OFG Bancorp — Q2 2020 Form 10-Q
Business context and reporting period
OFG Bancorp is a Puerto Rico-based financial holding company operating Banking, Wealth Management and Treasury businesses. This unaudited filing covers the quarter and six months ended June 30, 2020. Results include the Scotiabank Puerto Rico and U.S. Virgin Islands operations acquired on December 31, 2019, so year-over-year comparisons reflect a larger business as well as underlying performance.
Financial performance and position
| Metric | Q2 2020 | Comparison |
|---|---|---|
| Net interest income | $105.1 million | Up 29.6% from Q2 2019 |
| Net interest margin | 4.78% | Down from 5.39% in Q2 2019 |
| Provision for credit losses | $17.7 million | Approximately flat year over year; included $5.0 million attributed to COVID-19 |
| Non-interest income, net | $27.2 million | Up 18.3% year over year |
| Non-interest expense | $85.5 million | Up 66.1% year over year |
| Net income / diluted EPS | $21.8 million / $0.39 | Net income down 9.1%; diluted EPS was $0.43 in Q2 2019 |
| Efficiency ratio | 66.70% | Up from 51.89% in Q2 2019 |
For the six months, net interest income was $210.2 million, provision for credit losses $64.8 million, net income $23.6 million and diluted EPS $0.39, versus $162.9 million, $30.0 million, $47.4 million and $0.86, respectively, in the first half of 2019. Six-month net interest margin was 4.84%, versus 5.39%; efficiency ratio was 66.59%, versus 52.19%.
At June 30, total assets were $9.93 billion, net loans $6.74 billion, deposits $8.54 billion and total borrowings $104.4 million. Cash and cash equivalents plus restricted cash were $1.90 billion, compared with $852.8 million at year-end 2019. Repurchase-agreement borrowings were eliminated; FHLB advances were $67.5 million and subordinated notes $36.1 million. Six-month operating cash flow was $21.6 million, investing cash flow $407.5 million and financing cash flow $618.2 million.
OFG reported Q2 ROA of 0.92% and ROE of 8.44%. At June 30, its CET1 ratio was 12.03%, total risk-based capital ratio 14.96% and leverage ratio 10.16%; management said the Company and Bank exceeded well-capitalized requirements. Book value per common share was $18.69 and tangible book value was $16.01. The common share price was $13.37, down 43.4% from year-end.
Material changes versus comparable periods
- Net interest income rose with loan growth, including acquired Scotiabank balances and PPP lending, and $6.0 million of one-time interest recoveries on acquired credit-impaired loans. These gains were partly offset by lower asset yields following Federal Reserve rate cuts; Q2 net interest margin declined 61 basis points year over year.
- Higher expenses reflected the larger acquired workforce and footprint, systems integration, electronic banking activity, and COVID-related costs. Management also cited increased broker-dealer claims and settlement reserves.
- Six-month credit-loss provision rose substantially amid COVID-19 uncertainty. Allowance for credit losses was $232.7 million at June 30, up from $116.5 million at year-end 2019; the increase includes CECL adoption and subsequent provision expense.
- Non-performing assets were $198.8 million, or 2.00% of assets, versus $118.7 million, or 1.28%, at year-end. The filing attributes much of the increase to acquired PCD loan pools and the new CECL presentation; non-performing loans also rose from $85.5 million to $172.6 million.
- Deposits increased 11.0% from year-end, while borrowings decreased 65.8%, reflecting deposit inflows and a strategy to replace higher-cost wholesale funding with core deposits. Investment securities declined 49.5%, in part following securities sales and maturities.
Outlook, commentary, risks and unusual items
Management characterized the Company as financially strong and said it expected to complete Scotiabank integration by year-end 2020, improve efficiencies and continue investing in operations. The filing provides no quantified earnings or margin guidance. Management emphasized substantial uncertainty about the duration and economic effects of COVID-19 and the impact of government actions.
- OFG had processed approximately $2.08 billion of COVID-related payment deferrals across 45,097 loans, about 30% of the stated loan population; most deferrals were no longer than 120 days. Management noted that some borrowers could seek additional deferrals.
- By June 30, OFG had approved 4,342 PPP loans totaling $286 million. Management reported more than $500 million of Q2 loan production, including PPP loans.
- Management warned that prolonged economic weakness could increase credit losses and provisions, reduce demand and fee income, and affect liquidity. Deferred-loan interest accrues when considered collectible, but could be reversed if collection later becomes doubtful.
- OFG had $1.899 billion in unrestricted cash, $353.7 million in unpledged investment securities and $859 million in additional FHLB borrowing capacity. Risks include deposit outflows, funding access and costs, and required advances on certain serviced mortgage loans.
- Credit and concentration risks include Puerto Rico’s fiscal and economic conditions, government debt restructuring, natural disasters, and exposure to vulnerable industries. Legal matters had an $8.7 million accrued liability; management said reasonably possible losses were not significant, while noting adverse outcomes could affect particular periods.
- CECL adoption reduced retained earnings by $25.5 million after tax; regulatory rules allow a phased capital impact. The Company recorded a $3.5 million Q2 bargain-purchase gain related to the Scotiabank acquisition and incurred $3.0 million of Q2 merger and restructuring charges.
Important facts for investors to verify
- How loan deferrals perform after scheduled payments resume, and whether further deferrals or accrued-interest reversals arise.
- Whether the allowance adequately captures economic deterioration, particularly in commercial exposures and acquired PCD portfolios; distinguish CECL and acquisition-accounting effects from new credit deterioration.
- Trends in delinquencies, charge-offs and non-performing assets, including the extent to which reported increases reflect acquired loan pools and accounting presentation.
- Progress and remaining cost of Scotiabank integration, and whether expense growth and the efficiency ratio improve as management expects.
- Sustainability of earnings excluding one-time acquired-loan interest recoveries and the bargain-purchase gain, and the effect of lower rates on net interest margin.
- Capital and liquidity resilience under continued stress, including deposit stability, FHLB capacity and the staged regulatory transition of CECL.