OFG Bancorp (OFG) — Q2 2019 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless noted. OFG is a Puerto Rico-based financial holding company offering banking, lending, wealth management and related services.
Financial results and condition
Amounts below are in millions, except per-share data and ratios.
- Q2 earnings: Net income was $24.0 million, up 22.0%; diluted EPS was $0.43 versus $0.35. Income available to common shareholders rose 38.1% to $22.4 million; lower preferred dividends partly explain the larger increase relative to net income.
- Six-month earnings: Net income was $47.4 million versus $36.6 million, and diluted EPS was $0.86 versus $0.65.
- Revenue and margin: Q2 net interest income rose 4.5% to $81.1 million. Net interest margin increased to 5.37% from 5.23%. Net non-interest income was $22.9 million, including a $4.8 million gain on securities sales; reported net revenue increased 3.3% to $99.2 million. Q2 banking and financial service revenue declined 1.7% to $18.1 million.
- Expenses and returns: Q2 non-interest expense declined 1.6% to $51.5 million, and the efficiency ratio improved to 51.89% from 54.49%. Return on average assets was 1.48%, up from 1.23%; return on average common equity was 9.36%, up from 8.15%.
- Credit costs and quality: Q2 provision for loan and lease losses was $17.7 million versus $14.7 million, including an approximately $8.8 million provision tied primarily to planned sales of distressed acquired residential mortgages. Management said provision excluding that item declined $5.8 million, reflecting improved asset quality. Non-performing assets were $145.6 million, down 9.8% from year-end 2018; the allowance for loan and lease losses was $162.6 million versus $164.2 million.
- Loans and deposits: Total net loans were $4.47 billion, up 1.0% from December 31, 2018. Total deposits were $4.95 billion, up 0.8%; core deposits were $4.56 billion, up 4.0% from year-end. Six-month loan production declined 18.7% year over year to $602.9 million, mainly due to lower U.S. program originations.
- Cash flow: Operating cash flow for the first six months was $34.4 million versus $48.5 million. Investing activities provided $363.0 million, principally reflecting securities sales; financing activities used $170.0 million, including lower repurchase-agreement funding and dividend payments. Cash, cash equivalents and restricted cash ended at $677.4 million.
- Debt and liquidity: Total borrowings declined to $356.8 million from $570.4 million, primarily after OFG used proceeds from securities sales to reduce repurchase agreements. Deposits and borrowings together were $5.30 billion. OFG reported $676.4 million in unrestricted cash and cash equivalents, $403.2 million in unpledged investment securities and $784.8 million of additional FHLB borrowing capacity.
- Capital: Stockholders’ equity was $1.045 billion, up 4.5% from year-end. OFG’s CET1 ratio was 17.48%, total risk-based capital ratio 21.14%, and leverage ratio 15.20%. The Bank was classified as well capitalized.
Material changes and unusual items
- OFG sold $349.7 million of mortgage-backed securities in Q2, recording a $4.8 million gain. It used the proceeds to reduce $191.2 million of repurchase agreements and $62.8 million of brokered deposits. This one-time gain increased reported non-interest income; the sale also reduces future securities interest income.
- OFG entered agreements on June 26, 2019 to acquire Scotiabank de Puerto Rico and certain Bank of Nova Scotia operations and assets in Puerto Rico and the U.S. Virgin Islands. The transaction was not completed as of June 30 and is not reflected in the financial statements. Management targeted closing before year-end 2019, subject to regulatory approvals and other customary conditions. Q2 included $1.0 million of merger and restructuring charges.
- OFG adopted the new lease standard in 2019, recognizing $20.4 million of right-of-use assets and $22.2 million of lease liabilities at June 30. The filing says the standard did not materially affect operating results or cash flows.
- OFG reclassified $424.7 million of held-to-maturity securities to available-for-sale at adoption of updated hedge-accounting guidance.
Outlook, management commentary and risks
- Management expressed optimism about Puerto Rico’s improving economy and said loan production, core deposit growth, credit quality and capital supported its strategy. It expects the Scotiabank acquisition, if completed, to strengthen its market position. The filing provides no quantified earnings or revenue guidance.
- OFG said it planned to sell approximately $54 million of unpaid principal balance of mostly distressed acquired residential mortgages before year-end 2019. The filing describes the planned portfolio and carrying/fair-value details in different places; investors should verify the final sale scope, timing and realized results.
- OFG expects to implement the current expected credit loss standard (CECL) on January 1, 2020. Its preliminary assessment indicated an effect on the credit-loss reserve, but the amount was not yet clear and depends partly on portfolio composition and economic conditions at adoption.
- Key exposures include Puerto Rico’s economy and fiscal condition, municipal and government-related credit, natural disasters, interest-rate movements, deposit pricing and the availability and cost of wholesale funding. OFG cautioned that brokered deposits may be less stable than core deposits and that funding access could deteriorate under adverse conditions.
- The Scotiabank transaction depends on regulatory approvals and successful integration. OFG warned of possible delays or failure to close, integration costs, asset-quality surprises, customer or employee losses, and benefits that may be delayed or not achieved. Under specified conditions, OFG may have to reimburse BNS for documented transaction expenses up to $2 million if closing does not occur within one year of signing.
- Management said pending legal and regulatory matters were not expected to have a material adverse effect on financial condition, while acknowledging that an adverse outcome could affect results or cash flows in a particular period. It reported no material changes to previously disclosed risk factors other than the acquisition-related risks.
Most important facts for investors to verify
- Whether the Scotiabank transaction received approvals, closed on the expected timetable, and delivered the anticipated integration savings and growth.
- The actual proceeds, timing and credit-loss impact of the planned distressed-mortgage sale, and whether the provision associated with it was sufficient.
- How much Q2 and year-to-date earnings growth persists after excluding the $4.8 million securities-sale gain and considering higher funding costs.
- Trends in non-performing assets, charge-offs, loan production and Puerto Rico municipal exposure, alongside the adequacy of reserves.
- The eventual CECL reserve impact and OFG’s ability to maintain low-cost deposits and liquidity as funding markets and interest rates change.