OFG Bancorp — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Unaudited consolidated results; balance-sheet comparisons are to December 31, 2012. Unless otherwise noted, dollar amounts below are USD millions.
Business context
OFG is a Puerto Rico-based financial holding company operating banking, financial-services and treasury businesses. Results reflect the December 2012 acquisition of BBVAPR for $500 million, which materially expanded its loan, deposit, branch and employee base. Accordingly, comparisons with 2012 are not on a like-for-like basis. The company changed its name from Oriental Financial Group to OFG Bancorp in April 2013.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net interest income | $105.4 | $33.2 | $198.0 | $72.1 |
| Net interest margin | 5.56% | 2.29% | 5.13% | 2.45% |
| Provision for loan losses | $38.7 | $5.3 | $47.3 | $15.4 |
| Non-interest income | $7.8 | $17.8 | $18.9 | $31.0 |
| Non-interest expense | $68.8 | $29.7 | $135.6 | $59.1 |
| Income before taxes | $5.6 | $16.0 | $33.9 | $28.6 |
| Net income | $37.5 | $15.0 | $58.7 | $25.6 |
| Income available to common shareholders | $34.1 | $13.8 | $51.8 | $23.2 |
| Diluted EPS | $0.68 | $0.34 | $1.05 | $0.57 |
- Operating revenue was $113.2 million in Q2 and $216.9 million for the first half, up 121.9% and 110.3%, respectively. Loan growth from the acquisition and lower funding costs drove net interest income; reduced investment balances partially offset the gains.
- Q2 pretax income fell despite higher net interest income, mainly reflecting the much larger loan-loss provision and expenses. Net income benefited from a $31.9 million income-tax benefit; the six-month tax benefit was $24.8 million. The benefit primarily reflects Puerto Rico’s increase in the corporate tax rate from 30% to 39%, which increased the deferred tax asset by about $37 million.
- Efficiency ratio improved to 53.24% in Q2 from 66.55%; first-half ratio was 55.35% versus 62.16%. ROA and ROE were 1.77% and 18.56% for Q2, and 1.36% and 14.29% for the first half.
- Six-month operating cash flow was $58.9 million, investing cash flow was $618.9 million, and financing cash flow was negative $798.2 million. Cash and cash equivalents fell $120.4 million to $748.3 million.
- At June 30, total assets were $8.44 billion, down 8.3% since year-end; net loans were $4.99 billion, down 3.4%; and investment securities were $1.86 billion, down 16.7%. Management attributed declines primarily to portfolio deleveraging, maturities and repayments, and mortgage-loan reclassification.
- Deposits were $5.67 billion, nearly flat versus year-end. Total borrowings fell 30.3% to $1.74 billion, including $1.31 billion of repurchase agreements. Cash was $748.3 million; disclosed additional borrowing capacity was about $714 million at the FHLB and $885 million at the Federal Reserve discount window. Management nevertheless noted continued significant reliance on repurchase funding.
- Stockholders’ equity was $870.9 million. OFG reported a 13.96% Tier 1 risk-based capital ratio, 16.02% total risk-based ratio and 8.54% leverage ratio; the Bank was categorized as well capitalized. Common dividend remained $0.06 per share for Q2.
Material changes, outlook and risks
- Credit costs and mortgage reclassification: Q2 non-covered loan-loss provision was $37.5 million. During the quarter, $55 million of non-performing residential mortgages were transferred to held-for-sale at fair value, with an approximately $27 million charge-off; the reclassification also increased provision needs. Management said the fall in reported non-performing loans was largely attributable to this transfer, not a broad underlying improvement.
- Acquisition integration: Merger and restructuring charges were $5.3 million in Q2 and $10.8 million for the half-year, including systems integration, employee-related costs and contract cancellation charges. Management described these as non-recurring integration costs. The filing reports completion of mortgage-operation integration and consolidation of eight branches in Q2.
- Other unusual items: No securities-sale gain was recorded in 2013, compared with $12.0 million in Q2 2012 and $19.3 million in the first half of 2012. Q2 2013 included a $2.1 million recovery from a Lehman Brothers bankruptcy claim. The new Puerto Rico gross-revenue tax added about $2.0 million of expense.
- Management direction: Long-term priorities include expanding lending, growing fee revenue, integrating banking and financial services, managing assets and liabilities, and improving operating efficiency. The filing provides no specific earnings or financial forecast for the remainder of 2013.
- Risks: The business and credit exposure are concentrated in Puerto Rico, where economic growth, employment, housing and government fiscal conditions remain challenging. Other key exposures include credit quality, interest-rate and market movements, liquidity and wholesale-funding availability, regulatory changes, and execution of acquisition integration. A 200-basis-point rate increase was modeled to raise one-year net interest income by 2.08% under a static balance sheet and 2.90% under a growing-balance scenario; the filing cautions that simulations rely on assumptions.
- Contingencies: Management said legal and regulatory matters were not expected to materially affect financial condition, though adverse outcomes could affect results or cash flows in particular periods. No significant estimate of reasonably possible losses was disclosed.
- Reporting items: The filing states disclosure controls were effective at a reasonable-assurance level and reports no material quarterly change in internal control over financial reporting. OFS Securities merged into Oriental Financial Services on August 1, 2013.
Most important facts for investors to verify
- Reconcile the filing’s differing non-performing asset and non-performing loan figures: the detailed table reports $209.0 million of non-performing assets and $91.8 million of non-performing loans, while narrative passages cite different totals. Understand the effect of the $55 million mortgage transfer on reported credit trends.
- Assess whether the elevated loan-loss provision, charge-offs and mortgage credit performance are temporary or signal persistent deterioration; evaluate allowance adequacy and collateral values.
- Separate recurring earnings from the substantial tax benefit and other unusual items, and assess earnings after acquisition-related costs and FDIC shared-loss expense.
- Monitor the sustainability of net interest margin and acquired-loan accretion, deposit costs and mix, and exposure to rising rates and mortgage prepayments.
- Review liquidity and refinancing risk, particularly the $1.31 billion repurchase-agreement balance, maturity profile, collateral requirements and access to wholesale funding.
- Track BBVAPR integration costs, expense synergies, loan production and portfolio performance; reported year-over-year growth is materially affected by acquisition timing.
- Review Puerto Rico’s tax changes, regulatory capital-rule implementation, legal contingencies and the collectability and remaining duration of FDIC indemnification assets.