OFG Bancorp — Form 10-Q Summary
Business context and reporting period
OFG Bancorp is a Puerto Rico-based financial holding company operating banking, wealth-management and treasury businesses. Its activities include commercial, consumer, auto and mortgage lending, deposits, brokerage, insurance and trust services. This unaudited filing covers the quarter and six months ended June 30, 2016; balance-sheet comparisons are to December 31, 2015.
Financial performance and condition
| Metric | Q2 2016 | Prior comparable period / change |
|---|---|---|
| Net interest income | $73.3 million | Down 10.9% from Q2 2015 |
| Net interest margin | 4.65% | 4.92% in Q2 2015 |
| Provision for loan losses | $14.4 million | Down 7.0% from Q2 2015 |
| Non-interest income, net | $15.2 million | Compared with a $4.7 million loss in Q2 2015 |
| Non-interest expense | $53.8 million | Down 16.5% from Q2 2015 |
| Net income / common EPS | $14.3 million / $0.25 | Q2 2015 net loss of $3.1 million; common EPS loss of $0.15 |
| Efficiency ratio | 58.76% | 59.16% for first-half 2016; 63.39% for Q2 2015 in selected financial data |
For the six months, net interest income was $148.3 million, down 13.8%; provision was $28.2 million, down 51.1%; net non-interest income was $28.7 million versus $2.2 million; and net income was $28.5 million versus a $6.1 million loss. Common earnings were $21.6 million, or $0.49 per diluted share, versus a $13.0 million common loss, or $0.29 per share. The improvement in six-month provision partly reflects the $24.0 million PREPA-related provision recorded in Q1 2015.
At June 30, total assets were $6.713 billion, down 5.4% from year-end; net loans were $4.374 billion, down 1.4%; deposits were $4.644 billion, down 1.6%; total borrowings were $1.037 billion, down 24.4%; and stockholders’ equity was $915.9 million, up 2.1%. Cash and cash equivalents were $517.0 million. Six-month operating cash flow was $31.3 million, investing cash flow was $394.8 million, and financing cash flow was negative $445.7 million, resulting in a $19.7 million decline in cash and cash equivalents.
Capital remained above regulatory minimums: consolidated CET1 was 12.64%, Tier 1 risk-based capital 16.71%, total risk-based capital 18.00%, and leverage ratio 11.92%. The Bank was classified as well capitalized. Tangible book value per common share was $14.96, versus $14.53 at year-end.
Material changes versus prior periods
- Lower interest income, especially from acquired loans as balances ran off, drove the decline in net interest income. Originated loan interest income grew, but not enough to offset shrinking acquired portfolios.
- Q2 non-interest results improved substantially year over year, chiefly because FDIC shared-loss expense fell to $3.4 million from $23.2 million. First-half results also included a $12.2 million gain on securities sales and a $12.0 million loss from early debt extinguishment.
- Operating expenses declined, with lower foreclosure-related expenses and costs following branch closures and other cost initiatives; higher insurance expense partly offset these savings.
- The securities portfolio fell 18.3% from year-end, principally reflecting sales of mortgage-backed securities and Puerto Rico government bonds. The company sold all but one of its Puerto Rico government bond positions.
- Funding shifted: repurchase agreements declined by $308.6 million, while brokered deposits fell 28.3% from year-end. Core deposits increased, including non-interest-bearing demand deposits.
Outlook, risks, contingencies and unusual items
- No specific earnings or financial guidance is provided. Management said it expected the PREPA fuel-line restructuring to be completed by the end of 2016, subject to milestones involving other creditors and legislative action.
- PREPA exposure is a key credit risk: the company’s participation had $183.0 million outstanding, was classified non-accrual, and carried a $53.3 million allowance. Interest payments have been applied to principal since 2015. Management’s analysis concluded sufficient cash flows existed for repayment, but collection and restructuring remain uncertain.
- Total Puerto Rico government-related loans and securities were reported at $405.3 million. The filing highlights Puerto Rico’s recession, fiscal stress, defaults, unemployment and population decline as risks to credit quality and asset values. Most government-related loans were current, but PREPA was the significant exception.
- Non-performing assets were $345.8 million, down 6.0% from year-end; non-performing loans were $292.5 million, down 4.2%. However, first-half net charge-offs on originated loans increased to $19.5 million from $16.3 million, and the annualized loss rate rose to 1.25% from 1.13%.
- Effective June 30, a supervisory-directed policy change required derecognition of acquired credit-impaired loans and related allowances when loans exited pools. This reduced recorded loan balances and allowances by $80.7 million, with no provision impact; the overall allowance fell to $162.2 million from $234.1 million. This accounting change should be separated from underlying credit trends.
- Liquidity resources included $517.0 million of unrestricted cash, $546.5 million of unpledged investment securities and $895.0 million of additional FHLB borrowing capacity. The company nevertheless remained reliant on wholesale funding, including $624.5 million of repurchase agreements and $561.6 million of brokered deposits.
- Subordinated capital notes of approximately $103 million mature September 29, 2016; the redemption fund stood at $67 million. The filing states that FHLB advances maturing by the report date were renewed as one-month advances.
- Management said pending legal and regulatory matters were not expected to materially affect financial condition, while acknowledging an adverse outcome could materially affect results or cash flows in a particular period. Management also identified uncertainty around deferred tax asset realization and goodwill valuation in a deteriorating Puerto Rico environment.
- New accounting guidance on expected credit losses (CECL) was issued in June 2016, effective January 1, 2020, with early adoption permitted in 2019. The company was evaluating its impact.
Most important facts for investors to verify
- Progress, terms and repayment prospects for the PREPA restructuring, including the adequacy of the $53.3 million allowance.
- Underlying credit quality and charge-off trends, distinguishing reported allowance declines caused by the acquired-loan policy change from actual loss performance.
- Whether originated loan growth and fee income can offset acquired-loan runoff and continued net interest margin pressure.
- Funding stability, brokered-deposit dependence, repurchase-agreement collateral requirements, and repayment or refinancing of the September 2016 subordinated notes.
- Exposure to Puerto Rico economic and fiscal deterioration, including government-related loans, the remaining PRHTA bond and the assumptions supporting deferred tax assets and goodwill.