OFG Bancorp — 2014 Form 10-K
Reporting period: Year ended December 31, 2014; filed February 26, 2015. OFG is a Puerto Rico-focused financial holding company operating Banking, Wealth Management and Treasury businesses, primarily through Oriental Bank, with 53 branches in Puerto Rico. The prior-year comparison is 2013 unless otherwise noted.
Financial performance and position
| Metric | 2014 | 2013 | Change / context |
|---|---|---|---|
| Net interest income | $408.5 million | $409.7 million | Down 0.3%; net interest margin rose to 5.84% from 5.46%. |
| Net interest income after loan-loss provision | $347.8 million | $336.8 million | Up 3.3%; total provision fell to $60.6 million from $72.9 million. |
| Net income | $85.2 million | $98.4 million | Down 13.5%. |
| Income available to common shareholders; diluted EPS | $71.3 million; $1.50 | $84.6 million; $1.73 | Down 15.7% and 13.3%, respectively. |
| Core banking and financial services revenue | $77.9 million | $86.2 million | Down 9.5%; banking service and mortgage banking revenue weakened. |
| Net non-interest income | $17.3 million | $17.1 million | Includes net FDIC shared-loss expense of $65.8 million in 2014. |
| Non-interest expense; efficiency ratio | $242.7 million; 49.90% | $264.1 million; 53.27% | Expense fell 8.1%, partly because 2014 had no merger and restructuring charges. |
| Return on average assets; return on average common equity | 1.10%; 9.50% | 1.15%; 12.03% | Both declined. |
| Total assets; stockholders’ equity | $7.449 billion; $942.2 million | $8.158 billion; $884.9 million | Assets down 8.7%; equity up 6.5%. |
| Loans, net; investment securities | $4.827 billion; $1.402 billion | $5.019 billion; $1.615 billion | Loans down 3.8%; securities down 13.2%. |
| Deposits; borrowings | $4.924 billion; $1.420 billion | $5.383 billion; $1.707 billion | Down 8.5% and 16.8%, respectively. |
| Capital ratios | Tier 1 leverage 10.61%; Tier 1 risk-based 16.02%; total risk-based 17.57% | 9.06%; 14.38%; 16.16% | All increased; the Bank reported as well capitalized. |
Net interest margin improved as asset yields increased and deposit costs declined, despite lower average earning-asset balances. Common earnings were lower mainly because 2013 included a $36.9 million deferred-tax benefit and $17.7 million of merger and restructuring charges; these items make the year-over-year comparison less indicative of recurring performance.
Cash flow: Operating activities provided $175.0 million, investing activities provided $559.9 million, and financing activities used $782.7 million. Cash and cash equivalents fell $47.8 million to $573.4 million. Investing cash flow benefited from securities maturities and loan repayments; it should not be read as recurring operating cash generation.
Material changes and credit quality
- Loan production declined 38.1% to $919.4 million. Commercial production fell 62.5% to $262.9 million and mortgage production fell 29.8% to $215.4 million.
- Non-performing loans rose 26.4% to $108.9 million; non-performing assets rose 14.7% to $178.1 million. Mortgage and auto delinquencies increased, while the company cited Puerto Rico’s prolonged recession and weaker property values.
- Net credit losses on originated and other loans, excluding acquired loans accounted for under ASC 310-30, were $29.1 million, or 1.11% of average loans, versus $46.4 million, or 2.69%, in 2013. However, auto and leasing charge-offs increased sharply; the filing reports $26.0 million of such charge-offs in 2014.
- The allowance for non-covered loans increased to $69.5 million from $54.3 million. The separate allowance for covered loans was $64.2 million; covered loans are subject to FDIC loss-sharing arrangements.
- The FDIC indemnification asset declined 48.5% to $97.4 million, reflecting reimbursements and amortization. Most indemnification for non-single-family loans was expected to end in the second quarter of 2015, while the recovery-sharing period extends longer.
- Deposits declined, particularly higher-priced time deposits; non-maturing deposits increased 1.5%. Repurchase-agreement balances fell $287.5 million as maturities were repaid.
- Stockholders’ equity rose, while OFG repurchased 1,153,998 shares for $16.9 million. The annual common dividend increased to $0.34 per share from $0.26.
Outlook, risks and unusual items
- Management said its priorities were to manage acquired loans, originate prudently, optimize yields and credit costs, control expenses, build capital and preserve flexibility to deploy capital. It described a three-to-five-year horizon for its broader strategy but gave no specific earnings or revenue guidance.
- Puerto Rico concentration and government exposure: The filing reports approximately $619 million of credit facilities to the Commonwealth, its agencies, public corporations and municipalities, all outstanding at year-end. A separate table reports $639.9 million of related loans and securities, including $20.9 million of investment securities; verify the scope and reconciliation of these disclosures.
- PREPA exposure: OFG’s participation in a fuel-purchase revolving facility had a $200 million unpaid balance. After an extension through March 31, 2015, the loan was classified substandard and a troubled-debt restructuring; OFG kept it on accrual status and recorded no impairment based on its analysis. PREPA’s liquidity, restructuring and repayment capacity remain material uncertainties. The filing also says the court invalidated Puerto Rico’s Recovery Act in February 2015; the Commonwealth planned to appeal.
- Funding and liquidity: Management reported $568.8 million of unrestricted cash and cash equivalents, $207.4 million of unpledged investment securities, $606.6 million of FHLB borrowing capacity and $715.5 million available at the Federal Reserve discount window. Wholesale funding—including repurchase agreements and brokered deposits—remains a risk, and much of the securities portfolio is pledged.
- FDIC loss-sharing transition: The non-single-family shared-loss agreement was due to expire during 2015. OFG warned that the end of coverage could increase credit-related costs and regulatory risk weights on affected assets; certain transactions also require prior FDIC consent to preserve loss-share protection.
- Regulatory and tax changes: Basel III capital rules became effective for OFG and the Bank in 2015, with phase-ins and a capital conservation buffer through 2019. Management expected to elect to exclude most accumulated other comprehensive income from regulatory capital. Puerto Rico tax reform proposals were pending and could change tax rates and introduce a value-added tax.
- Other risks and contingencies: Risks include continued recession, real-estate weakness, interest-rate and securities valuation changes, mortgage repurchases and representations-and-warranties claims, cyber and third-party service disruptions, and potential loan-loss or goodwill impairment. Legal proceedings were described as routine; management did not expect aggregate liability to materially affect financial condition or results, though adverse outcomes could affect particular periods.
- Unusual accounting estimates: Management changed the historical loss look-back period for consumer and auto portfolios from 12 to 24 months and revised the commercial real-estate loss realization period. These were prospective changes in estimates. The company recorded $25.1 million of foreclosure, repossession and other real-estate expenses, up from $16.5 million.
- KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management and the auditor concluded internal control was effective at year-end.
Most important facts for investors to verify
- Reconcile Puerto Rico government exposure across the reported $619 million of credit facilities and the $639.9 million table total, and confirm collateral, maturities and deposit concentrations.
- Track the $200 million PREPA facility: restructuring terms and milestones, repayment performance, impairment assumptions and subsequent developments.
- Assess the sustainability of earnings excluding the 2013 tax benefit and restructuring costs, while monitoring core fee revenue, FDIC shared-loss expense and mortgage banking results.
- Examine credit trends beneath the lower aggregate loss ratio, especially rising non-performing loans and auto/consumer charge-offs, and test the adequacy of allowances.
- Confirm the effect of 2015 FDIC loss-share expirations and Basel III implementation on credit costs, risk-weighted assets, capital distributions and regulatory capital.
- Evaluate liquidity and funding stability, including brokered deposits, repurchase agreements, pledged collateral and available borrowing capacity.