OFG Bancorp (Oriental Financial Group Inc.) — Q2 2011 Form 10-Q
Business context and period. Unaudited results for the quarter and six months ended June 30, 2011. The Puerto Rico-based financial holding company provides banking, mortgage, wealth management, insurance and related services. Comparisons are with the same 2010 periods unless otherwise noted; balance-sheet comparisons are with December 31, 2010. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
- Q2 earnings: Net income was $26.5 million versus $0.6 million. Income available to common shareholders was $25.3 million, or $0.56 per basic and diluted share, versus a $4.2 million common loss, or ($0.13) per share.
- Six-month earnings: Net income was $29.5 million versus $12.6 million; income available to common shareholders was $27.1 million versus $6.5 million. Basic and diluted EPS were $0.60 and $0.59, respectively, versus $0.22 for both measures.
- Interest income and margins: Q2 net interest income rose 15.6% to $42.7 million; six-month net interest income rose 20.2% to $79.9 million. Net interest margin expanded to 2.63% for Q2 and 2.44% year to date, from 2.16% and 2.03%, respectively.
- Non-interest income and expenses: Non-interest income was $16.9 million in Q2 and $24.4 million year to date, compared with a $4.3 million loss and $3.7 million of income in 2010. Non-interest expenses increased 10.2% to $30.7 million in Q2 and 27.5% to $61.5 million year to date, largely reflecting the Eurobank acquisition and integration. Management’s non-GAAP pre-tax operating income was $18.5 million in Q2, up 23.1%, and $31.6 million for six months, up 14.8%.
- Credit costs and asset quality: Q2 provision for non-covered loan losses was $3.8 million; the six-month provision was $7.6 million, plus $0.5 million net provision for covered loans. Non-covered net charge-offs were $2.3 million in Q2 and $4.8 million year to date. Non-performing loans were $129.7 million, up 6.0% from year-end; non-performing assets were $142.3 million, or 2.19% of assets excluding covered assets. The non-covered allowance was $34.2 million, or 2.85% of non-covered loans.
- Balance sheet and funding: Total assets were $7.08 billion, down 3.1% from year-end. Net loans were $1.71 billion, down 3.7%; deposits were $2.39 billion, down 7.9%; and borrowings were $3.91 billion, broadly stable. Repurchase agreements were $3.46 billion and were the principal borrowing source. Cash and cash equivalents fell to $281.0 million from $448.9 million.
- Cash flow: For the six months, operating activities used $51.1 million, investing activities provided $121.3 million, and financing activities used $238.1 million. Cash and cash equivalents declined $167.9 million to $281.0 million.
- Capital and shareholder returns: Stockholders’ equity was $724.4 million. Group capital ratios were 9.74% leverage, 30.40% Tier 1 risk-based and 31.68% total risk-based; the Bank was categorized as well capitalized. OFG repurchased 2.41 million shares for $29.1 million at an average $12.10 per share and authorized a further $70 million repurchase program, with no purchases under that new program through the report date. Common dividends declared were $0.05 per share in Q2.
Changes, outlook and risks
- Results benefited from higher net interest income and sharply smaller derivative losses than in 2010. Q2 included a $9.1 million securities-sale gain and a $3.6 million derivative loss; the six-month derivative loss was $7.6 million. These items make reported non-interest income comparisons volatile.
- Management attributed margin improvement to lower funding costs and higher asset yields. Lower deposit costs reflected the maturity of higher-priced certificates of deposit. Mortgage-backed securities income also benefited in Q2 from lower premium amortization as prepayments slowed.
- On April 1, 2011, the Bank changed its policy so well-collateralized residential mortgages in collection become non-accrual at 90 rather than 365 days past due. This brought $39.8 million of loans onto non-accrual status. A $1.8 million adjustment was recorded for previously accrued mortgage interest deemed uncollectible.
- Management said it did not expect non-performing loans to cause significantly higher losses, citing collateral and loan-to-value positions. However, Puerto Rico remained in a prolonged recession, and the filing highlights local economic and fiscal conditions, rising delinquencies, credit and real-estate exposure, interest-rate and market risks, and dependence on wholesale funding. Repurchase agreements include counterparties’ put options; the company cautions that funding may become less available or more costly.
- The portfolio included $61.7 million amortized cost of structured credit investments with $16.0 million of unrealized losses. No other-than-temporary impairment was recorded in the first half; management estimated recovery of principal and interest, while reporting modeled impairment scenarios for one CLO.
- The FDIC shared-loss agreements cover 80% of specified losses and recoveries on covered assets. The related indemnification asset was $437.4 million; an estimated $11.1 million net true-up/clawback liability was noted. Covered-asset cash flows and FDIC reimbursements remain subject to estimates and agreement terms.
- Puerto Rico tax-law changes caused a $5.4 million first-quarter deferred-tax-asset reduction and tax expense. Q2 included a tax benefit, including benefits from settling tax contingencies; the filing says prior tax years before 2010 were closed to further Puerto Rico assessments. Legal proceedings were described as ordinary-course matters, with no material adverse effect expected by management.
- No formal earnings guidance was provided. Management’s forward-looking statements are subject to economic, credit, market, regulatory, funding and other risks. After quarter-end, on August 5, 2011, S&P downgraded the U.S. credit rating to AA+; the filing identifies potential effects on securities, markets and financing as a risk.
Investor verification priorities
- Track non-performing loans, delinquency trends and the effect of the 90-day mortgage non-accrual policy, including any further interest reversals or reserve needs.
- Assess the quality and liquidity of the securities portfolio, particularly structured credit holdings, unrealized losses and sensitivity to rate and credit-spread changes.
- Verify the sustainability of margin gains and core earnings apart from securities gains, derivative marks/terminations, tax settlements and FDIC-asset accretion.
- Monitor deposit outflows, reliance on repurchase-agreement funding, upcoming put dates and the availability of unencumbered collateral and liquidity.
- Follow covered-loan performance, FDIC reimbursement claims and the estimated true-up/clawback obligation.
- Confirm capital and shareholder-return capacity after repurchases and dividends, and review the execution and funding of the newly authorized $70 million buyback.