OFG Bancorp — Second-Quarter 2015 Form 10-Q
Business context and period: OFG Bancorp is a Puerto Rico-based financial holding company operating through banking, wealth management and treasury businesses. This unaudited report covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are to December 31, 2014.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest income | $99.4 million | $125.9 million | $206.4 million | $249.0 million |
| Net interest income | $82.3 million | $106.1 million | $171.9 million | $209.5 million |
| Net interest margin | 4.92% | 6.10% | 5.14% | 5.96% |
| Provision for loan losses | $15.5 million | $14.8 million | $57.7 million | $26.5 million |
| Non-interest income, net | $(4.7) million | $0.5 million | $2.2 million | $5.7 million |
| Non-interest expense | $64.4 million | $59.8 million | $120.8 million | $121.3 million |
| Net income (loss) | $(3.1) million | $21.3 million | $(6.1) million | $45.1 million |
| Net income (loss) available to common shareholders | $(6.6) million | $17.8 million | $(13.0) million | $38.1 million |
| Basic and diluted EPS | $(0.15) | $0.40 basic; $0.38 diluted | $(0.29) | $0.84 basic; $0.80 diluted |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $46.5 million | $94.9 million |
Margins and costs: Q2 interest-rate spread was 4.68% versus 5.91% a year earlier; the efficiency ratio rose to 63.39% from 47.89%. Deposit costs declined year over year, but lower asset yields and declining acquired-loan balances weighed on interest income.
Financial condition, liquidity and capital
- At June 30, total assets were $7.40 billion, down 0.7% from year-end; net loans were $4.64 billion, down 3.9%, while investments rose 15.3% to $1.62 billion.
- Deposits totaled $4.75 billion, down 3.5% from December 31. Borrowings were $1.60 billion, up 12.6%, including $1.16 billion of repurchase agreements. Total deposits and borrowings were approximately $6.35 billion.
- Cash and cash equivalents were $553.5 million. Management reported additional liquidity capacity of $221.7 million in unpledged investment securities, $620.0 million at the FHLB and $699.1 million at the Federal Reserve discount window.
- Stockholders’ equity was $911.6 million, down 3.2% from year-end. Book value per common share was $16.81 and tangible book value was $14.67. The common stock market price fell to $10.67 from $16.65 at year-end.
- OFG’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 12.26%, 15.85%, 17.41% and 11.05%, respectively. The Bank was reported as well capitalized.
- Six-month cash flows: operating activities provided $46.5 million; investing activities used $16.0 million; financing activities used $50.4 million. Cash and cash equivalents declined $19.9 million to $553.5 million.
Material changes and management commentary
- Quarterly net loss available to common shareholders was $6.6 million, versus $17.8 million of income a year earlier. For the first half, the company recorded a $13.0 million common loss versus $38.1 million of income in 2014.
- Management cited reduced interest income as acquired loans ran off and yields declined, and as PREPA was placed on non-accrual and PRASA repaid its $75 million balance. Q2 interest income fell 21.0% year over year; net interest income fell 22.4%.
- First-half loan-loss provision increased 117.8%, primarily including a $24 million PREPA reserve recorded in Q1. The total allowance for loan and lease losses was $174.3 million at quarter-end, versus $133.8 million at year-end.
- Nonperforming assets increased to $368.9 million from $178.1 million at year-end. Nonperforming loans were $312.0 million; the increase was principally associated with PREPA. Management said most such loans were well collateralized, but this remains a significant credit watchpoint.
- Core banking and financial-services revenue increased 2.5% in Q2 to $19.4 million. Non-interest expense rose 7.7%, including higher foreclosure and real-estate costs, partly offset by lower compensation and taxes. Management attributed increased real-estate costs in part to collateral markdowns under its de-risking efforts.
- The company reported Q2 pre-tax, pre-provision operating income of $37.2 million, down 42.8% from $65.1 million a year earlier. This is a company-defined non-GAAP measure.
- Management reported second-quarter loan production of $286.7 million, up 29.4% year over year, including stronger commercial and mortgage production; auto and leasing production declined.
Risks, contingencies and unusual items
- Puerto Rico exposure: Credit facilities and securities tied to the Commonwealth, its public corporations and municipalities totaled approximately $536.3 million at June 30, including $515.3 million of credit facilities. The filing describes a prolonged recession, fiscal deficits, debt-service uncertainty and rating downgrades as risks to repayment, collateral values and liquidity.
- PREPA: OFG’s participation in a syndicated fuel-purchase line had $197.6 million outstanding, was classified substandard and on non-accrual, and carried a $24 million specific reserve. The forbearance agreement was extended through September 15, 2015; interest received was applied to principal. A restructuring was under discussion, with no assurance of agreement.
- FDIC loss sharing: Commercial and other non-single-family loss-share coverage expired June 30, 2015; residential coverage continues to June 30, 2020. On July 2, OFG agreed with the FDIC on potential coverage of up to $20 million for losses on a specified portfolio sale completed within 120 days. The FDIC true-up liability was $23.6 million.
- Other unusual items: OFG sold mortgage servicing rights to Scotiabank Puerto Rico for approximately $7.0 million and recognized a $2.7 million loss for the transaction during the first half. A $2.1 million payment required by the broker-dealer’s regulator increased wealth-management expenses. The deferred tax asset rose to $138.4 million; realization depends on future taxable income.
- Funding and market risks: The company remains dependent in part on wholesale funding, including repurchase agreements and brokered deposits, which may be less stable or more costly during market stress. It reported that a 200-basis-point rate increase would raise modeled one-year net interest income by 2.11% on a static balance sheet and 2.31% in a growing-balance-sheet simulation; results depend on assumptions.
- Legal and regulatory matters: OFG and subsidiaries face ordinary-course litigation and regulatory examinations. Management said reasonably possible losses were not significant, but adverse outcomes could affect results or cash flows in particular periods. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
- No specific earnings or financial guidance was provided in the supplied filing text. Management’s stated longer-term priorities include expanding lending, growing fee revenue, managing assets and liabilities, and improving operating efficiency.
Important facts for investors to verify
- PREPA restructuring progress, payment terms, September 15, 2015 forbearance status, and adequacy of the $24 million reserve.
- Further trends in nonperforming loans and assets, charge-offs, provisioning, and collateral values, especially for commercial credits.
- Ability to stabilize net interest margin as acquired loans run off and deposit and wholesale funding costs evolve.
- Deposit retention and wholesale funding reliance, including repurchase-agreement balances and access to reported contingent liquidity sources.
- FDIC loss-share recoveries, post-expiration claims, the potential portfolio sale, and changes in the true-up obligation.
- Puerto Rico government fiscal and debt developments and their effect on OFG’s credit exposures, deposits, securities and capital.