FIRST BANCORP quarterly report, Q3 FY2018

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First BanCorp. — Q3 2018 Form 10-Q

Business context and period: Puerto Rico-based financial holding company operating through FirstBank and other subsidiaries in Puerto Rico, the U.S. and British Virgin Islands, and Florida. This unaudited report covers the quarter and nine months ended September 30, 2018; quarterly results are not necessarily indicative of full-year results.

Financial results and position

  • Profit and revenue: Q3 net income was $36.3 million, or $0.16 per diluted common share, versus a $10.8 million net loss, or $0.05 loss per share, in Q3 2017. Nine-month net income was $100.5 million ($0.45 diluted EPS), compared with $42.8 million ($0.19) a year earlier. Q3 total revenue, defined as net interest income plus non-interest income, was $151.0 million.
  • Interest income and margins: Q3 net interest income rose 7.9% to $132.5 million; net interest margin increased to 4.54% from 4.33%. Nine-month net interest income rose to $387.7 million from $369.3 million; margin was 4.48% versus 4.40%.
  • Credit costs and asset quality: Q3 provision for loan and lease losses fell to $11.5 million from $75.0 million, largely because Q3 2017 included a $66.5 million hurricane-related reserve build. Q3 net charge-offs increased to $33.0 million from $17.6 million (annualized 1.52% versus 0.80%), including $12.5 million on loans transferred to held for sale. The allowance was $200.6 million, or 2.30% of held-for-investment loans, versus $231.8 million, or 2.62%, at year-end 2017. Non-performing assets, including held-for-sale loans, were $522.8 million, or 4.28% of assets, down from $650.6 million, or 5.31%, at year-end 2017.
  • Expenses and taxes: Q3 non-interest expense increased to $90.9 million from $85.6 million, including higher OREO losses, compensation, occupancy, and promotion costs; lower FDIC insurance expense partly offset the increases. Q3 income tax expense was $12.3 million, compared with an $8.4 million benefit in Q3 2017. The 2017 comparison included hurricane-related tax benefits.
  • Cash flow: For the first nine months, operating activities provided $213.8 million, investing activities used $139.9 million, and financing activities used $133.5 million. Cash and cash equivalents decreased $59.6 million to $656.8 million.
  • Balance sheet and funding: Total assets were $12.21 billion, down $51.6 million from December 31, 2017; stockholders’ equity was $1.93 billion, up $58.3 million. Deposits were $9.15 billion, up $125.6 million. Borrowings comprising repurchase agreements, FHLB advances, and other borrowings totaled $974.2 million, down from $1.22 billion at year-end. Brokered CDs fell $476.7 million to $673.7 million; $369.6 million mature within 12 months.
  • Capital and liquidity: First BanCorp. reported a 20.13% CET1 ratio, 20.54% Tier 1 ratio, 23.85% total capital ratio, and 14.85% leverage ratio. Estimated core liquidity was $2.0 billion, or 16.8% of assets; additional FHLB capacity was $503.6 million, with approximately $1.3 billion of unpledged liquid securities.

Material changes and notable items

  • Improved earnings reflected higher net interest income and a substantially lower provision than in the hurricane-affected prior-year quarter. On management’s non-GAAP adjusted basis, Q3 net income was $34.7 million versus $27.4 million; nine-month adjusted net income was $93.9 million versus $79.7 million.
  • Non-performing assets declined from year-end, partly through loan restorations to accrual, collections, sales, charge-offs, and transfers to held for sale. The company transferred $74.4 million of non-performing commercial and construction loans during the first nine months, with $22.2 million of related write-downs. Q3 also included a $2.7 million net loss on sales of non-performing commercial and construction loans.
  • Hurricane-related qualitative reserves were reduced by $2.8 million in Q3 and $11.2 million in the first nine months; $24.9 million remained at September 30. Management cited updated borrower performance, payment patterns, and portfolio repayments, while noting continuing uncertainty about affected customers and the regional recovery.
  • Non-interest income for nine months was $61.8 million versus $47.4 million, primarily because 2017 included a $12.2 million Puerto Rico government debt impairment charge. 2018 included a $2.3 million gain from repurchasing $23.8 million of trust-preferred securities. The investment portfolio’s unrealized losses contributed to a $42.3 million nine-month OCI loss.
  • Loan balances declined about $100.8 million from year-end, with reductions in Puerto Rico and the Virgin Islands partly offset by Florida growth and increased consumer lending. Approximately 74% of held-for-investment loans were concentrated in Puerto Rico, 20% in the U.S., and 6% in the Virgin and British Virgin Islands.

Outlook, risks and contingencies

  • Outlook: The filing provides no formal earnings guidance. Interest-rate simulations estimate that a gradual 200-basis-point increase could raise next-12-month net interest income by $17.0 million, or 2.96%, under a growing-balance-sheet scenario; a falling-rate scenario estimates a $18.2 million, or 3.16%, decrease. These are model scenarios, not forecasts or guarantees.
  • Management expects some hurricane-related customer deposit balances to decline over time, but cannot predict when or by how much; disaster-relief funds and insurance settlements could also produce further growth. Puerto Rico economic recovery, government fiscal measures and PROMESA-related debt restructuring remain uncertain.
  • Funding risks include continued reliance on brokered CDs, access to wholesale funding, and the potential effect of credit-rating downgrades. The company stated available borrowing capacity and deposit-growth efforts should meet foreseeable funding needs, but noted funding availability and terms cannot be assured.
  • Regulatory approvals remain necessary for FirstBank dividends to the holding company and for holding-company dividends, debt payments, and certain capital actions. Preferred dividends had approval through December 2018; common dividends were not declared. The company reported preferred dividends paid of $2.0 million during the nine months.
  • Direct Puerto Rico government, municipal, and public-corporation exposure was $221.4 million, including $152.9 million of investment securities at amortized cost and $68.5 million of loans. Separately, the company had $113.3 million of mortgage loans guaranteed by the Puerto Rico Housing Finance Authority. Its $144.8 million held-to-maturity Puerto Rico municipal bond portfolio had fair value of $131.7 million; management reported all bonds current, but acknowledged future impairment risk from fiscal developments.
  • The hurricane-related qualitative allowance remains subject to revision. Other credit risks include a 34.63% non-performing rate in construction loans including held-for-sale balances, and $625.7 million of TDR loans held for investment. Management also identified legal, market, operational, regulatory, and economic risks.
  • The company said it remediated the material weakness identified at year-end 2017 concerning commercial-loan allowance assumptions through revised methodology and testing; management concluded disclosure controls were effective as of September 30, 2018. It expects to recognize approximately $100 million of lease liabilities upon adopting the lease standard in 2019 and does not expect to early-adopt CECL; the CECL impact remains under evaluation.

Important facts for investors to verify

  1. Whether the decline in non-performing assets and lower credit provisions reflect durable credit improvement, particularly after transfers, write-downs, sales, and reserve releases.
  2. Performance of the remaining $24.9 million hurricane-related reserve and the effect of the Puerto Rico and U.S. Virgin Islands recovery, fiscal plans, and disaster-relief funding.
  3. Deposit stability as hurricane-related balances normalize, brokered-CD maturities and replacement funding, and continued access to regulatory approvals and wholesale liquidity.
  4. Credit exposure and valuation assumptions for Puerto Rico municipal securities, government-related borrowers, TDRs, and impaired commercial/construction loans.
  5. Progress in sustaining allowance controls after the reported material-weakness remediation, and the eventual effect of CECL adoption and the expected lease liabilities.
  6. Developments in the insurance-commission class action and other contingencies; management reported no material-loss disclosure was required based on its assessment at September 30, 2018.