OFG Bancorp — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. OFG is a Puerto Rico-based financial holding company operating in banking, wealth management and treasury. Unless otherwise noted, amounts below are in millions of dollars.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $77.6 | $75.6 | $151.6 | $150.2 |
| Provision for loan and lease losses | $14.7 | $26.5 | $30.2 | $44.2 |
| Non-interest income | $18.7 | $24.9 | $37.2 | $44.0 |
| Non-interest expense | $52.3 | $52.8 | $104.4 | $104.5 |
| Net income | $19.6 | $17.1 | $36.6 | $32.3 |
| Income available to common shareholders | $16.2 | $13.6 | $29.6 | $25.3 |
| Diluted EPS | $0.35 | $0.30 | $0.65 | $0.57 |
- Q2 net interest margin was 5.24%, up 6 basis points year over year; the reported efficiency ratio was 54.49%, versus 56.49% in Q2 2017. Q2 return on average assets was 1.23% and return on average tangible common equity was 9.20%.
- Six-month operating cash flow was $48.5, compared with $5.6 in 2017. Investing activities used $456.3, versus providing $183.0; financing provided $298.0, versus using $221.8. Cash, cash equivalents and restricted cash declined $109.9 to $378.4.
- At June 30, total assets were $6.502 billion, up 5.0% from year-end 2017. Net loans were $4.316 billion, up 6.4%; investments were $1.353 billion, up 16.0%. Cash and cash equivalents were $375.3 million, down 22.6% from year-end.
- Deposits were $4.880 billion, up 1.7%; total borrowings were $552.3 million, up 68.0%, mainly reflecting repurchase agreements used to finance securities purchases and additional FHLB advances. Stockholders’ equity was $957.8 million, up 1.3%.
- OFG Bancorp’s regulatory capital ratios remained above minimums: CET1 14.14%, Tier 1 risk-based 18.38%, total risk-based 19.67%, and leverage 13.92%. The Bank was reported as well capitalized.
Changes and drivers
- Year-over-year Q2 net income rose 14.9%, as lower loan-loss provisioning and higher net interest income more than offset lower non-interest income and higher taxes. Six-month net income rose 13.4%.
- Provision expense fell substantially against 2017, which included additional municipal-loan provisions. Q2 2018 provision was nevertheless $14.7 million; management said most incremental commercial, consumer and auto charge-offs had previously been reserved.
- Non-interest income declined because Q2 2017 included a $6.9 million gain on securities sales. The six-month 2017 comparison also included a $1.4 million FDIC shared-loss benefit. Banking and financial service revenue grew 2.6% in Q2 and 3.6% for the half-year.
- Originated loan growth was led by commercial and auto lending, while acquired BBVAPR and Eurobank loan balances continued to run off. Management reported Q2 average loans of $4.3 billion, up 3.0% sequentially, and new loan production of $432.1 million, up 39.7% from Q1.
- Non-performing assets increased to $176.2 million from $156.7 million at year-end, although the ratio to total assets excluding specified acquired credit-impaired loans declined to 2.82% from 2.95%. Non-accrual loans rose to $122.1 million from $99.7 million; the filing’s non-performing-assets table separately reports non-performing loans of $130.2 million, reflecting additional accruing categories.
- Common equity Tier 1 and other risk-based capital ratios declined from year-end despite higher capital amounts, partly alongside growth in risk-weighted assets. Tangible book value per common share was $15.96, up from $15.67 at year-end.
Outlook, commentary and risks
- Management described performance indicators as positive and said it was positioned to continue the trend for the rest of 2018. It cited loan growth, customer and core retail deposit growth, stable credit quality, and the launch of online commercial-credit service Oriental SmallBiz. This is qualitative commentary; the filing provides no numerical earnings guidance.
- Management said most hurricane-related payment moratoriums had expired and credit metrics were mostly better than, or returning to, pre-hurricane levels. It reported no additional hurricane-related operating losses by June 30, 2018; a $0.5 million insurance recovery receivable remained.
- Puerto Rico concentration is a central risk: most operations, customers and credit exposure are on the island. Risks include its prolonged economic and fiscal challenges, government debt restructuring, natural disasters and the pace of recovery. Management also identified credit, interest-rate, liquidity, operational and funding risks.
- Liquidity included $375.3 million of unrestricted cash and cash equivalents, $849.9 million of unpledged investment securities and $775.6 million of additional FHLB borrowing capacity. The filing cautions that wholesale funding and brokered deposits may be less stable or become more costly or unavailable.
- Commercial and auto credit warrant attention: originated non-accrual commercial loans increased 34.6% from year-end, and auto non-accrual loans rose 163.3% to $11.1 million. Six-month net charge-offs on originated loans and leases were $26.3 million, up 8.7% year over year. Management said its allowance included hurricane-related risks; it also revised certain allowance estimation assumptions prospectively.
- Commitments to extend credit were $539.7 million. Management said pending litigation and regulatory matters were not expected to have a material adverse effect on financial condition, but noted that an adverse outcome could affect results or cash flows in particular periods. The filing gives no clear estimate of potential losses beyond stating that reasonably possible losses were not significant.
- OFG expects CECL adoption on January 1, 2020 to increase its credit-loss allowance, with the amount dependent on portfolio, credit quality and economic conditions. It expected the 2019 lease-accounting adoption to recognize operating lease assets and liabilities, preliminarily less than 1% of total assets.
Important facts for investors to verify
- Whether the improvement in earnings persists when 2017’s securities gain and FDIC benefit are excluded, and whether loan growth can offset acquired-loan runoff.
- Subsequent delinquency, non-accrual and charge-off trends, especially in commercial and auto portfolios, and the adequacy of the allowance as hurricane effects and local conditions evolve.
- The sustainability and cost of funding after the sharp increase in repurchase agreements and FHLB advances, including reliance on brokered deposits and collateral availability.
- The sensitivity of net interest income to rates: the filing’s one-year simulation estimates a 2.98%–3.35% increase under a 200-basis-point rise and a 1.48%–1.66% decrease under a 100-basis-point decline, depending on balance-sheet scenario.
- Puerto Rico government exposure and related collateral and deposit concentrations. The filing reports $94.9 million of originated government loans and $145.6 million of municipal loans and securities in a separate exposure table; the scope and reconciliation of those figures should be checked. A $2.5 million Puerto Rico bond matured and was paid in July 2018.