OFG Bancorp — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. Amounts are in U.S. dollars; financial figures are in millions unless otherwise stated.
Business context
OFG is a Puerto Rico-based financial holding company operating through banking, wealth management and treasury businesses. Its activities include commercial, consumer, auto and mortgage lending, deposits, brokerage, insurance and trust services. The company reported 48 branches in Puerto Rico and a subsidiary in Boca Raton, Florida. Its lending and substantial portion of credit exposure are concentrated in Puerto Rico.
Key financial results and position
| Metric | Q1 2017 / March 31, 2017 | Comparable / prior period |
|---|---|---|
| Interest income | $86.2 | $91.3 in Q1 2016; down 5.6% |
| Net interest income | $74.6 | $75.0 in Q1 2016; down 0.5% |
| Net interest margin | 5.10% | 4.67% in Q1 2016; up 43 basis points. Management reported a 16-basis-point increase from Q4 2016. |
| Provision for loan and lease losses | $17.7 | $13.8 in Q1 2016; up 28.0% |
| Non-interest income | $19.1 | $13.5 in Q1 2016; up 41.3% |
| Non-interest expense | $51.7 | $54.9 in Q1 2016; down 5.8% |
| Income before taxes / income tax expense | $24.4 / $9.2 | $19.8 / $5.7 in Q1 2016 |
| Net income / income available to common shareholders | $15.2 / $11.7 | $14.2 / $10.7 in Q1 2016 |
| Diluted earnings per common share | $0.26 | $0.24 in Q1 2016 |
| Operating cash flow | $25.0 | $23.5 in Q1 2016 |
| Cash and cash equivalents | $480.3 | $510.4 at December 31, 2016 |
| Total assets / stockholders’ equity | $6,414.6 / $931.4 | $6,501.8 / $920.4 at December 31, 2016 |
| Loans, net / deposits | $4,089.7 / $4,717.8 | $4,147.7 / $4,664.5 at December 31, 2016 |
| Total borrowings | $672.4 | $795.4 at December 31, 2016 |
| Common equity Tier 1 / total risk-based capital | 14.30% / 20.05% | 14.05% / 19.62% at December 31, 2016 |
Cash flows from investing activities were $21.7 million; financing activities used $76.8 million. Cash and cash equivalents decreased $30.2 million during the quarter. The company also reported $480.3 million of unrestricted cash, $801.6 million of unpledged investment securities and approximately $1.004 billion of FHLB-NY borrowing capacity at March 31.
Management reported Q1 return on average assets of 0.95%, return on average common equity of 6.15%, return on average tangible common equity of 7.00%, and an efficiency ratio of 56.15% (59.56% in Q1 2016). Tangible book value per common share was $15.33, versus $15.08 at year-end 2016; the common dividend was $0.06 per share.
Material changes and notable items
- Net interest income was nearly flat year over year: lower interest income, reflecting smaller average asset balances, was largely offset by lower funding costs. Interest expense fell 29.2%, particularly as repurchase-agreement and other borrowing costs declined. The company said growth in originated auto and consumer lending supported yields while acquired loan balances continued to run off.
- Credit costs increased: provision rose to $17.7 million, including higher provisions on acquired BBVAPR and Eurobank loans. Originated-loan net charge-offs were $10.6 million, or 1.40% of average originated loans, compared with $10.0 million, or 1.30%, in Q1 2016. Separately, management said delinquency, non-performing loan and net charge-off rates declined from Q4 2016.
- Non-performing assets were $148.6 million, down 5.3% from year-end; non-performing loans were $99.2 million, down 8.3%. Allowance for loan and lease losses totaled $121.0 million, up from $115.9 million at year-end. These measures exclude certain acquired credit-impaired loans from non-performing classifications.
- OFG and the FDIC terminated the Eurobank shared-loss agreements on February 6, 2017. OFG paid $10.1 million; the termination eliminated the $14.4 million indemnification asset and $26.8 million true-up obligation, and generated a reported net benefit of $1.4 million. This was a significant one-time comparison item; Q1 2016 included a $4.0 million FDIC shared-loss expense.
- Borrowings fell 15.5%, mainly following maturity of a $232 million repurchase agreement. Deposits increased 1.1%. Brokered deposits were $575.9 million, and repurchase agreements were $530.4 million excluding accrued interest.
- The Q1 2016 comparison also included a $12.0 million loss on early debt extinguishment and a $12.0 million net gain on securities sales; no securities were sold in Q1 2017. Accordingly, reported year-over-year non-interest income and pretax comparisons reflect differing unusual items.
- Puerto Rico government-related loans and securities totaled $207.3 million. The $10.7 million PRHFA loan was supported by abandoned and unclaimed funds and had an $8.0 million allowance. The remaining Puerto Rico government security was a $4.7 million PRHTA position; management recorded no credit loss, citing its cash-flow analysis and payment history.
Outlook, risks and contingencies
The filing provides no numerical earnings or revenue guidance. Management described long-term priorities of expanding lending, growing fee income, improving integration and operating efficiency, and maintaining effective asset-liability management. It cited strong auto and consumer loan generation, deposit growth and a new integrated online and mobile personal-loan application. These are management commentary, not quantified forward guidance.
- Puerto Rico concentration: The company warned that fiscal restructuring, government defaults, weak economic conditions, population decline and housing-market pressure could affect credit quality, loan demand, asset values and earnings.
- Funding and liquidity: OFG depends partly on wholesale funding. Brokered deposits may be less stable than core deposits, and funding availability or cost could worsen in market disruption or adverse company-specific developments. Management stated that financing sources might not remain available on favorable terms.
- Interest-rate and market risk: A one-year simulation estimated net interest income increases of 4.03% under a 200-basis-point rise and 2.04% under a 100-basis-point rise on a static balance sheet; corresponding growing-balance-sheet estimates were 3.50% and 1.78%. A 50-basis-point decline was estimated to reduce it by 0.96% and 0.82%, respectively. Management cautioned that simulations depend on assumptions and are not forecasts.
- Legal and regulatory matters: The company and subsidiaries face ordinary-course litigation and regulatory examinations. Management said reasonably possible losses were not significant and did not expect the matters to materially affect financial condition, while acknowledging an adverse outcome could affect results or cash flows in a particular period.
- Other exposures: Commitments to extend credit were $459.4 million. Standby letters of credit and financial guarantees were $4.5 million; mortgage loans sold with recourse totaled $8.0 million. The company also had $47.6 million of foreclosed real estate.
- Capital and accounting: The company and bank met applicable capital requirements; the bank was classified as well capitalized. Adoption of the expected-credit-loss standard (CECL) was still under assessment, with implementation scheduled for fiscal years beginning after December 15, 2019.
Important facts for investors to verify
- Whether the higher loan-loss provision and acquired-loan allowances adequately capture Puerto Rico economic and borrower risks, including trends in delinquencies, charge-offs and recoveries.
- The sustainability of the 5.10% net interest margin as acquired portfolios run off, loan mix changes and deposit or wholesale funding costs respond to interest rates.
- The terms and ongoing effects of the FDIC shared-loss termination, including the settlement payment and removal of future indemnification and true-up arrangements.
- The quality and concentration of Puerto Rico government exposures, especially the PRHFA loan, municipal lending and the remaining PRHTA security.
- The availability and cost of funding, including brokered deposits, repurchase agreements and FHLB capacity, and the collateral supporting borrowings.
- How much reported earnings improvement reflects recurring operations versus FDIC-related and prior-year securities-sale and debt-extinguishment items; also verify the company’s non-GAAP efficiency and tangible-capital calculations.