
- Management warns that Puerto Rico’s prolonged recession, fiscal pressures, below-investment-grade government ratings, unemployment and population decline could affect borrowers, collateral values, securities and funding. A further downgrade or government default could impair the company’s Puerto Rico exposures.
- Funding depends partly on wholesale sources: quarter-end repurchase agreements were $1.010 billion and brokered deposits were $712.9 million. Management cautions that funding access or pricing could deteriorate and affect liquidity, margins or lending.
- Other risks include interest-rate and market volatility, loan losses, FDIC shared-loss estimates and true-up obligations, litigation and regulatory matters, and reliance on third-party technology and mortgage-servicing providers.
- Non-performing assets increased, foreclosure and repossession expenses rose 90.3% year over year, and net credit losses excluding acquired loans increased to $5.2 million from $3.4 million. Management stated that it considered the allowance adequate; actual outcomes remain subject to estimates and economic conditions.
- Management said pending legal matters were not expected to have a material adverse effect on financial condition, but adverse outcomes could materially affect results or cash flows in individual periods. Disclosure controls were assessed as reasonably effective; no material change in internal control over financial reporting was reported.
Investor verification priorities
- Assess the sustainability of the 5.90% net interest margin and the contribution from covered-loan accretion and FDIC-related accounting.
- Review trends in non-performing assets, auto and consumer delinquencies, charge-offs, provisions and allowance adequacy, including the change to a 24-month loss look-back period.
- Evaluate Puerto Rico government exposure, collateral and repayment sources, deposits from government entities, and potential effects of further rating downgrades or fiscal deterioration.
- Confirm the quality and availability of liquidity sources, and monitor reliance on repurchase agreements, brokered deposits and other wholesale funding.
- Separate recurring operating performance from the $4.4 million securities-sale gain, FDIC shared-loss expense and the absence of prior-year merger charges; also assess the higher tax burden.