OFG Bancorp — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; filed August 8, 2014. OFG is a Puerto Rico-based financial holding company operating banking, wealth-management, and treasury businesses.
Financial performance
Dollar amounts are in millions except per-share data. Quarterly results compare with Q2 2013; six-month results compare with the first half of 2013.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $106.1 | $106.3 | $209.5 | $199.9 |
| Provision for loan losses | $14.8 | $38.7 | $26.5 | $47.3 |
| Non-interest income, net | $0.5 | $6.7 | $5.7 | $16.6 |
| Non-interest expense | $59.8 | $68.7 | $121.3 | $135.3 |
| Net income | $21.3 | $37.5 | $45.1 | $58.7 |
| Diluted EPS | $0.38 | $0.68 | $0.80 | $1.05 |
- Quarterly net interest margin was 6.10%, up from 5.66%; the six-month margin was 5.96%, versus 5.26%. Management attributed the improvement mainly to higher yields on earning assets, including investments and covered loans.
- Q2 return on average assets was 1.10% and return on average common equity 9.54%, down from 1.76% and 19.50%. The efficiency ratio improved to 47.89% from 52.49%. Pre-tax, pre-provision operating income, a non-GAAP measure, fell 3.5% to $65.1 million.
- Operating cash flow for the first half was $94.9 million, investing cash flow was positive $369.7 million, and financing cash flow was negative $489.3 million. Cash and cash equivalents ended June at $596.5 million, down $24.8 million from year-end.
Financial condition, liquidity, and capital
- Total assets were $7.71 billion at June 30, down 5.5% from December 31, 2013. Net loans were $4.94 billion, down 1.7%; investments were $1.47 billion, down 8.9%.
- Deposits were $5.14 billion, down 4.5%; total borrowings were $1.48 billion, down 13.5%. Repurchase-agreement borrowings declined 20.1% to $1.01 billion. Brokered deposits were $718.5 million.
- Stockholders’ equity was $925.2 million, up 4.6%. The Company reported regulatory capital ratios of 10.26% Tier 1 leverage, 15.49% Tier 1 risk-based, and 17.30% total risk-based; the Bank was categorized as well capitalized.
- Management reported $611.7 million of unrestricted cash and cash equivalents, $222.7 million of unpledged investment securities, $629.1 million of additional FHLB borrowing capacity, and $881.4 million of Federal Reserve discount-window capacity.
Material changes and notable items
- Q2 2014 net income and diluted EPS declined year over year, but Q2 2013 included a $36.9 million deferred-tax benefit from a tax-rate change, as well as other unusual items. The filing estimates that Q2 2013 non-recurring items had a net positive impact of $16.3 million. The comparison is therefore not a like-for-like measure of underlying earnings.
- The lower loan-loss provision versus Q2 2013 partly reflects a $21.0 million additional provision in that prior-year quarter for non-performing residential mortgages transferred to held-for-sale. Q2 2014 provision was $14.8 million; the allowance for covered and non-covered loans totaled $119.9 million at June 30.
- Core banking and financial-services revenue fell 23.1% to $18.9 million in Q2. Banking-service revenue declined partly because auto-loan late charges were reclassified to interest income in late 2013; mortgage banking revenue fell amid lower sales and higher repurchase-related losses. Q2 non-interest expense fell, including because there were no merger and restructuring charges, versus $5.3 million in Q2 2013.
- Non-performing loans rose 9.2% from year-end to $94.1 million; non-performing assets were $166.3 million, or 2.90% of assets excluding covered assets and acquired credit-impaired loans. Foreclosure, repossession, and other real estate expenses rose 76.3% in Q2 to $6.6 million, which management linked to more foreclosures and lower real-estate values.
- OFG had $655.3 million outstanding in loans to Puerto Rico government entities and approximately $22.4 million in Puerto Rico government-related securities. A $200 million participation in a PREPA fuel-purchase credit line matured August 14, 2014; the line was accruing, rated special mention, and subject to a short-term forbearance agreement while discussions continued.
- The Company changed allowance-estimation assumptions prospectively, extending the consumer and auto look-back period to 24 months and giving greater weight to economic environmental factors in selected portfolios.
Outlook, risks, and contingencies
The filing provides no specific earnings, revenue, or margin guidance. Management’s stated long-term priorities include expanding lending, growing fee revenue, maintaining asset-liability management, and improving efficiency. The Company cautions that results depend on economic conditions, credit quality, interest rates, funding access, and regulatory requirements.
- Puerto Rico’s recession, fiscal pressures, below-investment-grade government ratings, and the new Public Corporation Debt Enforcement and Recovery Act create uncertainty for the Company’s government-related loans, securities, and deposits. Management stated it believed the Puerto Rico bonds in unrealized-loss positions would be collected according to contractual terms and did not consider them other-than-temporarily impaired at June 30.
- OFG remains reliant on wholesale funding, including repurchase agreements and brokered deposits. The filing warns that funding availability or cost could worsen and affect liquidity, lending, earnings, or asset sales.
- Management said legal and regulatory matters were not expected to have a material adverse effect on financial condition, but an adverse outcome could materially affect results or cash flows in a particular period. The filing does not provide a clear quantified estimate of reasonably possible losses.
- Act 77-2014, signed July 1, changed Puerto Rico tax provisions; the Company assessed the impact as immaterial. New share-based payment guidance was still under evaluation.
Important facts for investors to verify
- Whether PREPA repaid or refinanced OFG’s $200 million exposure at maturity and the outcome of the forbearance discussions.
- Changes in Puerto Rico public-sector credit risk, the Recovery Act’s legal status and effects, and the Company’s related loan, securities, and deposit exposures.
- Subsequent trends in non-performing loans, charge-offs, foreclosed assets, and allowance adequacy, including the effect of revised reserve assumptions.
- Whether deposit balances and wholesale funding remain stable, and whether disclosed borrowing capacity remains available on acceptable terms.
- How recurring earnings develop after separating the prior-year tax benefit and other unusual items from current-period results.