OFG Bancorp (Oriental Financial Group Inc.) — Q3 2011 Form 10-Q
Business context and reporting period
Unaudited results cover the quarter and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010. The Puerto Rico-based financial holding company provides banking, mortgage, wealth-management, insurance and related services. Its banking subsidiary operates 30 financial centers in Puerto Rico. The filing includes the acquired Eurobank portfolio, subject to FDIC loss-sharing arrangements.
Key financial metrics
Amounts below are in millions except per-share data and ratios.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $32.5 | $38.2 | $112.3 | $104.6 |
| Net income (loss) | $16.8 | $(7.8) | $46.3 | $4.8 |
| Income (loss) available to common shareholders | $15.6 | $(31.7) | $42.7 | $(22.1) |
| Diluted EPS | $0.35 | $(0.75) | $0.95 | $(0.66) |
| Net interest margin | 2.02% | 2.15% | 2.30% | 2.09% |
| Net provision for loan losses | $1.9 | $4.1 | $10.0 | $12.2 |
| Non-interest expenses | $30.4 | $32.7 | $91.9 | $81.0 |
- Q3 operating revenue, as defined in management’s discussion, was $49.6 million versus $27.7 million; the comparison reflects substantially fewer unusual losses in 2011. Non-GAAP pre-tax operating income was $11.5 million, down from $12.8 million. For nine months, the measure was $42.5 million, up from $40.3 million.
- At September 30, assets were $7.023 billion, down 3.9% from year-end; cash and cash equivalents were $517.3 million. Net loans were $1.684 billion, down 5.0%, chiefly reflecting runoff in FDIC-covered loans. Deposits were $2.378 billion, down 8.1%; total borrowings were $3.826 billion, down 2.5%. Repurchase agreements accounted for $3.356 billion of borrowings.
- Stockholders’ equity was $727.9 million, slightly below year-end. Book value per common share was $14.99. The bank was reported as well-capitalized: the Group’s leverage, Tier 1 risk-based and total risk-based capital ratios were 10.12%, 31.47% and 32.74%, respectively.
- For the first nine months, operating cash flow was negative $46.0 million, investing cash flow positive $451.3 million, and financing cash flow negative $336.9 million. Cash increased $68.4 million to $517.3 million.
Material changes versus comparable periods
- Q3 net interest income fell 15.0%, mainly because lower rates increased mortgage-backed-securities premium amortization and the investment portfolio was smaller. Nine-month net interest income rose 7.4%, including higher covered-loan income and lower funding costs. Net interest margin declined in Q3 but improved year to date.
- Non-interest income was $17.2 million in Q3 versus a $10.5 million loss in Q3 2010; nine-month income was $41.6 million versus a $6.8 million loss. The prior periods included significant derivative losses and other-than-temporary securities impairments. 2011 results included securities-sale gains of $14.0 million in Q3 and $23.1 million year to date, partly offset by a $4.8 million loss on early extinguishment of a repurchase agreement.
- Nine-month non-interest expense rose 13.5%, primarily reflecting Eurobank integration and servicing costs; Q3 expense fell 7.0%, which management attributed mainly to cost reductions. The efficiency ratio increased to 69.55% in Q3 from 65.89%, and to 63.64% for nine months from 60.63%.
- Non-performing loans increased 8.2% from year-end to $132.4 million. Non-performing assets were $148.6 million, or 2.28% of assets excluding covered assets. The allowance on non-covered loans rose to $35.9 million from $31.4 million.
- The bank changed its residential mortgage non-accrual policy effective April 1, 2011: qualifying, well-collateralized mortgages in collection are placed on non-accrual at 90 rather than 365 days past due. This moved $39.8 million of loans onto non-accrual at the change date and contributed to reported non-performing-loan growth.
Outlook, management commentary and risks
- No specific earnings or financial guidance is provided. Management said it expected no significant results impact from announced HARP enhancements, while noting final program guidance was pending. Forward-looking statements are subject to economic, market, interest-rate, regulatory and credit risks.
- Management reported improved expected cash flows on certain acquired covered-loan pools, resulting in a $1.4 million net covered-loan loss recapture for the first nine months and a $71 million transfer from non-accretable discount to accretable yield. The FDIC generally absorbs 80% of covered-asset losses and shares 80% of recoveries. The related indemnification asset declined to $392.1 million; an estimated $12.8 million FDIC clawback liability was disclosed.
- Credit quality remains a key watch item: non-accrual non-covered loans were $132.4 million, versus $73.6 million at year-end, with the change partly driven by the revised mortgage policy. Commercial non-performing loans rose 58.6% to $37.5 million. Management said it expected limited additional losses on non-performing loans, citing collateral, but that assessment depends on collateral values and borrower performance.
- Funding is heavily reliant on wholesale sources: repurchase agreements represented 88% of borrowings. Many structured repurchase agreements have quarterly put options, including substantial put dates in late 2011; counterparties had not exercised puts through the filing date. Management cautioned that funding availability and cost are not assured. The Group reported $153.4 million of additional FHLB borrowing capacity.
- Interest-rate sensitivity simulations estimated that a 200-basis-point rise could increase one-year net interest income by about 25%, while a 50-basis-point decline could reduce it by about 5.4%–5.6%; management cautioned simulations depend on assumptions. The filing also highlights interest-rate, mortgage-prepayment, structured-securities valuation, U.S. government credit, liquidity and Puerto Rico concentration risks. Puerto Rico was described as being in its sixth year of recession with fiscal challenges.
- The $48.1 million fair-value loss on new cash-flow hedges was recorded in other comprehensive income, not current-period earnings. Legal proceedings were described as ordinary-course matters; management did not expect their aggregate liability, if any, to materially affect results or financial condition. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether growth in non-performing loans and commercial credit exposures continues, and how the 90-day mortgage non-accrual policy affects subsequent trends and charge-offs.
- Whether FDIC-covered loan cash-flow estimates, recaptures, the $392.1 million indemnification asset and the estimated clawback liability remain supportable as claims and asset resolutions progress.
- Near-term repurchase-agreement put dates, counterparty renewal decisions, collateral requirements and the Group’s ability to replace or reduce wholesale funding.
- The sustainability of net interest income and margin given mortgage prepayments, securities premium amortization, deposit costs and hedge performance.
- Valuation and expected recovery assumptions for structured credit securities, including the $61.9 million amortized-cost portfolio with $20.9 million of unrealized losses.
- Effects of ongoing share repurchases and dividends on capital, liquidity and per-share results; the filing reports subsequent purchases under the new program after quarter-end.