OFG Bancorp — 2019 Form 10-K
Business and period: OFG Bancorp is a Puerto Rico-based financial holding company operating Banking, Wealth Management and Treasury businesses, primarily in Puerto Rico and the U.S. Virgin Islands. This annual report covers the year ended December 31, 2019; the Scotiabank PR & USVI acquisition closed on that final day, so acquired operations contributed no post-acquisition operating results to 2019 earnings.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $373.8 million | $360.4 million |
| Net interest income | $322.8 million | $315.9 million |
| Net interest margin | 5.37% | 5.28% |
| Provision for loan and lease losses | $96.8 million | $56.1 million |
| Non-interest income | $82.5 million | $80.1 million |
| Non-interest expense | $233.2 million | $207.1 million |
| Net income | $53.8 million | $84.4 million |
| Income available to common shareholders | $47.3 million; $0.92 diluted EPS | $72.4 million; $1.52 diluted EPS |
| Operating cash flow | $109.6 million | $133.4 million |
- Management’s non-GAAP adjusted net income available to common shareholders was $83.4 million, or $1.61 per diluted share, versus $72.4 million, or $1.52, in 2018. Adjustments principally remove the loan-sale provision, acquisition-related expenses and securities-sale gain; this measure is not GAAP.
- Fourth-quarter net loss available to common shareholders was $2.6 million, or $0.05 per share, compared with $23.1 million net income in fourth-quarter 2018. The quarter included $21.5 million in acquisition-related merger and restructuring charges and $6.6 million in additional provision related to non-performing loans selected for sale. Management reported a 5.35% quarterly net interest margin and $404.9 million of loan production.
- Year-end assets were $9.30 billion, up 41.2%; net loans were $6.64 billion, up 49.9%; and deposits were $7.70 billion, up 56.7%. Growth primarily reflects the Scotiabank transaction.
- Stockholders’ equity was $1.05 billion, up 4.6%. Book value per common share rose to $18.75; tangible book value was $15.96, down 1.2%.
- Borrowings totaled $305.6 million, down 46.4%, including $190.3 million of repurchase agreements, $78.0 million of FHLB advances and $36.1 million of subordinated notes. Year-end cash and cash equivalents were $851.3 million. Management also cited $675.5 million of unpledged investment securities and $983.0 million of FHLB borrowing capacity.
- Operating cash flow was $109.6 million. Investing cash flow was $842.2 million, including acquisition cash received and acquisition consideration paid; financing cash flow was negative $549.1 million. These acquisition-related flows make cash-flow comparisons less indicative of recurring operations.
- The efficiency ratio increased to 58.88% from 53.07%, reflecting acquisition costs and other expense growth. Return on average assets declined to 0.83% from 1.31%.
Material changes and significant transactions
- On December 31, 2019, Oriental acquired Scotiabank de Puerto Rico and specified BNS Puerto Rico and USVI banking assets and liabilities. The filing describes a $550 million purchase price for SBPR and a $10 million premium on USVI deposits; net cash consideration paid was approximately $430.4 million after settlement adjustments. The transaction added approximately $2.2 billion of loans and $3.0 billion of core deposits and produced a $315,000 bargain-purchase gain.
- Acquisition-date fair values were preliminary, including $2.216 billion of loans and $41.5 million of core deposit intangible. The filing says valuations may be refined during the one-year measurement period and that further adjustments could be material.
- Acquisition costs were $24.1 million for the year. Oriental also sold $95.0 million of non-performing loans, increasing provision expense by $54.3 million, and sold approximately $672 million of available-for-sale securities for an $8.3 million gain.
- Credit quality indicators improved in reported totals: non-performing assets were approximately $118.0 million versus $161.3 million, and non-performing loans were $84.7 million versus $124.6 million. The company attributed much of the reduction to the non-performing loan sales. Net charge-offs on originated and other loans rose to $73.5 million from $49.6 million; the net charge-off rate increased to 1.92% from 1.41%.
- Regulatory capital ratios declined with the enlarged balance sheet but remained above minimums. Consolidated CET1 was 10.78%, total risk-based capital 13.76% and leverage capital 9.24%; the Bank was reported as well capitalized.
Outlook, risks and contingencies
- The filing provides no numerical earnings or revenue guidance. Management describes a long-term focus on deposit relationships, commercial and consumer lending, financial services, efficiency and asset-liability management.
- Management said core fourth-quarter operations were strong and most credit-quality measures improved. It expects acquisition integration and related payments to continue into 2020; realization and timing of anticipated cost savings and synergies are uncertain.
- Major risks include Puerto Rico’s prolonged economic and fiscal challenges, exposure to government restructuring, local real estate and credit conditions, and hurricanes, earthquakes and other disasters. Significant earthquakes struck Puerto Rico in January 2020. Oriental reported no structural damage or operational interruption and said its initial assessment found no significant credit-portfolio impact, while noting that assessment would continue as information became available.
- Other material exposures include acquired-loan valuation and credit performance, interest-rate and funding risk, deposit competition, mortgage repurchase and representation-and-warranty obligations, operational and cyber risks, regulatory compliance, and the effect of possible changes to Puerto Rico tax treatment and IBE benefits. Direct credit exposure to four municipalities and a public corporation was approximately $134.0 million at year-end.
- Loan commitments were $853.1 million, versus $541.4 million, and standby letters of credit and financial guarantees were $47.3 million. Loans sold with recourse had a $147.4 million outstanding balance, largely associated with the acquisition. Legal proceedings were described as ordinary-course matters; management did not consider the reasonably possible loss estimate significant, but noted an adverse outcome could affect particular periods.
- Oriental planned to adopt the CECL credit-loss standard on January 1, 2020. The cumulative retained-earnings and capital effect was not quantified clearly in the filing; management expected the company to remain well capitalized and planned to phase in the regulatory-capital impact over three years.
Important facts for investors to verify
- Track the final Scotiabank purchase-accounting valuations, acquired-loan performance, integration costs and realized synergies; acquired balances were recorded at preliminary fair values.
- Assess recurring earnings separately from the $54.3 million non-performing-loan-sale provision, $24.1 million acquisition charges and $8.3 million securities gain; compare GAAP results with management’s non-GAAP adjustments.
- Monitor credit trends beyond the lower non-performing-asset balance, including charge-offs, newly acquired loans, loan-sale effects and the Puerto Rico municipal exposure.
- Review capital and tangible book value after the acquisition and CECL adoption, as well as liquidity, deposit mix, borrowing capacity and pledged assets.
- Check subsequent disclosures on earthquake-related borrower effects, acquisition integration and any changes in Puerto Rico economic, fiscal, regulatory or tax conditions.
Controls and audit: KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded controls were effective, but excluded the acquired Scotiabank operations from its year-end control assessment because of the timing of the acquisition.