OFG BANCORP annual report, FY2017

OFG Bancorp — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017; filed March 12, 2018. This is an annual report, not a standalone fourth-quarter filing. OFG is a Puerto Rico-centered financial holding company with Banking, Wealth Management and Treasury segments and 48 Puerto Rico branches.

Financial performance and position

Metric	2017	2016
Net interest income	$304.2 million	$299.4 million
Net interest margin	5.23%	4.82%
Provision for loan and lease losses	$113.1 million	$65.1 million
Non-interest income	$78.7 million	$66.8 million
Non-interest expenses	$201.6 million	$216.0 million
Net income	$52.6 million	$59.2 million
Income available to common shareholders; diluted EPS	$38.8 million; $0.88	$45.3 million; $1.03
Return on average assets; efficiency ratio	0.84%; 53.99%	0.88%; 57.82%

Net interest income increased $4.7 million as the net interest margin improved; lower funding costs and higher yields on originated loans helped offset declining income from acquired loan portfolios.
Reported earnings were burdened by a $32.4 million pre-tax hurricane-related loan-loss provision. Excluding that provision, management reported non-GAAP adjusted net income of $74.9 million, adjusted income available to common shareholders of $61.0 million, diluted adjusted EPS of $1.34, adjusted ROAA of 1.20% and adjusted return on average tangible common equity of 8.88%. These are management-defined non-GAAP measures.
At year-end, assets were $6.19 billion, down 4.8%; net loans were $4.06 billion, down 2.2%; investment securities were $1.17 billion, down 14.4%. Deposits rose 2.9% to $4.80 billion.
Total borrowings fell 58.7% to $328.7 million, principally reflecting repayment and reduction of repurchase agreements. Year-end repurchase agreements were $192.5 million, versus $652.2 million a year earlier; subordinated capital notes were $36.1 million.
Cash and cash equivalents were $485.2 million. Operating, investing and financing cash flows were respectively $151.4 million, $187.3 million and negative $364.0 million; cash declined $25.2 million during the year. Additional liquidity included $921.6 million of unpledged investment securities and $919.9 million of FHLB borrowing capacity.
The allowance for loan and lease losses increased to $167.5 million from $115.9 million. Non-performing assets were $156.7 million, or 2.61% of assets excluding acquired loans with deteriorated credit quality; non-accrual loans were $99.7 million. The allowance on originated loans equaled 87.35% of non-performing loans.
Capital remained above regulatory minimums: consolidated CET1 was 14.59%, total risk-based capital 20.34%, and leverage capital 13.92%. The Bank was classified as well capitalized. Stockholders’ equity was $945.1 million; tangible book value per common share was $15.67.
Operating cash flow was positive; the filing reports no separate free-cash-flow measure. Common dividends declared were $0.24 per share for the year.

Material changes versus 2016

Net income declined 11.0% and diluted EPS fell from $1.03 to $0.88, despite higher net interest income and lower operating expenses, as the loan-loss provision rose sharply.
The provision increase reflected the hurricanes, as well as higher commercial credit reserves and a municipal-loan loss. Management noted $4.3 million recorded to charge off a municipal-loan sale and $5.9 million added to the general municipal-loan allowance.
Non-interest income rose 17.8%, including the end of FDIC shared-loss expense and $6.9 million of securities-sale gains. Banking service revenue, wealth-management revenue and mortgage-banking revenue each declined.
Deposits increased while investment securities, total assets and total loans declined. Originated consumer and auto loans grew, while acquired BBVAPR and Eurobank portfolios continued to run off.
OFG and the FDIC terminated the Eurobank shared-loss agreements in February 2017. OFG paid $10.1 million and recognized a net benefit of $1.4 million; the indemnification asset and related obligation were eliminated.
Common stock closed at $9.40, down 28.2% from $13.10 at year-end 2016. Goodwill was not written down, although the Banking reporting unit failed step one of the impairment test: its adjusted net book value exceeded estimated fair value by about $204.2 million, or 22%. Step two found no goodwill impairment.

Outlook, commentary, risks and unusual items

Management described rapid restoration of operations after Hurricanes Irma and Maria as a major achievement and said the short-term outlook was hopeful, citing expected federal, insurance and other reconstruction funding. The filing provides no quantified earnings or revenue guidance; recovery timing and assistance remain uncertain.
OFG offered loan-payment moratoria after the hurricanes. Approximately 83,000 loans totaling $2.6 billion were under the program at year-end. Moratoria affected reported delinquency measures, and $39.7 million of interest accrued but had not been collected.
Hurricane-related response losses were estimated at $6.6 million. Management considered recovery of $2.2 million probable; $1.0 million had been received and a $1.2 million receivable recorded. Loan losses from the storms remained uncertain, and management said the additional provision could prove insufficient or could later be reduced.
Puerto Rico concentration is a central risk: about 99% of the $4.1 billion loan portfolio was associated with Puerto Rico borrowers, and 55% was secured by Puerto Rico real estate. The Commonwealth and agencies were in court-supervised Title III restructuring under PROMESA. OFG disclosed approximately $145.2 million of exposure to four municipalities.
Other material risks include prolonged local recession, property-value declines, migration and austerity, further natural disasters, borrower defaults, interest-rate and funding volatility, reliance on brokered deposits and wholesale funding, and regulatory, cyber, third-party service and mortgage-repurchase risks. Brokered deposits and repurchase agreements together represented approximately 14% of interest-bearing liabilities, according to the filing.
OFG repurchased $3.2 million of loans from GNMA and FNMA during 2017. Management stated that pending legal proceedings were not expected to materially affect financial condition or results, while acknowledging that an adverse outcome could affect results or cash flows in a particular period.
The audited financial statements received an unqualified opinion, and management and KPMG concluded that internal control over financial reporting was effective as of December 31, 2017.

Important facts for investors to verify

Whether hurricane-related delinquencies, restructurings, collateral damage and eventual credit losses exceed the $32.4 million provision, particularly after moratoria effects unwind.
Trends in commercial and municipal credit quality, including the $145.2 million municipal exposure and the allowance increase.
Whether deposit growth and available liquidity remain sufficient as brokered deposits, repurchase agreements and other funding mature or reprice.
How quickly acquired-loan runoff is offset by originated lending, including the U.S. commercial-loan initiative launched in October 2017.
The assumptions behind management’s adjusted, non-GAAP hurricane-excluded results and the Banking unit goodwill impairment analysis.
Future dividend capacity, given regulatory limits on Bank-to-parent distributions and the company’s preferred-stock obligations.