OFG BANCORP annual report, FY2015

OFG Bancorp — 2015 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2015; the filing also reports fourth-quarter results. OFG Bancorp is a Puerto Rico-based financial holding company operating Banking, Wealth Management and Treasury businesses, primarily through Oriental Bank, which had 48 Puerto Rico branches. The consolidated financial statements received an unqualified audit opinion; management and KPMG reported effective internal control over financial reporting.

Financial performance and condition

Metric	2015	2014
Interest income	$406.6 million	$485.3 million
Net interest income	$337.4 million	$408.5 million
Net interest margin	5.03%	5.84%
Provision for loan and lease losses	$161.5 million	$60.6 million
Non-interest income, net	$52.5 million	$17.3 million
Non-interest expense	$248.4 million	$242.7 million
Net income (loss)	$(2.5) million	$85.2 million
Net income (loss) available to common shareholders	$(16.4) million; $(0.37) per diluted share	$71.3 million; $1.50 per diluted share

Revenue pressure reflected a smaller, lower-yielding acquired-loan portfolio, reduced government-related lending, and the PREPA facility moving to non-accrual. Deposit repricing lowered deposit costs; total interest expense fell 9.9% to $69.2 million.
Net non-interest income includes a $20.0 million FDIC reimbursement for losses on a loan sale and $42.8 million of net FDIC shared-loss expense. Core banking and wealth-management revenue was $76.6 million, down 1.7%.
The efficiency ratio rose to 60.0% from 49.9%. Management’s non-GAAP pre-tax, pre-provision operating income fell 32.0% to $165.6 million.
Fourth quarter: Net loss was $1.0 million and loss available to common shareholders was $4.4 million, or $0.10 per share, versus common income of $17.1 million, or $0.36 diluted per share, in fourth-quarter 2014.

Balance sheet, funding and cash flow

Total assets were $7.10 billion, down 4.7%; net loans were $4.43 billion, down 8.1%, while investment securities rose 15.3% to $1.62 billion. Originated loans grew 7.4%, but acquired loans declined 29.7%.
Deposits totaled $4.72 billion, down 4.2%; total borrowings were $1.37 billion, down 3.4%. Borrowings included $934.7 million of repurchase agreements, $332.5 million of FHLB advances and $102.6 million of subordinated notes. The filing identifies wholesale funding as a material source; brokered deposits were $783.0 million at year-end.
Cash and cash equivalents were $536.7 million, including approximately $526.2 million described as unrestricted cash and cash equivalents in the liquidity discussion. Management also reported $477.9 million of unpledged investment securities and $770.6 million of FHLB borrowing capacity.
Operating cash flow was $97.1 million, compared with $175.0 million in 2014. Investing activities provided $153.0 million and financing activities used $286.8 million; cash and cash equivalents decreased $36.7 million.
Total stockholders’ equity was $897.1 million, down 4.8%; book value per common share was $16.67. Common dividends declared were $0.36 per share. The filing states that the Bank was well-capitalized; the Company’s CET1 ratio was 12.14%, total risk-based capital 17.29%, and leverage ratio 11.18%.

Material changes and unusual items

The $161.5 million loan-loss provision included a $53.3 million provision for the PREPA credit and provisions tied to a bulk sale of acquired non-performing loans. The allowance for loan and lease losses ended at $234.1 million, versus $133.8 million a year earlier.
OFG sold acquired non-performing commercial loans and foreclosed property in September 2015. The Eurobank loans sold had $197.1 million unpaid principal and $100.0 million carrying value; the sale price was $36.3 million. The transaction generated a $20.0 million FDIC reimbursement. Certain BBVAPR loans and foreclosed property were also sold, with related provisions and losses recorded.
Commercial FDIC loss-share coverage expired June 30, 2015, reducing future reimbursement protection. Remaining coverage applies to certain single-family residential loans through June 30, 2020.
The company reduced exposure to Puerto Rico government borrowers: its year-end table reports $433.2 million in government-related loans and securities. Separately, the filing reports approximately $415 million of credit facilities to government entities; the measures are not presented as identical.
OFG recorded a $1.5 million credit-related impairment charge on Puerto Rico government securities. It also reported a $2.7 million loss on the sale of mortgage-servicing rights and $9.3 million of loss related to the bulk sale in non-interest expenses.
Management revised commercial-loan allowance assumptions, including extending the historical loss look-back period from 12 to 36 months and setting the commercial real-estate loss realization period at 1.60 years. These were treated as changes in accounting estimates and applied prospectively.

Outlook, commentary and principal risks

No specific earnings or financial guidance is provided. Management describes a long-term strategy focused on growing lending and fee-based services, attracting deposits, improving efficiency and managing assets and liabilities. It reported $1.014 billion of 2015 loan production, up 10.3%, and 15,400 net new retail customers.
Puerto Rico’s prolonged recession, fiscal and liquidity crisis, population decline, unemployment and property-market weakness expose the company to higher credit losses, weaker loan demand and deposit pressure. The Commonwealth and certain public entities faced default and restructuring uncertainty.
PREPA is a central credit and restructuring risk. OFG’s $190.3 million participation was classified substandard and on non-accrual; the company applied subsequent interest receipts to principal. A restructuring support agreement depended on milestones, including actions by third parties. The reported $53.3 million allowance left approximately $137.0 million net of allowance against the stated principal balance.
Liquidity and funding risks include reliance on repurchase agreements, brokered deposits and other wholesale sources, which may be less stable or more costly than core deposits. Interest-rate movements, securities values and mortgage prepayments may also affect earnings.
Other disclosed risks include loan-credit deterioration, mortgage repurchase and representation-and-warranty claims, regulatory and tax changes, cyber and third-party service disruptions, litigation, and possible impairment of goodwill or deferred tax assets. Management said the annual goodwill test found no impairment, although Banking reporting-unit fair value was below its carrying value at the first testing step.
Management judged the aggregate outcome of legal proceedings not likely to materially affect the consolidated financial condition; it cautioned that an adverse outcome could affect particular quarterly or annual results. The filing provides no clear quantified estimate of reasonably possible legal losses.

Important facts for investors to verify

PREPA restructuring progress, repayment milestones, and the adequacy of the $53.3 million allowance against the $190.3 million stated principal balance.
The trajectory of non-performing assets, commercial credit quality, charge-offs and the $234.1 million total allowance, including the impact of acquired-loan accounting.
How much of the reported $433.2 million government-related exposure overlaps with the separately cited approximately $415 million in credit facilities, and the current repayment status of each material exposure.
Deposit stability and the cost, collateral and maturity profile of brokered deposits, repurchase agreements and FHLB advances.
Whether core earnings and margins recover as acquired loans run off, FDIC coverage diminishes and credit provisions normalize; distinguish recurring revenue from FDIC reimbursements and other unusual items.
Potential effects of Puerto Rico fiscal developments, tax changes, mortgage repurchase obligations and any changes in the realizability of deferred tax assets.