OFG Bancorp — Third-Quarter 2017 Form 10-Q
Business context and reporting period
OFG Bancorp is a Puerto Rico-based financial holding company operating through banking, wealth management and treasury businesses. This unaudited filing covers the quarter and nine months ended September 30, 2017; balance-sheet comparisons are with December 31, 2016. Hurricanes Irma and Maria struck Puerto Rico during the quarter, materially disrupting customers and local economic activity.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $80.5 million | $76.9 million | $230.7 million | $225.2 million |
| Provision for loan losses | $44.0 million | $23.5 million | $88.2 million | $51.7 million |
| Non-interest income | $17.9 million | $20.2 million | $61.9 million | $48.9 million |
| Non-interest expense | $50.5 million | $54.9 million | $155.0 million | $163.6 million |
| Net income | $3.3 million | $15.1 million | $35.6 million | $43.6 million |
| Income available to common shareholders | $(0.1) million | $11.7 million | $25.2 million | $33.2 million |
| Diluted EPS | $0.00 | $0.26 | $0.56 | $0.76 |
All amounts in the table are reported GAAP figures. The company’s selected financial data reports a Q3 net interest margin of 5.64%, up from 4.95%, and a nine-month margin of 5.25%, up from 4.77%. The Q3 efficiency ratio improved to 51.66% from 57.69%; the nine-month ratio improved to 54.71% from 58.66%.
- Balance sheet at September 30: Assets were $6.29 billion, down 3.3% from year-end 2016. Net loans were $3.96 billion, down 4.4%; investments were $1.16 billion, down 15.0%.
- Funding and liquidity: Deposits were $4.83 billion, up 3.5%. Cash and cash equivalents were $720.7 million. Borrowings totaled $419.3 million, down 47.3%, principally after repayments and maturities of repurchase agreements. The filing cites $849.5 million in additional FHLB-NY borrowing capacity and $810.3 million in unpledged investment securities.
- Credit and reserves: The allowance for loan and lease losses was $154.2 million, versus $115.9 million at year-end. Non-performing assets were $148.9 million, or 2.76% of total assets excluding acquired loans with deteriorated credit quality, compared with $156.9 million and 2.88% at year-end.
- Cash flows, nine months: Operating activities provided $106.1 million, investing activities provided $316.8 million and financing activities used $212.6 million. Cash and cash equivalents increased $210.3 million to $720.7 million.
- Capital: OFG Bancorp’s CET1 ratio was 14.89%, Tier 1 risk-based ratio 19.53%, total risk-based ratio 20.82% and leverage ratio 14.07%. The filing states the Bank met regulatory requirements and was “well capitalized.” Stockholders’ equity was $937.6 million.
Material changes versus comparable periods
- Q3 net income fell 78% year over year, and income available to common shareholders turned slightly negative. The main driver was the $27.0 million pretax hurricane-related loan-loss provision; higher provision more than offset stronger net interest income and lower operating expenses.
- For the first nine months, net income declined 18.5%. Net interest income rose 2.4%, while provision expense increased 70.7%. Non-interest income rose 26.6%, helped by the termination of the Eurobank FDIC shared-loss agreements and securities-sale gains; non-interest expense declined 5.3%.
- Management presented non-GAAP adjusted Q3 net income of $22.3 million and diluted adjusted EPS of $0.40, excluding the $27.0 million hurricane provision and related tax effect. These figures are not GAAP results and may not be comparable with similarly named measures at other companies.
- Acquired BBVAPR and Eurobank loan balances continued to run off. Total assets and loans declined, while deposits increased and borrowings fell materially.
Outlook, commentary, risks and unusual items
- Hurricane effects remain uncertain. Management said it would refine credit estimates as more information became available. It offered payment forbearance across consumer, auto, mortgage, commercial and credit-card portfolios. Approximately 100,000 loans with unpaid principal of $3.7 billion were under the automatic three-month forbearance program at quarter-end.
- The filing warns that hurricane damage, power and communications outages, business interruptions, collateral damage, delayed court proceedings and the pace and funding of Puerto Rico’s recovery could affect borrower repayment, loan losses, collections and operations. Management stated the $27 million additional provision may not cover eventual losses; losses could also be lower if insurance or borrowers’ resources are adequate.
- Puerto Rico concentration is significant: the filing states approximately 99.7% of the $4.1 billion loan portfolio was attributable to Puerto Rico-based borrowers and 56.1% was secured by Puerto Rico real estate. Risks also include Puerto Rico’s fiscal crisis, government debt restructuring, weak economic conditions, population decline and future natural disasters.
- On February 6, 2017, the Bank terminated its Eurobank FDIC shared-loss agreements, paid the FDIC $10.1 million and recorded a $1.4 million net benefit for the nine-month period. The indemnification asset and related true-up obligation were eliminated.
- As a subsequent event, the Bank organized OFG USA LLC to provide mainland U.S. commercial lending and contributed $50 million on October 23, 2017.
- Management said pending legal and regulatory matters were not expected to have a material adverse effect on financial condition; it also cautioned that an adverse outcome could affect results or cash flows in a particular period. No formal earnings guidance is provided in the supplied filing text.
- Management reported reasonable assurance that disclosure controls were effective. It also disclosed a third-quarter migration to a new accounting and financial-reporting platform and hurricane-related control modifications; it planned continued evaluation and testing of controls.
Important facts for investors to verify
- Subsequent hurricane-related delinquencies, restructurings, charge-offs, collateral valuations and whether the $27 million provision proves adequate.
- Forbearance loan performance and repayment behavior after deferment periods, including effects on reported delinquency and non-performing loan measures.
- Puerto Rico economic recovery, government debt proceedings, public-sector exposures and deposits, and the company’s high geographic concentration.
- Sustainability of net interest margin and earnings as acquired loan portfolios run off, deposit costs change and wholesale funding is reduced.
- Execution and funding implications of the $50 million OFG USA contribution, as well as results of testing controls following the new reporting-system implementation.