FIRST BANCORP quarterly report, Q1 FY2018

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First BanCorp. — Q1 2018 Form 10-Q

Reporting period: Quarter ended March 31, 2018. First BanCorp. is a Puerto Rico-based financial holding company operating through FirstBank in Puerto Rico, the U.S. and British Virgin Islands, and Florida. Financial amounts below are in U.S. dollars; “m” and “bn” denote millions and billions.

Financial results and condition

  • Profit and revenue: Net income was $33.1m, or $0.15 per diluted share, versus $25.5m, or $0.11, in Q1 2017. Net income attributable to common shareholders was $32.5m. Total interest income was $149.4m and net interest income was $124.7m; non-interest income was $22.8m, making total revenue of $147.5m on the filing’s presentation.
  • Margins and expenses: Net interest margin was 4.40%, down from 4.42%; interest-rate spread was 4.05%, versus 4.15%. Non-interest expense declined to $86.0m from $87.9m. The efficiency ratio improved to 58.33% from 67.19%.
  • Credit costs: Provision for loan and lease losses was $20.5m, down from $25.4m. Net charge-offs were $26.5m, or 1.21% annualized, versus $27.8m, or 1.26%. The allowance was $225.9m, 2.60% of loans held for investment, compared with $231.8m, or 2.62%, at year-end.
  • Asset quality: Non-performing assets, including loans held for sale, were $637.2m, down from $650.6m at December 31, 2017. Non-performing loans held for investment were $412.0m; non-performing loans held for sale were $64.9m. Early delinquencies (30–89 days past due) fell to $202.5m from $244.7m, although commercial and construction early delinquencies rose, largely following the downgrade of a Florida commercial mortgage.
  • Cash flow: Operating activities provided $95.4m and investing activities provided $111.8m; financing activities used $79.7m. Cash and cash equivalents increased $127.4m during the quarter to $843.8m.
  • Balance sheet and funding: Total assets were $12.20bn, down $60.9m from year-end. Deposits were $9.07bn; borrowings were $1.10bn, including $715m of FHLB advances, $200m of repurchase agreements, and $184.2m of other borrowings. Brokered CDs were $956.1m, of which about $548.3m mature within 12 months. Stockholders’ equity was $1.88bn.
  • Liquidity and capital: Management reported a $2.0bn core liquidity reserve, or 16.2% of assets, and a basic liquidity ratio of 21.9%. Additional FHLB capacity was approximately $689.5m; unpledged liquid securities were about $1.0bn. First BanCorp.’s CET1, Tier 1, total capital, and leverage ratios were 19.24%, 19.66%, 22.98%, and 14.18%, respectively. FirstBank’s corresponding ratios were 17.70%, 21.26%, 22.52%, and 15.35%.

Material changes versus comparable periods

  • Net income increased $7.6m year over year. Adjusted net income, a company-defined non-GAAP measure excluding specified unusual items, was $31.3m versus $25.2m.
  • Net interest income rose $2.1m, supported by higher income on variable-rate commercial loans, interest-bearing cash balances, and investments. Higher funding costs and weaker residential mortgage and consumer interest income partly offset those gains.
  • Reported non-interest income increased to $22.8m from $8.2m. The comparison reflects the absence of a $12.2m Puerto Rico government securities impairment recorded in Q1 2017 and a $2.3m debt-extinguishment gain in Q1 2018; excluding those items, non-interest income was broadly flat.
  • The tax line shifted from an $8.1m benefit in Q1 2017 to a $7.8m expense in Q1 2018. The prior-year result included a $13.2m benefit from subsidiary tax-status elections.
  • Assets and loans declined from year-end, while cash increased. Core deposits grew after the hurricanes, while brokered CDs fell by $194.4m and the company repaid a $100m short-term repurchase agreement. Accumulated other comprehensive loss widened to $44.7m, mainly reflecting lower fair value of available-for-sale securities.

Outlook, management commentary, and key risks

  • Outlook: The filing gives no numerical earnings or revenue guidance. Management said available borrowing capacity and efforts to grow retail deposits should support funding needs for the foreseeable future. It expects some hurricane-related deposit accumulation to unwind over time, but timing and extent are uncertain.
  • Hurricane effects: The company recorded a $6.4m net hurricane-related reserve release, leaving a hurricane-related allowance of $62.1m. It also reported $9.4m of hurricane response costs and casualty losses, a $5.3m insurance receivable, and potential further insurance recoveries contingent on agreement with carriers. Customer repayment prospects and the broader recovery remain uncertain.
  • Puerto Rico and regional exposure: About 75% of gross loans held for investment were concentrated in Puerto Rico. Direct exposure to the Puerto Rico government, municipalities, and public corporations was $213.4m. Separately, three previously TDF-guaranteed hotel loans had $116.2m principal outstanding and were non-performing; two were transferred to held for sale. The $150.5m held-to-maturity Puerto Rico municipal bond portfolio had a reported fair value of $134.9m. The filing highlights fiscal restructuring, economic recovery, demographic, infrastructure, and government-funding uncertainties. USVI government loans totaled $76.7m and were reported performing.
  • Credit and model risk: Management revised commercial-loan allowance methods and engaged an independent reviewer. A $46.8m Florida commercial mortgage downgrade contributed to increased adverse classifications. The allowance review was still in progress.
  • Controls: Management disclosed an unremediated material weakness in controls over review and approval of assumptions used to estimate commercial-loan loss reserves. Disclosure controls and procedures were deemed ineffective as of March 31, 2018. Remediation work was underway, but management had not fully tested effectiveness; completion was expected during 2018 after independent review.
  • Regulatory and shareholder distributions: The Federal Reserve had terminated its 2010 Written Agreement, but the company continued to require regulatory approval for specified dividends, debt payments, borrowing, and capital transactions. Preferred dividends had approval through June 2018; common dividends were not declared. The company remained dependent on approvals for future distributions and payments.
  • Other unusual items and contingencies: The company repurchased $23.8m of trust-preferred securities at a discount, recording a $2.3m gain. A Puerto Rico insurance-agency class action was revived on appeal for class-certification and preliminary-injunction hearings; the company said no disclosure of a reasonably possible material loss was required based on its assessment at quarter-end. Future adoption of CECL was still being evaluated; the standard was scheduled to take effect for the company in 2020.

Important facts for investors to verify

  1. Progress and independent validation of remediation for the commercial-loan allowance material weakness, and any resulting allowance revisions.
  2. Hurricane-related borrower performance, the $62.1m reserve, deposit persistence or runoff, and collection of insurance claims.
  3. Trends in non-performing assets, early delinquencies, charge-offs, OREO, and the disposition of loans transferred to held for sale.
  4. Liquidity and funding sensitivity, particularly brokered-CD maturities, the callable $200m repurchase funding, and continued access to FHLB capacity.
  5. Credit quality and valuation of Puerto Rico municipal and government exposures, TDF-related hotel loans, and USVI public-sector loans amid fiscal restructuring.
  6. Regulatory approvals for preferred dividends and subordinated-debt payments, and whether capital remains available for distributions or other corporate actions.
  7. Potential outcomes of the insurance-agency litigation and the company’s progress in assessing the impact of CECL.